Matt Taibbi, Squid Hunter

Matt Taibbi of Rolling Stone magazine has made a name for himself as a prominent populist critic of Wall Street, most especially criticizing what  is today considered the preeminent Wall Street firm, Goldman Sachs (GS).

Taibbi coined the term 'the great vampire squid' to describe the company, and it has stuck. For instance, whenever friends and colleagues send us a GS research piece, it is usually prefaced with something like 'the latest from the squid'.

 

Reading Taibbi's stuff, one comes away with the impression that Goldman Sachs practically rules the world. For example, in an article he published in early April, 'America's Great Bubble Machine', Taibbi wrote:

 

From tech stocks to high gas prices, Goldman Sachs has engineered every major market manipulation since the Great Depressionand they're about to do it again

“The first thing you need to know about Goldman Sachs is that it's everywhere. The world's most powerful investment bank is a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money. In fact, the history of the recent financial crisis, which doubles as a history of the rapid decline and fall of the suddenly swindled dry American empire, reads like a Who's Who of Goldman Sachs graduates.”

 

(our emphasis)

Now, as far as the part we emphasized above goes – that is just an assertion without proof. Taibbi does not provide any proof for it, mainly because it doesn't exist. We are supposed to accept on faith that Goldman Sachs is so powerful that it has 'engineered every major market manipulation since the Great Depression'.

To this is should be pointed out that every time a single player in the market attempts to manipulate the market concerned, the effort usually ends with the bankruptcy and disgrace of the manipulator. When Joseph Leiter tried to corner the Chicago wheat market between 1897 and 1898, the market promptly crashed on him. At one point Leiter held 12 million bushels of wheat and refused to deliver them, driving panicked shorts to cover their positions at ever higher prices. Alas, instead of 'making his millions' as the papers suspected he would, he actually lost about $10 million in the end (a vast amount at the time), ended up bankrupt and had to be bailed out by his father, Levi Leiter.

When the Hunt brothers tried to corner the silver market in 1980, their success proved rather fleeting as well. In the end, they were bankrupted. When a Sumitomo metals trader, Yasuo Hamanaka, attempted to corner the copper market in 1995, it ended up costing his employer the princely sum of $1.8 billion.

We could go on and on with similar examples. Yes, there are many instances in history when traders have tried to manipulate a market. In nearly all cases, the manipulators ended up as 'bag holders' – proving over and over again that no single person or firm can hope to be 'bigger than the market'. Not even governments are bigger than the market, although their manipulations can suspend reality for longer time periods due to the unlimited capacity of the central bank's printing press. A recent case in point is the ECB's attempt to manipulate the bond prices of peripheral sovereign debtors in the euro area. It has pumped almost € 80 billion into these bond market manipulations, which is  an enormous amount considering the relatively small size of the bond markets concerned. After all, Portugal, Ireland and Greece collectively represent only a mid single digit percentage of the euro area's total economic output. And yet, the ECB was entirely unable to stop the collapse of these bonds.

We would therefore suggest that it is simply not possible for Goldman Sachs to have 'engineered every major market manipulation since the Great Depression'. In fact, the two examples Taibbi briefly mentions – the bubble in tech stocks and 'high gas prices' can not possibly have been the outcome of a single entity manipulating the market. In both cases the root cause was monetary pumping by the Fed and other central banks. 

By employing such hyperbole, Taibbi immediately loses credibility with anyone who is familiar with the markets.

This is a pity, because there is certainly a lot worth criticizing. It is for instance true that Goldman Sachs, along with other banks and investment banks, is representative of the US form of State Capitalism. These firms have been granted special privileges – most notably the privilege of fractional reserve banking – in exchange for helping to prop up government borrowing and deficit spending and are deeply involved in the inflationary policy that makes it all possible. There is a steady movement of executives of Goldman Sachs and other banking firms into positions of power in the political realm.

The financial crisis of 2008 stands as en emblematic event that shows that the privileges granted to these firms extend to their being entirely excepted from the vicissitudes of the market. They are free to rake in vast profits and bonus payments for their executives during boom times and when things go wrong they can rely on being bailed out by tax payers and savers.

However, what should be the focus of critique is not a single firm, but rather the system of State Capitalism and fiat money as such. Taibbi, by implication is  saying: 'we must do something about Goldman Sachs'. He doesn't say what exactly, but one presumes he believes the firm should be held criminally liable for, well, whatever sticks.

This is putting the cart before the horse. In a truly free market system – i.e. a system of honest money and without special privileges granted to influential firms – there would be no problem to get worked up over. After all, the main reason why people feel cheated is not that Goldman Sachs and other Wall Street firms and banks make a lot of money – they feel cheated because these firms were  bailed out at great cost to tax payers and savers, even while said tax payers and savers themselves were left struggling with the economic downturn. There can be little question that bankers did very foolish things during the boom. If they had been allowed to fail, this would be a big 'so what' today. Needless to say, the excesses of the boom would not even have been possible if we had a sound, market-chosen money. It would still have been possible for individual banks to make mistakes and incur losses – but a boom-bust sequence of the magnitude we have experienced, with virtually the entire financial system swept up in the creation of unsound credit and unsound investments to an extent that would bring the system to the verge of collapse could simply not have happened.

It is true that during inflationary booms, graft and fraud begin to proliferate. Inflation not only harms the economy by furthering malinvestment and capital consumption, it  also tends to weaken people's morals.

We would submit that regardless of how deserving of criticism Goldman Sachs may be, Taibbi's implicit suggestion that the world could be made right again if only it were somehow punished for its transgressions misses the mark.  As long as the system of State Capitalism, a centrally planned fiat money and the legally sanctioned fraud of fractional reserves banking are with us, the booms and busts will continue to be repeated. What is worth criticizing is this system as such, and the fact that the losses of the financial firms have been socialized.

 


 

Vampiroteuthis infernalis, a.k.a. the vampire squid

(Photo via runtogold.com)

 


 

Taibbi's Latest Jeremiad

What has actually been the reason for us to look at the topic is Taibbi's latest article entitled 'The People vs. Goldman Sachs'. In this, Taibbi, based on a recent Senate report, argues that Goldman Sachs not only behaved unethically in the run-up to the mortgage finance bust, but that its trades provide evidence of criminality. Therefore, given that no-one has been indicted,  he concludes that the firm is 'above the law'.

We wouldn't even quibble too much with Taibbi's conclusion that 'the law in America is subjective, and crime is defined not by what you did, but by who you are', as he puts it, even though this is a bit of an exaggeration. Still, the state of the judicial system is far from ideal as anyone looking into it will soon realize. It happens quite often that big Wall Street firms get away with major infractions, suffering not much more than a slap on the wrist, while not having to admit to any wrongdoing. As an example off the cuff, the SEC once found that Morgan Stanley had manipulated quotes on numerous Nasdaq stocks for three years running. The company was fined $500,000, which at the time didn't seem to represent much of a deterrent.

However, the examples Taibbi brings in this article have a major flaw. Apparently, the 'crime' Goldman Sachs committed was that it sold its 'cats and dogs' type mortgage securities and CDOs before they collapsed, and in addition had the temerity to actually short the market via the ABX-HE indexes and a number of other vehicles.

We are supposed to commiserate with the likes of Morgan Stanley, a few hedge funds and other institutional players who lost money on the deals, while Goldman actually managed to make profits concurrently.

First of all, given the fact that Goldman too required public assistance ranging from the Fed making good on AIG's CDS losses to TARP funding and later financial help from Warren Buffett, it can not have made enough money to balance out its losses.

Secondly, Taibbi evidently doesn't understand how structured finance deals between institutions work, or what Goldman's role was.

The fact that Goldman sold securities it expected to go down in price only shows that it exhibited good business sense. Praising these securities as good investments was certainly questionable from an ethical point of view, but the buyers of the securities were themselves institutions with vast research capabilities. They simply failed to do the proper due diligence, or rather, failed to appreciate that the market had overpriced these securities and that their prices would fall. They bought these securities because they expected to make a profit – and as it turned out, they erred. Goldman did not sell these securities to widows and orphans, but to professionals who were perfectly capable of coming to their own conclusions about the future state of the market. In fact, by selling in good time, Goldman fulfilled its fiduciary duty to its shareholders by limiting its losses.

Similarly, by being one of the few major Wall Street firms to put on a number of big short positions, Goldman merely proved that it was better at assessing the market than others.  Let us say that the firm became aware of the dangers in mortgage finance and decided then, in spite of this awareness, to not sell its mortgage related securities and not put on short positions. In what way would that have improved the situation? It would merely have landed the firm in even bigger trouble than it experienced anyway when the bust struck.

Moreover, Taibbi overlooks that Goldman often acted as a market maker. In this function it is actually expected to take a position opposite to the buyers of securities – and the buyers know it. 

In conclusion, we think Taibbi is barking up the wrong tree. We are certainly not saying that everything  Goldman Sachs did before, during and after the bubble was commendable (we are not in a position to judge whether or not it broke the law in some instances; but we do have an opinion regarding securities transactions between institutions, as mentioned above). Similar to the rest of Wall Street, it was instrumental in blowing up the bubble and creating and marketing securities that in hindsight were nothing but 'toxic waste'. But inflationary bubbles are not the result of the doings of one company. They are first and foremost the result of too loose monetary policy and government intervention in the market. In the case of the mortgage credit bubble, government sponsored enterprises and government regulations aiming to increase home-ownership played a major role in enabling it. It is a characteristic of bubbles that a large majority of people and companies get swept up in a kind of mass hysteria. This mass participation and collective delusion tends to produce enormous excesses – but at he root of these events, we always find a vast expansion in the supply of money and credit. As we have pointed out previously, the US 'Austrian' broad money supply measure TMS-2 has increased by nearly 150% over the past decade. This was only possible because the Fed accommodated and actively furthered the monetary expansion and it is no wonder that a major bubble, with all the unpleasant consequences this brings about was the result.

If Taibbi wants to look for a scapegoat, he should look no further. Instead of attacking the symptoms – as worthy of critique as they may appear to be – he should rather strike the root.

 


 

 

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9 Responses to “Open Season On The Squid”

  • Floyd:

    Another issue is conflict of interest management.
    These behemoth financial institutions are fraught with conflict of interests, and cannot possibly manage them well.
    Now, if they were truly private, and competition was free, then market forces would address the issue.
    Obviously, consumers would gravitate toward those providers with the most compelling offerings.
    Alas, with the current heavy-handed-regulatory-framework, it is virtually impossible to compete as a small player.
    Put it other way, the briar for entry is exceeding high (not only in finance, but across most of corporate America).

    PS: The situation is not unique to the US.
    Along the generations large corporations learned to embrace and extend the regulatory framework, recognizing that the more convuluted it is, the less is the threat from new entrants (as navigating the red tape is a fixed overhead, and the larger an entity is, the less is the relative burden).

    • Indeed, this over-regulated and privileged sector does not have to deal with the competitive pressures that it would have to face in a truly free market. I think a free banking system’s regulations would basically fit on a napkin – and it would be a better world for all of us. The current state-capitalistic arrangement with a central-bank led banking cartel injures also innocent bystanders, as the boom-bust behavior of the economy is a direct result of its practices.

  • Alan Simpson:

    Ah, blaming the “Central Bank” would be a step too far for any progressive. It takes reasoning to get that far, the are rather short of that.

    • To be fair, Taibbi has written articles that were critical of Fed policy as well. However, even those articles had the private sector participants in the Fed’s schemes as their main focus. However, it is a case where I would be prepared to give him more slack, as both the Fed and the privileged private sector actors that had access to its extraordinary financing facilities during the crisis are equally worthy of condemnation. I have written this article mainly because I wanted to create a counterpoint to his ‘squid hunt’, which strikes me a failure to address the root causes of bubbles by laying blame solely on a single private firm. I even agree that GS may be found to have broken the law in some cases – but to this one must note that what is and what isn’t prosecuted is often a function of the social mood of the day. Currently, the social mood is vindictive. The mob wants retribution, whether it is justified or not. Taibbi caters mainly to these instincts.

  • Rick Hull:

    Great points, Pater. One other thing that I think Taibbi gets wrong is his conception of the GSCI as being “long only” and thus pushing commodity prices up as people invest in the index. While I don’t have a great analytical handle on the workings, my understanding that GSCI is “long only” for the duration of the contract, at which point it sells the contract, so as not to take delivery. Taibbi seems to think that, by being “long only”, GSCI is somehow buying and never selling.

    Given that GSCI has a “mindless, long-only” strategy with a predictable rollover period, it surely leaks capital into the greater market as other participants can predict and front-run its activities.

    So, far from absorbing commodity capital as Taibbi seems to think is happening, it is the opposite.

    I’d love to hear your thoughts on this, as I have only sort of pieced together this big picture, being fairly new to commodities.

    • Rick Hull:

      Actually, now having gotten a hold of Griftopia, it seems Taibbi has a better understanding of GSCI than I do. I must have been reacting to a bad reading of it.

      • Rick Hull:

        Gah, now reading further into it, I do think his analysis is off. His explanation of the mechanics is good, but I think his prediction of the effect is off. Since the contract has to be sold, you can’t unilaterally set the price of a “car” at “$500,000”. If you never had to sell your “car”, then sure. But since you regularly have to sell your car at market price to a party willing to take delivery, your hand is forced, and any “inflationary” chickens will come home to roost.

        • Floyd:

          I’m not aware of a simple method to run up a commodity market without willingness to take delivery in meaningful quantities (and warehouse the goods delivered).

          This does NOT mean there is no way to manipulate markets. Just, that I don’t see how. (Then again, this isn’t something I do in my line of business).

          In fact, I’m aware of two mechanisms, but I’m rather skeptic that they would be effective for long.
          First, a trader could buy futures and sell them prior to delivery but with a progressively later time vs. delivery. This might induce some pressure on the said commodity market due to an illusion of lagging supply.
          However, the time window to play with is quite limited, and sooner than later such trader would run out of time-window to play with.
          Second mechanism, traders can mark up the said commodity. This is easier the tighter supply is, and the less alternative marketplace are. Suppose that starting a new marketplace is a major barrier for entry, then it would be difficult to undercut those marking up the said commodity in the existing marketplaces.

          2c

        • Indeed, with regards to that, Taibbi overlooks that it is simply not possible to drive a market way beyond its fundamentals for long periods of time. Real world supply-demand will always catch up with the would-be manipulator in the end. Of course in commodity markets, the central bank’s policies ARE an important fundamental datum that is influencing prices. Interest rates are very important in evaluating stocks of commodities that are after all not sporting a yield. An extremely low interest rate means that the opportunity cost of hoarding commodities becomes extremely low as well. The central bank can not expect market participants to simply ignore its efforts to devalue the monetary unit and abstain from investing in areas where the central bank doesn’t like to see the effects of inflationary policy manifest themselves. Savers and investors are basically forced to take certain risks if they want to preserve the purchasing power of their savings. Hence it makes sense that investment bankers cater to this need by offering products that are linked to the performance of commodities. Their prices would however rise with or without such product offerings.

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