Let these Members lead financial rules reform

There are 13 members of Congress who at least seem to understand more than the average senator or representative about how equity markets work. From The Wall Street Journal:

Senators have criticized Goldman Sachs Group Inc. for profiting from the housing collapse. And Congress is considering legislation to curb Wall Street risk-taking, including the use of financial instruments known as derivatives and of leverage, or methods that amplify returns.

According to The Journal’s analysis of congressional disclosures, investment accounts of 13 members of Congress or their spouses show bearish bets made in 2008 via exchange-traded funds—portfolios that trade like stocks and mirror an index. These funds were leveraged; they used derivatives and other techniques to magnify the daily moves of the index they track.

Short selling is a critical part of our equity markets: It’s a way for market participants to send a negative signal about the direction of a particular investment or the markets more broadly. That kind of information is important to have in a decentralized marketplace, even if you wouldn’t know it from listening to members of Congress rail against “speculators.”

Georgia’s own Sen. Johnny Isakson is one of the 13. He’s also one of the four members whom the Journal cites as making negative comments about trading behaviors that were very similar to the trades he did or had done on his behalf:

In February, Sen. Johnny Isakson (R., Ga.) argued on the Senate floor that “we don’t need those speculating in the marketplace to take unfair advantage of the values of equities that are owned by Americans all over this country for the sake of making a buck on a short sale.”

On Oct. 8 and 9, 2008—as the Federal Reserve was bailing out American International Group Inc.—an account Sen. Isakson held invested more than $30,000 in ProShares UltraShort 7-10 Year Treasury and UltraShort 20+ Year Treasury, the records show. These are “leveraged short” funds, designed to gain $2 for each $1 drop in the daily value of U.S. Treasury bonds.

Sen. Isakson said his account is professionally managed by Morgan Stanley Smith Barney and he has no control over it. “They make those decisions and I report what they do,” Mr. Isakson said. “I put money away in my career so I can hopefully retire one day.”

Sen. Isakson said, “Short selling has a role to play in the market.” He said he supports legislation to limit it but wouldn’t prohibit it.

Another of the 13, Rep. Shelley Berkley (D., Nev.), made several well-timed shorts as markets were falling, moves she attributed to a money manager. Berkley no doubt wasn’t talking about that money manager or those kinds of trades when she said in February, “Representing Las Vegas, let me assure you, no casino on the planet behaves as irresponsibly and recklessly as Wall Street does. Wall Street ought to be ashamed, and take a lesson from the casino industry.”

But at least Berkley, Isakson and the other members, or the people around them, recognize in practice that markets don’t only go up, and that investments — yes, even “speculations” — anticipating a decline in the markets are legitimate. That’s a fuller grasp of the subject than many of their colleagues in the Capitol display.

41 comments Add your comment

John

May 4th, 2010
10:53 am

I think what everyone is mad at Goldman for is because they sold these “legitimate” investments to people who thought they were getting a good product. Then, the whole time they were doing this, they were shorting them behind closed doors. Surely, Kyle, you can see something wrong with this.

Kyle Wingfield

May 4th, 2010
11:05 am

John, one of the reasons Goldman didn’t lose their shirts like a lot of other banks is that they consistently bet both ways. Sure, they had net long or short positions, but they were never overly exposed one way or the other. The banks that didn’t do this are the ones we bailed out. Do you really think Goldman should have done it the way everyone else was doing it?

As for the securities specific to the court cases against Goldman, I haven’t spoken with anyone who works in the financial industry who thinks any investor in these synthetic CDOs would ever think the product could only go up; we are not talking here about little old ladies in Keokuk, Iowa, investing their Social Security checks. And if they did think so, it’s because they thought they were rigging things in their own favor. There are two sides to these kinds of investments; are you saying it would have been OK if Goldman had been telling the short-side investors that the products would surely go down, but was betting on them to go up?

On Wall Street, more than anywhere else, caveat emptor applies. And the banks that bet long on the Goldman CDOs knew this, or should have, better than anyone.

Banned By Cindy

May 4th, 2010
11:26 am

Don’t forget the ratings agencies with 90% of previously highly-rated CDO’s now considered as junk.

Of course, their not being rounded up like some others. And the eternal fundamental – let the market deem them not worthy of doing business with – will not be followed due to interventionist legislation and knee-jerk politics.

And Chris Dodd is a fraudulent scum bag who deserves a blood-letting punch right in the middle of his lying two-face. Or maybe taser him for 15 minutes.

Jess

May 4th, 2010
11:29 am

I think what Goldman did was nothing more than Insurance, which is good business sense. If I buy fire and flood insurance on my house, it is not because I think these things will happen, it’s because they may happen. If I decide to sell my house, I do not think a potential buyer will think there is looming disaster simply because they learn that I have insurance.

Now if I am aware of bad wiring which greatly increases the chance of a fire, and I do not disclose this, I have a legal problem. As far as I can see this is not the case with Goldman. I do not think they had any better insight into the impending collapse than any other financial institution.

Ragnar Danneskjöld

May 4th, 2010
11:31 am

One has to appreciate the irony of our junior senator’s grandstanding. Long the protector of FNMA/FHLMC and other stimulus to the housing industry, he also profits personally using the instruments he derides as bad for the country. Wonder how many others were on the wrong side of both issues?

Hillbilly Deluxe

May 4th, 2010
11:33 am

I still think of CDO’s as being pretty much the same as trying to pick which shell the pea is under. There is one difference though, the flim-flam man on the street corner can’t take the whole economy down with him.

I view Wall Street and Las Vegas the same way. The game is rigged and you aren’t going to consistently beat the house. I’ll just sit on the sidelines and let somebody else do the “gambling”.

David S

May 4th, 2010
11:39 am

There is only one member of Congress who knows anything about the monetary system (at the root of everything) and that is Congressman Ron Paul. The only other possible addition would be Alan Grayson (Dr. Paul’s co-sponsor of the Audit the Fed bill).

The fact that Mr. Isakson knows how to work the system to his own personal advantage is just another reason why that loser needs to go. He would have voted for the Stimulus package if it had incorporated more money for his friends and interests in the real estate industry. Our financial system needs to be addressed with morals and with principles, and Mr. Isakson appears to be sorely lacking in both.

No More Progressives!

May 4th, 2010
11:53 am

John

May 4th, 2010
10:53 am
I think what everyone is mad at Goldman for is because they sold these “legitimate” investments to people who thought they were getting a good product.

There is a Latin phrase, known in the legal world, as Caveat emptor, or “buyer beware.” If you charge ahead and buy an investment you don’t fully understand, buyer beware.

This does not let an unscrupulous stockbroker off the hook if fraud or deception is involved.

No More Progressives!

May 4th, 2010
11:55 am

And by the way: It is reported that George Soros made $2.8B “shorting” the housing market.

Where, oh where, is the outrage???

CJ

May 4th, 2010
12:07 pm

Kyle: “On Wall Street, more than anywhere else, caveat emptor applies.

True. That’s what Obama and Congress is seeking to remedy.

A reminder that the SEC case is about lack of disclosure regarding John Paulson’s full role in the creation of the the product under scrutiny, not about whether those who took the long side of the bets realized that others [generic] were taking the short side.

Kyle Wingfield

May 4th, 2010
12:16 pm

And one difference between you and me, CJ, is that you seem to think they are able to remedy such a thing.

Kyle Wingfield

May 4th, 2010
12:22 pm

Actually, it’s more than that, CJ. It’s a big problem that you and others think in the first place that it would be desirable to “remedy” as basic a tenet of the economy as caveat emptor. Laziness and recklessness due to a false sense of security — owing to easy money, the implicit (now explicit) taxpayer guarantee for firms that are “too big to fail,” etc. — contributed heavily to the financial crisis. They are arguably one of the main reasons why the thing you call “greed,” an eternal and immutable human trait, proved so destructive on this occasion.

“Remedying” a cautionary principle like caveat emptor will create far more problems than making people aware, even painfully aware, of their need to adhere to it.

lmno

May 4th, 2010
12:27 pm

I believe that it should be law that any member of congress, and any higher level employees in the executive and judicial branches should be barred from earning any unearned income in the way of investments. When they enter office, their assets should be liquuidated and placed into money market or other cash like equivalents. They should not be allowed to own stock, bonds, or investment real estate. This would remove suggestions of improper governance to profit in the private sector. Take Dick Cheney’s relationship with Haliburton for example. Whether or not it was coincidence or not that the company profited from the prior administration’s actions is inconsequential. The fact that a suggestion of impropriety could be made is reason enough that all ties should have been severed.

retiredds

May 4th, 2010
12:34 pm

“The banks that didn’t do this are the ones we bailed out. Do you really think Goldman should have done it the way everyone else was doing it.”

Kyle, I generally agree with your article and your response to John above. But I think your comment about the banks that didn’t do it (short the market) were the ones we bailed out is very simplistic. If you take Citi, for example, I am sure they had shorts in many areas of their portfolios but a major piece of their losses came from real estate (residential and commercial) and consumer loans, of which they make a boatload globally.

If you take the banks in GA that have gone “belly up” because of their narrow view that what goes up never goes down, as an example, my reading was they were speculating in the real estate market and probably never even had a notion of what a short sale was or is. Most amateurs really don’t know how short sales work. They made bad bets because “greed” became the underlying security (or insecurity in reality).

But back to my main point, when you, me, or others, make the mistake of trying to pin the failure in the banking system on one item it is a most naive way of addressing an incredibly complex issue. By way of example let me ask a question, How much of the depression/deep recession is psychological versus real? I ask that because you and I know that markets are driven by perceptions as well as reality (the other side of a short position is a long position). Also while you and I might agree that the financial markets got way “out of whack”, it is also true that when we talk about global financial institutions that reach into every corner of the globe, it no longer is just a simplistic solution that works. Unfortunately , hind sight being 20/20, the undoing of the Glass-Stegall Act 20 some years ago was probably the undoing of whatever safety net there was. There is a lot more I could comment on (sub-prime loans, 0 down payments on real estate, interest only payments with balloons, etc.) but will leave it here.

CJ

May 4th, 2010
12:38 pm

It’s a big problem that you and others think in the first place that it would be desirable to “remedy” as basic a tenet of the economy as caveat emptor.

Transparency is another basic tenet of the economy. It’s a big problem that you and others think that it would be desirable operate an economic system without transparency at its foundation.

Kyle Wingfield

May 4th, 2010
1:01 pm

CJ, regarding transparency: I’m not aware of any allegation that any party to the transaction in question was unaware of the composition of the CDO. If Goldman told ACA, IKB, et al. that Securities A, B and C were part of the CDO when in fact X, Y and Z were in it, that would definitely be fraud. As far as I’m aware, that didn’t happen.

Instead, according to the court filing, ACA had veto power over all specific securities in the CDO and exercised that power in some cases. At one point in the court filing, the government describes an internal ACA email questioning why Paulson didn’t want certain things in the final product. The government goes on to say that those certain things were considered higher-quality securities — implying that Goldman and Paulson were trying to stack the deck, but offering no evidence that either party gave ACA a false or misleading answer. Given the liberal use in the filing of seemingly incriminating email snippets and statements, I’d have expected more than an implication there. But we will of course have to wait and see what comes out in the trial.

I’d also point out that ACA surely expected there to be short-side investors, and it surely expected those investors to conduct their own due diligence before they went short.

I’m not here to play Goldman’s defense lawyer. My point is that, after all this, what we’re left with is caveat emptor. The need for it will always be with us. And while I agree that transparency is a good thing, we will ultimately create more problems (and suckers) if we try to legislate wariness and due diligence out of the system.

Churchill's MOM

May 4th, 2010
1:02 pm

2+ years ago when I was really upset about amnesty, I thought that Saxby was a bad influence on Johnny but as I watch them, it is obvious that Johnny Bailout can take care of him self and may be even worse that Saxby. Most people know Saxby is a crook but think Johnny is a “nice man”.

Daddy said that 1 of Johnny’s staffers called yesterday asking for a “donation”, Dad slammed the phone down.

Wing Boy last week you bet no one could name 2 Libertarian candidates, well it’s your & the AJC’s fault, because all you write is about our 2 GREEN parties.

Kyle Wingfield

May 4th, 2010
1:07 pm

retiredds: You’re right that I made a somewhat simplistic statement there, but I don’t think it was off-base. Citi and others were holding too many bad assets which they believed to be good — in part, as Banned by Cindy notes above, because of the problem with the assets’ ratings — without hedging those positions. For whatever reason, they left themselves exposed, and we’re all paying for it.

There are all kinds of other elements in the crisis, faulty capital requirements being a prime example. John Allison, the longtime chairman and CEO of BB&T, now a professor at Wake Forest, gave an excellent overview of these and other missteps at a presentation in Atlanta last week, and I hope to write about his thoughts soon.

JustCurious

May 4th, 2010
1:16 pm

Kyle, just curious. How did you do personally in the market over the period of the collapse and recovery?

Chuck

May 4th, 2010
1:17 pm

Hedges, short-sells, default-swaps, etc. are in and of themselves not problematic. It’s the conflicts of interest, manipulation of markets, improper risk-assessment, and cloudy judgment that caused the problems.

Everyone hedges bets. The problem is, when you have a $500,000 insurance policy on a $100,000 house, you’re no longer all that motivated to prevent the thing from burning down.

Jefferson

May 4th, 2010
1:22 pm

If AIG was allowed to fail, they would have taken Goldman with them. Paulson knew that.

retiredds

May 4th, 2010
1:46 pm

Kyle, we are in agreement now. I had left out the rating agencies which is a whole other kettle of worms.

The Tar and Feathers Party

May 4th, 2010
1:49 pm

Die Goldman, Die…stick a fork in them, they are done, DONE.. Their alleged profits are really money they have stolen from all of us collectively by “front running” aka “high speed trading.” The exchanges sell goldylocks our buy and sell orders a half second prior to the orders executing. Goldman computers then calculate the difference between buy and sell, determines which is greater, then jumps in line in front of us to buy/sell, thus driving the price up, then offers to buy/sell at a slightly higher price to us. Since our orders are in the queue, there is nothing we could do about it, even if we had knowledge of goldmans thievery. So they make 1 to 3 % ten thousand times a day, sending us the bill. Note there is nothing for us or the markets to gain by this line cutting by the thieves, and IMHO the sharing of our buy/sell orders by the exchange with goldman (for a fee) violates their fiduciary responsibility. I say hang goldman and all their people from the nearest tree….

Peter

May 4th, 2010
1:56 pm

Kyle…..I still wonder why the rating agency’s are not getting investigated ?

There would be no A+ paper if they had not said it was so.

Can you answer that question ?

CJ

May 4th, 2010
2:30 pm

Kyle @1:01, Congress isn’t seeking to legislate wariness and due diligence out of the system.

I second (third?) the comments/complaints about the complicity of the ratings agencies. Congress has held hearings questioning why they rated crap as being equivalent to the gold standard, but I don’t think anybody has found a solution that stands out.

JF McNamara

May 4th, 2010
2:46 pm

This statement isn’t entirely correct.

“Short selling is a critical part of our equity markets: It’s a way for market participants to send a negative signal about the direction of a particular investment or the markets more broadly. ”

Shorting is a way of creating volatility and artifically inflating the float of a stock in order to achieve “price discovery”. They are the counterbalance needed for short term long side traders to make money.

If it weren’t for the short term longs and shorts, the liquidity needed for long term traders wouldn’t be there causing greater short side volatility without the balance of short squeezes. Essentially, banning short traders would eliminate all short term traders but increase the volatility due to lack of liquidity.

With or without short sellers, the market would get the signal from those who actually own the stock selling it. We don’t need people borrowing and selling something they don’t own for signaling.

DEWSTARPATH

May 4th, 2010
2:46 pm

Tar & Feathers:

– I agree with you about Goldman Sachs (except for the lynching part).
The culpability of these firms that engage in automated profiteering for
the sole purpose of making a quick buck is not really being addressed
by financial reform. Sarbanes-Oxley legislation was fine, but the current
trends in illegal trading can be traced back to the early 90’s, when market
speculation based on dubious “derivative” calculations was rampant. It
was a new trend at the time, and it set the stage for other scams such as
“amateur day-trading” and “house flipping” (in the real estate market).

Chris Broe

May 4th, 2010
2:59 pm

The comments here today display a very in-depth understanding of the Goldman Sachs charges! I don’t know why I bothered watching the hearings last week.

Linda

May 4th, 2010
3:00 pm

The singling out of Goldman, the pretense of attacking the feeding hand & the timing are not coincidental. The strategy was to infuriate the American people & obtain approval for financial reform. It’s working as designed.

USAA is an insurance company & bank for our military, founded decades ago by retired military officers to serve “those who stood tall for this country…with proven financial advice.” It is a “top-rated insurance & financial services organization with incredibly high loyalty among members.” This is a copy of a letter/email sent to members by Josue (Joe) Robles, Jr., Major General, USA (Ret.) President & CEO:

“Rarely in our 87-year history have we turned to USAA members to weigh in with elected representatives on an issue of great importance. But, we are now.

The U.S. Senate currently is considering legislation (S.3217) that would impose new rules on the nation’s financial services industry, including USAA.

As the leading provider to financial services to American’s military community, USAA supports financial services reform. However, the current Senate bill would disproportionally impact USAA because we are a unique and fully intergrated association. USAA is not like the banks and other companies that helped bring down our economy, and we never took a penny of TARP funds. We do not engage in the harmful practices this legislation seeks to resolve.

If unchanged, the bill would:
Prevent USAA from managing the association’s portfolio as we have for the past 87 years.
Jeopardize our ability to continue offering many of our competitive products.
Limit our ability to return money to our members. Last year, USAA returned $1.2 billion to our members in the form of distributions, dividends and bank rebates and rewards.

So, we are asking all USAA members and employees to urge their U.S. senators to amend a portion of the bill, known as the ‘Volcker Rule,’ to eliminate its effect on a company like USAA. Please know that this legislation does not impact individual member’s investments.

Regardless of the outcome of the legislation USAA will remain a unique and enduring association that’s all about you–the military and their families.

Please take action on this matter by immediately contacting your U.S. senator.

Thank you for your help and support.”

Beth

May 4th, 2010
3:01 pm

Regarding the Goldman investigation, please remember that A) Paulson was a nobody a few years ago. We know him now because he made a good trade. B) The investors who bought the ACA deal were highly intelligent “accredited” investors. Accredited investors is a legal term. These investors, like the Madoff investors, were highly intelligent and conducted their own due diligence. C) This Goldman case is only a case because large pension funds [read: UNIONS = OBAMA VOTERS] lost a lot of money in the deal, they can’t pay their legal retirement pension obligations and want someone [namely Goldman] to bail them out for their stupidity. The Unions can’t just tax their way out of a sorry investment situation.

Kyle Wingfield

May 4th, 2010
3:10 pm

JustCurious: All of my investments are in broad-based index funds, so they’ve risen and fallen as you’d expect.

Jefferson: Wrong Paulson.

retiredds: Glad to hear it.

Peter: Good question.

Kyle Wingfield

May 4th, 2010
3:11 pm

Make that “fallen and risen” to get the chronology right. Or maybe, “risen, fallen and risen”…

Jefferson

May 4th, 2010
4:00 pm

Kyle, I’m wrong referring to the Secr of the Treasury? I owe you a coke or what?

Jefferson

May 4th, 2010
4:01 pm

Linda

May 4th, 2010
4:40 pm

Here is a real Golden Sack! I’m old & had the BEST lunch I’ve ever had at the Mediterranean Grill. 3 locations in Decatur/Emory, East Cobb & Midtown. The Business Lunch Combo Special should cost $20 but goes for $6.49 including soft drink. I’m going every week for the rest of my life. They also cater.

Michael H. Smith

May 4th, 2010
6:10 pm

Peter and CJ should look into Limited Purpose Banking. It would put these rating agencies you two complain about out to pasture and probably a few other GUB’MENT agencies that don’t really do their job.

A Banking System We Can Trust

http://www.forbes.com/2009/04/22/loan-mortgage-mutual-fund-wall-street-opinions-contributors-bank.html

Taxpayer

May 5th, 2010
7:02 am

When you make a bet, should you have the money to cover it dedicated to that bet until said bet expires? And what of the counterparty to said bet. Should they also be able to pay or do we need to set up a system whereby certain people show up to collect said winnings and if you do not have the money then they take something of equal or greater value instead. Don’t you just love the concept of a truly free market.

Kyle Wingfield

May 5th, 2010
10:30 am

Praytell, Taxpayer, who set the rules about capital ratios and reserves? Not to mention such other niceties as which and how many rating agencies were authorized?

In other words: What free market?

David S

May 5th, 2010
12:36 pm

Yes, what free market indeed. With the Federal Reserve controlling interest rates (price fixing) thus making easy credit available without commensurate savings or other market based requirements, there is no way to look at anything that has gone on financially in this country since 1913 as a “free market.”

Shorts, longs, and other bets on the market are appropriate signals that something may be up. When the government can manipulate markets with a single vote, the stroke of a presidential pen, or the actions of an unelected bureaucrat, you have the worst kind of economic marketplace you can imagine.

The consumer in a truly free market system is the most powerful force there is. With a legal framework in place to address force or fraud (yes, this is critical to the free market), the economic actions of the citizenry are far more powerful than any vote for any politician ever could be. But that force has been undermined by regulations and crony-capitalism and now the economically ignorant are incorrectly blaming the free market instead of government who deserves ALL of the blame.

Jefferson

May 5th, 2010
1:11 pm

If a free market the uninformed will be swindled, by the confidence men/women.

Taxpayer

May 5th, 2010
7:32 pm

And who, praytell, Kyle, says we need an FDIC for that matter. Free market, indeed. Besides, I did use the word, “concept”. And do tell how capital ratios and reserves apply to derivatives. I seem to recall Senator Phil Gramm’s legislation had something to do with making sure that those nasty CDS’s were freed from all those burdens associated with regulated markets. Las Vegas gambling is a surer bet when it comes to getting paid one’s winnings. They actually have rules and rule enforcers out there.