Kass: Ben Stein, Back Off Goldman Sachs

Stein's views on the big broker/dealer are materially misguided and unsupported by fact.
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This blog post originally appeared on RealMoney Silver on Dec. 5 at 9:02 a.m. EST.

A quick disclaimer before I defend

Goldman Sachs

(GS) - Get Report

and criticize Ben Stein's

New York Times article

(and tell you about my own role in the brouhaha): My credentials in championing consumer advocacy and criticizing Wall Street run deep. I am not your average card-carrying Wall Streeter/defender of all that is capitalist.

Thirty-five years ago, I was a "Nader Raider" and co-authored

Citibank: The Ralph Nader Report

with Ralph Nader and the Center for the Study of Responsive Law. The book was a critical expose on the dealings of the bank and how it mistreated consumers and overindulged its corporate clients. I continue to support Nader's

Citizen Works

, an organization that exists to advance the progressive citizen movement by building coalitions that speak for the public interest.

Since working with Nader, I have been more critical of the Wall Street community than almost anyone extant. (Well, not more critical than Jim Grant!) Just go through the archives or read several of my interviews or editorials I have

written

about Wall Street in

Barron's

.

And unlike the majority of Wall Streeters, I have never voted Republican.

Finally, I am currently short nearly every brokerage stock.

That said, let's move on to why I believe Ben Stein's article this weekend in

The New York Times

was so unfair and off base.

Regular readers of this column are aware of my history with Stein.

Throughout 2007, I have written extensively on what I believe to be Ben Stein's unrealistic view of the U.S. economy, as represented in a series of

New York Times

articles he penned this year.

Here are a few of those articles:

"Ben Stein Whistles Past Mortgage Mess,"

my first column on Stein's rose-colored economic views, in which he declared that the subprime mess was a media hoax in an attempt to "talk America into a panic."

In

"No Quick and Easy Fix for This Market

I discounted the idea that the subprime market was an isolated problem and how it would, over the course of time, move up the credit ladder.

Stein still chooses to ignore the mortgage mess and write "Happy Talk" in the

New York Times

.

On Sunday (and again last evening on

"Kudlow & Company"

), Ben Stein continued to demonstrate not only a Pollyanna view of the credit crisis (and its economic impact) in writing

"The Long and Short of It at Goldman Sachs"

in the

New York Times

but he also attacked Goldman Sachs, its economist (Dr. Jan Hatzius) and its former chairman (Henry Paulson Jr).

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In Sunday's column, the author made a number of allegations that "all started percolating in my fevered brain last week when a frequent correspondent, a gent in Florida who is sure economic disaster lies ahead (and he may be right, but he's not), forwarded a newsletter from a highly placed economist at Goldman Sachs named Jan Hatzius."

Being the "gent" in question, and thus feeling somewhat responsible, I feel it is my duty to defend Goldman, Hatzius and common sense:

Ben Stein criticized Hatzius ("not a serious overview of the situation") for a "combination of theory, data, guesswork, extrapolation and what he recalls as history to reach the point that when highly leveraged institutions like banks lost money on subprime, they would cut back on lending to keep their capital ratios sound -- and this would slow the economy."

Stein specifically questioned Hatzius' hypothesis that home prices would fall an average of 15% nationwide and that, as a byproduct, financial institutions would be reticent to lend. He concluded that the economist was selling fear, a consistent theme of Stein's over the year of articles in

The New York Times

.

My response: I read the object of Ben Stein's scorn three times over the last week -- Hatzius' Global Economics Paper No. 162, Nov. 27, 2007. The conclusions in his exhaustive 30-page report were well-documented, based on historical evidence and

Federal Reserve

reports and analysis, noninflammatory, and were supported by 19 exhibits -- as well as academic studies and regression models.

At the core of the entire article is that Ben Stein still believes in Goldilocks -- that all is well in the U.S. economy, the credit markets are sublime (not subslime) and that those who disagree with him are fanning fears of panic. In contrast to Hatzius' well-researched tome, Ben Stein's responses seem to be from the gut and undocumented.

Unlike Hatzius, he offers no statistical evidence in support of his views, which are as hazy as his continued contention that the mortgage problem is contained and ring-fenced -- a view that is in sharp contrast to even what the Federal Reserve's Kohn and Bernanke recently offered.

Indeed, his objection to Goldman's overview not being serious applies so much more to his own observations/musings.

As to what appears to be Stein's principal objection to Goldman's analysis -- namely, that it is unlikely for the U.S. to experience a 15% nationwide drop in home prices -- Hatzius' contention does not seem unreasonable based on the detailed analysis in the report. Nor is his prediction of a 15% home-price drop an outlier, as it conforms exactly to what the Case-Shiller Futures Market (traded on the Chicago Mercantile Exchange) predicts for home prices.

By contrast, Stein seems to provide no substantive support for his anti-Hatzius view (or of a Goldilocks economic expansion); he simply declares that Hatzius is wrong.

As I

discussed

yesterday, there is a mountain of economic evidence (which seems to be supported by recent Federal Reserve warnings) that a recession is either close at hand or that we are currently in one.

Stein also accuses Goldman Sachs of circulating Hatzius' report in order to buoy its short position in collateralized mortgage obligations, or CMOs. He goes on to suggest that Hatzius, like many others, was not objective, as there is "a tendency to paint what their patrons, who pay them, want to see."

Finally, he accuses Goldman Sachs of shorting the CMOs at the same time it was peddling the product to institutional investors -- it was one of the top 10 sellers of CMOs in the last two and a half years -- and he compared this practice to that of

Merrrill Lynch's

(MER)

Henry Blodget, who recommended companies that he really thought "were garbage."

My response: The concept of

caveat emptor

(buyer beware) is a long-standing principle in commerce that states, without a warranty, the buyer takes the risk. At times, the doctrine has been misused by Wall Street, but this is not such a time.

As Jim Grant wrote in Minding Mister Market, "Wall Street exists for a purpose, not to provide "service," not to raise capital for a growing America but to sell stocks and bonds. The higher the market, the easier it is to sell, but the more disingenuous the sales pitch beomes." Anyone who thinks otherwise is naïve: Anyone who thinks a disingenuous pitch is illegal is wrong.

There is a lesson, I suppose, why the old

New York Stock Exchange

was surrounded by a church on one side and a cemetery on the other -- it's a rough and competitive game. It is important to recognize that accompanying historically low interest rates in the early 2000s was a simultaneous advance in almost every asset class (bonds, stocks, commodities, residential and nonresidential real estate, etc.).

In this situation, it was the investor class that searched (and ultimately reached) for higher yields. In turn, the investor community increased its acceptance of risk and reduced its demands for due diligence. Wall Street simply gave investors what it wanted.

Thanks to the hard work of former New York Attorney General Eliot Spitzer (in part because of the abuses of Blodget and others), all research reports now are mandated to include lengthy disclaimers. The Goldman report includes such a qualifier stating that, among other things, the report "should not be construed as an offer to sell or the solicitation of an offer to buy anything, it is to be used for general information purposes and that from time to time, Goldman might have 'long' or 'short' positions in, act as principal in and buy or sell the securities or derivatives of any company mentioned."

Stein also demonstrates a limited knowledge of the Wall Street practice of packaging, selling and secondary market trading in securities. Wall Street firms routinely take short positions (again, which are disclosed in the disclaimer of the report) based on an opinion of the trading desk or an individual trader -- or to accommodate clients (in order to facilitate institutional trades or make markets).

As well, Goldman likely sold short the subprime mortgage indices, in part, to hedge their large book of credits. And even if Goldman Sachs took large short positions in its proprietary trading accounts, there is nothing dishonest or unethical about it.

To think that Hatzius' report would serve to reduce the general value of CMOs, and thus benefit Goldman Sachs, is extremely naïve. The CMO market is huge, and no one has that effect. Importantly, Stein doesn't realize that a firm like Goldman Sachs has profit centers that vie for compensation (read: very large bonuses). In this setting, profit centers are in actual competition with each other; in fact, they often want the other to fail. So, it is highly likely that the CMO agency department never even communicated with the CMO proprietary desk.

Finally, while Hatzius has maintained a negative view of the residential real estate market for over two years, his recent report was issued

after

a precipitous drop in the mortgage indices. (Neither Stein nor anyone else even knows for sure whether Goldman's prop desks still have their short positions on.)

During the time leading up to 2007, the subprime paper showed no degradation. Goldman's proprietary traders only could have prospered on the short starting in January 2007, so it is likely that they formed independent views from Hatzius as to the timing of the mortgage demise.

Moreover, my experience is that prop traders rely on a whole host of inputs from across the street in determining positions.

Often, their own economist (as Larry Kudlow mentioned last night) is the

least

important factor in the decision. And more often than not, the firm's economist is not even informed on the size and directional bets of the proprietary desks.

Stein also questioned whether Henry Paulson Jr. -- "who formerly ran a firm that engaged in this kind of conduct" -- should be serving as Treasury secretary.

This contention is as sophomoric as it is silly. I will go one step further: It is inflammatory and, again, not rooted in sound reason.

Stein also suggested that an inquiry be made into "what the invisible government of Goldman (and the rest of Wall Street) did to create this disaster" and into why Goldman simultaneously shorted the same product it pumped into the system.

Again, this is a ridiculous view of a conspiracy that simply doesn't exist. Goldman Sachs' alumni are in high places (Thain, Rubin, Corzine, et al.) because they have earned that honor through achievement, hard work and sacrifice.

Over the years, I have done a lot of business with and have been in partnerships with several present and former partners and employees at Goldman Sachs. I worked directly with Omega's Leon Cooperman (who ran Goldman's institutional department), the hardest-working man in the investment business, and, as such, I have witnessed the formative impact of one of Goldman Sachs' most famous alumni on his future business ethics and work élan.

To put it directly, Goldman Sachs people are universally smart, hard-working and ethical. Quite frankly, I cannot make such a broad statement about any other investment firm.

I also have read almost every book on Goldman Sachs in order to become a better investor. Back in early 2006, I highlighted John Whitehead's

A Life in Leadership: From D-Day to Ground Zero

, in which I commented on the remarkable integrity and sound business practices of Goldman Sachs.

As I mentioned previously, I try to stay away from ad hominem attacks, so I will try to be more politic than usual in my evaluation of Stein's attacks on Goldman Sachs last Sunday.

Stated simply, his criticism of Hatzius was materially misguided and unsupported by fact, and his questions regarding possible legal improprieties into Goldman Sachs' business dealings and/or its business ethics are similarly unwarranted. And Stein's analysis of the economy is equally nonsensical.

At time of publication, Kass and/or his funds were short Merrill Lynch, although holdings can change at any time.

Doug Kass is founder and president of Seabreeze Partners Management, Inc., and the general partner and investment manager of Seabreeze Partners Short LP and Seabreeze Partners Short Offshore Fund, Ltd.

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