In today’s congressional hearings, Goldman Sachs was bluntly accused of fraud. Goldman Sachs has among the smartest people in the world working for them. Some of them are my friends. I don’t blindly support all things capitalism, but it’s infuriating to see Congress make a dog-and-pony show out of routine business practice to appease the misguided anger Main Street has towards Wall Street. To understand why these congressional hearing are asinine, it’s important to understand that Goldman Sachs was simply a market maker in the transaction which the SEC is labeling “fraud”.
Say you think the Lakers are going to lose in the playoffs this year – yes they have a great track record, but after looking at their statistics you believe they are going to lose. To profit of this belief, you have to place a bet against the Lakers, and you’d make this bet through a bookie. The bookie has to take your bet and find someone willing to take the other side of it – someone who believes the Lakers are going to win, and is willing to bet against you. The bookie has just become a market maker, and this is essentially what the SEC is calling fraud.
Irrespective of what Goldman’s internal positions were – whether they were short or long the housing market it doesn’t change the fact that two educated institutional clients who had differing views on the housing market bet against each other. Institutional investors have teams of employees who solely assess the products in which their firms are taking positions, and they make educated decisions on which way they feel the markets are moving. Sometimes they are wrong as IKB Bank was, and sometimes they are right as John Paulson was. However, it’s important to stress, that both firms voluntarily entered into opposite sides of the bet, and Goldman Sachs was simply the market maker.
Making calculated decisions on the direction of markets and taking positions to reduce exposure-hedging– is routine business practice and this is how companies offset risks in everything from currency fluctuations to commodity costs. For firms to hedge the types of risks that are integral to their operations they have to turn to market makers to help them find someone willing to bet against them. Market makers play a crucial role and hedging is routine business practice for large firms. To retroactively try and criminalize standard business practices simply to appease public tempers is a grave mistake.