Wednesday, May 12, 2010

Why single out Goldman?

My earlier post on the fraud case against Goldman has drawn some strong responses. I can understand the anger against firms such as Goldman. But it cannot be that Goldman becomes a target because it has been more successful than others. The case against the integrated investment banking model, with its potential conflicts of interest, has not yet been made.

An article in FT points out the pervasiveness of the practices that form the basis for the present against Goldman.

Of the banks that dominated the market a few years ago, why would the government target the only one to survive the crisis financially intact? It is not because Goldman was unique. In Abacus 2007-AC1, Paulson & Co, a hedge fund, suggested securities for the deal and also bet against it in a swap with Goldman. That feature is not uncommon. According to a recent report from ProPublica, there were 26 deals in which Magnetar, a hedge fund, both sponsored CDOs and bet against them. (Magnetar says these deals were perfectly legal.) They were arranged by Citigroup, Credit Agricole, Deutsche Bank, JPMorgan Chase, Lehman Brothers, Merrill Lynch, UBS and others (not Goldman). There are hundreds of non-Goldman CDOs that no one has yet investigated.

.....More fundamentally, if the other big investment banks had made similar “net short” trades in 2007, there would not have been a financial crisis. Bear Stearns, Lehman Brothers and Merrill Lynch collapsed because they took massive positions in the opposite direction. Given the cost of government bail-outs, why chastise the only prudent investment bank?
I am no unabashed admirer of Goldman. But it is hard to resist the impression that Goldman is being targeted because it survived and remains profitable. That is quite ridiculous.


Anonymous said...

"But it is hard to resist the impression that Goldman is being targeted because it survived and remains profitable. That is quite ridiculous...."

Mr.TTR: i) Yes, Goldman is being targeted because it survived; this is a tautological judicial principle - you cannot target someone who has not survived.
ii) Because it is successful. Yes, because success, if you want to call it that in "management" speak, is a "revealed" approach (a la revealed preferences) of their shenanigans, insider trading, oligarchic connections and overall devil-take-the-hindmost-simpleton strategy.

Usually, I've found myself in frequent agreement, but perhaps the geographic, institutional and operational distance has confused you. Please find out more - there's ample stuff out there ....

blackadder said...

Perhaps we will never agree on this, but taken to its logical extreme, the GS defence makes any concept of fraud / deception invalid. Any transaction takes place because the buying and selling party agree based on the information they possess. Now if, hypothetically, I was to sell you milk mixed with water, I can say that you were free to get the milk examined by a lab before buying it or conducting a quick test on it yourself. Will this defence absolve me of all the blame? The point being made here is the disclosure norms are designed to minimize market failures due to information asymmetry. Firms like GS by indulging in such behaviour make the development of a smooth capital market more risky because counter parties will be more conservative in taking the opposite side of a trade. Given that one of the functions of a market is to allocate capital efficiently, surely this goes against the noble principles of trust. Am sorry to say, GS's approach is pretty much like a Viking pillage raid.

Anonymous said...

Anonymous, bear stearns, lehman individuals can still be targeted. Remember repo 105, what about a criminal case on that?

Secondly, there are no simpletons in Goldman's world - it has no products catering to the retail investor.

blackadder, remember that the milk was rated by a rating agency. Remember that the milk components were selected by a third party specialist that lost money (along with Goldman).

Remember that everyone knew that they were subprime mortgages. Remember that it didn't matter in the end which ones they would have chosen.

Also note that Goldman was clearly not acting in a fiduciary role as they would in their investment management business.

I do have a problem with the weird process of the deal - why the disclosure to ACA about Paulson's interest? And, did the german bank know about Paulson's involvement?

Ideally, in a market making scenario, GS would give Paulson the exposure it needs without disclosing his identity to others. And, then go look to hedge their exposure by selling to german banks or what have you. ACA could have been given a preferred list (that was Paulson's list) without actual disclosure and ACA would in its main role do whatever the heck it was supposed to do (unclear to me) in an unbiased way without knowing about the end investors.

There was absolutely nothing wrong with the outcome but the process was a bit shady and could be tightened.

Anonymous said...

Additional points:
Ofcourse, the ratings agencies were far more culpable and if there was some proof of coercion from GS then that would be charge-able.

Also, remember that this deal is probably the worst instance that SEC could find. If that is the case, its pretty mild overall for GS as per my last comment.