Ben Stein vs. Goldman Sachs: Market-Makers, Brokers, and Trusted Advisors
Yes, that Ben Stein. Bane of Ferris Bueller. Droll protagonist of Comedy Central’s Win Ben Stein’s Money. Pitchman for beachball eyeball medication. And—lest you forget—economist.
In this Sunday’s NY Times, Ben Stein let fly with an article—The Long and Short of it at Goldman Sachs —that must have raised a few hackles even at that above-it-all Wall Street institution.
Stein’s breezy style is to write—as he would put it—all ‘round Robin Hood’s barn, until he ends at a very sharp point. So he does here; but he pulls his punch.
Background. Alone among Wall Street players, Goldman Sachs not only didn’t lose money in the subprime debacle—they made a great deal of money, by going short, or betting against, the very packaged subprime mortgage-backed securities they were selling to customers. (See Allan Sloan’s excellent Fortune article on a sample Goldman offering .)
Stein reminds us of Merrill Lynch analyst Henry Blodget in the last overdone market; Merrill hyped tech stocks to investors, while Blodget privately called them “junk” to his friends. In 2003, he was permanently disbarred from the securities industry.
Then he pulls the trigger.
“How different would [the Blodget situation] be from selling short the junky stock that your firm is underwriting? And if a top economist at Goldman Sachs was saying housing was in trouble, why did Goldman continue to underwrite junk mortgages into the market? …
It is bad enough to have been selling this stuff. It is far worse when the sellers were, in effect, simultaneously shorting the stuff they were selling, or making similar bets…
Should Henry M. Paulson Jr., who formerly ran a firm that engaged in this kind of conduct, be serving as Treasury secretary? Should there not be some inquiry into what the invisible government of Goldman (and the rest of Wall Street) did to create this disaster…
Bracing stuff, that—simultaneously calling Goldman Sachs a bunch of salesmen, questioning the moral rectitude of the Secretary of the Treasury, and calling for an investigation of the investment banking industry.
If you like that sort of thing, you’re probably woo-wooing and high-fiving Ben Stein. But the truth is, by demonizing Goldman Sachs, Stein lets everyone off too easily.
Here’s what I mean: What’s the difference between a market-maker, a broker, and a trusted advisor?
A market-maker is socially and legally authorized, even required, to take the other side in a transaction in order to maintain liquidity in trading.
A trusted advisor has your best interests at heart—gives you advice based on what is best for you, not necessarily best for the advisor.
A broker is usually found somewhere in the middle—making markets, giving advice, and trying to avoid the perception that his own self-interest is driving the position. Which, all too often, it is.
Which was Goldman Sachs?
Some might say market-maker. You can’t be a viable institution if you don’t systematically manage risks. If you’re going to sell $100 billion in CMOs, you might also want to hedge your exposure. Goldman just hedged well.
Some will say Goldman is a trusted advisor. Some customers, perhaps. I suspect Goldman will, anyway. They point out that they were not the only ones to sell CMOs. True. Not much of a proof for trusted advisorhood, but true.
But broker sounds more likely to me. The question is only partly one of transparency. Were Goldman’s short positions really hedges, or separate bets for their own accounts? Did Goldman tell buyers of CMOs that Goldman was net short?
But transparency alone can get reduced to “letter of the law” stuff. Motives matter too. No one would accuse a pure market-maker of claiming that one side of the deal was “better” than the other—the market-maker’s job is devoid of advice.
And no one would accuse a trusted advisor of having shaded advice to suit his own ends—because his trusted advisorhood would be instantly shot.
Life in those cases is clear; there are the black hats and the white hats. And Ben Stein is pretty clear about the black hats.
The question comes when those motives are unclear. When you just can’t tell what role Goldman was playing—when Goldman itself isn’t clear, or sends out weak messages (others sold CMO’s too; we are not a crook)—or we ourselves don’t know what role we want from Goldman—that’s when we’ve got a social, institutional, broad-based trust problem.
Now that’s a real problem, Mr. Stein.
Charlie — You hit the nail on the head: Goldman Sachs, like all traditional investment banks, plays all of the multiple roles you identify, although by far the bulk of their business now comprises market making, broking, and, more recently, investing for their own (and other investors’) account.
The patently obvious conflicts of interest that are embedded in this business model are well understood within the investment banking industry and the regulators who oversee them. For the most part, i-banks do a pretty good job of preventing these conflicts of interest from degenerating into outright fraud or client mistreatment. In part, this happens because the interests of the personnel working in different divisions or departments are aligned with those of those departments. In other words, GS employees watch their clients’ backs against possible misbehavior by other GS employees because it is in their interest as well.
The role GS and its peers have difficulty pulling off nowadays, however, is that of trusted advisor. Most clients have figured this out, and they hire them with the expectation that GS will provide competent transactional execution advice in doing a deal. These clients understand, however, that their investment bank advisors are ultimately the friend of the deal, not the friend of the client. As long as this is understood by everyone, no-one gets hurt (at least not too often).
As far as any social obligation of Goldman Sachs or any other investment bank, however, that is entirely another story. Ben Stein was frankly off the reservation in his piece, and it is telling to me that presidential candidate Chris Dodd has picked it up as a cudgel to use in a little election year demagoguery.
A trusted advisor GS may not be, and perhaps can no longer aspire to be, even if they wanted to. It is another thing entirely to accuse them, as Stein appears to do, of perpetrating fraud. Naughty, naughty.
Thanks E.D., good to have the voice of someone closer to the industry than I.
I wonder what you think of Jonathan Knee’s book, The Accidental Investment Banker? In short, Knee suggests that investment banking did, at one time, have Trusted Advisor-like aspirations and capabilities, but that disappeared in the 90s.
My take on your take is that the critical thing is transparency about motives. Someone in society does have to play all the roles above, and as you say, if everyone is a big boy and knows all the rules, then there’s not much of a problem.
But what about one link away in the chain? Do the clients play by the same rules in turn with their clients? Does someone play friend-of-the-deal broker on the supply side and then turn around and play trusted advisor on the demand side? I’ve met very few, if any, such people.
Somewhere in the system, it seems to me, there is likely to be this fundamental confusion about objectives, and it’s usually accompanied by opacity, because that’s in the interests of the one playing the more self-oriented games. Look for opacity–the smoke–and you’ll find fire about objectives. Transparency is good, if not sufficient, medicine.
Sometimes, I see CEO of large companies get grilled when their accountant tells them it’s not wise to have most of their wealth in a single company (the one they run), and they sell a large swathe of it to "rebalance their portfolio".
CEOs are well paid – better than most shareholders – and there is nothing that impresses investors like tying the CEO to a ship so that if it sinks, the captain goes down together.
Kings used to send their own sons to battle for precisely the same reason.
If Goldman Sachs sees it fit to hedge their bets, shouldn’t the investors buying the CDOs be doing that too?