What I've learned about Goldman Sachs .

[flamin lib]

I’ve been wondering how a stock broker could make money on an investment that lost value. So I went to Wikipedia and what I found absolutely blew me away.

It’s called short selling or shorting. A broker sells an investment to someone. The broker then borrows the investment back with the promise to return it at some later date. Next the broker sells the borrowed investment to a third party, another investor. If the investment falls apart and becomes worth less than it was when the broker sold it to the third party, he buys it back at less than he sold it for and returns it to the first investor who still owns it anyway.

What Goldman Sachs did was to build an investment, mortgage-backed securities, that they knew would fail. Then they got a bond rating firm, which is paid by the banking industry, to rate it AAA. They sold it to investors, many of which were pension funds and the like. Then they borrowed it all back, resold it to other investors. When it tanked, which they knew it would, they bought it back for pennies on the dollar and returned it to the original investors.

To make this as simple as possible, they made a worthless security, lied about its value, sold it, borrowed it back and sold it again. They sold something that they didn’t own and was already owned by someone else.

You may ask yourself, “Is this legal?” Yes it is and it’s part of what happened in 1929. The only thing Goldman is in trouble for is not telling any of the investors that they knew the mortgage-backed securities were junk.

This points out a number of weaknesses in the investment banking industry. First how can it be legal to sell something that you do not own? Second, how can two parties own the same item? Third, why should anyone trust an investment’s rating if an employee of the investment bank that invented it provides the rating?

Yep, there’s a lot of work to be done.

[tridim]

1. I learned about it along with Eddie Murphy in "Trading Places"

"Sounds to me like you're a couple of bookies"

[BobbyBoring]

5. And

Any actual $ you make is taxed as Capital Gains. Figure that one out! You borrow something, make $ on it one way or the other and then pay 15%??? WTF Maybe we should all quit our jobs and be short sellers!

[Duer 157099]

22. Heh, me too. That film inspired me to learn about the stock market

It really did.

[no_hypocrisy]

2. Reminds me of the premise of "The Producers"

You sell over 100% interest in a show, pick a play that is guaranteed to close on opening night, and keep the money.

And I remember the jury foreman giving the verdict: We find the defendants incredibly guilty.

[closeupready]

3. From what I understand, they did not rate the securities.

The rating agencies did.

Why did the agencies rate junk as AAA? Now that's the most interesting question of this thing, for me.

[flamin lib]

4. The rating agencies are paid by the investment banking industry, so

they are in effect employees of the investment bankers.

What some have said about the AAA rating is that the securities were so complicated that they couldn't be understood by the rating agencies or that because they were mortgage backed and mortgages are only made to people who can repay them it was assumed that the securities were safe.

[closeupready]

10. The rating agencies charge a fee.

I'm not sure how that's collected - whether it's paid by the investment bank, or at initial public offering as some kind of percentage, but that doesn't make them employees of the investment bank.

But I do think they were making lots of money in fee income, since the real estate market was exploding, resulting in tons of new business, and thus, fees. Perhaps they were scared if they failed to rate stuff as AAA, they'd miss out on further work?

[flamin lib]

12. Tecnically correct, but

the agencies are paid their fee by the owner of the security they are asked to rate. They are very much like a sub-contractor to the owner of the investment.

http://rwer.wordpress.com/2010/04/12/the-tyranny-of-the-bond-markets/

[AnArmyVeteran]

7. Because the 'rating agencies' are just a set up scam of people working for those they rate...

If the democratic leadership doesn't bury the republican party this November they should all be fired for total incompetence. Even an imbecile could capitalize off of the republican resistance to financial reform.

[closeupready]

11. The rating agencies have been around for a long time, though.

They are, in theory, an essential part of capitalism's formula. They are supposed to be impartial and independent.

[dmr]

18. As it was explained on Bill Moyers:

There are 3 major ratings agencies competing with one another. If a firm doesn't like your ratings, they'll go to another until they get the rating they want.

IOW, if you don't give them what they want, you lose business, which kicks out fair and honest ratings.

It's also true that the securities were so complex, they were difficult, if not impossible to understand.
:hi:

[dkf]

6. Before you can short it you have to sell it to someone so you can borrow it.

And when you are creating a Frankenstein zombie security I doubt the buyer knows as much as you do about it. This has the potential for real abuse especially if Goldman was looking for a truly crappy product just for the purpose of shorting it.

[flamin lib]

9. According to some of the e-mails that is exactly what they did,

design a product that they knew would fail so they could short it and make a bundle. On something they didn't even own!

[flamin lib]

13. Yor don't have to be the original seller of the item. If you can get

the owner of any investment to loan it to you then you can short sell it. What makes the Goldman deal so egregious is that they actually created the securities, sold them, borrowed them back and then sold them again all the time knowing that they were worthless and would fail.

[dkf]

21. It's different when you short things you gave no control over.

But if you deliberately make something fail so you can make money on the short side that is bad.

[defendandprotect]

8. .... and the watchdogs were rubber stamping this stuff "AAA" . . .!!!

[Skidmore]

14. And if you or I did this with, say a car, we would be indicted for

fraud.

[Ruby the Liberal]

15. Shorting is a legitimate hedge strategy

Where Goldman crossed the line, in my opinion, was not making a market in the security (finding people who wanted it and matching them with people betting against it), they traded on their proprietary desk - for themselves. KNOWING that the security was going to blow up. It is legal (for now), but tres unethical and borders on inside information. That and they didn't divulge their position.

However, On top of shorting, they took out insurance policies that would pay them huge bucks if the security failed. This is where AIG came into play - they sold these insurance policies.

So, the security fails, and as you mention, Goldman wins for being short. Goldman ALSO wins because they called AIG and filed a 'claim' on the insurance.

The US Government steps to the plate and gives AIG $160 billion to pay off all of these insurance policies in Sept 2008 when it all went down. The bankers originally agreed to $0.40 on the dollar, but then steps in little Timmy Geithner who structured the deal for $1.00 per $1.00.

So it looked like this: Taxpayer > AIG > Banks. That is why you will hear some pundits and the like call it the "backdoor bailout". Our $$ went through the front door of AIG and straight out the back to pay off the bets by the banks - which they did not have to pay back (AIG is on the hook for the $$, the banks used it to pay bonuses).

This is how they all made money on it all.

[T Wolf]

16. Point is - hedges and other schemes SHOULD BE ILLEGAL. They pervert the original idea

of investing in something that has actual value (or will in the case of a new business).

All of these schemes and scams must be eliminated and funding must be made available for worthwhile purposes, not merely to game a zero-sum racket that benefits only those running the system.

[Ruby the Liberal]

17. I totally agree.

Used to be, the banks found investors and gave their cash to businesses to operate.

Now, they just all play the great roulette wheel of "high finance" betting on side bets on anything they can think to bet over.

[ozone_man]

20. Shorting is a necessary function

to restore fair value to overpriced equities. Otherwise, dangerous bubbles form, like we had in 2008. Without shorting, the bubble would have been larger and more destructive when it finally popped. Unfortunately, we are still in a bubble that needs the air let out of it, fueled by trillion dollar deficits, Wall Street bail outs of GS and all of the other crooked banks.

The problem is that derivatives are unregulated. These banks need to have an escrow that makes them responsible for their own actions and not expect tax payers to bail them out. GS should really give back the money that the tax payers gave to them as a counter party of AIG. Then let's see how big their record breaking profits and bonuses look then.

Glass-Steagall needs to be reinstated. GS is not a bank, but a giant vampire squid.

[pansypoo53219]

19. gambling + incest+ greed=wall street bankers.

read kevin philip's american theocracy's 1st + 3rd section. predicted the crash in 06. lots of dirt on this shit. of course i saw this coming and i am an art school graduate.

[amborin]

23. shorting, in and of itself, is not the issue:

"some dealers (most notably Goldman and DeutscheBank) had programs of heavily subprime synthetic collateralized debt obligations which they used to take short positions. Needless to say, the firms have been presumed to have designed these CDOs so that their short would pay off, meaning that they designed the CDOs to fail. The reason this is problematic is that most investors would assume that a dealer selling a product it had underwritten was acting as a middleman, intermediating between the views of short and long investors. Having the firm act to design the deal to serve its own interests doesn’t pass the smell test (one benchmark: Bear Stearns refused to sell synthetic CDOs on behalf of John Paulson, who similarly wanted to use them to establish a short position. How often does trading oriented firm turn down a potentially profitable trade because they don’t like the ethics?)

But she’s not sure how the federal action will play out: “Strange as it may seem, structured credit-related litigation is a new area of law, with few precedents. Until the credit crisis, unhappy investors seldom sued dealers and other key transaction participants.”


The S.E.C. says the bank defrauded clients on bundled mortgages. Will it lose its privileged position on Wall Street and in Washington?
.For the handful of Americans who haven’t read this, here’s a good bare-bones explanation of what the firm allegedly did from Annie Lowrey of The Washington Independent: “The hedge fund Paulson & Co … handpicked mortgage-backed securities that were doomed to stop performing, being backed with subprime mortgages, and Goldman packaged them into a kind of bond. Paulson bet against the bond, with Goldman acting as the broker; at the same time, Goldman sold the bond to other clients without disclosing that Paulson had engineered the bond to fail. The S.E.C. filing notes that those other clients lost $1 billion. Goldman had no direct stake in the success or failure of the CDO. It made money either way.”

“Finally!!!!” adds Dakinikat at the Confluence. “The details of a S.E.C. lawsuit against Goldman Sachs basically confirms everything we’ve been saying for some time out here in the financial/economic blogosphere. GS basically let some of its hedge fund managers design CDO’s that were bound to fail, sold them as safe, and then placed sidebets knowing full well they would fail. My biggest hope is that this translates into tougher regulation and more transparency in the derivatives market. We’ve been seeing just the opposite as reform moves through committees. If more of this comes, it will be hard for Dodd to pass watered-down regulations while the focus on such antics is sharp.”

“This isn’t just about the fact that Goldman sold its clients some bonds and then later bet against them,” writes Stephen Spruiell at The Corner. “In my view, that wouldn’t be so bad.” So what’s the problem?

Goldman structured and sold a particular bond, a structured product known as a Collateralized Debt Obligation (CDO). … The outside consultant Goldman hired to select which mortgages would go into the CDO, a hedge-fund manager named John Paulson, is now known as one of the most famous housing shorts ever — he made an estimated $3.7 billion betting that these kinds of mortgage-backed bonds would go bad. So it is pretty disturbing that Goldman would bring him in as an “independent manager” to help it construct a CDO and not disclose this fact to the CDO’s buyers.

It would be like holding a basketball game, letting a Vegas sharp secretly select the players on one of the teams, and then presenting it to the public as a fair game. The sharp would have an incentive to select the worst players for his team and then bet against it. According to the SEC, that is exactly what Paulson and Goldman did.

......

http://opinionator.blogs.nytimes.com/2010/04/16/goldmans-stacked-bet/?scp=43&sq=goldman%20sachs%20and%20shorting&st=cse

[spanone]

24. i learned that the mentality and the arrogance of their corporate honchos is astounding

yuppie spawn

[annabanana]

25. How do brokers convince people they've just sold something to

to lend that thing right back to them? If it meant something to them they wouldn't have sold it in the first place.... Why wouldn't the original buyer charge a big rental fee for that thing?

[flamin lib]

26. The wole OP is a gross oversimplification. It' s an example of

"explain it to me like I'm a four year old."

In fact, it's a use of Puts and Calls. A Call is the promise to buy an investment, a Put is the promise to sell. In neither case does the broker have to either own the investment or have the total reserves to pay for it. It's a contract to do something at a later date.



GS contracted to deliver Product A at some future time if Investors paid current market value for the right to receive it at the future value. If Product A goes up in value it's a good deal for the investor, if it goes down it is a good deal for GS. It's a gamble based not on a physical product but on the performance of some product. This is the essence of a "Derivative"; the value of the investment isn't in the product but is DERIVED from the way the product performs.

There isn't any problem with this IF the investment exists in inventory for sale. The problem is brokers don't need to actually buy the investments, just promise to do so. No money invested.

Nor does the broker need to have all the money on hand to actually pay for the stock when the Call comes due. You might have heard that some of the investments were "leveraged" at 30:1. That means that the broker only had 1/30th of the money to pay for the promised purchase.

To a lesser degree, even if the broker doesn't own the investment, he's on a level playing field with the investors UNLESS he knows something they don't. That's the case with GS and so many other marketers of "derivatives"; they made the contents of the investment so complicate and secret that investors just had to take their word for the value of the instrument they bought.

See why I took the "four year old" approach?