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Don't Blame Goldman

Can one firm create a bubble? Can one firm create four bubbles?

Maybe, but it's damn hard to prove. That's why it's so unimpressive that a fervent 10,000-word rant by Matt Taibbi in Rolling Stone's July 9 issue-devoted purely to "Goldman's big scam"-spent 12 pages on the subject of Goldman Sachs' "Great American Bubble Machine" but never delivered any plausible proof. The mammoth article disappointingly failed to provide the smoking gun that so many people on Wall Street-who have envied and admired and hated Goldman for much of this decade-would have been delighted to see.

Context and good facts were in short supply in favor of a lively, if incoherent, narrative. As a fellow financial journalist put it: "If you read the article without knowing anything about finance, by the end you would still not know anything about finance-but you would hate Goldman Sachs."

Goldman Sachs
Goldman Sachs

True. Goldman's reputation is its own business-I've never owned any of its stock and don't have any friends who work there-but as someone who's written about Wall Street for a decade, it annoys me to see the public that wasn't fully educated about the financial crisis before it happened get snookered again by misleading reporting afterwards. Megan McArdle of the Atlantic apparently feels the same way, having dubbed Taibbi "the Sarah Palin of journalism" and pointing out intelligently that "[i]t's not that everything he says is wrong, but the bits that are true aren't interesting, and the bits that are interesting aren't true. The whole thing dissolves into the kind of conspiracy theory he so ably lampooned in The Great Derangement. The result is something that's not even wrong. It's just incoherent." In his rebuttal, Charlie Gasparino of CNBC said the article made him "ill" in his "Stop Blaming Goldman Sachs" rebuttal to Taibbi. (Allegedly, Gasparino and Taibbi will settle their differences with the modern-day version of pistols at dawn, which is a dual appearance on Imus.)

Here's why I'm on record as siding with the skeptics: Taibbi set himself an impossible task in trying to prove that one firm is that evil and that smart. The thing about bubbles is that they take a village-everyone has to become disinhibited, and greedy, on a mass scale to buy into a really bad idea. The whole history of Wall Street is guys with homes in Greenwich complaining about guys with ranches in Telluride, billionaires bashing millionaires, and in the end, the whole Street is in on it together because they all get paid the same way. The idea that one person or firm could be behind any of it is at most a distant delusion. It is not a conspiracy launched in one place and foisted on others-it is people responding to the incentives we give them. (And, by the way, there are some good people in there, too, although that often gets forgotten.) All Wall Street firms and their hedge fund friends played a part in fueling the tech bubble, got involved in unsavory amounts of trading in mortgage-backed securities, and toyed with credit-default swaps, because that's how they could make money at the time. Wall Street almost always moves in lockstep. That's why the bailouts that helped Goldman actually helped other firms even more: They're too interconnected to fail.

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Not too many people, however, have addressed the bulk of the actual factual and contextual inconsistencies in Taibbi's Rolling Stone article. The facts won't change the debate-as Barry Ritholtz points out, the Goldman article is more about having someone to blame for the credit crisis, one target, fair or not, for all of society's frustrations-but it's still useful to get them out there. So here's a little factual perspective about Wall Street and its bubbles that I wish more readers had had with them as they were reading the Rolling Stone article.

Let's start with the AIG thing. Everyone has read about how Goldman received $12.9 billion from AIG to cover money AIG owed Goldman on credit-default swaps. That $12.9 billion, in turn, came from the government via the first bailout of AIG. The conspiracy theory says that the government paid out all of AIG's debts because Goldman alone would have failed without that $12.9 billion in hand. That's hard to believe: AIG's bailout went to pay several firms, not just Goldman: Bank of America Merrill Lynch received $12 billion, as did France's Societe Generale and Germany's Deutsche Bank. England's Barclays Plc received about $6 billion, and Switzerland's UBS received about $5 billion, all of your taxpayer dollars. Goldman says it would have been fine regardless (which is admittedly hard to believe, since $12.9 billion is, after all, real money). But whether Goldman would be fine is beside the point. The point is that when AIG collapsed-in fact, because AIG collapsed-it owed money to several banks, and when the government took over AIG, it owed that money to the banks, too.

IPO King of the Internet era?

Taibbi is equally misguided in his account of the technology bubble. Taibbi's argument is that Goldman created and fueled the technology bubble. "Goldman quickly became the IPO king of the Internet era," Taibbi writes darkly, calling the firm "a leading underwriter of stocks during the boom."

This is giving Goldman way too much credit. Anyone who actually lived through the tech boom had to be flummoxed by this. Goldman? The IPO king? In tech circles, Goldman was often considered an also-ran in tech IPOs. What about Frank Quattrone at Credit Suisse First Boston, or Mary Meeker, "the queen of the Internet," at Morgan Stanley? Quattrone himself may have earned as much as $100 million in a single year from his technology IPO exploits and is now making a comeback.

Taibbi argues that Goldman's tech IPOs lacked "quality," but, given the barnyard trough that was the tech bubble, that's a ridiculous claim. Nearly all the tech IPOs, by all underwriters, became essentially worthless; in addition, IPOs work through syndicates of five to 20 banks that sell shares, and many IPOs are "led" by two or more banks that do the heavy lifting. The quality of each tech IPO reflects equally badly on all the banks involved, who all put their names behind the companies and sold the shares to people in the markets.

In any case, the "IPO king" label seemed definitely false. I requested data from Thomson Reuters to double-check how much Goldman dominated tech IPOs. I asked Thomson for the "league tables" of bank rankings based on the dollar value of the IPOs they backed. Just as I thought: Goldman was, for much of the tech boom, a laggard, generating significant (significantly? Or cut?) billions of dollars of business less than its rivals. If Goldman was profiting from a bubble, it wasn't doing as well as others.

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In 1997, Goldman Sachs was No. 4, behind No. 1 Deutsche Bank-then the home of Quattrone-and No. 2 Morgan Stanley-the home of Meeker. The next year, in 1998, Goldman Sachs was No. 5 in tech IPOs, with Morgan Stanley taking the crown as No. 1 and Credit Suisse hiring Quattrone to jump to No. 3 from its previous No. 8 rank. Where Morgan Stanley underwrote $51 billion of tech IPOs in 1998 and Credit Suisse underwrote $28 billion, Goldman underwrote just $19.9 billion.

In 1999-as Taibbi points out-Goldman finally started to compete, rising to No. 2 behind Morgan Stanley and just ahead of Credit Suisse. But that year, Morgan Stanley underwrote $62 billion of IPOs, while Goldman underwrote only $50 billion. In 2000-the last full year of the tech bubble-Goldman Sachs was No. 3, behind both Credit Suisse and Morgan Stanley. The tally that year: Credit Suisse, $136 billion; Morgan Stanley, $108 billion; Goldman Sachs, $97 billion. At the height of the tech boom, Goldman Sachs underwrote 29 percent less in dollar value than its most successful competitor, Credit Suisse.

Considering that banks make money on the percentage of the total IPO value they underwrite-around 7 percent-missing out on $39 billion of IPOs was nothing for Goldman to brag about. That would have been approximately $2.6 billion of fees that Goldman failed to put in its own pocket. Taibbi never explains why Goldman, the IPO king, would choose to do such a thing. The tech IPO boom clearly belonged to Morgan Stanley and Quattrone at Deutsche, then Credit Suisse.

What about Taibbi's other charge that Goldman engaged in "laddering," or promising shares of hot IPOs to insiders or "friends and family" who would buy more later? And "spinning," or giving company executives super-cheap shares in exchange for the promise that they would buy more?

Yes, Goldman may have been involved in something like that. It helps, however, to point out that the class-action lawsuit on laddering included 55 underwriters as defendants. Including Goldman, yes, but also Morgan Stanley, Credit Suisse, Deutsche Bank, Salomon Brothers, Robertson Stephens, and literally every bank on Wall Street. The lawsuit-launched in 2001-was just settled this year, and it was all of $586 million for all of the banks as well as 300 of the failed companies they took public. That was an amount those banks and companies earned before afternoon tea on tech stocks during the boom year. The whole point of the lawsuits, however, is that the banks and companies were in it together-at least 355 entities in all. To single out one bank of 355 as particularly rapacious is ridiculous. What were the other 354 doing, then?

The oil bubble, too?

As for spinning, the best example is far from Goldman. It's actually the "Friends of Frank" program presided over by Quattrone, who watched over technology investment banking, research and even the part of the brokerage business that sold shares to individuals. Quattrone was in good company, however; so many banks offered similar deals on IPO stocks that executives told The IPO Decision author Jason Draho that they could not have played favorites, since they got sweet deals from everyone.

Taibbi points out that the Internet bubble was "one of the greatest financial disasters in world history," which is true. But there's no way that Goldman alone created it-every investment bank was involved, because Wall Street offers crazy incentives to create bubbles.

So, what about Taibbi's attack on Goldman for its alleged part in the $4-a-gallon gas disaster of 2008? Taibbi points out Goldman asked for-and received-an exemption to speculate in the oil markets 17 years ago when such speculation was limited to actual holders of oil. Taibbi mentions in passing that 14 other firms received the same exemption. That means that 15 banks over 17 years were speculating in the oil markets due to a regulatory exemption. When you have 15 firms doing the same thing for nearly two decades, how is the government playing favorites?

In addition, Rolling Stone bolsters its point by quoting Goldman's research analysts on the price of oil. Research analysts are forbidden from communicating with much of the rest of the firm, according to a 2003 settlement; at many firms, you need special identification just to enter the floors where research analysts sit, just to make sure they stay independent. If Goldman's analysts believe oil would rise to $100 a barrel, it's a good bet that they actually, really believed it-unless there's proof that they didn't or that they were influenced by the firm's management or traders. When that proof comes up, maybe there's a conversation. It's too bad, because Taibbi makes a good point about oil supply not tracking oil demand-a paradox of the oil bubble that would have been a great story in itself. Still, you can't have a supply-demand curve for a major commodity like oil based on a single firm's actions; the whole market has to skew those numbers.

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Next, let's look at the context of the housing crisis, where Taibbi alleges that Goldman underwrote collateralized debt obligations-little bundles of mortgages that are packaged with some good ones and some bad ones to spread the risk around. McArdle has already pointed out many of the flaws with his argument. Taibbi argues that Goldman both underwrote terrible-quality CDOs and "shorted" them, or bet that they would go down in value. That's legal, but that's beside the point.

The point is more that Goldman was in the middle of the pack when it came to much of the CDO market. Taibbi points out, for instance, that Goldman paid a $60 million settlement to Massachusetts, which accused the firm of promoting unsavory home loans. But, as the New York Times pointed out, Goldman barely cracked the top 10 and more often just barely (word repetition) made the top 20 financiers of subprime mortgages.

However, what most people in finance know is that most of Wall Street underwrote terrible-quality CDOs and did so far more egregiously and with far worse consequences for taxpayers than Goldman. Merrill Lynch and Citigroup underwrote more CDOs-and suffered more deeply-than any other firms. Merrill and Goldman ranked No. 1 and No. 2 in CDOs, while Goldman just jangled around somewhere in the top 5. In fact, CDOs are a major reason that the government lavished hundreds of billions of dollars on Merrill and Citigroup. Bank of America later claimed $138 billion in government guarantees and direct aid, allegedly because of Merrill Lynch. Citigroup, the No. 2 underwriter of CDOs during the boom, later required a whopping $326 billion in taxpayer dollars and federal guarantees. Goldman, as Forbes recently pointed out, was different only because it "hedged" its mortgage investments, or designed them so that it didn't lose more than it could afford.

And those firms, unlike Goldman, actually made an active effort to gobble up more and more risky CDOs, even knowing that they would never be able to make enough money to offset the loss later. And while Merrill and Citigroup were taking all this risk at the top, they were also holding on to a lot of Main Street, mom-and-pop money-Merrill Lynch has its famous 12,000-strong brokerage force, and Citigroup was the top holder of consumer bank deposits in the United States. Goldman is proud that it deals only with institutions-other, savvy high-level investors, like banks and companies and hedge funds.

Case in point

Merrill Lynch is a great case in point and the closest thing to a poster child there is on the subject. In 2006, Merrill actually fired a top executive, Jeff Kronthal, for not taking enough risk on CDOs. One Merrill trader was known for racking up $5 billion to $6 billion of bad-quality CDOs every quarter to hold on Merrill's own balance sheet.

The firm ended up taking over $25 billion in writedowns on CDOs before selling a bunch valued at $30.6 billion for less than 22 cents on the dollar.

Nor was Goldman's bet against CDOs unusual. Hedge fund manager John Paulson (no relation to the former treasury secretary) bet against the mortgage market for years; it finally paid off in 2007, when he made so much money that his paycheck alone was $3 billion (or nearly the equivalent of Goldman's most recent quarterly profit).

Goldman's combination of underwriting CDOs and shorting the mortgage market is partly a result of Goldman's isolated "proprietary trading" group, which makes investments for the firm's own account. Yes, the right hand can act against the left hand. That's standard on Wall Street, where information between units is tightly policed.

Does all of this context mean that Goldman is totally innocent? Of course not. You can never know what happens inside a firm. What it does mean is that if you're going to label one big firm as a bubble machine, first make sure that the others aren't.