Old News

Back in July of 2009, Matt Taibbi wrote a Rolling Stones article on the Wall Street machinations that helped create the current crises. He focused on Goldman, Sachs, and whenever bankers are attacked, we know Megan McArdle will rush to their defense. Which she did:

[Taibbi's account] is all technically true, and collectively nonsense.

It's always fun to be there at the birth of an internet tradition. McArdle can't call Taibbi a liar without being sued, so she says that the truth makes no sense, narratively speaking. At this point her pants should have spontaneously burst into flame, but most unfortunately that appears to merely be a playground taunt, and, while narratively true, is factually nonsense.

Investment trusts--aka mutual funds, now heavily regulated--were not the cause of the Great Depression. They were not even the cause of the stock market crash. They were an interesting sideshow that Galbraith included in his book because they were a vivid example of the froth. And Goldman was not the center of investment trust activity. They were one player among many whom Galbraith picked as an example, presumably because they happened to be still around and had a recognizable name. In other words, because their activity had been less extreme, and hadn't taken the bank down with it. Yet Taibbi turns this into a central example in the exhibit against them. Then there's a 65-year gap in the indictment, presumably because no one has written an engaging popular book about the stock market convulsions of the 1970s.

Then the reserve of popular investment post-mortems fattens, and suddenly there's a lengthy litany of new complaints about Goldman: pumping, laddering, spinning. Eric Martin defends Taibbi on the grounds that it's all true. I myself firmly believe that these things are true (she said, looking demurely over her shoulder at the nice man from Legal).

McArdle is forced by those horrid things, namely, facts, to admit that Taibbi is telling the truth. So what does an expert on failure do when she is forced to explain how her heroes of the universe failed? Pump, ladder and spin, just like the objects of her worship.

But it's all old, old news.

It was 2007.

It's not even a particularly well-written or thoughfully analyzed summary of the exhaustive treatments of the subject by the fuzzy headed moderate business journalists Taibbi disdains.

There are simply too many notes.

Investment banks treated their clients disgracefully during the internet bubble, and a lot of the clients were managers who did the same to their shareholders. But what does this have to do with the current financial crisis? Perhaps more to the point, how is it a special indictment of Goldman, the ostensible topic of his piece? Other banks did more and worse.

Who knew that successful methods for analyzing failure including saying, "he did it too!"

Even as an indictment of the system this thing is lacking, and showcases Taibbi's lack of fundamental conceptual understanding.

Arguing from authority only works if you are an authority.

He complains about CDO's on the grounds that Goldman hid the atrocious risks inside a fancy dan derivative package that no one could understand. But in fact, everyone was aware that CDO's were repackaging crap mortgages--that was the point. The idea was pure portfolio theory, broadly agreed upon by everyone involved. Everyone knew a lot of the mortgages might go bad, either by defaulting or prepaying. (This is a risk for bankers, who don't like the idea that if interest rates drop, their 7% mortgage might suddenly turn into a pile of non-interest-bearing cash which can only be invested at 5%.) But if you pool the risk, only some of the bonds will go bad, while others pay off. The result is a less risky, less volatile investment than any individual junk mortgage bond. And it would have worked, too, if it hadn't been for those crazy kids a collapse in the housing market of a scale not seen since the Great Depression.

Taibbi quoted a hedge-fund manager who pointed out one simple fact--everyone didn't know about the weakness of the CDO, because Goldman didn't tell them. The quote:

"That's how audacious these assholes are," says one hedge-fund manager. "At least with other banks, you could say that they were just dumb - they believed what they were selling, and it blew them up. Goldman knew what it was doing." I ask the manager how it could be that selling something to customers that you're actually betting against - particularly when you know more about the weaknesses of those products than the customer - doesn't amount to securities fraud.

"It's exactly securities fraud," he says. "It's the heart of securities fraud."

Faced with inconvenient facts, McArdle flounders around with bogus excuses.

First of all, of course banks sell people positions they aren't themselves taking. Sometimes the bank is right, and sometimes the customers are; differences of opinion are what make marriages and horse races.

Irrelevant. The issue is Goldman's knowledge that the positions were bad.

Second of all, the banks that went down, the ones that arguably caused the financial crisis, were long their own toxic waste (and that of others).

Irrelevant, for the same reason.

Third of all, Goldman itself might argue that its mortgages were not as toxic as others, and for all I or Matt Taibbi know, they might be telling the truth.

The question is, what if they aren't? Is not!/Is too! isn't really a productive method of argument.

Fourth of all, the disconnect between the underwriting and the customer side of the investment houses was not only legal, but in some cases, mandatory. Excessive entanglement between the two is why Henry Blodget, whom Taibbi references elsewhere, has been banned from the securities industry for life. That Taibbi could even ask how this was not securities fraud is really troubling.

You know who else asked if this was fraud? The SEC.

Undisclosed in the marketing materials and unbeknownst to investors, a large hedge fund, Paulson & Co. Inc. ("Paulson"), with economic interests directly adverse to investors in the ABACUS 2007-AC1 CDO, played a significant role in the portfolio selection process. After participating in the selection of the reference portfolio, Paulson effectively shorted the RMBS portfolio it helped select by entering into credit default swaps ("CDS") with GS&Co to buy protection on specific layers of the ABACUS 2007-AC1 capital structure. Given its financial short interest, Paulson had an economic incentive to choose RMBS that it expected to experience credit events in the near future. GS&Co did not disclose Paulson's adverse economic interests or its role in the portfolio selection process in the term sheet, flip book, offering memorandum or other marketing materials provided to investors.

In sum, GS&Co arranged a transaction at Paulson's request in which Paulson heavily influenced the selection of the portfolio to suit its economic interests, but failed to disclose to investors, as part of the description of the portfolio selection process contained in the marketing materials used to promote the transaction, Paulson's role in the portfolio selection process or its adverse economic interests.

[Goldman, Sachs employee Fabrice] Tourre was principally responsible for ABACUS 2007-AC1. Tourre devised the transaction, prepared the marketing materials and communicated directly with investors. Tourre knew of Paulson's undisclosed short interest and its role in the collateral selection process. Tourre also misled ACA into believing that Paulson invested approximately $200 million in the equity of ABACUS 2007-AC1 (a long position) and, accordingly, that Paulson's interests in the collateral section process were aligned with ACA's when in reality Paulson's interests were sharply conflicting.

Megan McArdle was utterly incapable of assessing and analyzing the failure of Goldman, Sachs and the entire banking industry because she is utterly incapable of accepting a reality in which her pet authority was wrong and venal. She simply ignores the facts, makes up a long list of bullshit reasons to ignore the facts, and calls the bringer of the facts a big poopyhead who doesn't know what he's talking about and who won't listen to the smart elites who do know what they're talking about. Like Megan McArdle, Queen of Failure and Defender of Banks' Honor.