Did Wall Street Bet On Failure?
"Did Wall Street bet on failure?" This headline appeared in a widely read trade magazine. The article further asks whether Wall Street firms engaged in activities created a conflict of interest with their own clients.
Let's skip the drama and get to the answer: yes. Of course, that's not what the article says. Instead the article refers to a New York Times article that points to an "investigation" that will determine whether it's true or not. The "yes" comes from me. How do I know?
First, let's clarify the allegation. Basically the big boys, Goldman Sachs, Morgan Stanley, Deutsche Bank AG, et al sold CDO's - a sophisticated derivative product that played a big role in the recent financial crisis - to their clients. Then they turned around and "shorted" the same products they sold their clients.
In case you're not sure what this means, it's basically that they sold something to their clients, then bet against it. The net effect would be that they would make money on the sale, then make money again if the products failed. The Wall Street firms would make money twice. Their clients would lose money.
Add to this the fact that these smart, sophisticated bankers and traders would not have bet against these products if they thought that the products had a chance to succeed. In other words, they probably knew that there was a high probability that these products would fail and sold them to clients anyway, simply to make a buck (a very BIG buck, by the way).
This, friends, is a conflict of interest - you see that, right?
Now the article in the trade magazine takes more of a "wait and see" attitude. It would seem they're trying to be objective - you know, innocent until proven guilty. The editor points out, for example, that if the firm selling the products were itself heavily invested in them, the shorting activity (betting against them) could be simply part of normal hedging activities that the firms normally engage in.
Seems fair and evenhanded taking this position, doesn't it? So am I jumping to conclusions? I don't think so.
First of all, Lloyd Blankfein, CEO or Goldman, in recent testimony to Congress, already referred to similar activities his firm was accused of and characterized them as "improper" and admitted his esteemed firm engaged in them. (I'm not sure if the activities to which he referred were the same as the ones this article discusses.)
Next, you can read a particularly egregious example of similar activities on the part of Goldman Sachs in the book "When Genius Failed" by Roger Lowenstein. The author details how, back in the late 90's, Goldman sold massive amounts of Russian bonds to clients, then bet against them. The bonds failed, so Goldman made money on the sale to their clients, then made a fortune shorting the bonds: exactly what they're accused of doing today.
By the way, Blankfein did not mention this notorious incident in his recent testimony. He made it sound like Goldman's current "improper" activities were an exception to the rule.
Will Goldman and the other firms get away with this? Probably. Maybe they'll pay a fine if the evidence is so overwhelming that some gesture has to be made to keep the public calm and dumb. We'll see. I don't think Goldman ever paid a price for the Russian bond deals. And I don't know how many other conflicted deals these firms have made. But do you think it's a safe bet to say there have been others? I'll leave it to you to answer that.
Let's skip the drama and get to the answer: yes. Of course, that's not what the article says. Instead the article refers to a New York Times article that points to an "investigation" that will determine whether it's true or not. The "yes" comes from me. How do I know?
First, let's clarify the allegation. Basically the big boys, Goldman Sachs, Morgan Stanley, Deutsche Bank AG, et al sold CDO's - a sophisticated derivative product that played a big role in the recent financial crisis - to their clients. Then they turned around and "shorted" the same products they sold their clients.
In case you're not sure what this means, it's basically that they sold something to their clients, then bet against it. The net effect would be that they would make money on the sale, then make money again if the products failed. The Wall Street firms would make money twice. Their clients would lose money.
Add to this the fact that these smart, sophisticated bankers and traders would not have bet against these products if they thought that the products had a chance to succeed. In other words, they probably knew that there was a high probability that these products would fail and sold them to clients anyway, simply to make a buck (a very BIG buck, by the way).
This, friends, is a conflict of interest - you see that, right?
Now the article in the trade magazine takes more of a "wait and see" attitude. It would seem they're trying to be objective - you know, innocent until proven guilty. The editor points out, for example, that if the firm selling the products were itself heavily invested in them, the shorting activity (betting against them) could be simply part of normal hedging activities that the firms normally engage in.
Seems fair and evenhanded taking this position, doesn't it? So am I jumping to conclusions? I don't think so.
First of all, Lloyd Blankfein, CEO or Goldman, in recent testimony to Congress, already referred to similar activities his firm was accused of and characterized them as "improper" and admitted his esteemed firm engaged in them. (I'm not sure if the activities to which he referred were the same as the ones this article discusses.)
Next, you can read a particularly egregious example of similar activities on the part of Goldman Sachs in the book "When Genius Failed" by Roger Lowenstein. The author details how, back in the late 90's, Goldman sold massive amounts of Russian bonds to clients, then bet against them. The bonds failed, so Goldman made money on the sale to their clients, then made a fortune shorting the bonds: exactly what they're accused of doing today.
By the way, Blankfein did not mention this notorious incident in his recent testimony. He made it sound like Goldman's current "improper" activities were an exception to the rule.
Will Goldman and the other firms get away with this? Probably. Maybe they'll pay a fine if the evidence is so overwhelming that some gesture has to be made to keep the public calm and dumb. We'll see. I don't think Goldman ever paid a price for the Russian bond deals. And I don't know how many other conflicted deals these firms have made. But do you think it's a safe bet to say there have been others? I'll leave it to you to answer that.
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