Goldman Sachs is in the news, again, well always, this time it is with respect to an FCIC inquiry for more information regarding the valuation and pricing of assets and liabilities related to transactions with AIG. Their detailed response provides an interesting overview of the mortgage meltdown and Goldman’s participation in the CDO and other related markets. Did GS act appropriately? I am not aware of enough facts to comment, but the level of detail GS is able to provide seems to indicate to me that they were very careful about what they were doing and in line with industry business practices.
As a former trader of mortgage-backed securities, married to another former one (now ordained pastor), we have had many discussions about not just good, but ethical business practices in sales and trading. I do believe their is a strong distinction between retail ( you and me ) and institutional ( hedge funds, pension funds…) clients with respect assumed levels of understanding of product offerings. Honesty, appropriateness, and full transparency should always be governing principals for both. That said people will have differing opinions about whether a security is cheap or rich, and that is what makes markets. Valuation of securities, bonds, stocks or CDOs is ALWAYS based on assumptions regarding underlying cash flows, and people have different assumptions. So does all this mean that “SCF 8A A1NV an early 2006 vintage mezzanine super senior CDO” ( from GS press release) should have ever been created? Debatable. Arguably market forces should dictate what is created (with disclosure rules) and where there is demand, supply will follow.
The deeper question is what forces created the demand for toxic waste securities? I have a yet to be written essay on that topic but I believe the main, but not only reason, was the thirst for incremental yield. With interest rates so low for so long, and with Fannie and Freddie needing to grow earnings through expanding their investment portfolios and business lines, thereby collapsing spreads and yields, both the FED and these agencies played a major role in crowding out other investors and forcing them in to look for yield in all the wrong places. I am sure there are whole BOOKS dedicated to this topic that I wrote just three sentences on, but that is my premise.
As for Goldman they have done a heck of a lot in response to the crisis, as they should. They recently set up a committee to review their business practices, which will be made public and perhaps set a new industry standard. They have not been against financial reform, and in fact they outlined their recommendations here. Bottom line, I do not believe GS was doing anything most other firms were not doing, but that does not make it all ok. There was a massive train wreck and they played a role, as did so many others, and have to accept the consequences. Hopefully the outcome will be healthier and more sustainable financial markets. Time will tell.