Financial Crisis Commission Testimony: Goldman's Cohn Defends Derivatives

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Goldman Sachs's second in command, Mark Cohn, testified before the Financial Crisis Inquiry Commission as part of a hearing on derivatives Wednesday. When Goldman Sachs's (GS) second in command, Gary Cohn, testified before the Financial Crisis Inquiry Commission on Wednesday, he came across, somewhat surprisingly, as clear and charming -- far more so than Goldman CEO Lloyd Blankfein had during his Congressional testimony in April. First of all, Cohn (pictured) opened with an apology: an apology about the Commission's frustrations in getting documents from Goldman, not about Goldman's role in the crisis, but still, an apology. And that's not all.

While nothing that was said during the hearing on derivatives Wednesday -- and in particular the portion focused on Goldman Sachs's relationship to AIG (AIG) -- should affect the Securities and Exchange Commission's lawsuit or other litigation against Goldman, Cohn was worth watching.

'No Denial'

Asked why Goldman came through the crisis so well, Cohn explained that Goldman "marked our portfolio to market every day," even if it thought the prices of the trades were inappropriate. This mark-to-market, or fair value, accounting, means that it kept current with the market values, not the book values, of its assets. Goldman had "no denial" built into its valuations.

While Goldman's valuations were denial free, Cohn's description of how Goldman got more than $12 billion in taxpayer money from American International Group was oddly passive. He said, essentially, that the government made the company take the $12 billion in taxpayer money that it received.

Cohn and his colleague Craig Broderick stressed that they didn't ask AIG for the money; they took it at AIG's request, "consistent with the government's plan to make AIG's counterparties whole." Cohn emphasized that Goldman made no demands on taxpayers: "In the eleventh hour, when the Federal Reserve was trying to strike a deal with the counterparties with AIG, we were sent documents on a Sunday afternoon" and strenuously urged to sign them. Cohn also denied that Goldman would be in trouble without the money, noting that it had hedged the risks of its exposure to AIG.

Defining Goldman's Business

Cohn defined Goldman's business in two ways, first describing Goldman as "client facilitators" and then more frequently calling its business "risk management." The "client facilitators" commend was surely aimed beyond the panel to Goldman's many clients, given charges that Goldman bets against its clients. Although Goldman has rejected those charges before and did again today, it has acknowledged conflicts with its clients.

Meanwhile, risk management was why Goldman started shorting the mortgage market at the end of 2006, Cohn said. Goldman's profit and loss reports showed results that were at odds with its risk reports, and the discrepancy acted as a big red flag that prompted the shift. Risk management was why Goldman planned to convert into a bank holding company before the financial meltdown occurred. Being in the risk-management business, rather than the investing business, was a key reason why Goldman fared better than AIG, Cohn hypothesized. That and Goldman's relentless mark-to-market accounting.

Responding to a lot of criticism about derivatives, Cohn defended them better than anyone else I've seen testify so far. He described financial structures like synthetic collateralized debt obligations and naked credit default swaps as similar to more familiar securities, like those based on the Dow, because each involves reference securities. He also claimed that derivatives are socially useful in five ways, although those ways were along the lines of "brought in more capital" and so were debatable. But at least he had a direct answer to the question.

The hearing continues tomorrow with two panels, one on AIG and Goldman and one on the regulators.
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