Tuesday, May 25, 2010

Nuance and Financial Regulation

The Wall Street Journal is my "paper of record" these days.  I succumbed to TBG's railing against the New York Times' liberal bias several years ago and canceled my subscription.  But the San Fransisco Chronicle just didn't make the cut as a purveyor of news; we quickly adopted its local nickname: The Comical.  Unwilling to give up newsprint in the morning, I entered into a long term relationship with the WSJ.  It's been a happy commingling of disparate points of view.  I'm reading the source material for what used to pass as conservative dialogue and I'm happily arguing with them in my head over oatmeal and skim milk.

The Opinion page is my favorite part (though I do love the little articles below the fold on the first page: seating for airport waiting areas... "Lost"'s foam set decorations... England's tax policies in 1530..... and that's just this week).  Every once in a while, there's an article on finance which I can understand.  That's usually because TBG's been talking about the subject, worrying about the subject, being furious and over-wrought and anxious and outraged about the subject and, over time, the details have made permanent imprints on my brain.  This is no small feat for a woman who, as the Big Cuter described it last week, is "sometimes willfully unable to learn things," and most of those "things" have to do with numbers.

But Edward Jay Epstein's article in today's (Saturday, May 22) paper was one of those times when I knew the background and had followed the story.  I was prepared.  And I was hit, once again, by the lack of nuance in most of what is reported as fact.  In this case, if Goldman Sachs were a person (and given our Supreme Court's latest ruling I suppose that personhood has been bestowed upon it) I'd say that it was being bullied by the SEC.


I'm of the opinion that the real bad guys in the economic melt-down were the bastards sons-of-bitches low-life scum  individuals who convinced low-income homeowners to refinance with adjustable rate mortgages, who made 6-figure home loans to taxi drivers pulling down $35,000/year, who preyed on the most vulnerable and made a good living themselves while doing the dirty deeds.  The packagers of the loans, the institutions which bet for or against the housing market, the Wall Street tycoons against whom the press is screeching, they don't bother me as much.  The only people on whom they were preying were each other.  As I tried to explain once before, every trade needs a buyer and a seller.  As Edward Jay Epstein wrote 
Of course, ACA knew someone was short the deal, since it sold Goldman a $900 million credit default swap precisely for that purpose.
 Or, in plainer English
The losers in the deal in question sold Goldman insurance to cover a down-turn in housing prices.  Goldman paid them $900 million for that insurance.  ACA then "effectively invested" its commission from that sale in securities designed to pay off if the housing market continued to rise. 
 Need it simpler?  I did, the first hundred times TBG explained it to me.  Try this:
The trade (a buyer + a seller) was for a financial instrument made up of sub-prime mortgages.  Some investors (ACA, for example) invested in a way that would pay off if the mortgages were kept current.  Some investors (John Paulson, at the time a little-known hedge fund operator) would win if the mortgagees defaulted.  Each side of the transaction knew that someone was on the other side, betting on red while they were betting on black.
Did it matter whether each side knew the identity of the other?  The SEC claims that it does, in this instance.  The fact that it had rarely been considered material in hundreds of other similar transactions has gotten lost in the clamor.  In any event, since almost all the instruments made up of sub-prime mortgages were losers (because the loans were made to people who couldn't pay them back), did it really matter which ones were in the instrument ACA purchased? 
I don't think so.  I agree with Mr. Epstein that the case against Goldman Sachs is a weak one.  They are being accused of doing business as usual.  Goldman lost $75 million on the deal.  That sounds like a lot of money to you and me, (ok, to me, anyway) but consider this: Goldman Sachs posted $45.17 billion in 2009 revenue.  $75 million is 0.0166% of $45.17 billion.  It's just not that much money.  

Oh, and did you notice the incongruity in the last paragraph?  Goldman LOST money.  They bet alongside the investors the SEC is claiming were damaged.  Wouldn't it have made sense for them to have invested on the other side if they were really running a scam?  After all, they didn't have $45.17 billion dollars in revenue by consistently making losing bets.  And you know what they say, $75 million here, $75 million there, soon you're talking about Real Money.

So, one wonders, why would the Democrats appointed to the SEC click here for background on the SEC  agree to bring the case at all?  Because the financial regulation bill was working its way through Congress.  The lobbyists were primed on the one side; there was no doubt that Wall Street's minions were working the legislators, promising this and that and the other.  All the Democrats had on their side was the notion that this was the right thing to do.  Without voter outrage, our elected officials would hear from only the financial sector's advocates.  With the SEC spanking Goldman Sachs in public, our news outlets had a field day.  It's a much simpler story to tell when you leave out the nuance.  Goldman is crooked.  All of Wall Street is crooked.  There were our liberal soundbites, our talking points, our reason-the-economy-tanked..... it's all because Goldman Sachs did something immoral and illegal and heinous and they ought to be punished.  We called our representatives, we emailed, we wrote letters to the editor and the financial reform bill is now in conference and is soon to be signed.  

Our outrage was real, I'm just not so sure it was well placed.   The nuances of the deals are arcane.  They deal with numbers and the market and securities and most of us on the leftish side of things don't seem to be very comfortable with the facts attendant on those subjects.  We can rant and rave all we want, all the while forgetting that Bill Clinton hired Bob Rubin, Co-Chairman of Goldman Sachs, to right the ship.  At the time, his experience at the investment bank was seen as deliciously wonderful - a Democrat with financial smarts.  I don't recall much outrage when he opposed regulating the derivatives markets back in 1997.
Yet, had he and Alan Greenspan allowed the natural tension between the players and the rule-makers to exist, my guess is that none of this would have happened. 

Once again, without the nuance, without taking the time to really investigate what needs investigation, by taking the short, soundbite way out of things, we've lost something.  I wouldn't care if what was lost was unimportant.  But it's not.  It's the ability/desire/effort taken to make our own decisions based on facts and thoughtful consideration. 

I've written about this before and I will be writing about it again.  There is so much more to say.