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Goldman was hedging–how evil!!!!

According to the Washington Post:

Goldman admits it had reduced its exposure to the overheated U.S. property market and had sought to limit possible losses through a strategy that would make money if home prices fell. It says such “hedging” is a routine part of its business and is intended to moderate risk to the firm, an especially vital function when markets shift violently, as they did in 2008.

The Post puts “hedging” in quotes like it is some fatuous excuse by Goldman. Let’s see: Goldman is accused of betting against the housing market (that housing prices would fall). It also had other bets that housing prices would rise. It is prudent to not bet the whole firm one way or the other on something so uncertain as housing prices. Having bets on both sides is called “hedging” and is Finance 101.  Goldman Sachs is on the hook for a lot of possible sins, of which it may be indeed guilty. Hedging is not one of them. That the media and politicians can’t even understand hedging is not reassuring when the largest financial reform in a generation is underway.

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  1. Rod wrote:

    Ring the alarm!

    Posted April 25, 2010 at 4:49 pm | Permalink
  2. Stephen Jones wrote:

    I’m afraid Bill you’ve just given the typical reaction of a blinkered theorist who thinks the world goes according to the definitions in his economic dictionary.

    Firstly Goldman Sachs is not being accused of hedging. It is accused of withholding necessary information from its clients. That is to say it sold the client a CDO without informing it that much of the composition of the CDO had been chosen by another client who was betting on it going down. If I buy a house on which the builder will make millions on an insurance policy if it burns down, then I ought to know about it.

    Secondly whilst hedging, like speculation, may be a necessary part of any functioning economy, very often it can be used for illicit ends. Have a look at the scandal of Citibank and the Ceylon Petroleum Corporation where the bank sold the company a grossly perjudicial hedging arrangement after having taken all the executives on ‘training courses’ abroad in luxury five star hotels.

    Posted April 25, 2010 at 4:53 pm | Permalink
  3. Stephen Jones wrote:

    Bill you have changed your posting from what was originally there. That is very naughty as it means the comments are now referring to another article that is no longer visible.

    Posted April 25, 2010 at 5:54 pm | Permalink
  4. William Easterly wrote:

    Stephen, my apologies, it was a chaotic day at Aid Watch, as I drafted the original post on my iPhone & then the site crashed before I could clean it up. Your comment remains valuable. Bill

    Posted April 25, 2010 at 6:08 pm | Permalink
  5. Silly wrote:

    Are you blind? Goldman is not accused a hedging, they are accused on fraud. It’s sad that an economist doesn’t know the difference.

    Posted April 25, 2010 at 6:08 pm | Permalink
  6. Masshole wrote:

    Isn’t Goldman saying it was ‘hedging’ when in fact it realized that their first batch of sub-prime CDOs was going bad so it was now betting strongly against the market while continuing to make toxic CDOs for clients? So Goldman was putting bets both ways yes, but by early 2007 it was mostly betting that house prices would fall, but their CDO sales office was behaving as if the firm as a whole thought prices would rise.

    Posted April 25, 2010 at 7:10 pm | Permalink
  7. Morgan Price wrote:

    I agree that hedging is in Finance 101, but that doesn’t prove that it’s a good idea in the real world. What social purpose did it serve for Goldman Sachs to take huge risks creating questionable securities, run huge hedges to (maybe) protect themselves from their own junk — but without, apparently, considering counterparty risk — and then be bailed out by the feds (via the full repayment of AIG’s counterparties)?

    Posted April 25, 2010 at 10:23 pm | Permalink
  8. George wrote:

    In the words of John Stewart – “Those f***ing guys!”

    They’re being charged with fraud not because they hedged (i.e. not because hedging is being taken as evidence that they were “misselling” long bets on subprime), but because they allowed the firm that shorted them to select the very worst units of subprime to make up the instrument which they then sold to other investors as profitable.

    The closest metaphor is an insurance company allowing a mechanic to take out life insurance on you, then having done so, to “fix” your brakes, without telling you.

    And even that (the GS version) is not unambiguously a crime.

    Posted April 26, 2010 at 5:49 am | Permalink
  9. Mozza wrote:

    Hedging can be wrong. Here’s how.

    The Magnetar Trade: How One Hedge Fund Helped Keep the Bubble Going (Single Page)

    Posted April 26, 2010 at 8:31 am | Permalink
  10. John wrote:

    A little context please. Goldman’s internal emails show they went beyond hedging, specifically selling these contracts to clients who they thought wouldn’t understand the assets. Intentionally withholding information is fraud in the financial world.

    An e-mail from a mortgage trader named Fabrice Tourre urges his colleagues not to approach “sophisticated” hedge funds about selling them mortgage investments because “they know exactly how things work.”

    Rather, Tourre suggested that Goldman approach “buy-and-hold ratings-based buyers” who might not do as much research into the investment.

    Clients did not take well to Goldman’s suggestions.

    An e-mail from an unnamed Goldman employee to Daniel Sparks, head of the mortgage unit, says there is a “real bad feeling across European sales about some of the trades we did with clients. The damage this has done to our franchise is very significant.”

    Posted April 27, 2010 at 11:33 am | Permalink
  11. CaptFamous wrote:

    I think his outrage has more to do with the lack of differentiation between the actual theory of hedging (not putting all of your eggs in one basket), and financial instruments that are often used for hedging (short positions, derivatives, etc).

    For example, that Magnetar article. It’s true that they were hedging, but their “bets” against the CDOs were not the hedge. It was their long position on the CDOs, the purchasing of the equity, and the investor fees that they collected because of it, that was the hedge. Their primary goal was to make money off of the crash (why anyone would deal with a company named after a powerful collapsing star at the end of a bubble is beyond me).

    Posted April 27, 2010 at 3:33 pm | Permalink

2 Trackbacks

  1. […] under: Social Justice — terence @ 9:25 pm Tags: Injustice, Matt Taibbi, USA Over at AidWatch Bill Easterly is upset because someone writing in the Washington Post has implied that hedging is illegal. Fair enough, […]

  2. […] in an of itself is not a sin, William Easterly […]

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