Monday, December 3, 2007

Ben Stein's Challenge to Goldman

Ben Stein in Sunday's NY Times ("The Long and Short of It at Goldman Sachs"), citing Allan Sloan's research for Fortune magazine, questions the propriety of Goldman Sachs for underwriting securities representing packages of loans while simultaneously short-selling mortgage indexes. He also takes to task Goldman economist Jan Hatzius for being excessively bearish on mortgages and suspects that Goldman’s short-sellers were grateful for the negative portrait.

Stein is questioning the view that the marketplace is divorced from morality, that if someone wants to buy junk from Goldman's securitization window at overly high prices, caveat emptor and good for Goldman. Similarly, if Goldman's traders want to bet that the housing market is going to continue to deteriorate (in part because of a collapse of mortgage values), and they place their bets accordingly, what's wrong with that? If Goldman’s bets win at both windows, tant mieux.

This point of view depends, I think, on there being a wall between departments of the kind that the Glass-Steagall Act of 1933 put up between banking activities and investment banking. Is there anything left of this wall? Is there a limit on communication between Goldman's traders and the people who investigate the quality of loans that they packaged?

On the issue of excessive bearishness, I believe the Case-Shiller indexes and various estimates of the total likely losses support the idea that downward adjustment in housing markets has considerably further to go. But several factors will come into play to mitigate the impact:
1. Continuing infusion of central bank liquidity in the United States and overseas.
2. Local judicial insistence on seeing all the documents before permitting foreclosures, such as is occurring with Deutsche Bank in Ohio, which may slow down foreclosures - at some cost to the credibility of the American mortgage system.
3. Industry association assistance to mayors to help with easing the impact of foreclosures on local communities (the Mortgage Bankers are providing $100 per foreclosure to create a foreclosure database and to fund counseling services).
4. Congressional action to freeze interest rates on ARM interest rates that are about to float up.