Goldman Smart. You Dumb.

Read this Michael Lewis piece:

What Does Goldman Know That We Don’t?   

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  1. Michael Schumacher commented on Jan 17

    Goldman doesn’t count for some of the reasons this piece mentions. So it’s “insane” to think that that Paulsen would tip off anyone with any juicy news items??
    It may not be him making the phone call to Blankfein but you can be assured that they get information that others do not get.

    They have gotten a free pass in this whole mess and we are supposed to believe that “two traders”-how about a name?- convinced the uppers that all the other Wall Street firms were wrong (including them)???

    This sounds like the other side of the MS situation where we are supposed to believe that one trader (acting without ANY supervision and possesing an unlimited supply of capital) caused those losses.

    Sorry but I find that a bit of a stretch..even for someone writing a book with an apt title for this fiasco.

    It sounds like a story is being woven


  2. JS commented on Jan 17


  3. Steve Barry commented on Jan 17


    AMBAC is collapsing and we need something from you on the potential ramifications ASAP

  4. Neal commented on Jan 17

    Conduit from the goverment office with the “real” statistics and analysis.

  5. Steve Barry commented on Jan 17

    Barry posted this awhile back:

    The $2.5 trillion bond insurance problem
    Tue Nov 6, 2007 10:28am EST

    By James Saft

    LONDON (Reuters) – Bond insurance, a key safety net of the financial system, is looking vulnerable, raising the possibility of another round of forced sales, writedowns and contagion.

    Fitch Ratings said on Tuesday that it may cut the AAA ratings of bond insurers after an upcoming review of their exposure to complex collateralized debt obligations.

    This matters a lot, because the bond insurance companies, such as Ambac and Financial Guaranty Insurance Company, have insured a collective $2.5 trillion of bonds and structured financings.

    If the ratings of one or more of the bond insurers are cut, the rating on the bonds they insure, many of which are municipal bonds, will fall too. This may force some investors who can only hold very secure debt to sell, depressing prices which would already be under pressure due to the lower value of an insurance policy from a lower rated company.

    It could also touch off another round of writedowns by banks, insurance companies and others who hold instruments insured by these companies.

    It could hit the staid municipal bond market especially hard, as about $1.6 trillion of the bond insurance in force is municipal. The rest is asset-backed debt of various types, including subprime.

    None of this, including the review, will make it easier for the insurers to raise capital to shore themselves up.

    In the unlikely event of a default, things could get really dire.

    “What if the bond insurers default? You could think it does not matter because they are small companies,” Credit Suisse analyst Guillaume Tiberghien wrote in a note to clients.

    “The problem is that overnight the $2.5 trillion of insured bonds would reverse back to the ratings of the issuer… Imagine the impact on the economy of a downgrade of $2.5 trillion of assets.

  6. Eric Davis commented on Jan 17

    The ramifications, of ambac and mbia…. not that I was asked… will be the collapse of retirement accounts, and tons of dumped assets and bank runs from every type “Fund” that has to hold AAA; be it retirement, or money market….. it could be like a bank run….more baby boomer retirement money going down the toilet…

    “que panic number 2”

  7. 2and20 commented on Jan 17

    tipped off by paulson?? all they had to do was read Calculated Risk and they would have been short from mid/late 2006 as I’m sure many other sensible traders were. but I think it boils down to the fact they got lucky on getting one trade right. Goldman stock hugely over-valued since the market thinks they can now dodge every bullet, just wait for an earnings miss and it’ll get slaughtered. they still have to face an M&A slowdown, and massively reduced ABS issuance remember. how are they going to edge that???

    mid-2006, the stock was at $150. time are much worse today than it was then. ergo, this stock should be nearer $100 than $200.

  8. Steve Barry commented on Jan 17

    Should I dump my Muni bond funds? They have held up so far.

  9. Don commented on Jan 17

    Except for John Paulson, and a trifle few other maverick traders that were actually making one-way bets that would cost them dearly if the bets turned out bad, Goldman is the only big player that made money. But I’d say Goldman was more or less just a classic example of pump and dump, this time in exotic financial instruments instead of stocks. Paulson and the other mavericks just got the bet right. Bully for them. Goldman, like any good politician, said one thing while doing another. Can an investment bank be elected President?

    Disclaimer: This is not intended to start a political discussion. The political reference is just a lame joke…..

  10. M Regan commented on Jan 17

    I second 2and20´s touting of CR and I would add that anyone who read Michael Hudson´s article in the May 2006 edition of Harper´s knew what was coming and also with adequate research could have timed the beginning of the Big Slide. Article´s title: The New Road to Serfdom: An illustrated guide to the coming real estate collapse.
    Here´s the link:

    Fundamentals matter and lending huge sums of money to individuals with no means of paying it back is only possible when those making the rules game the system. The history of significant systemic shocks to the US economy have a curious contemporaneity with Republican administrations. Take a look at the depression in the 1870´s. If you read it closely, you will understand that the basic principles guiding the gamers´ con haven´t changed. Invest in yourself, your family, your business, your community. Starve the pirates o´ the Hamptons. And may the scurvy rot reach their reptilian brains.

    To Mr. Ritholz- Thanks for the blog. I have enjoyed it immensely. I recommend avoiding OD professional blatherers.

  11. jag commented on Jan 17

    Steve Barry: Muni bonds, even if downgraded from AAA to A, are still the least likely to default of any bond category.

  12. jmf commented on Jan 17


    this is what happens when the insurance is gone (ACA )

    from Merrill

    During the fourth quarter, credit valuation adjustments related to the firm’s hedges with financial guarantors were negative $3.1 billion, including negative $2.6 billion related to U.S. super senior ABS CDOs.

    These amounts reflect the write down of the firm’s current exposure to a non-investment grade counterparty from which the firm had purchased hedges covering a range of asset classes including U.S. super senior ABS CDOs.

    I assume Goldman has bought no insurance from the weakest player out there ….

  13. Brett commented on Jan 17

    That piece was awesome.

    I’ve often felt that if there was someone, somewhere, trading the exact opposite of what I trade they would make a killing. :)

    Mad Props to GS for actually implementing such a system.

  14. Jay commented on Jan 17

    The article is interesting but speculative and I’m sure it grossly oversimplifies what went on there, specifically, the nuances of how they came to those conclusions and when, who participated, etc. Frankly it seems like their take on the market was significantly more sophisticated than the rest of the herd, and why shouldn’t their success be acknowledged as such? Take for instance the internet bubble. Why is it self-contradictory, in an institutional sense, to recognize and invest in an emerging bubble, then sell it short just before it breaks? They’re making money riding it up, then making money riding it down, which is much more sophisticated than following a stock or market off a cliff. The trick is timing of course. And it makes the rest of the crowd look like a bunch of starry-eyed trend-following what-goes-up-must-keep-going-up MBA-credentialed clowns who invest (and manage) by spreadsheets. It’s the same mindset and lack of sophistication shown by the CEO of Circuit City.

  15. dblwyo commented on Jan 17

    Actually if you read the Lewis article carefully what he points out is that a very small shop inside GS was smart and the whole rest of the firm dumb. Except that unlike all the rest of the street the institution WAS smart and backed ’em. That’s corporate DNA.
    There are at least two major structural questions:
    1) how badly are the other big Banks and IB’s broken fundamentally – the whole trade for your own account thing seems to need more smarts and risk management than they can muster.
    2) why didn’t anybody see this coming ? A: lots did, e.g. as pointed out CR in particular though we should hat tip the Fleck.BUT….as Michael Lehmann reminded me today in correspondence the Economist was pointing a finger at a worldwide Housing bubble back circa ’04 ! But nobody paid any attention.
    BtW Michael has just started blogging himself (ex UCSF econ prof who wrote the guide to being your own economist). His piece on the downside for housing as a once in a multi-gen thing is worth reading and scary. Here’s his URL:

  16. lurker commented on Jan 17

    Goldman Rich. Me Not.

  17. Marcus Aurelius commented on Jan 17

    I am not surprised that one of the big players saw the obvious. I am surprised that only one saw it coming. The herding instinct among these people literally defies logic.

    Groucho Marx: Who ya’ gonna’ believe – me, or your own lying eyes?

  18. Moose commented on Jan 17

    Did anyone else notice that Merrill just knocked 9% off their book value due to counterparty risk from ACA’s downgrade? ($3.2B of the writedown compared to $33B of 3Q07 Book Value).

    How large will the losses be on MBIA and Ambac counterparty risk? They are many, many times the size of ACA in terms of the financial guarnetor business and the CDS protection written to Wall Street firms.

    This is a whole new onion that is about to get peeled in a hurry.

  19. Jack commented on Jan 17

    The key issues: Is it proper for an organization to wear three different hats? Does an underwriter cross a legal or moral boundary when shorting a promoted product? Do we need another definition of inside information that addresses the role of complex security design and the legal responsibilities of underwriters?

  20. Bob A commented on Jan 17

    think En-ron with b-rains
    (spam filter doesn’t like enron or brains)

  21. Mr Dunderhead commented on Jan 17

    It should be obvious that the whole banking system is the tail wagging the political dog. Not the other way around.

    Look at all the appointments from Goldman into the NSC, Treasury, etc. and all the positions given to ex-politicos in the banking firms. It’s almost as if National Security is actually Economic Security.

    Maybe that’s the way THEY see it. “We the people” are just along for the ride as THEY conquer the world.

    There is a huge disconnect between the way people perceive the way govt works and the way it actually works. You can vote for whomever you want but absolutely nothing will change or deviate from the path dictated by the conquest of controlling all commerce on the face of the earth.

  22. foo commented on Jan 17

    I strongly suspect that the fact that GS was shorting financial instruments at the same time as they were pushing the same instruments on state investment funds, pension funds and other large, politically well-connected institutions is going to keep some lawyers busy for a long time.

    My bet – before the year is out, GS will be groaning under the weight of class action lawsuits, and an investigation by an attorney general on the make

  23. toady commented on Jan 17

    Good new Ms. Johnson! Goldman made the right calls about CDOs and now is poised increased its market share.

    Yes, our firm hedged against that worthless paper and made a killing! Isn’t that great?

    Oh, no. I’m sorry. No, you still lost tons of money in CDOs. You were way long in that stuff just like every other cleint of mine. That’s not what I meant. The good news is that my job is safe and I’ll continue to be your broker.

  24. donna commented on Jan 17

    Yes, but is it worth it to be a gnome?

  25. bMH commented on Jan 17

    I do agree with Micheal Schumachers post.
    Maybe once that things get really ugly involving pension funds big scale etc. Goldman evolves as the biggest loser on wall street.
    It might be wise for any presidential candidate to return his/ her contributions from Goldman to campain funding ( It might even enhance the chance to be elected)

  26. Phil E commented on Jan 17

    I think a key detail that Lewis glossed over is that according the WSJ article, it was Goldman’s CFO who first went to the proprietary traders and asked them to start thinking about ways to hedge Goldman’s huge subprime exposure. It was only after that initial nudge that the 2 traders started looking into the softness in the subprime market and put on their short positions.

  27. Entrepreneur commented on Jan 17

    Moose hit the nail on the head IMO. What’s spooky here is the following question…

    “What would stop GS (or anyone else) from using this kind of structure to manipulate the market?”

    Once you become a recognized market leader and are widely regarded as “the smartest guy in the room”, couldn’t you use that to direct the herd with your left hand while you set them up with your right?

  28. v commented on Jan 17

    A bit of counterpoint, or perhaps better described as context-point, from F. Salmon:
    “Why GS Was Short CDOs”

    Not sure what the real story is, but it’s probably something in the middle but Salmon makes solid points (and isn’t completely disagreeing with Lewis anyway).

  29. Estragon commented on Jan 17

    I think it’s worth at least considering the possibility that the top dogs at Goldman not only saw the potential for the subprime mess, but may have actually seized an opportunity to act as a catalyst to influence the timing of the implosion.

    These are very smart people with access to trade flow and counterparty information giving them an overview of the situation not available to many others. Even without any sort of cloak and dagger stuff involving former executives, their own positions provide a unique perspective. If they were able to determine that the system was at or near a point of maximum potential instability, they have the resources to push the right buttons to push things over the edge at a time of their choosing. Everyone knew subprime was a disaster in waiting, only the timing and extent of the blowup was at issue.

    If they did in fact manipulate the timing of the blowup, the number of people who knew would have to be very limited. If the timing leaked, their moves would surely be front-run and the opportunity lost. As such, it wouldn’t be surprising to see their own traders caught offside when the top dogs made their moves.

  30. Shrek commented on Jan 17

    Im with Estragon on this one. This stuff is riddled with conflicts on interest. If stuff gets bad enough goldman may have to barricade its head quarters.

  31. v commented on Jan 17

    Just to clarify my earlier link. Even though I linked to Salmon’s blog, I don’t want to imply that Salmon is a finance expert. He’s gotten two recent posts on finance proper quite wrong. Also, his post on the “predatory borrowing” debate was also quite lacking (I’m sure TBP readers have already read it). Still, the subject of this matter (how GS hedged/bet against subprime) is more a journalist one of what the real story is. On that front, I feel Salmon’s post (which I linked to earlier) makes some solid points (and, once again, doesn’t completely disagree with Lewis).

  32. Blissex commented on Jan 17

    «Actually if you read the Lewis article carefully what he points out is that a very small shop inside GS was smart and the whole rest of the firm dumb. Except that unlike all the rest of the street the institution WAS smart and backed ’em. That’s corporate DNA.»

    The article is not quite saying that. To me they are heavily hinting that there was a huge agent-principal conflict between the bond underwriters and their commissions on one side and the capital of their firms on the other. The hint I read is that the difference between GS and the other is that the CEOs of the other houses were in on the agent-principal conflict (and O’Neill made a lot of money from his severance anyhow), and at GS the top of the firm had a stake in the firm’s capital base so they let the conflicted guys rake in lots of fees and commissions, and then hedged the GS of capital against that conflict.

    Put another way the impression I get is that GS and the other houses knew they had hired greedy crooks, and the difference is that GS management not only knew so but also cynically used that knowledge to make money both ways. They worked with what they got…

    Put another way, most Wall Street compensation is based on beta, and alpha is for suckers. But evidently at GS top management care about alpha too.

  33. John J commented on Jan 17

    Phil E.

    I think you are right. The focus should be on the GS CFO. It takes someone within the organization that has enough clout to come in and put a stop to the goose who is currently laying golden eggs. Apparently the GS CFO started the process by recognizing excessive risk exposure. It is interesting that what was started as a hedging operation turned into a risk position bet. They apparently were not hedging to neutrality but ultimately went short. A good bet. They won this time.

    Finally, I love reading Michael Lewis, but the way in which the media projects almost supernatural abilites out of their hero participants is amusing. A testament to how well Lewis tells a story. However, the initial and subsequent actions of the heros are born primarily out of necessity. Not to minimize the actions of very talented and perhaps bold people, but Billy Beanne of the Oakland A’s began to increasingly use printed statistics to evaluate players because they didn’t have the budget to finance an adequate scouting staff. The GS CFO was doing his job by looking at an excessive position creating too much risk and had the power to act and did act. I don’t think these guys are just random winners, as Beanne and the GS CFO probably generate better returns from their respective job positions than most others.

  34. D. commented on Jan 17

    Well for starters, they know what the Secretary of the Treasury really thinks.

  35. dblwyo commented on Jan 17

    Blizzex – very fair point which others touched on. Let me concede it to start. But if they were the only firm worried about Alpha (fundamentals) instead of Beta (woo woo, rhymes with death by rooroo but that’s another terrible joke) then my key point about a different DNA might still stand.
    As for agent-principal – that’s going to be an interesting fight indeed. This has been a market financially driven for a long-time and the driver behind that was perverse incentives ( ) that paid people on deal flow instead of underlying asset quality. How do we reverse that ? And will the major players clean-up their shops ? This is really the tech bubble all over again.

  36. Wayne C. commented on Jan 17

    I’m a big fan of Michael Lewis but he’s stretching on this one. Originating and securitizing mortgages is a business and there are infrastructure costs associated with starting one up. You could just stop that business when you feel risk has gotten to a point that it may affect your business but there’s a cost associated with doing that. For Goldman to utilize derivatives to hedge its risk is a prudent business practice and allows it to maintain the infrastructure of that business. To give an example in an industrial business setting, if Nucor decided to hedge the price of steel and made no money while other steel fabricators lost a ton of money, we wouldn’t be having this discussion.

  37. BDG123 commented on Jan 17

    Oscillators always fail. Stocks above or below MAs would have unsustainable draw downs and massive losses if tested over the last one hundred years. Even if used to approximate bottoms over a month. When will this fail? Possibly right now.

    This doodad is not telling you what it told you in 1998, 2000-2003.

  38. bob niederman commented on Jan 17

    Yeah, but GS have, last I heard, 155 Billion$ of Level 3 assets. What is that *really* worth?

    We won;t know the whole story until that gets marked to market.

  39. PureGuesswork commented on Jan 18

    I am supporting Goldman Sachs for president. Not any single person at the firm but the whole damn bank. This country could be great again. All we have to do is turn it into a kickass hedge fund.

  40. Blissex commented on Jan 18

    «But if they were the only firm worried about Alpha (fundamentals) instead of Beta (woo woo, rhymes with death by rooroo but that’s another terrible joke) then my key point about a different DNA might still stand.»

    Sure, the DNA is different, but the difference is not on the smart/dumb axis — all the subprime people were not idiots, they seem to me to be crooks who knowingly took massive advantage of being paid in beta to play with someone else’s alpha.

    I would then say that the different DNA is that GS had *two* sets of crooks, and the second set of crooks having insider knowledge of what the first set of crooks were doing bet against them (a sure bet!). Either because they have a stake in the alpha or because their beta was the other way round from that of the first set.

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