Thursday, April 29, 2010

Rotten Eggs and Rotten Legislators

Professor Bainbridge does a terrific job explaining why the Senate hearings on Goldman Sachs struck me as stupid...
Maybe Goldman sold investors some rotten eggs. Maybe not. So what? Goldman argues that it is being "railroaded by Congress for performing a normal market function—pricing risk and providing investment opportunities for grown-up investors," which strikes me as precisely right. It is a central tenet of the federal securities laws that you're allowed to sell rotten eggs, so long as you disclose that they're rotten. So long as Goldman fully disclosed all material facts, the fact that Goldman thought the securities being sold were "shitty," as one scatological email reference by an unwise trader put it, is not a breach of the securities laws.

...the New Deal Congress explicitly rejected the blue sky regulatory model in favor of a disclosure-based system. The SEC thus has no authority to pass on the merits of an offering of securities.

The system that resulted fairly has been called a rotten egg statute. You could sell all the rotten eggs you wanted as long as you fully told people just how rotten they were.

It would behoove the US Senate to learn this history before they conduct their next perp walk.
I saw another pretty good analogy on this point -- Goldman is the equivalent of a Vegas sportsbook offering a number of esoteric bets to gamblers. The folks working at the casino are taking the opposite position on any bet that comes in -- that is, they will win if the bet goes wrong for the gambler and vice versa. The politicians on the Senate panel seem to think that the casino has a blatant conflict of interest that should render the deal invalid.

But that's patently idiotic -- everyone on both sides of the transaction damn well knows the casino's on the other side of the transaction. If the bet is made according to set terms and neither side finds a way to manipulate the price or the odds unfairly (like fixing the outcome), it doesn't matter if the casino thinks the bettor is making a "shitty" deal.  The bettor wants to speculate, and the casino is providing him a means of doing so.  We could argue as to whether it's a good thing to allow such speculation, but we do allow it, and it seems moronic to claim that it's illegal to find a way to make a profit off of it.

The SEC case, for all its potential flaws, is substantially different than the critique levied by Carl Levin and his band of merry legislators.  The SEC case at its core is based around the idea that Goldman in some way lied about how the financial products it was selling were created -- the case is not premised on the idea that it's sinister that Goldman was on the other side of the transaction. 

Congress is merely screaming about Goldman's entirely legitimate role in selling the products themselves, which isn't even a concern for the SEC.  The problem here is that Congress wants to be seen shaking an angry finger at Goldman, because they did something "wrong." Never mind that nothing in the statute prohibits what Goldman did -- it's somehow wrong, period.  Unfortunately, the real wrong is that Congress can waste so much public time -- and money -- and succeed only at looking like idiots.  Then again, perhaps that's Congress' only true role.

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