Caveat Emptor

As many of you out there in finance land either read or write stories about the SEC charging Goldman Sachs with fraud, I sit on my couch this afternoon with a plenitude of different edible goodies, stuffing my face while watching the NHL playoffs.  While watching the greatest sporting event on earth (the NHL playoffs as a whole), I think about the best way to express my view of this new round of Goldman bashing.  Here’s my conclusion…

First off, I am not a lawyer or structured finance professional, yes I do understand much of legal and financial engineering jargon involved with this case, but that is certainly not my specialty.  That said, I’ll leave it to those who have far more expertise than I to pick apart the allegations in question.

Now, in doing my research on this story over the past 24 hours, it’s become supremely apparent to me just how bad main stream coverage of complicated and emotional topics such as these have become.  When I say bad, I mean the following: simply getting facts wrong, writing down to the lowest common denominator to the point that no real useful information is given, inserting an enormous amount of populist rhetoric, using a story to make a tangentially associated point, on and on.  Frankly it’s absurd just how bad the coverage has been, I’m not surprised.  To all of those who abhor the fact that our supposed quality houses of journalism are in such dire straights, and fear that there may be none left to give us quality news coverage soon, is this really good journalism?

The fact of the matter is that few if any of these journalist are experts in the fields they cover, especially structured finance.  How many people on this earth are experts on structured finance and law to the point where they should be reporting to the public on such a matter, maybe a handful?  What’s become very evident to me over the past 24 hours is the amazing quality of information and journalism that is being done by a group of financial bloggers.  The quality of their writing and analysis has far and away exceeded that of the esteemed publications.  Again, I’m not surprised.  The financial blogosphere is coming of age here, quickly.  Below you will find some of the best pieces I’ve read concerning the Goldman Sachs fraud case.

The SEC Complaint Against Goldman Sachs (Kid Dynamite)

Political Witch Hunting Is No Way to Change a Market (Fred Destin)

Open Questions About the Abacus Deal (Felix Salmon)

Moving on…

As I said, I’m not a structured finance expert, or a lawyer, so I won’t attempt to add anything to the specific conversation surrounding the SEC allegations.  But, there is something very important at the heart of this story which I would like to talk about, and it can be summed up in the simple phrase, caveat emptor.

First, let me talk a little bit about the capital markets and wall street in general.  Some people seem to believe that wall street exists for the greater good, to serve our nation in some way.  It’s time to grow up and realize that wall street has no moral duty to the public, they have no moral duty to their clients, they need only observe the laws on the books.  Wall street banks and investment firms are there for one reason and one reason alone, to make money, please don’t think otherwise.  I really don’t care for the argument that they don’t “make anything” or add to society in any way, I can make that argument about plenty of industries and people, but that doesn’t mean what they do should be changed or deemed illegal.

Next, most large firms on wall street or not there to make money for their clients, they are not investment managers.  Most are broker dealers, and the job of a broker dealer is to move paper.  By this I mean that these firms serve the purpose of being the intermediary between the business looking to raise capital and the investors looking for yield or capital appreciation.  The more paper they move, the more they get paid, it’s very very simple.  There are of course rules they must abide by when they do this, but make no mistake, they are not there to pass judgement on the paper they sell or the deals they put together.

As for the proprietary trading desks or internal hedge fund units of our larger financial institutions.  Why should firms like Goldman Sachs be vilified for taking short positions on the same products they sell to investors?  Please, make me a case because I’d really like to hear it.  See, instead of vilifying the other banks and investment groups who held these pieces of crap and pushed the financial system to the brink of collapse by losing so much money, people want to blame Goldman Sachs for having the foresight and risk management practice to not only stay away from holding these products to a large extent in the first place, but to take advantage of an opportunity to make money on the short side.  I just find this to be completely backwards, don’t you?  Although their actions should never be described as moral, for anyone in the business world they should be seen as a shining example of success.  Is Matt Tiabbi correct when he says that Goldman blows bubbles taking advantage of them both on the way up and on the way down, sure, that’s their job and I see nothing wrong with it.  Do they take advantage of the wider spreads that come with making deals in new markets, sure, so if you want to say that they are the vampire squid which sticks its blood funnel in every crack of society, go ahead.  But I’ll fight you every step of the way while you complain that what they do is illegal or in some way hurts the average man.  Moving on…

There is some kind of strange argument out there that says everyone who works in finance from the 1st year analysts all the way up through the CEO don’t deserve to make the kind of money they do.  Let’s just take Goldman Sachs for example.  The compensation model is built on the idea that Goldman Sachs operates as if it was a partnership.  In a partnership, the profits are distributed to, yes you guessed it, the partners.  I don’t understand why anyone should see it as strange that Goldman Sachs and many other wall street firms pay out half or greater of their revenue to their employees.  Who should they give the money to, charity, the government?  There are a whole group of people who complained that financial firms were paying out huge dividends to shareholders while they were losing money, so I doubt that’s your answer.  These institutions aren’t there to be non profits people, they are partnerships, the employees are the firm.  Now, taking bailout money when your firm is broke, and then paying your employees the same money they were getting when profits were abundant is utterly ridiculous, I won’t argue with that.  But I’m not here to talk about the bailout, we’ve been through that.

So here’s my plea…

It’s time that Americans realize that the capital markets are a two way street.  There is always someone on the other side of the trade, and it’s your responsibility to know who when you get involved.  The heart of the SEC allegation against Goldman deals directly with this issue, and there may or may not be some legal merit to the fact that Goldman did not disclose how the product was put together.  As I said, I’m not a securities lawyer so I won’t comment.  But the media, and many other people are attempting to make a different case.  They are trying to say that Goldman is guilty of selling a deal that they then went and shorted.  I repeat, there is nothing illegal about that, it is not their job to pass judgement on the deals they put together for investors, their job is to move paper.

To those out there in the institutional investing world:

It’s time that you start doing some god damn due diligence on the investments you make.  You’ve got to know who’s on the other side of your trade.  No one is forcing you to make any investment, when you sign that contract or push that buy button you’ve got to make sure that you have all the information.  you want to know what I call this allegation against Goldman Sachs, a sore loser crying to the government that they got beat at a very difficult game by a very smart market participant.  They had all the tools to avoid getting involved in this trade, just as AIG had the same tools.  Is it really the American way to be a sore loser?  I really just can’t stand this crap.  Investors putting their money into hedge funds have got to know what strategies they are running, and if they refuse, go tell them to screw themselves.  The same goes for pension funds and public investment pools.  When did risk management and due diligence get thrown out the window, this is the real crying shame!

And more importantly to those out there in the retail world:

CAVEAT EMPTOR!

The capital markets are a scary place.  Many of you do not have the tools or education to be taking part in them by investing in risk assets.  The markets are not there for your benefit, they are there for the benefit of companies trying to raise capital.  Being smart does not mean that you have the education to take part in the capital markets, in fact, I know a lot of pretty dumb people who are excellent market operators, and a lot of very smart people who are completely clueless.  The markets aren’t a one way street, the short side is just as moral and legal as the long side.  The markets aren’t supposed to just go up so that the average joe can retire at 60.  Do not trust anyone but yourself or your investment manager to make decisions on the value of an asset, and above all else, do not trust any sell side research firm or ratings agency.  Do your own research or don’t invest.

Look, I’m not defending the morality of Goldman Sachs or the wall street model, I’m just trying to say that negligence is no excuse for being beat.  If you want the model changed, lobby your representatives to change the rules.  But please, stop with the populist crap, it gets us nowhere and often retards the progress of real reform, which is sorely needed.

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