The Goldman hearing before a Senate subcommittee continued this afternoon with Senator Claire McCaskill (D-MO) addressing Goldman's role in market making with regard to synthetic Collateralized Debt Obligations -- the type of security at the heart of the SEC's claim. McCaskill actually uses an accurate analogy for Goldman's role, calling it a bookie. She's right: as a market maker, Goldman and other investment banks act a lot like a bookie by lining up investors who want to take separate sides of a bet. But she takes the analogy a little too far.

Bookies set the "line" of a bet, the price and return that can result from a bet. McCaskill accuses Goldman of doing a bad job of setting the line, since those who bet on the housing market lost quite badly, while those who bet against it did quite well. The problem with this claim, however, is that unlike bookies, market makers don't set the line -- the market does. All the traders do is align investors based on market demand and supply.

So why did those who shorted the housing market in early 2007 make so much money? Because the market was very, very wrong. Thus, any securities that would have provided a short on the subprime mortgage market would have been very, very lucrative. The same thing happens when an underdog is largely expected to lose a sporting event, but wins. If the odds were 50 to 1 for that game, then anyone who took that bet would be rewarded very handsomely.

But Goldman, and other broker-dealers, didn't set the housing market odds -- investors did. Most got it very wrong, which is why so many lost so much money. Investors were so far off, they triggered the worst financial crisis since the Great Depression. The few that got it right, however, made a killing.

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