Getting It

I have now heard the better part of the exchange between Senator Carl Levin and Lloyd Blankfein, Chief Executive Officer of Goldman Sachs. Poor Levin tried so hard to wring even the slightest sign of contrition from Blankfein and failed miserably. Blankfein, on the other hand, not only kept his cool but also, at least from a technical point of view, managed to give pretty direct answers to the questions he had to field. Indeed, according to the current norms of etiquette, he was surprising well behaved. Had he been more like Eric Schmidt, he probably would have, after having given the same answer for the fifth or sixth time, just erupted with, "You just don't get it, do you?"

This morning Steven Pearlstein, Business Correspondent for The Washington Post definitely got it. He recognized that "Planet Washington" and "Planet Wall Street" exist in entirely separate constructed realities, where "entirely" may even apply to the semantic substrate of the English language that their respective residents both speak. I would therefore side with his conclusion that the only thing we can take away from Levin's failure is an appreciation of how little Planet Wall Street is understood by anyone not living within that constructed reality. Pearlstein thus made his case by focusing on two of the most important misconceptions that the rest of us maintain.

He begins with the basic machinery that has thrown Goldman Sachs into such a negative light:

The first misconception is that having the ability to hedge positions on everything from copper prices to asset-backed securities is unquestionably good for the markets and the economy. Certainly it's useful if farmers can lock the price of their harvest before they plant their seeds, or if pension funds protect themselves from sudden increases or decreases in interest rates.

But as we learned from Tuesday's hearing, the ease with which a firm like Goldman can hedge against losses from esoteric financial instruments can make an investment bank rather sloppy about the securities it underwrites and distributes, or for which it serves as market maker. Indeed, that seems to be exactly what happened at Goldman, according to the documentary evidence uncovered by Sen. Carl Levin and his subcommittee staff.

Although Goldman analysts and traders had private doubts about the quality of the subprime mortgages coming out of lenders such as Washington Mutual and New Century Financial, the bank was more than willing to underwrite and make markets in securities based on those mortgages. Without the ability to hedge so easily and cheaply, Goldman and other investment banks might have been more careful about the securities they created and traded, and buyers would have been more careful about the ones they bought.

The second is the point that Blankfein kept repeating and that Levin never really got (or, perhaps, wanted to get):

The other big fallacy is that investment banks that underwrite securities are actually standing behind them. What we learned on Tuesday is that when Goldman Sachs lends its good name to a new offering and sends its vaunted sales force out to peddle it to some teachers' retirement fund in Omaha or a savings bank in Bavaria, it doesn't actually mean that Goldman thinks people should buy it.

In fact, there's a good possibility that Goldman knows it's a dog, or suspects that the market is about to tank, and has already lined up a big customer who wants to short the entire issue. And as Goldman sees it, the firm has no legal or ethical obligation to inform those buyers of its views or its conflicting interests.

There was a time when issuers would pay a premium to have Goldman Sachs underwrite their securities, just as there was a time when investors would pay a premium to buy into a Goldman-sponsored offering.

Today, Goldman has fully monetized the value of its reputation, and anyone who pays such a premium is a fool.

We can only start asking questions about regulation once these misconceptions are recognized. If we accept the claim made this morning on Democracy Now! that Republicans now get the bulk of the lobbying money from the financial sector, we may better understand why they do not even want regulation reform to be debated. Such debate could only lead to both legislators and the electorate they represent coming to a better understanding of just how Planet Wall Street really works, and Planet Wall Street is clearly in a much better position if that understanding is never achieved.