Goldman and Frankenstein's monster
The gulf of mistrust and misunderstanding between the US legislature and Goldman Sachs is something to behold.
The events of the past few days have been a propaganda battle between two enemies that would not have looked anomalous during the Cold War.
The Senate's permanent sub-committee on investigations has released Goldman e-mails that support its conviction that the world's leading investment bank made big profits from betting against the housing market and put the bank's profits before the interests of clients or the wider economy.
Goldman's response has been to release a barrage of other internal e-mails and management reports, which back up its contention that it did not generate enormous profits in this way.
Who is right?
Well, a bit like the Cold War, perception of the truth is conditioned by ideology.
Goldman would not disagree that it bet residential mortgage-backed securities (RMBS) and collateralised debts obligations (CDOs) manufactured out of subprime housing loans in 2007 - that it went short of them.
But it would see the adjustment of its own trading and investment positions as a defensive measure, a sensible precaution to avoid lethal losses, rather than an aggressive punt to make enormous profits.
And what it regards as conclusive proof of its innocent intent is that in the circumstances of a collapsing market for RMBS and CDOs, it didn't actually generate colossal winnings: its net revenues from residential mortgage-related products business in 2007 was $500m, not trivial but only 1% or so of its total net revenues that year; and in 2008 Goldman says it made a loss of $1.7bn from these activities.
To be clear, these net revenue figures probably understate the scale of its bet against subprime: what caught Goldman out in 2008 was the weakening in the better-quality home-loans market.
That said, Goldman's speculative position against subprime wasn't remotely as substantial as its big hedge-fund client, Paulson, or as the few other hedge funds that made a killing (many billions of dollars) out of shorting subprime.
The picture that emerges from Goldman's internal e-mails and management documents is certainly of its partners seeking to protect the firm's financial interests; but their first priority appears to be to limit the risk of a lethal loss rather than to maximise the potential for an enormous profit.
Now, most dispassionate observers would probably say it's a shame that more banks weren't a bit more like Goldman in respect of their risk controls: the banks that really let down taxpayers and citizens were those like Merrill Lynch, Lehman, Citigroup, UBS and Royal Bank of Scotland that made stupendous and insane bets that the bull market in debt would go on forever.
So it should not be dismissed as trivial that taxpayers' financial help for Goldman was considerably less than for most of its domestic and international competitors - which is not to ignore that when markets melted down in the autumn of 2008, Goldman too had to be bailed out.
But the big and important point is not about the quantum of Goldman's subprime bet or the quality of its risk management. It is about the essence of Goldman's business model, whether it remains appropriate for Goldman to have the twin priorities of maximising trading and investment profit for its own account, albeit subject to strict limits on the risks it runs, while also seeking to maximising returns for clients.
Those Goldman e-mails written in 2007, when the RMBS and CDO markets were entering the final gasping phase of their bubbled life before collapsing in August 2007, show that Goldman's partners were agonising about how far the price of housing-related investments would fall, whether - for example - prices were overshooting and would bounce.
It's an intelligent and fascinating debate between colleagues with palpable respect for each other. But did they show the same respect for their clients? Did they expose their concerns about the potential for a subprime debacle with those to whom they were selling RMBS and CDOs?
What's so potentially damaging for Goldman about Securities and Exchange Commission's recent fraud charges against it (see my posts on its role in creating and selling the Abacus 2007-ACI CDO) is the allegation that it didn't share relevant information about the risks of investing in a CDO with one important group of clients.
Goldman denies the charges and the broader critique.
But it is surely aware that the SEC case is simply an extreme version of a criticism routinely made by its investment and corporate clients: I have lost count of the number of times chief executives of big companies have said to me that they hire Goldman because the bank is so powerful and talented that they don't want it working for a rival, but they're not confident that every bit of Goldman is promoting their respective interests, rather than those of other clients or the bank's book.
Again, I should say, that at every instance of conflict of interest, Goldman is brilliant at showing that it plays by the rules.
And whatever the reservations of clients, those qualms haven't prevented Goldman becoming - arguably - the most influential and important investment bank since the heyday of the Rothschilds some 200 years ago.
Perhaps therefore the best way of seeing the assault on Goldman by Senate and SEC is as part of the wider debate about how to sanitize the banking system - about whether the risks of boom and bust in banking would be reduced if there were a clearer demarcation between banks that advise clients and institutions that deploy their own capital to generate trading and investment returns.
A couple of e-mails released by Goldman may come to characterise this debate.
They were written towards the end of January 2007, a good six months before Armageddon for the asset-backed securities market, by Fabrice "Fab" Tourre, the middle-ranking Goldman executive charged by the SEC.
Here are the resonant quotes, from flirtatious notes to Tourre's female pals:
"More and more leverage in the system. There is a risk that the entire edifice will collapse at any moment...Sole potential survivor, the fabulous Fab...,standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all the implications of those monstruosities (sic)!!! Anyway, not feeling too guilty about this, the real purpose of my job is to make capital markets more efficient and ultimately provide the US consumer with more efficient ways to leverage and finance himself, so there is a humble, noble and ethical reason for my job; amazing how good I am in convincing myself!!!"
"When I think that it is to an extent myself who has participated in the creation of this product (which, I should say in passing, is a pure product of intellectual masturbation, the kind of thing one invents while saying: 'well what if one invents something that has absolutely no purpose, is utterly conceptual, totally theoretical and no one knows how to price'), that makes me sick to see it implode in flight...It's like Frankenstein turning against its inventor".
It turns out that Tourre was a prophet; he saw the tsunami building on the horizon.
Many may well think it's a shame that Tourre's searing insights seem to have been reserved for his women chums.
But the big questions for his bosses - which will doubtless be put tomorrow by US Senators when they grill Lloyd Blankfein, Goldman's chairman - is whether they agreed that CDOs are a "pure product of intellectual masturbation" and whether the way they switched to shorting subprime showed that they too feared the collapse of "the entire edifice".
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