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Tuesday, April 20, 2010

Play to Lose

We have little sympathy for Wall Street Masters of the Universe. At the same time, we're not one of these knee-jerk "soak the rich" types: Who wants a bunch of soggy tycoons dripping about? Our point is, we try to be fair and balanced--in the literal, not the Fox News sense--in our thought process. All of which is by way of saying that, much as we'd love to see malefactors of great wealth suffer, we're not sure the government has much of a case against Goldman Sachs ("A Difficult Path in Goldman Case").

The way we understand the situation is as follows: A few years back, some financial wizard-type felt that the whole subprime mortgage market was going to implode--as, of course, it eventually did. Said financial wiz went to Goldman and got them to put together a package of dicey mortgages that he could then bet against. If he was right, and the value of the mortgages went south, he would make money (we have a tenuous grasp of how the whole "shorting" thing works, but that doesn't really matter here). On the other hand, if this guy was wrong, and the mortgages didn't collapse, he stood to lose money. At the same time, Goldman also sold shares in this portfolio to other investors, investors who were thinking that the portfolio would rise in value. The government's fraud case--at least as we understand it so far--rests on the idea that Goldman should have informed the outside investors that the portfolio had been put together based on the recommendations of someone who thought that these mortgages would lose value.

Frankly, we don't get it. We realize that, especially in hindsight, gazing out upon the financial wreckage and ruined lives of decimated homeowners, any discussion of someone planning to profit on other people's misery provokes a certain disgust. But let's pretend we're not talking about mortgages, about people's homes. What if some investor had a hunch that, say, the bottom was going to fall out of the athletic shoe market? Maybe in Jay-Z's latest video all the cool kids are decked out in Crocs and penny loafers. This investor then asks Goldman to put together a portfolio consisting of shares in Nike and Adidas and Reebok for the express purpose of betting against it. Well, if another investor looks at this portfolio and thinks it will make money, where is the fraud? Why should they be told that another investor asked for the creation of this portfolio on the assumption that it would lose money? For that matter, even if they were told this, why would we assume they wouldn't throw money into the portfolio anyway? One of the bedrock principles of investing is that some people are bulls and some are bears: Some people think stocks will rise, others think those same stocks will fall. We could imagine a situation where investors might be more inclined to buy a portfolio of stocks that someone else had "designed" to fail, on the simple assumption that the creator might have gotten it wrong.

Caveat emptor is a classic warning for a reason. If these financial titans empted without sufficient caveating, is that the fault of the seller or the buyer? More importantly, is it a crime?

1 comment:

  1. The problem with both your analysis AND the law is: None of the outrageous behaviour you listed IS the fraud! As insane as it may seem, Golman Sachs (under present law)COULD sell an instrument they knew to be crap, rate it as "good" and dump it on unsuspecting buyers (who, by the way, RELY on the "honest" evaluations of their brokers). They (under present law) COULD build a package DESIGNED TO FAIL and dump it! The "fraud" is only (under present law)in the fact that they didn't note (or, at least didn't note clearly enough) the fact that they were operating under the direction of the outside hedge-fund manager (Hence, the reason HE was not charged). The need to correct ALL this is what should be being addressed under the proposed changes. Which, by the way, isn't. But, hey, watchagonnado?

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