The Goldman Drama

[Cees Binkhorst]

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The herd mentality.
You either play or ...
But, whatever way, NOT FOR PROFIT ;)

Groet / Cees


April 27, 2010
Op-Ed Columnist
The Goldman Drama
http://www.nytimes.com/2010/04/27/opinion/27brooks.html
By DAVID BROOKS

Between 1997 and 2006, consumers, lenders and builders created a housing
bubble, and pretty much the entire establishment missed it. Fannie Mae
and Freddie Mac and the people who regulate them missed it. The big
commercial banks and the people who regulate them missed it. The Federal
Reserve missed it, as did the ratings agencies, the Securities and
Exchange Commission and the political class in general.

It’s easy to see why this happened. People who make it into the
establishment work and play well with others. They are part of the same
overlapping social networks, and inevitably begin to perceive the world
in similar, conventional ways. They thrive in institutions where people
are not rewarded for being cantankerous intellectual bomb-throwers.

Outside the establishment herd, on the other hand, there were
contrarians who understood the bubble (which was the easy part) and who
figured out how to take counteraction (which was hard). Michael Burry
worked at a small hedge fund in Northern California. John Paulson ran an
obscure fund in New York. Eventually, there were even a few traders at
the big investment banks who also foresaw the imminent collapse. One of
them was “Fabulous” Fabrice Tourre of Goldman Sachs.

If this were a Hollywood movie, the prescient outsiders would be
good-looking, just and true, and we could all root for them as they
outfoxed the smug establishment. But this is real life, so things are
more complicated. According to Gregory Zuckerman’s book, “The Greatest
Trade Ever,” Burry was a solitary small-time operator far away. Paulson
was cold and diffident.

And as for Fabulous Fab, he seems to be the product of the current
amoral Wall Street culture in which impersonal trading is more important
than personal service to clients, and in which any product you can sell
to some poor sucker is deemed to be admirable and O.K.

In this drama, in other words, the establishment was pleasant,
respectable and stupid, while the contrarians were smart but hard to
love, and sometimes sleazy.

This week the drama comes to Washington in two different ways. First, as
is traditional in our culture, the elected leaders of the clueless
establishment have summoned the leaders of Goldman Sachs to a hearing so
they can have a post-hoc televised conniption fit on the amorality of
Wall Street.

This spectacle presents Goldman with an interesting public relations
choice. The firm can claim to be dumb but decent, like the rest of the
establishment, and emphasize the times it lost money. Or it can present
itself as smart and sleazy, and emphasize the times it made money at the
expense of its clients. Goldman seems to have chosen dumb but decent,
which is probably the smart narrative to get back in the establishment’s
good graces, even if it is less accurate.

The second big event in Washington this week is the jostling over a
financial reform bill. One might have thought that one of the lessons of
this episode was that establishments are prone to groupthink, and that
it would be smart to decentralize authority in order to head off future
bubbles.

Both N. Gregory Mankiw of Harvard and Sebastian Mallaby of the Council
on Foreign Relations have been promoting a way to do this: Force the big
financial institutions to issue bonds that would be converted into
equity when a regulator deems them to have insufficient capital.
Thousands of traders would buy and sell these bonds as a way to measure
and reinforce the stability of the firms.

But, alas, we are living in the great age of centralization. Some
Democrats regard federal commissions with the same sort of awe and
wonder that I feel while watching LeBron James and Alex Ovechkin.

The premise of the current financial regulatory reform is that the
establishment missed the last bubble and, therefore, more power should
be vested in the establishment to foresee and prevent the next one.

If you take this as your premise, the Democratic bill is fine and
reasonable. It would force derivative trading out into the open. It
would create a structure so the government could break down failing
firms in an orderly manner. But the bill doesn’t solve the basic
epistemic problem, which is that members of the establishment herd are
always the last to know when something unexpected happens.

If this were a movie, everybody would learn the obvious lessons. The
folks in the big investment banks would learn that it’s valuable to have
an ethical culture, in which traders’ behavior is restricted by
something other than the desire to find the next sucker. The folks in
Washington would learn that centralized decision-making is often
unimaginative decision-making, and that decentralized markets are often
better at anticipating the future.

But, again, this is not a Hollywood movie. Those lessons are not being
learned. I can’t wait for the sequel.

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