The industrial sector of the economy produces the material wealth that makes our environment beautiful, comfortable, tasty, and fun. Some of this wealth is consumed immediately, while the rest can be invested for the future. But those who spend their time producing it don’t necessarily have expertise in where to best invest it. That’s why we have banks, which specialize in figuring out the most productive avenues to channel those investments into, for maximum future gain. Unfortunately this important economic function, but for which most of us would be consigned to lives of subsistence farming, is left obscure in media accounts of the banking industry. Instead, they fixate on out-of-context negatives, real or imagined.
The media focus on parts of the industry that are undeniably distorted, but rarely on the link between these distortions and previous acts of government intervention (monetary manipulation, deposit insurance, bailouts, equity ownership caps). The media focus on the compensation paid to bankers, but never on how the institution of banking broadly makes the difference between a society of back-breaking manual labor and one of brilliant, labor-saving machines and plentiful leisure. In return for this unacknowledged gift, then, the archetypical modern image of an evil exploiter of men is: the banker.
The latest shocked, shocked revelation of supposedly nefarious dealings at a major financial institution follows the usual pattern. We are told by someone with inside knowledge that, in this case, Goldman Sachs conducts business by pawning off garbage assets on naive clients and laughing about it behind their backs. “It makes me ill how callously people talk about ripping their clients off,” Greg Smith says of his colleagues in a resignation later recently published as an op-ed in The New York Times.
Prior to this letter, Mr. Smith is alternately described, by himself, as an Executive Director and, by someone else at Goldman, as a Vice President (a more junior position). He locates himself in the firm’s equity derivatives business.
I, myself, worked in derivatives at Goldman for two years at the beginning of my career. I never observed anyone trying to rip off a counterparty, and I never heard anyone discussing it.
I, and I presume Mr. Smith as well, worked on a trading desk within Goldman that offers financial products to counterparties, making its money by selling them for slightly more than it buys them and hedging any residual risk. This is the “market-making” side of the business, in which the counterparties are themselves sophisticated financial entities like hedge funds and asset managers comprising highly paid experts whose job it is to identify, vet, and then procure the best investments at the cheapest prices. They trade with Goldman as equals, not as inferiors relying on Goldman to act as a financial advisor or ensure that a given trade is consistent with all their objectives.
In each of these trades, no one is alleging that Goldman has withheld any information about the specific nature of the products being transacted. Both sides know the content of these products and differ, if on anything, about the tough, entrepreneurial question of how these products will perform in the uncertain future.
The idea of securities markets as pervaded by a set of chiseling insiders who systematically trick their institutional counterparties into buying lemons is a myth. And even if there does exist some dumb money chasing lemons, assuming no fraud occurs, counterparties who fail to do their own jobs and identify the lemons themselves deserve to lose money. That money should not have been under their control in the first place. After they lose that money—and the real stuff it represents: the machinery, the commodities, the labor services—it will flow to someone else who can make more productive use of it. When a fool loses his money, there is no net destruction of wealth, there is only a transfer of it to non-fools.
In reality, a large bank like Goldman is best viewed not as a single business but as a confederation of 20 or 30 different businesses, the trading desks, that share risk management, logistical, and higher-level strategic functions. And it is possible for one desk to be relying on naive clients in a way that doesn’t affect and is even unknown to those on other desks.
But let us step back from the content of Greg Smith’s accusations and consider what evidence he offers us for them: his say-so. He certainly could be telling the truth. It’s also possible his reasons for leaving Goldman have nothing to do with any questionable practices but are mundane and specific to him, and that he wanted to leave with a bang. For any matter other than the strident condemnation of businessmen, and bankers in particular, would the editors of The New York Times feel content with the say-so of a single disgruntled antagonist? Would they publish what is really a journalistic hit job by passing it off as an op-ed and thus evade the responsibility of fact-checking?