May 5, 2010

When Bad Things Happened to Good Firms, Like Goldman Sachs

Like many of you, I suspect, I've been following with some interest the latest act in the financial reform circus: the Goldman Sachs case. Despite the fact that Goldman executives looked inexplicably bad in front of Congress last Wednesday, April 28, I have to admit that I'm a bit conflicted on this one.

On the one hand, I don't believe that the SEC has any case against Goldman, nor does the case have anything to do with a fiduciary duty. On the other hand, it just might be the catalyst for getting a broker fiduciary duty reinserted into the Dodd financial services reform bill. Do the ends here really justify the means?

The case against Goldman is based on a complicated transaction, which by carefully picking and choosing a few isolated "facts," has been made to look bad to unsophisticated people such as Congress, the public, and, of course, the media. But the salient points tell a different story to anyone who's truly interested in getting to the bottom of this. Looks to me like Goldman CEO Lloyd Blankfein got it exactly right when he told Congress: "While we strongly disagree with the SEC's complaint, I also recognize how such a complicated transaction may look to many people..."

To my mind, here are the relevant facts:

  • The investment in question--Abacus 2007-1--is a synthetic CDO transaction in which one party takes a long position on the underlying securities, and another party takes a short position. Point: German bank IKB and hedge fund ACA, who split the $1 billion long position, knew that another firm would be taking the $1 billion short position, and that one of those two positions would lose $1 billion. The short position that Paulson & Co. (also a hedge fund) took was no hidden trick.
  • IKB and ACA lost $1 billion and are now trying to claim they were unfairly tricked, filing claims with the SEC. Point: Whining losers don't prove anything.
  • Paulson & Co. "worked with" ACA to "choose" the CDOs.

Point: This is very vague language which could mean anything from allowing ACA to use Paulson's database to having his firm help identify CDOs that fit ACA's criteria. Since Paulson hasn't been charged with fraud or any other crime here, it suggests that this was a benign event that simply "looks bad" out of context and was the only straw that ACA and IKB could grasp on which to base their shaky claims.

  • IKB and ACA are giant institutions and among the most sophisticated mortgage investors in the world, demonstrated by among other things their ability to place a $1 billion bet on a pool of mortgages.

Point: Their sophistication combined with their access to and choice of the 90 CDOs in Abacus means that the long investors were fully capable of and informed enough to make their own decision on whether to go long in this investment. Contrary to how they've been portrayed in the Congressional hearings, these are not Mom-and-Pop investors and had no need to rely on Goldman's advice to make their investment decisions.

To recap: the ultra-sophisticated "clients" knew there would be an equally sophisticated investor betting $1 billion against them in the Abacus investment, had ample access to the underlying investments (they picked them), did not rely on any representations or misleading information provided by Paulson & Co. (or it would have been charged), and clearly had as much expertise as Goldman or Paulson to evaluate the investment in question. This is an unbelievably weak case, trumped up by the losers to recoup their $1 billion and the SEC for reasons that look suspiciously political (two of the five SEC commissioners voted against filing the case, in a very rare lack of solidarity).

The bottom line? In my view a broker fiduciary duty is the most consumer-oriented part of the whole financial reform. So, I guess on balance, getting a good law for the wrong reason is still a win for financial consumers.

I wonder how the Goldman folks feel about taking one for the team?

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