Thoughts on Goldman Sachs Testimony

I’m watching the testimony live on Bloomberg TV right now and a couple things are sticking out.

  1. The question is coming up about the ability for a party to be a market maker and to also take part in the market. With highly liquid stocks, it seems like this is OK since there is a fair amount of visibility into the market. There isn’t an information gap between different parties. But with illiquid assets like the CDOs, knowing who is involved and moving in which direction gives you a huge advantage over other players. It would only take a little bit of info to shift the advantage dramatically. If the Senators are smart they’ll see that with these types of assets market makers shouldn’t be allowed to take part in the market. It’s back door insider trading.
  2. There is another line of questions on rating the CDO. Goldman Sachs is sticking with the line that everyone was a big boy and should have been able to look at the security and determine the risk. The problem is that this has been proven to be completely false. No one was able to accurately determine the risk of these items. The fact that they allowed Paulson to pick the contents and then short the CDO gave him a huge advantage in the deal. Whether this was illegal or not isn’t clear, it should not be allowed to happen again.
  3. The Goldman Employees referenced the mathematical models that allowed rating agencies to take BBB+ sub-prime mortgages and rate them as a group as AAA. It’s shocking how far from reality this model was. It’s these types of models and economic thinking that has spurred my interest in this area. How can the supposed top economic minds get things so wrong?