Tuesday, April 27, 2010

Never laid a glove on them

I attended part of Senator Carl Levin's Permanent Subcommittee on Investigations hearing concerning Goldman Sachs. Bottom line: they never laid a glove on them. As one report noted, "By day’s end, the investment bank’s market value had risen by $549 million." My comments follow.

1. When questioned about most matters, Goldman's CEO simply misdirected the questioner to an irrelevant portion of the inquiry. Specifically asked a direct question about the firm's short position (a position that benefits from a fall in prices, in this case, housing prices) in the mortgage market, the CEO referred to Goldman's 140 year history (this was a misdirection), and characterized the firm's position as a hedge (this was false). A key factor relates to relative position size. A $1 million dollar long position offset by a $1 million dollar short position is a hedge. A $1 million dollar long position offset by a $10 million dollar short position is a directional bet on the market, not a hedge.

2. In addition, Goldman's CEO purposely confused the market making role Goldman plays with their role as an underwriter. As a market maker, a size matched ($1 million long for $1 million short) hedge on a position is appropriate. This insures liquidity and an ability of the firm to respond to customer requests. As an underwriter, a bank is using it's reputation to sell product to clients. Underwriting carries with it a higher level of fiduciary duty. This is where misstatements about the construction of a security are critical. (Think of it this way. If you manufacture and sell cars, you have an implicit obligation to sell safe cars. I will not buy a car from you if I know that you, or a partner firm involved in the design and manufacture of the vehicle, have taken out a life insurance policy on me, the car buyer, and designed the car to maximize the chances that you, or a partner firm, will be able to collect on the insurance policy by reducing the reliability of the car's braking system. This is what the SEC says Goldman did.)

3. A question was asked about Goldman's use of the discount window at the Fed. The answer given by Goldman was not accurate. An accurate answer would have cited the total dollar amount of benefits the firm received from all Emergency Federal Reserve Liquidity Programs. These include the Term Auction Facility (TAF), the Primary Dealer Credit Facility (PDCF), the Term Securities Lending Facility (TSLF), the Term Securities Lending Facility Options Program (TOP), the Commercial Paper Funding Facility (CPFF), the Asset-Backed Commercial Paper (ABCP) Money Market Mutual Fund Liquidity Facility (AMLF), the Money Market Investor Funding Facility (MMIFF), as well as the currency swap arrangements with foreign central banks.

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