Is what Goldman Sachs did nothing but gambling?

Lawmakers at the Goldman Sachs hearing repeatedly compared the activities of investment banks to gambling. But that's not how Goldman officials view it. Here's how both sides argue the issue.

By , Staff writer

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    Goldman Sachs chairman and chief executive officer Lloyd Blankfein testifies before the Senate Subcommittee on Investigations hearing on Wall Street investment banks on Capitol Hill Tuesday.
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Is Goldman Sachs CEO Lloyd Blankfein a bookie?

That sounds harsh, but on Tuesday, senators repeatedly compared the activities of investment banks to gambling as they grilled Mr. Blankfein and other Goldman Sachs officials about short selling, synthetic collateralized debt obligations, and other arcane Wall Street arts.

Things went so far that eventually Sen. John Ensign (R) of Nevada, whose constituents include Las Vegas casinos, took umbrage. He said that his state’s version of gambling is fairer than what happens in the trading rooms of Manhattan.

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In Vegas, the croupiers do not change the odds on a game while it is in progress. But on Wall Street, bankers are “tweaking the odds in their favor” while deals progress, said Senator Ensign.

Eventually, Blankfein had enough. He objected to the continual use of the word “bet” by subcommittee chairman Sen. Carl Levin (D) of Michigan to describe short selling, an activity in which profit stems from a decline in asset price.

“You know, we live in different contexts,” Blankfein said to Senator Levin.

They do, indeed. Here’s a summary of how both sides view this question:

Why Blankfein’s a bookie

The underlying activity of financial trading looks a lot like betting on a horse or other sports event. Profit or loss depends on an unforeseen outcome over which the investor has little direct control.

Of course, that’s the way financial markets have operated for centuries. What lawmakers on Tuesday appeared to be homing in on was this: trading a new kind of financial instrument that seems to have no connection to any underlying real asset at all.

This instrument is the synthetic collateralized debt obligation (CDO). It’s a bundled investment that increases or decreases in value as its underlying bonds, or mortgages, or whatever, fluctuate in price. But the owner of a synthetic CDO does not actually own any piece of these underlying assets. Instead, CDOs are baskets of derivatives known as credit-default swaps.

Got that? Here’s how Blankfein described a housing-based synthetic CDO to senators on Tuesday: “It references securities indexed to particular mortgages.”

The further trading activity gets from the real economy, the closer it resembles blackjack, in the view of many lawmakers. In particular, Levin continually objected to Goldman’s short selling of a housing synthetic CDO the bank was marketing to customers.

“You are betting against the very security that you’re selling,” said Levin.

Why Blankfein’s not a bookie

To investment professionals, the context in which the buying and selling of securities takes place makes it very different from Las Vegas.

Trading synthetic CDOs is not analogous to betting on a hamburger-eating contest, say. Investors purchase these products as a means of protecting themselves against swings in the price of the underlying asset. Generally speaking, they are part of a complicated investment strategy – not a bet in and of themselves. Thus automakers can hedge against swings in the price of steel, or beverage manufacturers can try to make sure they’re not hurt badly by a rise in corn syrup.

“What clients are buying or customers are buying is an exposure,” said Blankfein on Tuesday. “The thing that we are selling to them is supposed to give them the risk that they want.”

It’s true that learning to be good at poker is one way to prepare oneself for life as a Wall Street trader, notes Robert Brusca, an economist for Fact & Opinion Economics in New York. But senators on Tuesday got tripped up and appeared confused about Goldman’s various roles in the financial markets, said Mr. Brusca in an analysis of Blankfein’s appearance at the Senate hearing.

Lawmakers also put too much emphasis on the blunt talk contained in Goldman e-mails released by the Senate Homeland Security and Governmental Affairs Committee's Permanent Subcommittee on Investigations. Obscenities and denigration of one’s own products are common among all kinds of salespeople – not just securities dealers, notes Brusca.

“The key here should be for the senators to pursue those charges that have to do with securities law violations or that have real moral character problems. They seem to have lost their way, although they did score some points,” writes Brusca.

Related:

Goldman Sachs hearing: Is Congress missing the point?

Goldman Sachs hearing pulls back curtain on bankers' ethics

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