A Valuable Note of Realism

A bit of sanity from the Washington Post:

… the broader implication raised by senators at Tuesday’s hearing [of the Senate Sub-Committee on Investigations] — that Goldman somehow rigged the market in subprime mortgages, and that this led to the meltdown — does not strike us as a terribly useful or even accurate analysis of the crisis. Yes, in its capacity as a market-maker, the firm sold complex derivatives to market players who wanted to bet on a rosy view of housing long after Goldman had turned more pessimistic. To that extent, Goldman’s interest in short-term revenue clashed with what, in hindsight, was society’s need for a whistle-blower. For the most part, though, these were large, sophisticated institutional investors who had the opportunity to conduct the same analysis of economic data that Goldman did. They knew that there was someone on the short side of every trade. And Goldman had no legal obligation to trade in the same direction as these clients did. Indeed, if it had, then Goldman could not have started hedging its own bets on housing early, as it did. The firm would have lost billions, and it might have wound up needing an even bigger bailout by U.S. taxpayers than it actually got. It could have ended up like Citigroup, which tried to ride the bubble until it was too late and had to be propped up with hundreds of billions of dollars in federal cash and credit guarantees.

Implicitly, Tuesday’s hearing was an attack not only on Goldman but on short selling itself. “Shorts” have never been popular, because they do, by definition, profit from the misery of others. However, they can inject a valuable note of realism in overheated markets; perhaps the housing bubble would have been mitigated if more shorts had piled in earlier…

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