Breaking News! Goldman Sachs is being sued by the SEC! They made money off of a trade that bet against the housing market! They bet against YOU the people! String ’em up. Take their money and spread it around!
Seriously though, Goldman Sachs is being sued because they played broker to two opposite sides of a trade. It’s interesting that the reason that they are being demonized is because they failed to disclose and they must have made a bunch of money. Not to mention they received TARP funds. Is this really a big deal, or is the media (gasp!) sensationalizing it?
Let’s look at the case and see if we can determine if Goldman played fair:
Henry Paulson of Paulson and Co Hedge Fund wanted to bet against the housing market. Specifically, he expected that CDOs (basically bonds with smaller debts imbedded) carrying garbage mortgages would collapse. So what did he do? He went to Goldman Sachs and asked them to take the other side of that bet. Goldman found a group of accredited investors (defined as having extensive investment knowledge and expertise as well as a lot of capital) who would bet that the housing market would continue to go up.
There were perhaps a handful of people in 2006 (when this trade occurred) who thought that the real estate market would never stop going up. Paulson was one of them. The allegations are specifically that Goldman failed to disclose that there were in fact garbage mortgages in the CDOs. This may be true, and if it is, Goldman has some explaining to do. However, I have looked at their presentation on synthetic CDOs and read the disclosures, which like most financial services company’s disclosures basically say you can lose all of your money and there are no guarantees.
As for the opposing parties not knowing what were in the CDO’s, they have armies of securities attorneys and analysts look over those things before they would make such a huge trade.
Turns out Paulson was right, his fund made over a $1 billion on the trade. The other people lost money. Goldman included. What the news won’t tell you is that they lost $90 million on that trade and only made $1.7 million on the commission. It makes little sense that they were purposefully hiding information from anybody.
Subsequently, Goldman began making money off of betting against the housing market (I wonder why?). It makes sense that after their experience losing money on this trade that they would bet in the way the wind was blowing and in fact did. There is no fraud or crime in that. Most corporations try to make money. And many, when they do, give gobs of it away. Does this excuse bad behavior? Of course not. There may, and I stress MAY have been some ethics violations, for which anybody should be held accountable. But to sue a company for failure to disclose, when it is obvious both parties knew what they were getting into is preposterous.
As for TARP funds. I know people are up in arms about the TARP money, but Goldman was the first to pay it back and may not have even needed the money to begin with.
Media sensationalism though, it may not be. Many take this case as the reason we need financial reform. I’m all for financial reform to protect investors. However, I’ve found that the simplest option is the best. The more we try to complicate regulation, the more likely ordinary investors are likely to get screwed. In this case, it was sophisticated investors who apparently didn’t read correctly.