Goldman Sachs defends itself well

It appears like nothing got solved today on Capitol Hill as Senators from the Permanent Subcommittee on Investigations grilled several Goldman Sachs traders and risk managers about their role in selling mortgage backed securities to clients while failing to disclose that they and John Paulson's hedge fund took the opposite side of the trade and shorted (or bought protection, however you wanna word it) the portfolio. Unlike in previous congressional hearings, the lawmakers actually seemed fairly well versed in the financial lingo and seemed to understand what was going on, but they failed in their attempt to get one of the Goldman witnesses to crack and admit that it was wrong what they did. The witnesses were well 'lawyered' by their firm and managed to waste a lot of time saying things like, "can you repeat the question?," or "what exhibit was that again?," throughly frustrating the members of the committee.

How this whole thing got started was, Paulson called up GS and said he was interested in shorting (betting that they will default and go down in value) certain mortgage backed securities that he thought risky. Goldman's job is to find someone that would take the opposite side of that trade and make money off the transaction. Back in 2006, before the bubble burst, the view that the real estate market would crash was a small minority view. Insurance companies and other firms who bought these AAA securities had years of data to back up that these instruments were relatively safe and carried a nice interest rate with them. Some were even backed by the government. If a client is willing to pay 20 cents on the dollar for a crappy MBS, then who are they to stop them? These companies have their own advisors and analysts that are telling them they're ok to buy. On a basic level GS are a bunch of salesman that want to get the deal closed. Do you think a car salesman tells you every negative thing about the car, how much you should pay for it, before you buy it? Do you think a real estate agent tells you every bad thing about the house so you don't buy it? No, they disclose only what they're required to disclose.

When it comes down to it, it seems no law was broken. In this case, Goldman Sachs merely acted as a market maker and was not required to disclose how they managed the risk on their books or that Paulson was involved in choosing some of the securities in the portfolio. Were they aggressive salesman? Yes. Did they think what they were selling was gonna blow up in their clients faces? No. Investors on the institutional level know that you need a buyer and a seller to make the transaction happen, most of the time it doesn't matter who's on the other side. Back in 2006 John Paulson was not the John Paulson of today. He was a relatively small hedge fund running $300 million (he's now one of the biggest managing $30 billion). When he called Goldman, it shouldn't have set off alarm bells that this whale of a trader wants to do this, so maybe we should watch out. Many hedge funds had the same opportunity to do what he did, but they thought it was too risky. Many did take the long side of the trade, because they thought that prices were good and the market would come back (they got burned).

Now on the other side of the equation, should it be unethical for an investment bank to sell a product to a client that might not know any better before fully giving their opinion? It's a tough question. Part of an investment bank's job is to provide liquidity to markets and find new ways for clients to leverage their assets to get more money to do more things and that's how the economy keeps growing. Maybe the clients should have bought more insurance on their investments or done more due diligence into what they were buying and not just go by that AAA rating which could be manipulated. I'm sure Goldman will walk away paying a relatively small fine, but the industry will surely face more regulation and legislation as a repercussion of this fiasco.

http://www.nytimes.com/2010/04/28/business/28goldman.html?ref=business