Team Goldman

While I realize this post has absolutely nothing to do with what I normally (for 4 posts) write about, but I figured I would switch it up.

After watching the Committee on Homeland Security and Government hearing regarding the role of investment banks in the financial crisis (cause Goldman Sachs was the only investment bank during that time?) it got me wondering why this whole SEC civil suit was such a big deal. For those who dont know the SEC filed a suit on April 16 against Goldman Sachs essentially claiming that Goldman knowingly betted against their clients. That is the easy version of what it is about. More complexly, the SEC claims that Goldman knowingly created a colateralized debt obligation (CDO) with Paulson & Co. (a hedge fund) through ACA Corp. and filled it with mortgage backed securities that were extremely risky, though highly rated. Goldman and Paulson & Co. decided to take a short position on this CDO (they bet against the success of the CDO, they essentially bet that the CDO was going to fail). Now Goldman then sold this CDO, named Abacus, to its investors. For a CDO to work, for every short position you need a long position (betting that the CDO would be successful). Goldman's investors were taking a long position, while Goldman itself was taking a short position. At the time when the Abacus CDO was made, April 07, it would have been a little odd for someone to take a short position on a housing CDO mainly because everyone thought the housing market would continue to decrease. It would have been more common for someone to take a long position on a CDO made up of these securities.

Now here comes the issue with the SEC, Goldman never told its investors that it was taking a short position on this CDO. They also think that if its investors had known that Goldman was shorting the CDO that it would have changed investor behavior, a hypothetical situation. Another issue is that supposedly investors thought Paulson was taking a long position, essentially they didnt know that Paulson was shorting the CDO. The SEC is saying that had investors known this it would have changed investor behavior, another hypothetical situation. Now had Paulson been a big name hedge fund at the time, it may have changed investor behavior. From my understanding Paulson was not that big of a hedge fund at the time and would have probably had a very small impact on investor behavior.

My other issue is, while Goldman knew the securities going into the CDO were pretty much junk, they were rated AAA by both Moddy's and S&P and it wasnt until 6 months later that the securities in the CDO were downgraded (Goldman didnt actually know that the securities were going to be downgraded or that the housing market would crash, they were just betting that it would). I think this become more of an issue with the credit rating agencies than it does with Goldman. Goldman was just smart enough to know that the securities werent the best regardless of their rating. Yeah, ethically, I do think that maybe they shouldnt have been as willing to sell highly rated "junk" securities to their investors but still investors knew the securities that were included in Abacus and they could have easily of done their homework. Regardless of their ratings, alot of investors were willing to buy these incredibly risky assets because 1. they thought the housing market was going to continue rising and 2. the riskier the asset the higher the payoff.

This also brings up the issue that during the early to mid 2000s investors relied heavily on credit rating agencies and what other people were doing. Dont invest in something unless you know what you are investing in. Coming from a lazy person, I probably wouldnt have done my homework, but looking at this case now, I know that if I ever invest in anything I will definitely do my homework, or I wont invest.

Had this issue come up in July or August of 2007 I dont think Goldman would be charged with anything. I think the only reason they are getting charged now is because the market crashed, and they read the market correctly. As a result, I think Goldman didnt necessarily do anything illegal, while it may have been morally questionable, but lets be real banking isnt the most morally sound industry (while I really wish it was). And yeah maybe we do need some more morals in the banking industry but I dont think that is the governments job I think it needs to be individual bankers who make the decision to stand by their investors rather than profits.

In the end, for now at least, I am all for Team Goldman!

Some interesting articles to read:

Abacus Deal: As bad as they come

Trader's Testimony Raises Legal Issues