Tuesday, July 14, 2009

Is Goldman Evil?


Goldman Sachs is one of the most respected private firms in the world. With their astronomical paychecks, and their selective recruitment, they clearly inspire a lot of envy.

Goldman is self-interested, which means they don't share all their ideas, and they don't hire everyone capable who wants a job there, but that's inevitable and you can't let that color your views. The latest hatchet job in Rolling Stone is by Matt Tiabbi, who has a profoundly adolescent and paranoid world-view that seems clever and witty only for the kind of people who read Rolling Stone to learn about finance. It's not worth a point by point rebuttal, because like Oliver Stone's JFK, you have so many issues of contention it becomes pointless rather quickly. The bottom line is Goldman is a large investment bank, so they have connections to everyone and everything. To hold them responsible for all the conspicuous bad things and people of the past is just a logical error, like blaming 7-11 for alcoholism (they sell a lot of alcohol!).

Those who think Goldman was the prime mover in our financial mess are simply wrong, as Goldman was as guilty as everyone who did not second-guess the assumption that aggregate housing prices do not fall in nominal terms (academics, legislators, regulators, investors, home buyers, investment bankers, rating agencies—did I forget anyone?).

Recently, Goldman filed a complaint against an ex-employee, and somehow got the Justice Department to effectively act as their attorneys in what should be a civil matter! That is, when I was sued by my ex-employer for 'violating my confidentiality agreement' in various nefarious ways (such as applying mean-variance optimization), it was a civil action. A criminal action is much more difficult to defend, and is very unusual for such a charge. Clearly Goldman has connections with the right people, but everyone knows that.

I think GS as an example of what happens when you have a bunch of smart, highly connected people working together to get rich. There is a lot of inside ownership, and so their large bonus structure clearly implies they understand the Lafffer curve, in that giving people stronger incentives helps everyone—capital and labor.

In the first half of 2009 suggested an average employee compensation of $700k per year. In general, GS pays about as much in bonuses they do in profits to shareholders. This suggests those on the ground, making the deals, are able to get about half of the profit.

This is often the case for alpha generators, as for example consider that hedge funds make 2 percent of assets and 20 percent of profits. Then over the glory years of convertible bonds from 1994 through 2003 when those funds returned 10 percent to investors with minuscule volatility, the owners of these funds pulled in about 4 percent of assets in profits for themselves, while investors received about 4.5 percent in annual returns above the LIBOR. As one might expect when you have two inputs, equally necessary, the split seems to be near 50–50. That is, in any investment with alpha, you have two things, equally necessary: he who identifies the alpha, and he with the capital. In any particular case the proceeds are split according to negotiating strength, but on average we should expect an approximate equal split, as there appears to be in high alpha strategies (I go over this in my book (of course) Finding Alpha).

The net result is that if you pay these lucky bastards a lot of money, as an equity owner you can make a lot of money too. There are surely a lot of overpaid Goldman employees as you would expect in any large organization (I know several!), and much of their value comes from Goldman's alpha: connections, brandname, and monopoly access. Yet on average these people are being rewarded appropriately and if you want a growing economy you have to accept this. I know this is hard for many people to accept because given the large number of smart, hard-working individuals of good integrity who don't make $700k a year, Goldman's workers are in that sense very fortunate and this is somehow unfair. You can't run an economy based on cosmic justice—that's for our creator—so you have to deal with the reality that life is somewhat arbitrary, and to accept that inequality in income is better than poverty. Considering they make this money out of their profits, not taxes, it doesn't bother me at all.

19 comments:

AHWest said...

I didn't like the Tiabi article either. I'm very much in favor of income inequality. But there was an element that's valid to explore - the government connections angle.

I'm no expert on the matter, but I do think there may be some just outrage if Goldman is profiting from the high and increasing state intervention in the financial system. Central banking, pump priming, Keynesianism, quantitative easing are all long run negatives for the US economy. If Goldman is actively encouraging it, and using their political connections to profit from it, then I'd say that's bad.

I'm not sure that the US population is against the rising tide of state intervention in the economy, but I'm pretty sure that they don't like seeing people get rich off political connections. Too bad they cannot see that the two are necessarily connected.

Billare said...

In one way I really admire Goldman Sachs, as people still admire Google and did Microsoft at its heyday, as the apotheosis of organizations supremely run by smart, competent people. In one rare example of a rightist blinder, too many there ascribe a stupidity and a partisanship to the firm that simply isn't evident to me, since I both know a couple of people who work there, and I read the blogs of people who are quite familiar with the pains it takes to curate its institutional advantages.

On the other hand many of the firm's luminaries strike me as too amoral for my taste. I feel like they would knowingly sell out the United States to the highest bidder, if only they could be assured that they ran things or received substantial equity stakes in the new enterprise. As evident in many organizations with substantial bureaucracy, I also think the firm incalculates an elitist group-think that is quite dangerous once exposed to our degrading political system through the avenues of lobbyists and Presidential appointments.

IMA5U said...
This comment has been removed by the author.
IMA5U said...

Goldman stacks the government. They are making record money courtesy of the tax payer's bridge loan known as TARP. Also, they are enjoying a below market rate on those FDIC guaranteed bonds.

In essence, they are a government guaranteed hedge fund.

If people have no problem with the tax payer taking the risk but not the reward then God Bless America -- the gap between the rich and poor just got wider.

And it's not you. Its Goldman.

Anonymous said...

And slowly but surely, in minor and undetectable ways We The People are reading these greedy crooks their last rites. Something has changed in the matrix, they just don't realize they are toast.

Anonymous said...

Slowly but surely those who used to be taxpayers and who are now unemployed will have all the time in the world to figure out who stole their money, and their job.

FischerBlack said...

Goldman is not smarter than you.

Goldman blew itself up last year. They blew up. The stock should be zero, their businesses should have been auctioned off and they should have gone the way of Bear and Lehman. They didn't, because the Feds carved out exception after exception for them, handing them free money, and backstopping their losses. This amounted to a deal which resembles the following: go ahead and keep all of your past profits and almost all of your future profits, and we'll make sure your losses are borne by everyone.

Why otherwise intelligent people aren't outraged as they churn out $1 billion in profits a month with an implicit government backstop (which their trading partners, clients, and counterparties love) boggles my mind.

There's probably no reason to worry. Most people aren't going to hit the streets with pitchforks and torches. Most people will probably let this one pass as they see their 401ks and home values start to recover.

But you never know.

Anonymous said...

How anyone can defend GS is beyond my comprehension, and Taibbi is spot on.

Seriously, tell me what these people "make"? What do they bring to the economy? Nothing.

They have huge pools of money that they shift around and around in a financial slight of hand that bilks the world economy.

They inflate speculative bubbles all over the place in stocks, commodities, basically any market anywhere that they can leverage control over through money, government, whatever.

Look at the $4 a gallon gas last summer. Look at the real estate bubble. Look at the tech bubble. Meanwhile, they rest of us pay for the insanity they call profits when we buy gas or juice or with our 401K or with the tax-payer funded TARP program and bailouts.

Are they bright? Are they talented? Yes. But if a guy who is the brightest and most talented thief robs you - then he is still a thief.

The whole notion that these investment bankers are doing economically rational work is absurd.

Jason said...

Simply calling the Taibbi article a "hatchet job" doesn't make it one. Why don't you try actually refuting the points in the article? Additionally, you've only attempted (and rather half-assedly at that) to refute one, relating the housing bubble. But "academics" didn't securitize 7% of the loans that led to the crisis, did they?

It wouldn't bother me either if they were making money out of their profits. Except the didn't. If it wasn't for the direct capital infusion from .gov (and the over the weekend conversion to a bank holding company giving them access to .gov guarantees and loans) and the back door capital infusion from .gov via AIG, they were done. Bankrupt. Out on their asses like the employees at a Pontiac dealership.

So lets not pretend they make their money purely out of their smarts and are entitled to it.

If you're ok with socializing the losses but passing the gains on to goldman employees and shareholders, thats certainly your prerogative. But lets not pretend they are doing anything other than gambling and getting a massive reboot from their rich uncle when they crapped out at the tables.

Anonymous said...

The fact that you ignored so much damning evidence in your article here suggests to me that you are one of the many "Wall St." types that still suffer from "financial crack" addiction and delusion over the last 15 years or so. The smoke has not quite cleared your brain yet. You do not have the capacity to think clearly and are still stuck in the financial drug smoke haze of yesteryear. Get thee to a clinic!

Anonymous said...

I don't think people who believe in a free market system take issue with income based on performance; what they take issue with is income based on preferential treatment (i.e. on connections) and monopoly access. Very basic....

Anonymous said...

Collaborators such as yourself will also be 'dealt' with.

Anonymous said...

The answer to your question is YES!!! And most of the points you make are pure rhetoric and nothing more than everything is correct because I am doing it!!!

Anonymous said...

Do you actually believe this crap you've written?

This is often the case for alpha generators, as for example consider that hedge funds make 2 percent of assets and 20 percent of profits.

Every reputable study has shown that after fees hedge funds underperform standard indexes.

Thus I think you mean alpha destroyers.

Pat said...

I have never read this blog before, but it gives the perfect Wall St. amoral answer that doesn't work in a systemic sense.

Capitalism as described by Adam Smith works when people work towards their selfish interests by making stuff other people need, and thus the economy works and grows. That is how self interest works, and in a system with no gov't to socialize the losses, Goldman would be out of business. Goldman uses its connections to further its selfish interests at the expense of the market in general, as trust in the market continues to fall. Taibbi makes a good point that at one time Goldman was more patient and provided a true service in the economy, but now they now see that they system won't hold up much longer so they are getting while the getting is good. They are essentially a parasite on the system and provide very little service as far as a real product to the system in general, unlike say a company like Intel which makes money for itself by selling good chips. Goldman is a perversion of the economic capitalist system as classically described by Smith and it is only able to makes its margins by taking risks that require on a more and more regular additions of gov't money in some form: liquidity, inflation, TARP etc. Its current programmed trading provides an excellent example of no public good and a parasitic effect directly on the NYSE. So long as Goldman continues to function in its current form, the "market" will continue to devolve and the US economy will continue to shrink in real terms and certainly on a per capita basis.

The person who writes this probably has not made a product that has created value to the broader market in general, and he can only justify himself by admiring Goldman.

You are standing on the shoulders of giants (the founders of this country and market system) who have weak knees from supporting tapeworms like you.

Jason said...

Falkenstein -

try this. Rather than accuse Taibbi (and you could at least have the decency to spell the man's name right) of running a hatchet job, why don't you respond to his points in this blog entry:

http://trueslant.com/matttaibbi/2009/07/16/on-goldmans-giganto-profits/

You think GS is an example of what happens when a bunch of smart people work to get rich.

I think its a result of what happens when the government turns over an obscenely massive amount of taxpayer money and provides loan guarantees so one can borrow for free.

But why don't you try to refute the factual assertions in Taibbi's post and explain to us how their success is because they are really smart and not because of enormous government subsidies.

Take your time.

Anonymous said...

Obviously the writer of this blog knows nothing about the real world. Matt Tiabbi wrote about his thoughts on Goldman and points were made, yet Goldman did not respond. Right or wrong, it is always up to the public to make their own mind, unlike the folks at CNBC that try to sell their ideas to people while NOT being unbiased.

Anonymous said...

it's only money.

my "concern" would be the length of their vacations and their working hours.
are they on the clock 24/7, feeling the pressure, always a phone call away?

or are they playing golf 7 days a week, while some automated system moves our money around?

but, as i said, it's only money.

time is the more valuable commodity.
as any father knows.

how much family time do you think these guys get?

Anonymous said...

The last statement saying "they make this
money out of their profits, not taxes" is
blatantly false. Depending on how you
count they took $12 to $20 billion dollars
of tax payer's money just on the bailout
of AIG. Please correct.