It's time to finally lay to rest claims stretching back as far as 2007 that Goldman Sachs was peddling securities backed by at least risky home mortgages while it was secretly betting that the US housing market was in trouble.
Far from being "secretly" down on the US housing market, very early on Goldman was publicly and privately warning that home prices would decline and that this decline would have an impact on mortgage backed securities.
The complaints about Goldman being on both sides of the mortgage trade stretch at least as far back as December, 2007. Ben Stein wrote a column complaining that Goldman had sold mortgage backed securities while it was shorting them. At that early date Goldman economist Jan Hatzius was saying the US housing market would cause serious problems for the economy. At the time, Stein was convinced that Goldman convinced that Goldman was over-playing the negative case to cause a panic and make its short bets pay out.
(Actually, it goes back even further than that. Stein's column was in part based on an earlier piece by Allan Sloan, to which I cannot find a link at the moment.)
More recently, the Goldman conflict conspiracy theory was taken up by Matt Taibbi. Today we got the most thorough version of this from McClatchy's Greg Gordon. The latest report says that in 2006 and 2007 Goldman sold $40 billion in mortgage back securities but "never told the buyers it was secretly betting that a sharp drop in U.S. housing prices would send the value of those securities plummeting."
But that really isn't true.
We know from Andrew Ross Sorkin's book Too Big To Fail that in 2007, Goldman Sachs was telling AIG it needed to put up more collateral for its credit default swaps. The reason? Goldman thought the mortage backed securities that AIG was insuring faced greater losses than previously anticipated. This view was brought up a number of times by senior people at AIG and became an "major irritant" to AIG financial products boss Joe Cassano. (See page 157 of Too Big To Fail.)
Similarly, Michael Lewis reports that in early 2006, an AIG employee was told by a Goldman guy that the mortgage backed securities insured by AIG were headed for trouble. "Between you and me, you’re right. These things are going to blow up," the Goldman employee reportedly said.
Even more tellingly, Goldman's top economist was warning about the housing market way back in 2005. In reaction to a study published by two academics in the Wall Street Journal that purported to show there was no housing bubble, Hatzius authored a note titled "Bubble Trouble? Probably Yes."
It was written in the same cautious language of most of these Wall Street economists notes but it's message was unmistakable: house prices are over-inflated and due for a serious decline. Hatzius reckoned that if interest rates increased, house prices would have to come down because the price increases had far outpaced the rise of incomes. What's more, this was hardly a "secret"--Hatzius gave Business Week permission to publish his note in full.
Here's a sample:
Thus, if interest rates rise from their unusually low current level, house prices would decline, perhaps sharply. An interest-rate-induced decline in house prices might have fewer macro implications because the interest rate increase itself might be the result of strength elsewhere in the economy. But, the house price decline would nonetheless be painful.
Of course, we now know the "macro implications" were far greater than Hatzius anticipated in 2005. But there can be little doubt that Goldman was publicly warning about house prices very early on. Which means these latest charges that Goldman was somehow misleading those who invested in mortgage backed securities are simply bunk.
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