The Senate displays, yet again, its ignorance of the financial world. Who are these people, and where did they come from?
3) Today’s inquisition was a sideshow. Here is what really happened: there was a bubble in housing prices. The bubble was mostly the result of government policy–loose money, combined with pressure on banks to make bad loans to unqualified home buyers. It all worked for a while because Fannie Mae and Freddy Mac, under the leadership of Congressman Barney Frank and others, created a secondary market for shaky mortgages. Goldman Sachs participated in this market, downstream, along with many other players. But the whole thing wasn’t an accident or a conspiracy, it was government policy. The home price bubble could have only one possible result. All bubbles burst–there is nothing else they can do–and the bursting of a bubble is always painful. The whole disaster that began in 2008 was the inevitable result of government policy, which is why Senators are so anxious to pass the buck to Goldman Sachs.
4) The Senators, seemingly without exception, are embarrassingly ignorant of modern risk management techniques. They really don’t seem to understand how and why firms like Goldman Sachs hedge their exposure to various economic trends. The most coherent explanation of what Goldman did came from the firm’s Chief Financial Officer, David Viniar:
I’d like to give you a sense for how we managed our risk during the period leading up to the crisis.
Through the end of 2006, we were generally long in exposure to residential mortgages and mortgage-related products. In that December, however, we began to experience a pattern of daily losses in our mortgage-related P&L. P&L can itself be a very valuable risk metric, and I personally read it every day.
I called a meeting to discuss the situation with the key people involved in running the mortgage business. We went through our positions and debated views on the mortgage market in considerable detail.
While we came to no definitive conclusion about how the overall market would develop in the future, we became collectively concerned about the higher volatility and recent price declines in our subprime mortgage-related positions. As a result, we decided to attempt to reduce our exposure to these positions. We wanted to get “closer to home.”
We proceeded to sell certain positions outright and hedge our long positions in an attempt to achieve these results. As always, the clients who bought our long positions or other similar positions had a view that they were attractive positions to purchase at the price they were offered. As with our own views, their views sometimes proved to be correct and sometimes incorrect.
We continued to reduce our positions in these products over the course of 2007. We were generally successful in reducing this exposure to the extent that on occasion our portfolio traded short. When that happened, even if these short positions were profitable, given the ongoing high volatility and uncertainty in the market, we tended to attempt to then reduce these short positions to again get closer to home.
This situation reversed itself in 2008, however, when the portfolio tended to trade long. And as a result, despite the fact that our franchise enabled the firm to be profitable overall, we lost money on residential mortgage-related products in that year.
While the tremendous volatility in the mortgage market caused periodic large losses on long positions and large gains on offsetting short positions, the net of which could have appeared to be a substantial gain or loss on any day, in aggregate, these positions had a comparatively small effect on our net revenues.
In 2007, total net revenues from residential mortgage-related products, both longs and shorts together, were less than $500 million, approximately 1 percent of Goldman Sachs’ overall net revenues. And in 2007 and 2008 combined, our net revenues in this area were actually negative.
For Goldman Sachs, weathering the mortgage market meltdown had nothing to do with prescience or betting on or against anything. More mundanely, it had everything to do with systematically marking our positions to market, paying attention to what those marks were telling us, and maintaining a disciplined approach to risk management.
This explanation is actually pretty clear, but it is doubtful that any of the Senators understood it.