The question at the center of Tuesday's Senate hearing on the role of investment banks in the financial crisis: Are Goldman Sachs bankers criminals or merely a big bunch of jerks?
Put another way: Did the employees of Goldman Sachs deliberately mislead investors by failing to disclose that one of the people creating a certain mortgage-backed security was also betting against it, as a new lawsuit by the Securities and Exchange Commission alleges? Or did they simply recommend mortgage-backed securities to investors, then turn around and bet against them—essentially betting against their own investors?
The Permanent Subcommittee on Investigations may have failed to prove the former, but it presented a strong case for the latter.
The hearing pitted senators determined to find wrongdoing—they sifted through a five-pound stack of internal e-mails, company memos, letters to investors, and financial statements—against Wall Streeters insisting they were just doing their jobs. As a result, the hearing was less about litigating the SEC case than it was about senators highlighting and assigning blame for the causes of the financial crash.
Committee chairman Carl Levin, D-Mich., who, as always, appeared to have stepped right out of The Pickwick Papers, got right to the point in his introductory remarks: "Goldman Sachs didn't just make money. It profited by taking advantage of its clients' reasonable expectation that it would not sell products that it didn't want to succeed, and that there was no conflict of economic interest between the firm and the customers it had pledged to serve." In other words, Goldman has an obligation to be honest with its customers. And part of that obligation is to tell them what Goldman thinks of the investments it's selling.
Goldman Sachs didn't just disagree. The half-dozen current and former employees dragged before the panel, including CEO Lloyd Blankfein, took a position so contrary, it's as if they were speaking a different language. Levin said Goldman was "shorting," or betting against, the housing market. Goldman said it wasn't—it was merely hedging against its bets that the housing market would succeed—and that its "short" was hardly "big." (The shorts just happened to outweigh the longs.) Levin argued that Goldman was misleading its clients by hiding the fact that it thought subprime securities would fail. Blankfein argued that its clients don't care what Goldman thinks of the assets it's selling, even if it were possible to ascertain what all 35,000 Goldman employees "think" of a security. Levin said Goldman has an obligation to disclose how an instrument is created. "I don't believe there's a disclosure obligation," Blankfein said.
That much was clear. Blankfein and company mastered the nonstatement so well they brought to mind Alberto Gonzales circa 2006. Take this exchange between Levin and Daniel Sparks, head of the Goldman Sachs mortgages department, over whether clients betting on the subprime securities should have been informed that Goldman was betting against them (edited for length):
Carl Levin: Should you have told [your customers] you were going short?
Sparks: Mr. Chairman, this is not particular to this specific—
Levin: No, this case. I'm asking in this case …
Sparks: Again, I don't know—
Levin: I know you don't know. My question is, assuming you get short …
Sparks: Again, I'm trying to understand what the question is. …
Levin: Don't you have a duty to disclose adverse interest to your client?
Sparks: The question is about how the firm is positioned, how the desk is positioned? …
Levin: If you have an adverse interest, do you have a responsibility to tell the client?
Sparks: Mr. Chairman I'm just trying to understand …
Levin: No, you understand it. I don't think you want to answer it. …
Sparks: Mr. Chairman I—
Levin: I'm just gonna go on, because you're not gonna answer the question, it's obvious.
Repeat for 10 hours.
Fine, then. If Team Goldman wasn't going to talk about its business, the senators would talk about it for them—using Goldman's own words. Levin first quoted an e-mail from a Goldman trader describing the instruments as "junk." He later cited references to the so-called "crap pools"—again, a Goldman employee's words—that the firm tried to sell. He also managed to repeat the phrase "shitty deal," used by another trader in an e-mail to describe a security Goldman Sachs was selling, more than a dozen times. "When your employees say, God, what a shitty deal. God, what a piece of crap. How does that make you feel?" Levin asked Goldman CFO David Viniar. Viniar replied: "I think that's very unfortunate to have that on e-mail."
Even as senators slipped away to cast their votes on financial regulatory reform along party lines, they united in bipartisan support of populist grandstanding. Sen. John McCain asked Blankfein if he realized that Americans were hurting, and what he planned to do about it: "Has Goldman tried to do anything to help smaller banks?" Sen. Claire McCaskill, D-Mo., compared Wall Street to Las Vegas, telling one Goldman employee he "had less oversight than a pit boss"—prompting Sen. John Ensign, R-Nev., to take offense: "In Vegas, you know the odds. On Wall Street, they manipulate the odds while you're playing the game." Sen. Mark Pryor, D-Ark., noticed another difference: "People in Vegas are betting with their own money."
Another refrain among senators was, essentially: I'm not angry. I'm just disappointed. "I'm not saying it's bad," said Sen. Ted Kaufman, D-Del., of shorting mortgage securities. "I'm not saying it's illegal. I'm just saying it's a tough conflict of interest that you have to deal with every day."
And there was the rub. The behavior the senators were bemoaning—that Goldman had bet against its clients—happens all the time. As the Goldman execs kept reiterating, Goldman acts as a "market maker." A middleman. It puts investors in touch with each other. Any time one of its clients makes a bet, Goldman is technically on the other side—at least until it finds another client to take the opposite side. Not always, of course. Goldman invests its own money, too. And it may have stretched the definition of "middleman" in this case by keeping the short positions on mortgages for itself instead of looking for other buyers. But what was it supposed to do, give away the best investments even as the mortgage market tanked? As Blankfein put it, Goldman can't serve its clients if Goldman doesn't exist.
That says nothing about the SEC case, of course. The lawsuit hinges on whether Goldman broke the law by failing to tell investors that a particular subprime CDO was assembled with the help of someone who was betting against it. If a court determines that that information was "material" to the investors' decision to buy, Goldman employees could face huge fines. *
But that's a separate question from whether investment banks should be able to bet against their own clients. Because there's no law against being a jerk, public shaming would have to do. "You say nothing you heard today troubled you," Levin said to Blankfein toward the end of the hearing. "That concerns me, and it concerns a lot of people in this country. You shouldn't be selling junk. You shouldn't be selling crap. You shouldn't be betting against your own customer you're simultaneously selling to." It's not a crime. It's just a shitty thing to do.
Slate V: Sen. Levin's NSFW outburst
Correction, April 28, 2010: This article incorrectly stated that the SEC lawsuit was a criminal case. It's a civil suit. (Return to the corrected sentence.)