The Goldman Sachs saga: hedging is one thing, swindling is another…

April 28, 2010

The details of the unfolding Goldman Sachs story are somewhat complicated, but the general scenario of the whole housing market collapse that led to the Great Recession and the Goldman Sachs involvement is simple to grasp.

Led by the high rollers on Wall Street and politicians who supported everyone owning their own house and making it work for them so none of us would ever have to do real work again, millions were induced to buy homes that were too expensive for their own incomes.

This all made a lot of money for a lot of people, to include the lenders (several layers of them since mortgages were bundled and sold as investment) and some borrowers who were quick enough to flip their homes in time.

This could not last forever, but not to worry for some of those connected with Goldman Sachs. While they were selling mortgage-backed securities they were secretly making bets that the housing market would fail (via the procedure of what is called “short selling” — the very securities they were selling).

Now it is not uncommon in business and in fact is considered prudent to hedge your position.

I recall attending a meeting a few decades ago when cattle ranchers were being introduced to the commodities market. They were told that they could lock in a price for their feeder cattle by buying cattle futures as a hedge. The upside would be they would know what the price would be before they committed all the money needed to get their cattle to the selling point. The downside would be that if the price of cattle suddenly spiked at the time of sale, they would have any profit shaved by the difference between the futures price they had agreed to and the newer, higher price.

And certainly securities traders and other investors have all kinds of ways to hedge bets. But hedging is one thing, swindling is another.

The problem, as I see it, is when the actions taken by traders goes beyond hedging and actually unfairly distorts the market to the gain of those who caused the distortion and the loss to unwitting investors.

And there is certainly a conflict of interest when an outfit, such as Goldman Sachs, is both trading something for its own gain and selling the same thing to a client. 

Above all the real problem is when all these games and sleights of hand affect the whole U.S. economy — that is when there is a real public interest in all of this.

To be sure, much of what is taking place in the Capitol Hill hearings is grandstanding by legislators to make themselves look good and the Wall Street folks look bad (so they, the legislators, will look good).

Thee is no doubt need for some improved regulation.  We certainly need protections against the gaming of the system. But I’m sure that there is a danger of over regulation. It’s better to enforce the laws already on the books than to create more laws that will just introduce more expense into the whole process — that expense always eventually paid out of the pockets of working Americans one way or the other.


And then there is this conflict of interest between our federal government and Wall Street.  President George W. Bush appointed Henry Paulson Secretary of the Treasury. Paulson had been CEO of Goldman Sachs. Isn’t it strange that Goldman Sachs was able to make money at the beginning of the fall of the housing market while others were losing and then had the good sense to become a bank holding company so it could get in on the taxpayer-funded bank bailout that was promoted by Paulson?