At the Intersection of Chinese Walls and Wall Street

In his missive in today’s New York Times, Ben Stein does what many would like to do: call out Goldman Sachs and introduce some tarnish to its shiny reputation. The thrust of Mr. Stein’s argument is that one of Goldman Sachs’
leading economic analysts, Jan Hatzius, basically put out a puffy “fear
piece” that would ultimately benefit the firm’s proprietary short
positions in the housing sector. And he suspects even greater bad behaviors but you get the gist. Now I don’t have a problem with Ben or anyone else trying to expose misdeeds or shady dealing, but I do have a problem with an analysis that is economical with the truth and detached from the realities of a business model that is both heavily regulated and under constant scrutiny. Either Mr. Stein doesn’t understand how Wall Street and the securities market work (unlikely) or he has a clear agenda and was in desperate need of a column for today’s paper (somewhat more likely). Whichever it is, I believe he is way, way off, and trying to concoct conspiracy theories directed at Goldman is somewhat similar to those he is creating with his own puffy fear piece. Those who throw stones… right?

As I interpret it, Dr. Hatzius was saying that the financial system
would possibly not be able to adjust to a level of financial losses
that are large on an absolute scale but small compared with aggregate
credit or the gross domestic product. He is also postulating that
lenders would have to retrench so deeply that lending would stall and
growth would falter — an event that, again, has not happened on any
scale in the postwar world, except when planned by the central bank.

In
other words, with the greatest possible respect to Dr. Hatzius, his
paper is not really what I would call a serious overview of the
situation. It is more a call to be afraid and cautious based on general
principles that he embraces and not on the lessons of history. (In this
respect, he is much like many economic journalists and commentators who
sell newsprint by selling fear. The common cause of journalists and
Wall Streeters in this regard is a subject I will address in the
future.)

Ok, so Dr. Hatzius has a view, and given his credentials and his perch I’d say his view is probably worth considering. Just because his paper doesn’t comport with Mr. Stein’s view of the world doesn’t make it wrong or its methodology flawed - it’s just that Mr. Stein doesn’t like it. That’s fine. But one need not intuit evil intent because of it. Anyway, Ben goes on to ask the following question:

Why, then, is his document circulating? Perhaps as a token of Dr.
Hatzius’s genuine intelligence, which is fine. But to me, his paper
seemed like a selling document in the real Wall Street sense of selling
— namely, selling short. (Dr. Hatzius notes that he has long been
bearish on housing, since faraway 2006, but I respectfully note that
that is a lot different from predicting a credit catastrophe. The
spokesman for Goldman also noted the company’s bearishness on housing
since 2006. He also noted that in the recent past, Goldman Sachs has
moved to a considerably larger short posture and that the firm is net
short.)

More thoughts came to me as I read a recent piece in
Fortune by my colleague Allan Sloan, a veteran financial writer. Mr.
Sloan traces the life and death throes of a Goldman Sachs-arranged
collateralized mortgage obligation. He shows how truly toxic waste was
sold to overly eager investors who now have major charge-offs, and he
also points out that some parts of the C.M.O. were indeed safe and were
either current or had been paid off.

But what leaps out at me
from this story is that Goldman Sachs was injecting dangerous financial
products into the world’s commercial bloodstream for years.

Ben, come on, you’ve got to be kidding me. He’s setting the table for his conspiracy theory, the foundation of which is that not only that Dr. Hatzius is biased in his view because of his firm’s trading book but that the firm itself has been engaging in destructive behaviors. Mr. Stein, CMOs, CBOs and all forms of ABSs have their place in the capital markets, increasing liquidity, re-allocating risk to those best able to accept it and supporting economic growth. The sub-prime mess does not, in and of itself, mean that pooled assets where participations are sold off to investors are bad. And his use of language and populist rhetoric severely dulls the strength of any argument he is likely to make from this point forward. Further, there are walls between groups that underwrite securities and those that issue research, for the reasons we all now know so well (read: Blodget-gate). So the likelihood that a senior economist is putting out reports that would knowingly benefit the firm’s positions and get paid for it is somewhat far-fetched, especially when the firm in question is Goldman Sachs. What firm would have more to lose from such a thinly-veiled ploy? I think they’re a little smarter than that.

And then, 2/3 of the way into his discussion, Mr. Stein drops the bomb:

Here is my humble hypothesis, even after talking to Goldman: Is it
possible that Dr. Hatzius’s paper was a device to help along the goal
of success at bearish trades in this sector and in the market
generally? His firm says his paper, like all of its economists’ work,
was not written to support any larger short-trading strategy. But
economists, like accountants, are artists. They have a tendency to
paint what their patrons, who pay them, want to see.

If I were Dr. Hatzius, I’d be making a little Ben Stein voodoo doll and sticking it like a pincushion. And just when you thought Ben had only gone off the reservation, be took an express trip to another galaxy far, far away. Check out this line of argument:

Doesn’t this bear some slight resemblance to  Merrill selling tech stocks during the bubble while its analyst Henry Blodget
was reportedly telling his friends what garbage they were? How
different would it be from selling short the junky stock that your firm
is underwriting? And if a top economist at Goldman Sachs was saying
housing was in trouble, why did Goldman continue to underwrite junk
mortgage issues into the market?

HERE is a query, as we used to
say in law school: Should Henry M. Paulson Jr., who formerly ran a firm
that engaged in this kind of conduct, be serving as Treasury secretary?
Should there not be some inquiry into what the invisible government of
Goldman (and the rest of Wall Street) did to create this disaster,
which has caught up with some Wall Street firms but not the nimble
Goldman?

Ok, now here is where my disbelief comes in. Wall Street firms are made up of separate groups. Walls are established among these groups where appropriate, particularly keeping those areas that touch clients separate from those that trade proprietary capital. So at any one time a firm may well have someone in research put out a “buy” rating (grounded in the logic and belief of the research team) on a security, while a prop trading desk elsewhere in the firm is already long a boatload of the issue. Does this mean that because research issues a buy that no desk in the firm can own the shares? That is absurd. Contrary positions across large, complex firms abound, and Chinese Walls exist to specifically protect against the inappropriate flow of information. And in my experience, these walls tend to work quite well. Further, during my time at both Citi and Deutsche our economists and securities analysts’ took positions that were either been helpful or hurtful to the positioning of our books, and it was what it was. There was no tip, no nod, no communication prior to the issuance of a report whatsoever. So I find Mr. Stein’s hypothesis both fascinating and fanciful, considering how smart he is yet how deranged his position happens to be.

And then further extending the witch-hunt to Mr. Paulson? Now, if both he and Dr. Hatzius are in on the scam to secretly help out Goldman, then why is Mr. Paulson trying to help the mortgage market with his support of the Super SIV, freezing ARM rates, etc., while his Goldman colleague is on the opposite side of the trade? Doesn’t this logically run counter to Mr. Stein’s contention? Maybe its me, but I feel like my affair with mainstream media is having a bad-hair week.

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COMMENT:

AUTHOR: BudH

EMAIL: eugeneharris@comcast.net

URL: 

DATE: 12/03/2007 12:08:47 PM

It seems Goldman is putting their mouth where their money is.  What’s wrong with that?

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COMMENT:

AUTHOR: jswede

EMAIL: jswede@comcast.net

URL: 

DATE: 12/03/2007 01:15:35 PM

What Ben Stein describes as “dangerous financial products” would - at a different (lower) price - be called “speculative” and to many a “good investment opportunity”.  The market sets the price, GS is one player on one side of the market - it can’t have any real effect on the price the market is willing to pay for securities that had rating agencys’ independent opinions on its quality.

So a part of Goldman thinks the market was mispricing the securities — and it acted upon that thought by shorting.  The part that was securitizing and selling CMOs was only giving the market what it wanted - the best performing mortgage funds of the last 5 years were full of this stuff, and no one was complaining then.

The only thing GS did “wrong” was to be right on its shorts — that was a propriatary trade and also involved risk.  Who is GS, or anyone else for that matter, to tell these smart institutional investors who supposedly know what they are doing that they, AND the rating agencies, are wrong?

For one, it’s not their business and two: What if GS was wrong on its shorts?  What would Ben Stein’s column say then?  (I can bet who’d he be accusing.)

but seriously, Stein comes up with this type of half-truth, one-sided political drivel on finance every week — it’s just time to stop listening.  Maybe the fact that it’s a NYT Opinion piece (though disguised in the business Section) should be enough of a hint?

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COMMENT:

AUTHOR: RBH

EMAIL: rbh.third@gmail.com

URL: http://www.iidb.org

DATE: 12/03/2007 01:51:10 PM

You write: “Ben, come on, you’ve got to be kidding me. He’s setting the table for his conspiracy theory, the foundation of which is that not only that Dr. Hatzius is biased in his view because of his firm’s trading book but that the firm itself has been engaging in destructive behaviors.”

Stein is showing his conspiracy theorist side in another arena, the teaching of science.  His participation in Expelled (http://www.expelledthemovie.com/), a compendium of half-truths and outright lies, with some interviews obtained by misleading the subjects (see here: http://tinyurl.com/2wu6vg) of the interviews.  Stein has too long believed his own publicity.

RBH

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COMMENT:

AUTHOR: sell_side_analyst

EMAIL: no@email.com

URL: 

DATE: 12/03/2007 02:03:40 PM

Economists are generally not considered “analysts” by bank compliance departments and therefore are not subject to the same Chinese Wall limitations.  I am not disagreeing with your thesis, Roger, but that part of your argument does not hold.

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COMMENT:

AUTHOR: Yaser Anwar

EMAIL: yaser@yaseranwar.com

URL: http://www.yaseranwar.com

DATE: 12/03/2007 03:39:41 PM

The core argument between Jan’s piece was already being talked about long before he did so, or at least part of it. Maybe Ben Stein didn’t read a book called “Financial Armageddon” by Michael Panzner, or maybe he never even visited Michael’s blog, or even Nouriel Roubini’s blog at RGE Monitor.

If he had, he would have known that there were already talks of how much this subprime hooplah would end up hurting banks et al. I’ve read Jan’s piece and certainly don’t think his intention was to fuel the GS prop book shorts. Was Stein sleeping when GS reported their results? Everybody who can, is shorting the ABX indexes, no wonder it costs a fortune to do so now.

Over the past two weeks I’ve seen the market swing for some of the most ridiculous reasons, but that’s the market. Short-term irrational, long-term less irrational. John Mauldin has been talking about this subprime mess for 4-5 months now, and I didn’t see the market swing so violently to his conclusions, why? With all due respect to JM, he’s not the Chief Economist at Goldman Sachs! Jan’s call was on at least 20 newspaper headlines/top-stories within minutes, that’s called media fueling the fire, it’s what they do best, regardless of whether they understand it or not.

Wake up Ben Stein. 

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COMMENT:

AUTHOR: Marc Milgrom

EMAIL: marc.milgrom@gs.com

URL: 

DATE: 12/12/2007 10:43:34 PM

I confess right off— I’m a GS employee.

All I can say for Stein is to quote him, “he is much like many economic journalists and commentators who sell newsprint by selling fear.” This tempest in a teapot has garnered him more attention than Win Ben Stein’s Money or The Wonder Years ever did, probably the most since Ferris Bueller was in high school.

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