The Goldman Housing Scandal Isn't a Scandal: It's Inevitable

From The Business Insider, Dec. 24, 2009:

The New York Times delivers a front-page expose on the original Goldman Sachs scandal: How the firm created derivatives (synthetic CDOs) to allow investors to bet on the housing market, sold the CDOs to clients who wanted to bet on additional housing market gains, and then went short the same CDOs because Goldman believed the housing market would crash.

The outcome, of course, was the same as it usually is: Goldman made a killing, on both the product origination fees and the proprietary bets.  Goldman's clients, meanwhile, got crushed.

One observer likens this to buying insurance on a house and then burning the house down:

“The simultaneous selling of securities to customers and shorting them because they believed they were going to default is the most cynical use of credit information that I have ever seen,” said Sylvain R. Raynes, an expert in structured finance at R & R Consulting in New York. “When you buy protection against an event that you have a hand in causing, you are buying fire insurance on someone else’s house and then committing arson.”

But is it really a scandal?

If you view Wall Street the old-fashioned way, yes: The firm sold its clients a product and then bet against it.  This allowed Goldman to make money two ways instead of just one: Product origination fees and trading profits, all at its clients' expense.

If you take a more realistic view of Wall Street, however, this is just an everyday reality.  Wall Street firms like Goldman sit between buyers and sellers, and they also buy and sell on their own behalf.  Every single transaction these firms conduct entails a conflict of interest: Everyone is always making bets, and someone is always winning and losing them.  It's just not obvious until later which party that is.

The way we suspect Goldman viewed its behavior in the housing scenario above is as follows:

• Clients are desperate for products with which to bet on the housing market

• We can help our clients by creating those products and get paid handsomely for doing so. 

• We're negative on the housing market, so we can use the products bet against the housing market.  If we're right, we'll make some money there, too.

Don't forget that the buyers of Goldman's CDOs were among the most sophisticated investors in the world. These investors were paid to analyze the housing market and make smart investment decisions based on that analysis.  The investors did their analysis and concluded that the housing market was going to go up.  Goldman did its own analysis and came to the opposite conclusion.  But it was at least relatively a fair fight. ...

Click here for the full post.

More coverage from The Business Insider:

• Goldman blasts the NYTimes hit-job
• How Goldman screwed its clients in the housing collapse