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Defending Goldman Sachs
Okay, I know that they don't really need my help, but why not take advantage of a rare opportunity to be on their side. Ben Stein somehow got his hands on a paper by Jan Hatzius, an economist at Goldman Sachs. According to Stein, the paper outlines a scenario for a financial market meltdown stemming from a collapse in the housing market. Stein reports that Hatzius projected a 15 percent decline in house prices.
Stein then goes on to essentially dismiss the report based on the fact that house prices have never declined by 15 percent since the great depression. Furthermore, he assures readers that the Federal Reserve Board will ensure that the banks will always have enough money to keep the economy rolling. Since he has decided that Hatzius's scenario is implausible, Stein then concludes that Hatzius is pushing scare stories to promote Goldman Sachs trading strategy which has involved extensive shorts of collateralized mortgage obligations (CMOs). He then calls for Goldman Sachs to be investigated.
Stein may have missed it, but in the years from 1995 to 2006 the United States had the largest run-up in house prices in its history. This is why it is very reasonable for Hatzius to draw up scenarios assuming a 15 percent decline in house prices. The run-up makes the crash possible and even likely. That's the way markets work. The stock market had the largest decline since the great depression in 2000-2002 because it had reached the highest price to earnings ratios since 1929.
While the Fed can take many steps to offset the impact of a housing crash, it is not the all-purpose rescue vehicle that Stein seems to think. It is supposed to make loans to solvent institutions, it is not supposed to give money to insolvent ones. If a huge spate of bad loans pushes many banks to the brink of insolvency, the Fed will not be able to just hand them cash to make them financially viable
The evidence that bailouts of a collapsing financial structure is not always easy can be found on a little Asian island nation near China called "Japan." Japan endured more than a decade of stagnation following the collapse of its stock and housing bubble in 1990. Clearly its central bank and government could have pursued better policies that would have hastened the recovery, but the fact that the recovery took so long should demonstrate that it is not easy to recover from the collapse of a bubble. I would hope and expect that the Fed would do a better job than Japan's central bank in responding to the fallout from the housing crash, but it is not ridiculous to imagine it will still be a very difficult process.
In short, Stein gives no reason whatsoever to doubt that Hatzius wrote a serious analysis of the current state of the U.S. economy. Of course Goldman Sachs should still be investigated.
--Dean Baker
COMMENTS (8)
"The evidence that bailouts of a collapsing financial structure is not always easy can be found on a little Asian island nation near China called "Japan."
lol.. I think Dean wins Ben Stein Watch for this week.
Posted by: Bruce Kovner's Gas-mask | December 2, 2007 11:19 AM
Of course Goldman Sachs should still be investigated.
I can't tell if this is serious or deadpan. If it's serious, why? It seems like you've disassembled Stein's assertion of wrongdoing, or suspicion thereof, so if there's some other reason to investigate, it's from context outside of this post.
Posted by: Nathan Williams | December 2, 2007 1:13 PM
ben stein believed in the housing bubble and then all of a sudden he went off the rails. I think some people can't handle being bearish and it messes with their economic thought.
Posted by: john | December 2, 2007 1:33 PM
I am generally skeptical of Ben Stein, who has over the years been riding his father's coattails. But like a clock that doesn't run and displays the correct time twice a day, Ben sometimes, perhaps rarely, is on target. His focus on Paulson is most interesting. People who leave major positions with Wall St. firms for government service usually go right back to Wall St. (Cornine may be the exception.) So what is wrong about being suspect?
Posted by: Shag from Brookline | December 2, 2007 2:37 PM
In response to the post by Nathan Williams, I think Dean is saying that Goldman Saks should be investigated simply as a matter of course. Very funny, and of course true. Goldman Saks and other investment banks are permanenty corrupt, investigation goes without saying.
Posted by: Shaun Snapp | December 3, 2007 12:15 PM
On Jon Stewart's show (of blessed memory), Alan Greenspan admitted that lowering interest rates was food for stock market investors, and bad for savers, adding that you aren't supposed to think of it that way. As a confirmed saver, I resent the idea that we should lower interest rates to protect people in the stock market. I'm with Atrios, stay away from the big s---pile.
Posted by: masaccio | December 3, 2007 4:35 PM
With the short shrift provided as a rebuttal to Ben Stein's article, I am provided with additional evidence that Dr. Baker has not properly read or thought out the implications of Ben Stein's article. Dr. Baker's arguments are in my opinion severely lacking. Toss in condescension and flippancy and it needs a reply.
For Instance: even if it is reasonable to expect a 15% or even 30% decline in house prices why is the Hatzius paper circulating? Or this particular one of his (several) forecasts?
For Instance: You state that Ben Stein seems to think that the Fed is an all-purpose vehicle. He never said anything approaching that. Also you state that "the Fed will not be able to just hand them (the banks) cash to make them financially viable". My question is, Has the Fed ever done anything other than 'just hand over cash?' And what about recently?. In two instances you are ascribing opinions to Mr. Stein that are not his.
For Instance: you then (incredibly) compare the US to 'a little island nation called Japan'. Well, in your favor, you do say you hope the Fed would do a better job but still - no way to support an argument. I think there is merit to Mr. Stein's article and the gentle caress given it is unjust.
Posted by: T Beaton | December 3, 2007 6:04 PM
In response to the question by Nathan, Shaun has it exactly right. I was just being flippant in saying that Goldman Sachs should be investigated. There was nothing in the Stein piece that suggested serious wrongdoing. I am not in the least troubled by the fact that they were issuing instruments that were partially based on an asset that their traders subsequently shorted. This happens all the time.
On the other hand there were a lot of investors that paid real money for assets that subsequently plunged in value. I think there are reasonable questions that could be asked as to whether Goldman Sachs made full and proper disclosure when it sold these instruments.
Of course the buyers included many deep-pocketed pension funds, mutual funds, and other large investors. If they were victimized by improper behavior on the part of Goldman Sachs, they should be in a position to take the necessary legal actions.
Posted by: Dean Baker | December 3, 2007 7:17 PM