There was a bit of questioning of the Risk Management Manager that when added to that of the CFO led to some very interesting insights into Goldman Sachs. The market making staff has the ability to hold or sell items that are taken opposite those of the customers at a time and place that maximizes the profits for Goldman Sachs.
Goldman Sachs as a firm has internal views into almost every market there is. Seeing both sides of trades as well as the demand for creation of new products. The Manager would not say that internal talk among different groups wasn’t used in the determination on how to handle products that Goldman itself held. He squirmed out of taking any position.
The clear implication that you can take from these different data points is that Goldman Sachs has the ability to hold any product that they like and sell those that they don’t. They are not a neutral market making entity. They don’t see selling products that they don’t like to their own clients as a conflict of interest. Customers of Goldman Sachs need to ask themselves why the firm is selling any product. Because, if the item up for sale was worth holding, Goldman itself would hold it and not sell to the customer.
Goldman Sach’s ability to take positions and to be a market maker should be stripped. There should be a requirement that they can’t profit by taking positions as a market maker. There is no way to separate the conflict of interest otherwise.
I’m watching the testimony live on Bloomberg TV right now and a couple things are sticking out.
- 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.
- 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.
- 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?