ProPublica is a non-profit investigative-journalism shop founded by Paul Steiger, the former managing editor of The Wall Street Journal. So you’d expect that when it moves into the world of finance, during a credit crisis which has thrown up its fair share of scandals, it would produce something really good.
Instead, it’s produced something really bad: a non-story about Goldman’s sell-side research on munis, larded generously with ridiculous overreach and, naturally, a generous pinch of CDS demonization. Today, the story leads in the LA Times.
The only really investigative bit of the story is that ProPublica’s Sharona Coutts has managed to get her hands on some sell-side research. Unfortunately, instead of simply phoning up Goldman’s press office and asking for it, she clearly got it through other channels — and as a result, her copy of the research has a "Proprietary and Confidential" stamp on it. Which is obviously all she and Steiger needed to conclude that there was scandal afoot.
The research in question recommended that Goldman’s buy-side clients buy credit protection on California’s bonds. As the article details, Goldman is in the process of trying to build up the municipal CDS market, and so it’s putting out research on it. I’m sure no one at Goldman thought for a minute that whenever that research suggested buying protection rather than selling it, they were risking a major exposé.
But Coutts has worked out the chain of causality: let’s assume that Goldman’s clients acted on its research. Then the price of credit protection on California might go up, and that could get people worried about California’s credit, and that in turn could show up in higher prices for new bond issues. Therefore, "the Wall Street titan’s activities could have harmed taxpayers".
Of course, the Wall Street titan’s activities could have helped taxpayers, too: by creating a liquid market in muni default swaps, investors could rest reassured that they would always be able to insure their bond holdings against default, even if the monolines all went bust. As a result, they might, at the margin, be less likely to avoid the muni market altogether.
The article, naturally, never goes there. Instead, we get this:
Some experts said the investment bank’s actions, while not illegal, might be inappropriate. "That’s not a good way to do business," said Geoffrey M. Heal, professor of public policy and business responsibility at Columbia University. "They’ve got a conflict of interest and they’re acting against the interest of their customers. . . . You act in the interests of your clients. You don’t screw them, to put it bluntly."
This is just silly. Banks are intermediaries: investors are just as much their clients as issuers are. Issuers want their banks to have this kind of conflict of interest, because it means those banks have good relationships with the investors who buy their bonds. It’s true that Goldman shouldn’t actively screw California, but I don’t think that putting out a CDS research product goes nearly that far.
Oh, and did I mention? The research hardly singled out California for shorting. Instead, California was just part of a much more general trade putting on a globally-bearish macro view:
The firm advised "shorting" — that is, betting on a price decline — in markets for corporate junk bonds, European banks, the euro and British pound currencies, and U.S. municipal bonds.
This constitutes "proposing a way for investment clients to profit from California’s deepening financial misery"? Come on. Investors want to buy in good markets and sell in bad markets. There’s no scandal there.
But of course, whenever CDS is involved, there must be scandal:
The swaps could be beneficial to the market, encouraging risk-averse investors to buy more municipal bonds. But like derivative securities in general, they can be dangerous to hold. That’s because they are often highly leveraged. A small investment can buy coverage on bonds worth much more. If defaults rise to unexpected levels, the swap sellers could be hard-pressed to make good on their promises.
The perils of the credit default swap market were brought home this year, when they were instrumental in the collapse of Lehman Bros. Holdings, American International Group and Bear Stearns. Lehman and AIG were rumored to owe far more than they could pay on swaps they had sold.
The more you look at this, the less it makes sense. "A small investment can buy coverage on bonds worth much more"? Um yes, that’s how insurance works. If you had to pay the full value of your house to insure your house, I doubt there would be many takers. As for the brief lesson in counterparty risk, it would be more convincing if Coutts didn’t go on to imply that Lehman Brothers was, like AIG, a net seller of protection: that’s simply not true.
And coming after 18 months of unprecedented upheavals in the financial markets, where thousands of previously-inconceivable events ended up happening, this is just plain funny:
What some traders found perplexing about the push for a market in municipal credit default swaps was that muni defaults almost never happen.
But when it comes to baseless speculation, it’s hard to compete with this:
The company may have hoped to parlay the swaps market into more activity in municipal bond trading, which is traditionally light because muni investors tend to hold the bonds to maturity.
Theoretically, the swaps index could lure speculators into the muni market, a development that would create much more fluctuation in daily prices, which in turn would generate revenue for trading desks at Goldman and other investment firms.
No one’s cited as source for this garbage: it seems to have come straight out of the feverish imaginations of the writers. It’s hard to know where to start — the bit about luring speculators into the muni market, for all the world as though Goldman’s some kind of Pied Piper and buy-side investors are guileless children; the very idea of the muni market as being a potential arena for speculative activity; the idea that such activity is bound to be profitable for the desks taking the other side of the trade — all of it tends to fall apart on a moment’s reflection.
Everything Goldman does in this article comes tinged with ulterior motives:
Goldman had "regularly urged" California to trade in the municipal swaps itself, ostensibly to hedge the state’s risks as a bond issuer.
Ostensibly? If California bought default protection on munis, that would quite genuinely protect the state against a rise in municipal borrowing costs. Municipal issuers regularly buy bond insurance from monolines when they issue; there’s no reason in principle why they shouldn’t save money by buying insurance in the CDS market before they issue, especially when many the monolines have disappeared from the market.
Naturally, the article ends with talk of Californian cutbacks in education and social services, linked by the most tenuous of speculative threads to that single Goldman Sachs research report. This isn’t responsible impartial journalism, it’s a gratuitous hatchet-job. And I’m frankly shocked that Steiger’s ProPublica would go there.
Update: Dick Tofel of ProPublica says in the comments that readers of this blog "should be aware of" two quotes from the story which I didn’t quote. Here they are:
"The giant investment firm did not inform the office of California Treasurer Bill Lockyer that it was proposing a way for investment clients to profit from California’s deepening financial misery. In Sacramento, officials said they were concerned that Goldman’s strategy could raise the interest rate the state would have to pay to borrow money, thus harming taxpayers.
"’It could exaggerate people’s worries about our credit,’ said Paul Rosenstiel, head of the public finance division of the treasurer’s office."
"Goldman ‘as a firm’ [is] no longer giving the trading advice to clients, [Goldman said]."
No one likes being the subject of investment-bank research which puts any kind of sell rating on a credit or stock, and California’s treasurer is no exception. But Goldman should be allowed to put out its research without fear or favor, and had no obligation to inform California in advance.
As for Goldman no longer giving the trading advice to clients, I’m pretty sure that’s a function of cutbacks in Goldman’s research department: those analysts, like Bill Tanona, no longer work at the firm. If Tofel wants to imply that they got fired because putting out this research was in any way unethical, he should come out and say so.