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Island Investing

Riffs, rants, and the upside of investing from way off Wall Street


Island Investing: Goldman Sachs

My column today from the best little newspaper south of Jewfish Creek, the Keys Weekly.

Q. What exactly did Goldman Sachs do to get into such trouble?

A. Late last week, the country’s premier investment bank Goldman Sachs was accused of securities fraud in a civil suit filed by the Securities and Exchange Commission. The SEC claims Goldman created and sold a complicated mortgage investment that was covertly designed to fail.

The investment that Goldman sold to investors was called a synthetic collateralized debt obligation, or CDO, which is essentially a bet on another bet tied to a bundle of very low quality mortgages. Goldman appears to have tricked investors into believing the CDO was being managed by people who wanted mortgage holders to keep making their payments, when in reality it was secretly created by a hedge fund that was the world’s biggest short-seller in the subprime mortgage market. Those guys badly wanted the mortgage holders to default, and they did. Investors lost over $1 billion, while the short-seller made a profit of $1 billion.

Why would Goldman do this? Fees – both from their own role in structuring the deal, as well as those paid by the hedge fund for other services it may have had Goldman provide. Whether or not Goldman made money by actively betting against the same bad CDOs they secretly helped create remains to be seen.

The case is significant for a number of reasons. The first is – and there is really no pleasant way to put this – the SEC has been a consistently horrible regulator for quite some time now. Pursuing this case against Goldman may mean the agency has finally found a spine. It also means the odds of serious financial reform just increased dramatically because Goldman can no longer push back.

This case highlights a major flaw in the business models of Wall Street banks, too. Namely, they treat their customers atrociously. The ultimate outcome of this case is in some ways immaterial. Everything you could ever want to know about how dishonest a big Wall Street bank can be is summarized in this case. And it is far more damaging than a lawsuit could ever be.