Wednesday, April 28, 2010

What Lloyd Blankfein Should Have Said at the Cogressional Hearings

Goldman Sachs CEO Lloyd Blankfein's comments before the Senate’s Permanent Subcommittee on Investigations was spot on as far as accurately explaining the role that Goldman plays in the financial arena (when it isn't raping American taxpayers through shady bailouts, see my update), but Lloyd just doesn't have the EPJ ability to drive home a point in a manner that people won't forget.

Blankfein accurately pointed out that in its money management business the firm has a fiduciary ability to do the best it can as far as picking assets that will perform well for a client, but that no such fiduciary ability exists in its role as a market maker. The Senators didn't seem to get this point, and regularly brought up the "conflicts of interest" that Goldman was supposedly facing as a market maker. What Blankfein should have pointed out is that the Senators were headed toward a solution that would "freeze markets" and "kill off a part of capitalism."

Here's what I mean. On any trade there are  always two sides, a buyer and a seller. As a market maker what Goldman is doing is providing a market for a client who wants to buy or sell something. By providing this market, Goldman either has to find someone else for the other side of the trade or take the other side themselves. The Senators appeared not to get the fact that in its market maker role Goldman is not providing advice. Thus, there is no conflict of interest. (Remember this is not the money management side of their business). If I have done my own research and want to buy 100 shares of Google, I really don't care what Goldman Sachs thinks about Google. If Goldman Sachs is willing to sell the shares by shorting them or by finding a willing seller, I really don't care, if I am just using Goldman as a market maker.

To the Senators, this seemed to be a conflict if Goldman thought Google was going down in price and they sold Google too me anyway. But if I am going to Goldman solely for their role as a superior market maker (not their opinion), think of the madness I would have to go through, for no reason, if I could only use their market making skills when they were bullish on Google. If I wanted to buy some Google stock weekly and they suddenly turned bearish, then I would have to find a bullish market maker. Then if that market maker turned bearish, they wouldn't be able to sell me Google stock any more and I would have to find another market maker that was bullish. And it could go on and on bouncing between market makers to find one that agreed with me even though I was relying on my own research and wanted a broker for market making skills, not research. A rule requiring market makers to be in sync with their clients would freeze up markets and make executions much more difficult because a market maker wouldn't be able to short the stock to me ( on the other side of the trade.). He would have to find someone through a bearish market maker (not directly) that wanted to sell the stock. These would all be major complications that would be inflicted on trades that have nothing to do with the service a market maker is valued for, that is trade executions. .

A further problem the Senators seemed to have was that Goldman doesn't routinely disclose who is on the other side of a trade. But think about this. Say Warren Buffett wants to buy a stock. Does it really make sense that Buffett's broker has to disclose that it is Buffett that wants to buy the stock? Can you imagine the price jump in stocks when word got out before a trade that Buffett was buying a stock. How is this fair to Buffett, who is using his own skill and research? It would create a huge disincentive for him to continue to discover great opportunities, if he is forced to reveal what he is buying in advance. That's why you rarely know who is on the other side of a trade.

The proposals that the Senators are hinting at, a proposal requiring disclosure of who is on the other side of a trade and a proposal that trades could only be executed by market makers who are in sync with an investor's thinking, would freeze up markets and kill off an important part of capitalism.

The Senators in their posturing and posing have no idea what the hell they are talking about and would be simply be driving a part of the money raising, capital allocation sectors of the economy off a cliff.

1 comment:

  1. Wenzel,

    As I watched the testimony it was clear to me that Congress was trying to create a "revisionist history" in which everyone played a role and must fess up to it, save them.

    It made me think of a situation in which a man had just backed the family car into the house, damaging both, then hauled the 4yo into the kitchen and began scolding him for his careless driving and demanding he fess up to his crimes in front of mommy and daddy.

    The 4yo is sitting there saying, "But I cant dwive!" and the dad says, "You know, I feel like we're speaking a different language here! Just answer the question, honestly-- do you feel any responsibility for crashing the car into the house?"

    "But Daddy, I can't dwive! I can't even weach the pedaws!"

    "Look, son, I don't have time for this discussion of physical mechanics. Obviously, the house and the car are damaged pretty bad here and I was expecting you to just come clean to mommy and I and accept some responsibility for what you did but I can see that I'm not going to get what I want. I am surprised and disappointed with your lack of ethical decision-making! Anyway, I am just going to be forced to take the wheels off of the car to make sure this kind of thing doesn't happen again."