Is what Goldman Sachs did nothing but gambling?
| Washington
Is Goldman Sachs CEO Lloyd Blankfein a bookie?
That sounds harsh, but on Tuesday, senators repeatedly compared the activities of investment banks to gambling as they grilled Mr. Blankfein and other Goldman Sachs officials about short selling, synthetic collateralized debt obligations, and other arcane Wall Street arts.
Things went so far that eventually Sen. John Ensign (R) of Nevada, whose constituents include Las Vegas casinos, took umbrage. He said that his state鈥檚 version of gambling is fairer than what happens in the trading rooms of Manhattan.
In Vegas, the croupiers do not change the odds on a game while it is in progress. But on Wall Street, bankers are 鈥渢weaking the odds in their favor鈥� while deals progress, said Senator Ensign.
Eventually, Blankfein had enough. He objected to the continual use of the word 鈥渂et鈥� by subcommittee chairman Sen. Carl Levin (D) of Michigan to describe short selling, an activity in which profit stems from a decline in asset price.
鈥淵ou know, we live in different contexts,鈥� Blankfein said to Senator Levin.
They do, indeed. Here鈥檚 a summary of how both sides view this question:
Why Blankfein鈥檚 a bookie
The underlying activity of financial trading looks a lot like betting on a horse or other sports event. Profit or loss depends on an unforeseen outcome over which the investor has little direct control.
Of course, that鈥檚 the way financial markets have operated for centuries. What lawmakers on Tuesday appeared to be homing in on was this: trading a new kind of financial instrument that seems to have no connection to any underlying real asset at all.
This instrument is the synthetic collateralized debt obligation (CDO). It鈥檚 a bundled investment that increases or decreases in value as its underlying bonds, or mortgages, or whatever, fluctuate in price. But the owner of a synthetic CDO does not actually own any piece of these underlying assets. Instead, CDOs are baskets of derivatives known as credit-default swaps.
Got that? Here鈥檚 how Blankfein described a housing-based synthetic CDO to senators on Tuesday: 鈥淚t references securities indexed to particular mortgages.鈥�
The further trading activity gets from the real economy, the closer it resembles blackjack, in the view of many lawmakers. In particular, Levin continually objected to Goldman鈥檚 short selling of a housing synthetic CDO the bank was marketing to customers.
鈥淵ou are betting against the very security that you鈥檙e selling,鈥� said Levin.
Why Blankfein鈥檚 not a bookie
To investment professionals, the context in which the buying and selling of securities takes place makes it very different from Las Vegas.
Trading synthetic CDOs is not analogous to betting on a hamburger-eating contest, say. Investors purchase these products as a means of protecting themselves against swings in the price of the underlying asset. Generally speaking, they are part of a complicated investment strategy 鈥� not a bet in and of themselves. Thus automakers can hedge against swings in the price of steel, or beverage manufacturers can try to make sure they鈥檙e not hurt badly by a rise in corn syrup.
鈥淲hat clients are buying or customers are buying is an exposure,鈥� said Blankfein on Tuesday. 鈥淭he thing that we are selling to them is supposed to give them the risk that they want.鈥�
It鈥檚 true that learning to be good at poker is one way to prepare oneself for life as a Wall Street trader, notes Robert Brusca, an economist for Fact & Opinion Economics in New York. But senators on Tuesday got tripped up and appeared confused about Goldman鈥檚 various roles in the financial markets, said Mr. Brusca in an analysis of Blankfein鈥檚 appearance at the Senate hearing.
Lawmakers also put too much emphasis on the blunt talk contained in Goldman e-mails released by the Senate Homeland Security and Governmental Affairs Committee's Permanent Subcommittee on Investigations. Obscenities and denigration of one鈥檚 own products are common among all kinds of salespeople 鈥� not just securities dealers, notes Brusca.
鈥淭he key here should be for the senators to pursue those charges that have to do with securities law violations or that have real moral character problems. They seem to have lost their way, although they did score some points,鈥� writes Brusca.
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