[EDITOR’S NOTE: This piece originally ran on The Basis Point April 28, 2010, but it’s relevant again since yesterday’s Why I’m Leaving Goldman Sachs NYT op-ed is still a top financial media story. This piece was written by a hedge fund friend of mine, and he does a good job of explaining Goldman’s reputation & legal issues in terms we can all understand…]
When you win, your bookie wins. When you lose, your bookie wins. No matter the outcome of the game, your bookie skims a little “juice.” Sometimes your bookie screws you (e.g. you leave your bet with his foolproof answering service and he claims it wasn’t received before tip off). Everyone ends up hating their bookie sooner or later.
Your recourse when you have a problem with your bookie however is usually limited. Bookies tend to have friends in low places (enforcers) and typically these aren’t the kind of people you want to mess with. Ultimately the best bookies are the ones that will reliably give you action on any bet you want to make, and who have the liquidity to pay you out when you want to be paid. Further, your favorite bookie is probably the one who is a little bit lenient and gives you a couple extra days to pay up when you need the time.
And so it is, or maybe “was,” with Goldman Sachs. To be sure, Goldman’s (and every other investment bank’s) business model is similar to the one described above. Their job is to introduce parties and skim a little juice. The more complicated the bet, the more juice they tend to skim. To make the analogy complete, we can think of the BIG enforcer in the case of the financial markets as the federal government and its various governmental agencies like the SEC and the DOJ.
In much the same way bookies lubricate the machine of sports gambling, investment banks help lubricate the financial markets. In doing so, they play a critically important role in facilitating the transfer of risk efficiently through our financial system.
This is the entire premise of our capital markets.
The investment bank has no fiduciary duty to either party. If they did, it would be an obvious conflict of interest and would be unfair to one side or the other.
Some industry observers, “main street,” the popular press, and populist commentators, and it seems some people at the SEC, are confusing the relevant details of the current Goldman Sachs situation. Goldman Sachs acts as a matching agent on behalf of both the buyer and seller in a Synthetic CDO transaction. A synthetic CDO is just a swapping of risk, very much akin to a bookie’s matching up of two opposing parties in a sports gamble.
To take a long position in a synthetic CDO means by definition that someone is making the opposite bet.
Goldman’s job, as a good bookie, is to find two parties that are willing to agree on the bet and to help them reach a market clearing price.
In the case of a synthetic CDO like the ABACUS 2007 deal, the bet is just slightly more complicated because the bet is on a collection of 90 or so subprime residential mortgage backed securities, “the reference portfolio.” Without agreement on the reference portfolio by both parties, the deal cannot get done. Paulson for its part, helped to select the reference portfolio, not the collateral. And the German bank on the other side, an experienced gambler in its own right, agreed to take the other side. The selection agent, or collateral manager, in this case ACA, did select the collateral. The collateral in a deal like this can be thought of as the place where the cash gets housed while the game is being played. It isn’t the same as the reference portfolio.
The only question of fact that matters is whether or not Goldman made false and misleading statements to either party in an attempt to gain themselves.
I am doubtful that the SEC will find significant proof that this occurred. As the oracle of Omaha has told us, Goldman is home to the smartest guys on Wall Street. And these guys have been making book for a long, long time.
I am not saying they are great guys looking out for your best interests. They just happen to be good bookies.
I was at an industry conference a couple months back that was sponsored by Goldman Sachs. The conference participants were made up of individuals seeking capital and individuals looking to provide capital. I sat and listened to five presentations made by the capital-seeking crowd. In four of the five presentations, somewhat disparaging remarks were made about Goldman Sachs. It seems they got a little aggressive in calling in cash from their clientele in 2008.
I knew then that the tide was turning, however I didn’t anticipate that the enforcer would also turn on the bookie. But when you run with these powerful crowds, loyalties can change fast. It’s all about winning. And even if Goldman continues to win, it appears the time has finally come for their enforcer to hate them … at least until the next game is played.