Goldman Sachs, Bubbles, Global Warming, and Statistics

Matt Taibbi’s article on Goldman Sachs, “The Great American Bubble Machine” is up and should be read (you’ll have already seen it if you homepage, as you should, Arts & Letters Daily).

As I read this piece, my view was reconfirmed that no company is too big to die. Taibbi writes:

The first thing you need to know about Goldman Sachs is that it’s everywhere. The world’s most powerful investment bank is a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money. In fact, the history of the recent financial crisis, which doubles as a history of the rapid decline and fall of the suddenly swindled dry American empire, reads like a Who’s Who of Goldman Sachs graduates.

I had only an indirect experience with Goldman, when I was at internet ad server DoubleClick (which is now part of Google). Goldman Sachs was one of the firms that took DoubleClick public. I had stock, as all employees did, and benefited from this offering.

When the crash came—as it does for all bubbles—but which nobody ever remembers—certain “improprieties” in the IPO were discovered by lawyers representing investors who lost money on DoubleClick stock. DoubleClick and Goldman were sued.

I cannot rate the merit of these suits, other than to say that they were thick on the ground when the internet bubble burst. A point in its favor: DoubleClick, unlike most other internet startups, made money.

Not every company Goldman represented in internet IPOs did well. Worse, Taibbi says that Goldman was aware that they would not. Their line was to tout the stocks as shamelessly as the Lemon Drop Kid pushed horses.

After the film of the tech bubble was being wiped off of Wall Street, and as we all know, Goldman and other banks turned to houses and money.

When I was a graduate student in statistics in the mid ’90s, finance was huge. There were lines out the door for stochastic calculus courses. Conferences had endless sessions (sermons) on “portfolio analysis.”

“What, you’re not doing finance!?” was the inevitable question to the poor saps who didn’t have the brains to see that money was it.

The math was complicated, but not that complicated. The models could be beautiful. They made sense once you assimilated a few key equations. News twists and turns were easy to propose and investigate. The future was green.

But I could never get past the feeling that these models, and the careers that went with them, were soul-sucking. Everybody would tell horror stories of statisticians they knew that went to Merrill, Credit Suisse, Goldman and others and were worked harder than young Conan was at the Wheel of Pain1.

You made a lot of money, sure, but you had no life.

The closest I came to working in finance was in the early 2000s, interviewing for a startup that believed it had discovered a fraction-of-a-cent arbitrage model for trades to be executed before any other firms’ computers became aware of them.

Somehow the profits were going to be just larger than transaction costs: bulk trades would guarantee riches. I was to assess the performance of this model and suggest improvements.

The leader did not, evidently, enjoy my stated lack of faith in the performance of finance models in general; perhaps he worried I would bring bad luck because of this, because I never heard from him again. The company is gone (I never followed them closely after the interview), but that doesn’t mean it died: it could easily have been absorbed, and probably was, during the growth of the last bubble.

The newest bubbles are, according to Taibbi, the “bailout”:

After the oil bubble…the financial safari…moved elsewhere, and the big game in the hunt has become the only remaining pool of dumb, unguarded capital left to feed upon: taxpayer money…Goldman went right back to business as usual, dreaming up impossibly convoluted schemes to pick the American carcass clean of its loose capital.

And then “global warming”: especially the upcoming Cap & Trade legislation. “Goldman wants this bill”, he says. Not for altruistic reasons, not to “save” the planet, but to systematically cheat the public out of trillions by managing this new mechanism for speculation.

Yes, it’s a bright future for finance. Too bad there isn’t an instrument for betting on bubbles themselves: guessing the nature of them and so forth. I would make a killing.

How? Well, I have this proprietary computer model that uses sophisticated, powerful mathematics. Send me some money and I’ll tell you how it works.


1This was where he was taken after his parents, and his entire village, were wiped out.


  1. “Yes, it’s a bright future for finance. Too bad there isn’t an instrument for betting on bubbles themselves: guessing the nature of them and so forth. I would make a killing. ”

    There isn’t a specific instrument, but you can always structure a basket of instruments that allow you to profit at each stage of a bubble. Invest normally on the way up, buy low, sell high, and make sure to bet against the bubble with some kind of hedge– CDSes are perfect for betting against the spread on credit instruments.

    The real challenge is knowing when the bubble peaks. Guys like Peter Thiel make pretty good money doing this.

  2. Matt:
    Interesting anecdote. My own IPO experience was not good. The company ended badly and the promises made to us were never fulfilled since they never could master the fundamental transactional part of their service offering. Good idea, poor execution. The founders made out OK. I took a risk, but should have trusted my reaction when I heard the CEO talk about their exit strategy before they had even established themselves as a business.

    One might make money in bubbles if one knows when the bubble peaks. The bigger question is the extent to which certain actors can influence the peaking of the bubble. The housing market was so obviously inflated that anyone who was enabling it to continue to grow, likely had their exit strategy mapped out ahead of time.

    Which reminds me based on the above experience – when I hear the words “exit strategy” mouthed by company executives, I put my hand on my wallet and execute my own exit strategy.

    I suspect that to operate effectively in this environment, one must fundamentally have the same morality as a used car salesman, i.e., be amoral. The latest response by GS is the ultimate “caveat emptor” defense. Hopefully it will be as effective for GS as it was for Bernie Madoff.

  3. The well has brackish water but in the desert its water is welcome. So people will pay for the water.

    The proprietors notice that after you drink a lot of this you get sick and maybe die sooner.

    So while they are selling the water, they buy life insurance policies on the customers.

    But the profit model isn’t satisfied because they aren’t dieing soon enough.

    So they poison the well. The customers die and there are no new customers, but who cares? the life insurance policies pay off and all is well.

    Besides, there’s a date tree next to the well and the dates, although not particularly tasty can be sold.

  4. The touble with betting against bubbles…

    Markets can stay irrational longer than you can stay solvent.
    — JM Keynes

  5. In my younger day as an engineer turned corporate treasury analyst, we had a lot of fun, encouraged by the likes of Goldman, looking at interest rate models (HW, HJM, BDT, etc.) as a potential means of converting corporate funding requirement dross into corporate profit center gold. To our credit, we never took the bait, notwithstanding the temptation then to at least act like investment bankers (if not be paid similarly). In retrospect, it was all just another waste of time and resources driven (like all bubbles since) by a tidal wave of liquidity courtesy of the Fed’s fractional-reserve banking cartel.

  6. Keynes was an insider trader – he made lots of money amanging his college’s assets. He would have felt at home at Goldman.

  7. Insider trading wasn’t illegal in Keynes days.

    As a money manager, an interesting conflict arises. Suppose you come across non-public information that you believe will negatively affect your client when it is publicized. A money manger is ethically required to protect his client. He is legally obligated to not act on that information.

  8. If you cut someone up and throw them overboard as did Freddy and Fannie- you can’t blame the death entirely on the sharks or the “vampire squid”

  9. If I might rummage a bit in Briggs’ attic.

    It appears that the CDO devised or assembled by Mr. FAB with Mr. Paulson’s advice was submitted for a rating to Moody’s, S&P, and another rating agency. Apparently Moody’s declined but the others rated it AAA, which sounds pretty good.

    My question is if this debt instrument was to be sold into a market of “knowledgeable investors,” what is the rating for?

    Is it possible that these “knowledgeable investors” were not trading for their own accounts but for their customers – some of whom might have required that anything purchased with their funds meet a AAA standard?

    It seems as though a standard for the adequacy of a disclosure might be measured downstream from the “knowledgeable investor” to include anyone whose funds were put to this particular risk.

    Clearly, anyone thinking an AAA provided any protection from finding the most higly speculative investments in their portfolios may have been confused.

    Does any of what I’ve written make sense to any of you?

  10. Regarding the AAA rating, the regulators require that bank holdings be rated by a “NSRO.” And assets with AAA ratings get preferential treatment. Extraordinary demand for AAA bonds drives the arbitrage that makes CDOs possible.

  11. Doug M,
    Does this mean that a CDO, such as Abacus *** and rated AAA could find itself in a bank’s portfolio? Would it have been Sach’s intention that this CDO pass muster for a bank’s holdings?

    One might assume that the quality of understanding of the “risk” of the instrument declines as you move downstream from the concoctors, assuming that they understood it.

    One wonders whether the duty to inform changes at each level to include observations on the risk perhaps not understood at each lower level.

    In other words, if Sachs was dealing only with adults, as they say, and their duty to inform was limited to the sorts of things that an adult would understand, does the duty required downstream increase as each lower level declines in understanding? Or is it a simple pass-through, where un-understood instruments are simply “distributed” by the middle men.

    A note to the effect that investing is risky and one should consult advisors who he believes are reliable, doesn’t cut it.

    Maybe something like the removal of privity as a fence to surround auditors is needed here with a requirement that specific disclosure written to the level of the lowest likely member of these food chain is what is needed.

    To the “meanest understanding.”

  12. The Abacus notes were sold to IKB bank and ABN Ambro. The notes were only for qualified institutional buyers. Many “smart” investors lost bundles. Obviously, the risks were misunderestimated.

    The problem is that banks need to hold AAA assets, and there are not enough to go around. CDOs served a function in satifying the demand for AAA assets. Most CDOs were not toxic. But, without knowing which ones were, they were all tarred. When they lost the perception that they were AAA, banks dumped them. That caused a massive feedback loop.

  13. Doug M

    Ah,” misunderestimated”, a fine word – one of George II’s better ideas.

    Thanks much for your explanations. I need to think more about where I get my information about issues like this. I had the impression that far more of these CDOs were shaky than you do, and that their possible overly optimistic AAA ratings had done real damage to our banking system. Sounds like my view is exaggerated.

  14. CDOs did do some real damage to our banking system. And, plenty were shaky, but then they became massively oversold, in the panic.

  15. Taibbi’s vicious loathing of Wall Street results from his inability to see any productive reason for its existence. He only sees a casino game where the Evil Ones fleece Granny. In fact, Wall Street, unlike Mr. Taibbi, performs a critical economic function. It allocates capital among competing uses, and it does this far better than any other existing system, and with far less costly errors. It certainly does it far better than the “experts” in centralized government bureaucracy which Mr. Taibbi probably prefers. The frantic chaotic search for profits, profits us all by loading money into the most productive businesses.

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