There seems to be a collective cheer as Goldman gets sued by the SEC. My initial reaction was that it was about time, however when I read what they were being sued for I was a bit uncomfortable with it. Don't get me wrong, I'm no Goldman fan or apologist (though you have to admire how they have their tentacles into seemingly everything...but you also must fear it). The issue at hand is that Goldman allowed a Hedge Fund manager (John Paulson) to essentially help design a security that the manager could then bet against. Goldman would then find buyers for these security, essentially another party to take the other side of the trade. Goldman would create the security, Paulson would bet against it - someone else would bet that it would work out (its actually a bit more complicated as Paulson did not short the security, he bought CDS protection on it...but don't worry about that now). Goldman is basically in trouble for NOT telling the people they sold the security to that others thought it would fail, but also because they appeared to have built into this security the most toxic of assets (again, technically this is a synthetic security meaning it was actually a derivative of another set of securities - essentially CDS contracts on other CDO's - again, ignore this).
Keep in mind that Goldman "sold" this security to willing buyers who were not amateurs and to my knowledge did not owe them a fiduciary duty (which in itself is a problem, but I could also be wrong, if they did owe a Fiduciary duty then they should be sued). These professional investors either bought these securities on Goldman's demand (which is just stupid) or they actually did research and determined that these securities where a good deal. Regardless, it is incumbent upon a professional investor to do their OWN homework before buying something. If Goldman puts together a Toxic, piece of junk security and professional investors look at it and think it is garbage, they are not forced to buy it.
Goldman didn't force anyone to buy their junk, they certainly where pushing for it to be purchased as they reaped huge fees, commissions and prestige - but they are salesman. As consumers, these professional investors KNEW that Goldman was acting as a salesperson and they should have done there research.
If Goldman knew the securities where going to blow up, they certainly weren't that smart in selling them to a bunch of their clients just to benefit one hedge fund. In fact, that would be a really stupid business move.
I think Wall Street is complicit in the meltdown and made it worse - the specific deal described in the lawsuit was one of the accelerants for the collapse. These firms couldn't get enough real product so they manufactured "synthetic" CDO's - which essentially are packaged Credit Default Swaps. These levered bets combined with CDS bets for and against these securities created derivatives that were four and sometimes five times removed from the actual underlying asset (essentially a home loan).
Without any of us knowing, our home loans became pawns in a massive game of chess, only we didn't know who had what interest in seeing them fail. To this day the real estate market is affected negatively because of the derivatives that have been created that create so many interests in one underlying property as to make it impossible to work that property out in a real modification.
I understand most of this post is over most people's heads (not a knock, its just complicated), it would have been foreign to me just three years ago. My basic point is that this particular transaction, though it represents the complete breakdown of our financial system was likely not something Goldman should be sued for. Of course, I'm sure they should be sued for all sorts of other things.
Goldman should lose its bank-holding company status and be required to pay back its FDIC insured debt. Wall Street needs reform, that is what this transaction really shows.
Scott Dauenhauer CFP, MSFP, AIF
