This week, a slew of current and former Goldman Sachs executives appeared before the Senate Permanent Subcommittee on Investigations to attempt to explain the firm’s practice of selling products that it internally regarded as “shi*ty.” The timing of the hearing was fortuitous for Democrats, as they try to shepherd Sen. Chris Dodd’s (D-CT) financial regulatory reform bill to a vote.
One of the more contentious aspects of the reform debate is that dealing with derivatives, after Sen. Blanche Lincoln (D-AR) released a surprisingly strong bill that goes further in bringing the opaque markets into the light than either Dodd’s or the bill passed by the House of Representatives last fall. And Goldman Sachs, along with the rest of Wall Street, are mobilizing to blunt the impact of the bill.
The five largest banks in the nation made $23 billion on derivatives trading in 2009, so this is a very lucrative business that they are trying to protect. But as former President Bill Clinton pointed out at the Peter G. Peterson Foundation yesterday, the problem with Goldman’s business model is that its transactions have nothing to do with an actual product or the legitimate use of derivatives to hedge against risk:
I like this idea of requiring greater reserves on derivatives and I think there ought to be clearinghouses as [CFTC Chairman] Gary Gensler suggested, because I think that too much of this stuff has no economic purpose no matter who wins and who loses. And to me that’s the bigger problem. These Goldman guys are mad because they think they were targeted at this time, and they think they didn’t violate the law. I’m not at all sure they violated the law. But I do believe that there was no underlying merit to the transaction, and that’s what I think we need to look at.
Clinton isn’t kidding. As I’ve pointed out quite a bit, there are $78 dollars in derivatives for every single dollar that is used by a company to hedge against risk. This is the kind of stuff Great Britain’s chief regulator, Adair Turner, is talking about when he says that “there are some profitable activities so unlikely to have a social benefit, direct or indirect, that [banks] should voluntarily walk away from them.” As Clinton suggested, banks should certainly have to put these trades through clearinghouses, which ensure that both sides of a trade have adequate collateral to back the deal up. Even better is putting the trades on a public exchange, so that other investors and regulators can get a much better sense of what is occurring in the market.