What They Should Have Asked Goldman Sachs

"Who wants to beat a millionaire?" is how Jon Stewart summarized the testimony of a group of Goldman Sachs (NYSE: GS) executives before a congressional panel on Tuesday. I'm hardly a Goldman supporter, but he's right: This was more political flame-throwing than it was a Q&A session. Some on the panel were quite versed in the financial services industry, had done their homework, and asked really good, informed questions. Others ... eh … not so much.

But no one asked the most pressing question that would reveal whether Goldman was betting against its clients.

Instead, throughout the nearly 11 hours of testimony, Goldman execs repeated the same tune: Goldman is all about clients, clients, clients. Its main role is as a market maker, they insisted, where it pairs up buyers and sellers. To do this, it holds huge amounts of certain financial products as inventory. To offset the risk of holding that inventory, the bank hedges certain positions. In the case of housing, Goldman had a huge "short" position, which it readily admits, but this, it says, was simply offsetting an equally large "long" position. In the end, Goldman didn't make much, if any, money ... on the client-driven, market-making side.

What about the other side?
This much is true, but it's not the entire story. Goldman isn't just a market maker for clients. It also has a massive proprietary trading arm that makes direct bets with its own money. It's like a hedge fund imbedded within the bank.

Don't take my word for it. Goldman's own annual report discusses its proprietary trading operations nearly three dozen times. "[W]e assist clients with their investing and trading strategies and also engage in proprietary trading and investing activities," says last year's annual report. "In our proprietary activities," it goes on, "we assume a variety of risks and devote resources to identify, analyze and benefit from these exposures."

We also know that the proprietary traders aren't exactly at arm's length from the client-driven side. Last summer, before anyone had heard of the Fabulous Fab, there was a little brouhaha when news broke that Goldman often shares trading ideas with choice clients at meetings called "huddles" before releasing research reports. Goldman's proprietary traders also attend the huddles. And while, according to the Wall Street Journal, Goldman says traders "must first share trading-huddle tips with clients before acting on the tips themselves," they can still make trades with internal knowledge of clients' moves, even if it's after the fact.

Now, all the congressional panel had to ask if it really wanted to know if Goldman was betting against its clients is this:

Did Goldman's proprietary trading arm, and that division in particular, have a directional bet on the housing market at any time, in either direction, while your investment bankers were structuring and selling CDOs? Remember, you're under oath.

Answering this should have been pretty straightforward, and would have gotten to the bottom of the 11-hour cacophonous ramble in short order. Instead, the panel pried relentlessly into whether the short position in Goldman's client-driven market-making side constituted betting against its clients. Well, it doesn't in this case, but that's irrelevant to the real question they were seeking.

Even if Goldman answered yes, that absolutely doesn't mean it committed a crime. Just about every big bank, from Citigroup (NYSE: C) to JPMorgan Chase (NYSE: JPM) and Bank of America (NYSE: BAC), has proprietary traders in one form of another. But the panel spent hours running circles around one specific question that could have been answered pretty quickly. The Goldman execs only answered what they were asked, which you can't blame them for. It was painful to watch.

Better luck next time.