We’re ruled by morons

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.


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29 responses to “We’re ruled by morons

  1. krazy kat


    The collapse had all manner of causes, many actors and a high degree of interconnectedness.

    I take issue with the conclusion of second point that you quote. While I believe that many senators are ill informed about the workings of dealers (ie McCain), not all of them are actually dumb.

    As you know, I work “in the business” and I howled multiple times yesterday when some Senator showed his apparent lack of understanding of market making, underwriting or hedging. I say “apparently” because I am not convinced that the naiveté was actual in all instances.

    That is, what’s important is how the whole thing is replayed by the Media and viewed by the public. Levin treated GS (and the entire Street by extension) as if they are disreputable car dealers selling clunkers in knowing violation of the lemon laws. While Retired IBr and Shoeless may agree with that assessment from a learned perspective, Main Street can relate to it as real-world concept and that is the audience to whom Levin and others played. Thus, IMHO, the criticisms from knowledgeable viewers and commentators, in or out of “the business”, are irrelevant.

    Same thing with the use of “sh!tty” which Levin and others seemed to intentionally take out of context. From my ears, what I heard in that email was a boss chastising a subordinate for running a lousy deal in which lost GS money. It was a description of their performance, not a denunciation of the underlying deal’s merits. And yet Levin proceeded to use that adjective 11 times knowing it would lead all news coverage and put GS in a poor light, no matter the actual context. Main Street will only hear the adjective and absorb the image of GS as snake oil salesmen.

    Sadly for my industry, based on my viewing of last night’s Stewart and Colbert shows and the covers of the NYC newspapers, Levin & Company accomplished their mission.

  2. LibertarianAdvocate

    Its my view that the same idiots who established the government policy discussed above are ultimately responsible also for the trigger that forced the collapse, namely our incredibly stupid oil exploration and drilling ban here at home. What likely precipitated and certainly at the very least contributed to the credit collapse was $150/barrel oil and nearly $5/gallon gasoline and $6/gallon diesel fuel during the several months that led up to the collapse.

    If the politicians in this country should understand anything at all about economics, it ought to be that high costs energy are lethal to our economy.

    Unlike China & India, where labor costs are a small fraction of ours, the cost of energy here has a major impact on everything. Couple that with a then extraordinarily weak greenback – due to low interest rates – which made oil, traded as it is in U.S. Dollars, comparatively cheaper still for the rest of the world’s economies.

    By banning drilling and exploration here, which would have the effect of keeping energy expenses at least manageable through an increase in supply, we can now see that it was the idiots in Congress who effectively created the conditions for a perfect economic storm leading to the financial markets collapse when many people and businesses ran up huge debt to pay for fuel. When they couldn’t keep up with servicing that debt, KAPOW, burst credit bubble.

    Throw da bums out in November and start with a clean slate.

  3. Anonymous

    Let’s conduct a root cause analysis of the housing meltdown. While the politicians and media try to make GS out as the cause of the problem, all they have done is to show anyone with a brain that the problem was caused by bad loans and ratings on those loans. The bad loans were mandated into market by CRA and an unregulated Fannie and Freddie.

    here is a link to a ppt summary…


  4. cos cobber

    Ah+hah. Looks like you are coming around to
    My side of the campfire. GS is guilty of some infractions
    But they are hardly the only ones to blame or the only ones
    That did it. Everyone has a role in this.

  5. greenmtnpunter

    Ther gummint is, at root, the heart of the problem. Without the worthless junk created by Fannie/Freddie, and their ilk, we wouldn’t be talking about this. Wall St is ok with it since they can make money with it- long and then short- the pols are ok with it since they can get re-elected and retain their protection racket stranglehold on GS et al. Hearings are just a charade of dis-information to make the collusion not look like a collusion. Then continue the giveaways as usual and keep the cycle going. Nice work if you can get it. And the regular schmucks get screwed? Time to file RICO suits against many in Congress?

  6. Fly Girl

    Not in the financial arena Krazy Kat, I appreciate your comments. The only issue I have is your take that Levin & Company accomplished their mission. I think more and more Mr. and Mrs. EveryDay understand the circus that is Senate hearings and see the ‘snippet mentality’ for what it’s worth. Even I got that Levin was intentionally taking words out of context.

  7. Sanjay Bigglesworth

    No matter how many times you say it, or how loud you yell it, No. 3 will never be true. The CRA/Fannie/Freddie conspiracy is BS.

    Irresponsibly ultra-low rates that led to a huge housing boom; a failure by the Fed to supervise non-bank lenders; An abdication of lending standards by both banks and non-banks; Radical deregulation of financial markets; the now discredited belief that markets can self-regulate; a shadow derivative market allowed to operate unlike every other financial product; Compensation schemes that rewarded short term risk taking over long term profitibility; Increases in leverage to the major investment houses from 12-to-1 to 35-to-1; These were the causes of the collapse — not some 1977 legislation.

    So if you want to start with the finger pointing, start with Al “Ayn Rand is the Truth” Greenspan.

  8. Sanjay Bigglesworth

    Edit to add – Levin and Co. should be embarrassed with yesterday’s bread and circus routine. When you point your finger, there are three pointing back at you.

  9. Krazy Kat

    All: As I said at the opening of my comment, all of the factors you mentioned came together to create the environment for collapse. The real issue, with 20/20 hindsight, is that there was no party with a vested interest to take away the proverbial punch bowl. Every single party benefited in way, shape or form and was either ignorant of the risks or ignored them.

    The few who saw this coming were either labeled Casandras if they said so publicly, or made a ton of money by expressing their view in the markets.

    Of course, whenever multiple players are culpable for a disaster, fingers point in every direction other than the one that points back to one’s self. Even Mom & Pop who used their homes as ATMs for lifestyle expansion are to blame but find an honest consumer to say as much.

    To quote Pogo, “We have met the enemy as he is us.”

  10. cos cobber

    Krazy Kat, what is your take on barry – I forget his name, rhinholt’s? view of the case against goldman as posted on his ‘big picture’ blog?
    I completely agree with your assessment.

  11. Fly Girl

    I am completely fascinated by the varying points of view from your readers who ARE in the biz. If they see the issues differently, lord help the rest of us for any chance of understanding.

    (CF: my cable modem service is going in and out of signal – I posted something like above a bit ago but it must not have gone through. If you see it twice, delete one. Thanks).

  12. Mr. 85 Broad St.

    Mr. Bigglesworth,
    The Fannie/Freddie issue in not a total red herring. They are not banks and as a result are not subject to a CRA rating. However, their regulators, OFHEO and HUD, did set annual “affordable housing goals” for them and the level of those goals was definitely subject to influence by both Congress and the Administration. In 2008, the goal was that 56% of their overall production be focused on low and moderate income households. Since the large majority of Fannie/Freddie conforming loans are not going to qualify for this test (since the borrowers did not meet that income definition), they had no choice but to be active in other indirect ways such as providing credit enhancement on municipal bonds for affordable housing projects, buying low income housing tax credits and buying “AAA rated” sub-prime RMBS to meet these goals. I have little doubt that absent these requirements, their book of business would have been focused high quality, full documentation, conforming loans and that as a result, they would not have failed. My personal opinion.

  13. Fly Girl

    BUT, none of those brilliant men manages my money nor has a job in the government to affect change. I am left to rely on the opinions of investment agents who look at the financial future to protect their own ass – not my pocketbook. And worse, if I can’t understand the issues enough to have an intelligent conversation with my broker, they have me at “sell”. Talk about “sh!tty”

    • Fly Girl, I recommend Eric Kreuter – (203) 862- 2114. He’s probably only a little smarter than me, and that’s pretty dumb, but the most honest financial advisor I know, even if he now works for UBS.

  14. Cos Cobber

    Correct, prior to the 2008 collapse there was tremendous presure on Freddie and Fannie to make investments in affordable housing. They met this goal exactly as 85 broad street outlined: LIHTC, credit enhancement (cha-ching) for affordable housing bonds and buying sub prime mortgage portfolios. Their investments in LIHTC affordable housing (income restricted rental housing) and bond credit enhancement have performed well, no issues there. Their investments in sub prime mortgages have obviously not faired well.

    If Freddie and Fannie werent out there buying this stuff the market would not have been as deep as it was and therefore the size of the sub-prime mess would have been smaller. Same issue for all banks subject to CRA; which are all the non investment banks prior to Sept 2008 when all the investment banks changed their charter in order to participate at the Fed window. All of the banks had CRA goals they were compelled to meet by law and they did so the same way as Freddie and Fannie. Their LIHTC and affordable rental lending business performed well, but sub prime was a disaster. If CRA didnt exist, much of the drive to push $ into sub prime would have been removed. I am not saying that we would not have been without a sub prime meltdown or even a real estate melt down, but it the meltdown may have been less severe and smaller in scope without the CRA push to sub prime lending.

    Now back to the GS witch hunt.

  15. Fly Girl

    IMO, the Senate is doing the GS dance for naught. IB/PE will make big deals and take risks no matter the consequences if there’s a pile of money to be had. I had alot of friends whose husbands worked for DrexelBL in the 80s. They “worked from home” for a while when the company went bust but many run a boutique firm today – the adrenaline rush from making the deal doesn’t go away, even if you have to sit and answer questions from the likes of Levin.

    CF, thanks for the recommendation. Many houses don’t let you in the door without double digit millions to play with. I may stick with Mickey and Goofy. At least they make me laugh.

  16. fat cat

    I think a) Greenspan is responsible for keeping interest rates artificially low in order to stimutlate the economy which caused consumers to lever up using cheap money and investors to seek additional yield by buying risky securities such as junk bonds in over levered companies and synthetic CDO squareds. B) The realtors who sold overpriced “sh*tty” houses to people who lied about their income in order to obtain a loan.

    It’s that simple

  17. HG

    I don’t think the affordable housing goals blew up Fannie and Freddie. I think if you look in their filings you will see that today they own huge numbers of foreclosed homes, mostly I would think these homes were financed by Fannie and Freddie under their normal underwriting standards to people with normal (non subprime) FICO scores. I would suggest that when you have a government operate a business like a shoe business, you are likely to get factories that make only left shoes in order to meet quotas (Poland, communist era). As bad as that is, when you have government operate a business like a lending business, where the cost of goods sold (loan losses) only becomes known in the future, you are asking for big trouble. People warned about it (mostly Republicans). They were ignored (by many Republicans and all Democrats). This is what you get.

    Galbraith’s “The Great Crash 1929” is the best historical perspective on what we have just experienced. “Animal spirits,” which is a nice way of saying that people are stupid, was the principal cause of the 1920s real estate bubble and the 2000s real estate bubble, and the stock market / financial panics that marked their ends. People are stupid because they like houses more the more expensive they are, and they like stocks more the more expensive they are. They don’t need punch bowls, exotic structures or Goldman Sachs to help them be stupid, although in each episode, all three are standing by ready to fuel the stupidity.

  18. Cos Cobber

    By no means am I arguing that affordable housing goals blew up Freddie and Fannie alone. Its just one of the many ingredients to our meltdown stew.

    My point was really just an effort to elaborate/endorse 85 Broad Street in response to Bigglesworth. To say these goals had no impact is as false as to say it was the sole causes. The federal housing agenda via CRA was an ingrediant.

  19. Sanjay Bigglesworth

    I understand the arguments being presented about Fannie and Freddie, but when you look at the most bubbilicious areas of the country (Miami, Las Vegas, Orange County, heck even Greenwich), how much of those loans do you think were targeted toward affordable housing?

  20. Cos Cobber

    You are broadening the scope of the discussion. My point is that CRA was a contributor to the meltdown in that it directed banks along with freddie and fannie to invest in sub prime to meet CRA mission goals.

    Actually, to clarify, Fannie and Freddie are technically governed by HUD and exempted from CRA law. However, Freddie and Fannie received plenty of formal and informal pressure from capitol hill to put dollars into affordable housing.

    btw, Miami and S. Florida has a ton of affordable housing while Las Vegas has some. Orange County and Gwich have very little as you know. Clearly the economic crisis spread well beyond sub prime and CRA, that I dont disagree on.

  21. Teri Buhl

    Let’s not forget as the Goldman abs traders and head of mortgage tried to explain but were cut off by Senator Levin et al (Dan Sparks is from New Canaan) the buyer of the CDO $IKB was also making a reverse request for the product. Here’s a bit of background on IKB’s investment strategy and why they wanted CDO’s with BBB rated subprime mortgages.

    and by the way IKB went to Deutsche Bank asking for the same damn CDO products

  22. Retired IB'er

    This whole mess, at its essence, is the fault of Greenspan/Bernanke (for low rates and not pricking bubbles) and the regulators/Congress (for not enforcing the law/repealing Glass Steagall). It was their collective actions/inactions that allowed Wall Street run amok. You don’t blame the kid for doing what comes natural; you blame the adult for not supervising properly.

    Wall Street is amoral; and, so not generally to blame. The Street is like water; it finds the lowest point and breaks through:the Street found the loopholes and exploited them.

    Still, the greed on the Street was/is of epic proportions and should not be excused.

  23. Krazy Kay

    Everyone is right, to an extent. As I said earlier, the entire mortgage securitization process was a gigantic loop that kept feeding back upon itself. If I could I would post it here but I can’t (maybe I will send it to Chris and he can post it).

    On the left side you had homeowner-borrowers. On the opposite end you had “the money” which was represented by money market funds, hedge funds, pensions, sovereign investors, banks, and individual investors (mostly through funds). In between you had real estate agents, realtor organizations, mortgage brokers, mortgage bankers and banks, appraisers, investment banks, accounting firms, the rating agencies, SIV sponsors, Frannie, taxing entities (municipalities), attorneys, developers, trades people, and every other player that was involved in housing, financing, etc. Basically, nearly everyone except renters and folks who owned homes and never refi’d or took out equity. I include the Fed, Barney Frank, George Bush and a cast of others with varied interests that helped pull or push this process.

    So the demand for cash or financing (equity withdrawal) was driven by consumers and the demand for the credit products was driven by the investors. As more credit was created, home prices were pushed upward by the easy money. Investors could not buy the higher than Treasury yields (AAA rated for much of this dreck) fast enough (think German bank IKB in the Abacus/GS case). Existing home owners, many with no mortgages, refi’d their homes to extract cash used for all manner of purposes. NINJAs bought homes with nothing down hoping to flip in 6mos time to the next fool.

    So around and around the cycle/loop churned with no “adult” to call a time out as the excesses built. Every person/firm involved in that loop is part of the cause of the collapse. My own sister, accusing me of being part of the “destructive Wall Street machine” had to admit that her two refi’s and equity extraction were part of the problem (only after I beat her with the issue).

    So, yes, the CRAs were at fault. The GSEs were at fault. Politicians of both flavors were at fault. The bankers, hedgies, money funds, pensions and other investors were at fault. Anyone who got paid for processing the mountains of paper were at fault, well, at least they benefited. Real estate agents, mortgage folks, etc etc etc were at fault.

    Only you long-time renters and outright owners can take the moral high ground on this one.

  24. Priapus

    Bullshit talks.

    Goldman walks.

    Take a report.

  25. Onthewcoast

    In 2003 I learned what a loan broker was doing with all loans being issued in the beach communities of Los Angeles. Exotic loans were being originated because the banks were not holding the loans, but selling them to investment banks. Countrywide and New Century were lending to anyone and turning them over. They didn’t care if the loan was sound because they had a market for the loans. The loans were then securitized with additional transaction fees.
    We still have community development agencies willing to lend to people who can’t afford to really buy a home. Local government is throwing money at specific communities in low income areas. All through block grants from the Federal government.
    This is not the Connecticut market, but it is happening to this day.

  26. Old School Grump

    The senators are a bunch of grandstanding, hypocritical buffoons on a witch hunt, and GS is the perfect witch to hunt: a totally unsympathetic character that made money from other people’s suffering. Making money from other people’s suffering is not the same thing as CAUSING other peoples’ suffering, but that is a distinction the senators are quite desperate to blur in their need to find a villain.

    Remember the Commodities Futures Modernization Act, a lovely piece of legislation signed into law in late 1999 or early 2000? It had nothing directly to do with mortgages or the housing market per se, but it supplied the oxygen that fueled the fire because it exempted financial derivatives from any meaningful regulatory oversight. Margin requirements, a clearing house, central price reporting, position limits; you name it, it wasn’t there. IBer at 6:30 is right; Wall Street is inherently amoral, and if it isn’t regulated correctly, well … Duh!

    So when I saw these long-term senators doing their righteous accusatory strut, I had to wonder … Did YOU vote for that piece of legislation? If so, do you even understand the connection between that and this? If so, could a little soul searching and perhaps a mea culpa on your part, be in order?

    Yeah, right, what planet am I from to even think that’s a possibility?

    It’s so amusing that other big offenders–Merrill and Citicorp come to mind– have not been summoned to this particular Senate witch trial. Why? Because, unlike Goldman, they had the good taste to lose money! Even though they were up to their armpits in creating and dealing in this stuff, the fact that they were long rather than short when the music stopped somehow means they had … integrity?