Goldman Sachs, Credit Default Swaps and the Infield-Fly Rule
My understanding of collateralized debt obligations and credit default swaps parallels my knowledge of the infield fly rule. Just when I think I finally understand them, that understanding flies out of my head, which I’m left to scratch.
CDOs and CDSs in the sub-prime mortgage industry led to the 2008 financial meltdown from which our economy is still recovering. The news coverage of civil charges against Goldman Sachs have led me to ponder exactly where the line gets drawn between an organization’s legal mandate not to defraud customers and the organization’s responsibility to prevent customers from doing something stupid.
I mean, I have a haberdasher. He regularly tries to get me to buy shirts with French cuffs – the kind that require cufflinks. Well, Raleigh just isn’t much of a cufflinks-kind of town. But I finally bought a couple of shirts with French cuffs a couple years ago. They hang in my closet, lonely, resentful and starched stiff as boards.
I sort of resent that my haberdasher sold me those shirts. But then again, it was questionable of me to buy them. I’m not thinking of petitioning congress to ban the sale of French cuffs on American soil.
As I understand it, the crux of the argument against Wall Street in general and Goldman Sachs in particular is that they had information about those collateralized debt obligations – CDOs that were made up of bundled sub-prime mortgage bonds – that they didn’t share with the customers who bought them. Then, Goldman Sachs in effect bought insurance policies – Credit Default Swaps – that paid them in the event that those Goldman customers who bought CDOs defaulted.
My head hurts.
There didn’t seem to be any law that required Goldman to disclose multiple, nuanced roles to anyone. But my question is this: If I were Goldman, would I feel comfortable explaining to all my customers my various involvements?
One could argue that in free markets, under capitalism, Goldman had no obligation to disclose. Capitalism and morality do not necessarily intersect.
What about merely doing the right thing? I work in a craft in which services can be provided and advice given only when our clients trust that we’re operating in their best interests. Does our firm have its own interests? Of course. But our interest in keeping our clients happy for the long term overrides any short-term interest in making a profit.
From my muddled perch – remember, I can’t even stay lucid on CDOs, CDSs and the infield fly rule – Wall Street was overwhelmed by the agnostic morality of money and markets. They made money in ways that were disconnected from the well-being of their customers.
What do you think? Two books I’ve read recently helped me gain some insights: The Big Short by Michael Lewis and Too Big to Fail by Andrew Ross Sorkin. I highly recommend both.
Comments
I would argue your parallel to the haberdasher is invalid. Unlike Goldman Sachs, your shirt maker had no vested interested to what happened to your shirts after you bought them from him, he did not gain from you wearing or not wearing your shirts, he didn't have cufflinks to sell you, he did not sell you a substandard product without disclosure. He flat out sold you goods that may or may not have been right for you. In a capitalist society, that is completely okay.
On the other hand, Goldman sold products to customers (CDOs) that they had a vested interest in the outcome of these products and betted on their failure by purchasing CDSs. GS did not fully disclose the risk involved to these products to their customers and did not disclose the potential conflict of interest. I don't see this being any different than a CEO selling his company's stock while at the same time buying puts to hedge against losses knowing the company is going under. Which while I am no SEC expert, I am pretty sure is illegal.
BTW, there is also plenty of blame to go around to the credit ratings agencies and the sketchy practices of some mortgage lenders.
"our interest in keeping our clients happy for the long term overrides any short-term interest in making a profit."
Spoken like a C-level who can't say anything /but/ that. I can totally understand the warm-and-fuzzy statement that you'd want a customer to succeed so that you can succeed, however, you're in a completely different industry than the financial sector.
Your customer base is someone who should be saying, "durrrr... I can't even spell HTML, let alone write it. Help?" while you say, "be cool, we've got this."
In complex derivatives, if someone is out there who can't manage to read the fine print and figure out that ANY asset (from stocks to homes to even the frickin' federal government itself) can lose value, well, how much does a seller of assets need to beat them over the head to make it okay?
Sometimes you have to put on the big boy pants. Haberdashers conveniently located outside the Nanny State sell those.
Dasher of Habers,
You've spoken like a investment banker who needs to continue to convince him or herself that deception is justifiable and acceptable in the free market.
Goldman gamed the system, purposefully obfuscated their products and downplayed risks. And then they bet against their own investments because they knew they would fail.
That isn't "wearing big boy pants." That's lying to customers for short term gain.
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