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Lloyd Blankfein (Pablo Martinez Monsivais / AP Photo) A report now says senior execs, including CEO Lloyd Blankfein, played a "pivotal role" in the mortgage unit accused of defrauding investors. The Daily Beast’s Roger Martin reveals how the charges against the financial giant stemmed from a zero-sum culture that produces precisely nothing besides profits—and how to change the rules.
When the SEC charged Goldman Sachs with fraud for allegedly letting a hedge-fund manager handpick subprime collateralized debt obligations to short, and then selling that same batch of CDOs to its unsuspecting customers, I immediately thought of the scene in the Hollywood classic Casablanca in which Captain Renault (Claude Rains) opines disingenuously that he was shocked to find out that gambling was going on in Rick's American Café.
As with Humphrey Bogart’s cafe, where anybody with any knowledge about Rick’s understood that gambling was not only going on at Rick’s but a prime reason for its existence, anybody with any knowledge of Wall Street knew what Goldman's traders were doing. Specifically, the only thing they know how to do: Make money from other people's losses. Know this: The only function of the trading operations of Goldman Sachs and its competitors, now and forever, is to make money from other people's losses. This is trading, not building. When you build something, a company, for example, there is the possibility of creating benefits for multiple parties. Steve Jobs created the iPod, sold it to all of us and both made our lives better and made a ton of money for Apple. That is a positive sum game.
This payoff structure: Hit a home run and you are mega-rich; strike out and you are merely very rich.
In Wall Street trading, if a trader makes one dollar, it is only because some other poor bloke loses exactly and precisely one dollar. It is a zero-sum game.
Who then is the optimal trading partner in this zero-sum game? He (I use 'he' because they mainly are 'he's') has three characteristics. First, he should be particularly clueless. Conveniently for traders, cluelessness is contextual: A partner can be smart about traditional products but clueless about a crazy new one that you create. Second, he should be deep-pocketed—that is, able to lose lots and lots of money because the amount of money that you cause him to lose defines the amount of money that you can make. Third, he shouldn't take losses too seriously.
• Charlie Gasparino: Goldman’s Dirty Pool• Alan M. Dershowitz: The Fallacy of Fraud• Big Fat Story: Can Goldman’s Chief Survive?How could the latter be? Doesn't everybody take losing money seriously? No, not really. People generally take seriously the thought of losing their own money, but not so much losing other peoples' money. So optimally the partner should be managing someone else's money—a so-called fiduciary institution, preferably a big pension fund. And if we want to get particular, there is a further preference on this front. The money manager hired by the fiduciary institution should be on a "2-and-20" compensation formula, which pays the manager 2 percent of assets under management regardless of how terribly he performs, plus 20 percent of the upside in case he does well. This payoff structure encourages managers to swing for the fences with their clients' money rather than actually take care of it—i.e. hit a home run and you are mega-rich; strike out and you are merely very rich.
So it was pretty simple, the Goldman traders needed clueless, deep-pocketed fiduciary institutions managed by folks swinging for the fences on the other side of their trades in order for Goldman to make maximal money.
Goldman created a product, ABACUS, which was attractive to clueless, deep-pocketed fiduciary institutions that were managed by folks swinging for the fences and then merrily traded with those partners and made gobs of money. This is not rocket science. It is tantalizingly simple.
Let me be clear: I think it is utterly disgusting and appalling if the allegations are proven. But it is not even minimally surprising.
This kind of behavior will continue to march forward until the rules of the game are changed. Under the current ones, the folks who make the most money in America create zero value. These traders—like John Paulson—just shuffle existing value from one entity to another; they don't build net value. Yet our society rewards them most; more than we reward builders of value.
And these traders will continue to have their way with pension fund managers as long as we force millions of Americans to place their pension dollars with monopolist managers who like being fêted and stroked by hedge-fund managers more than they like being prudent for their pensioners. Remember for John Paulson's firm to make a reported $15 billion in trading profits, it needed clueless fiduciary agents to waste $15 billion of their clients' savings—and waste it they did. If we don't like monopolies in America, why do we allow so many pension funds to have the monopoly right to serve large employee groups, such as the public employees of entire states?
It may feel good to see the SEC spank Goldman Sachs, but to prevent this from happening again in a couple of years, more fundamental changes need to be made. First, we need to impose stiff taxes on short-term trading profits to shift the balance away from trading as the single most profitable activity in America. And second, every pensioner needs to be given a choice in who manages their pension because monopolists operate for their own benefit, not their 'clients'.
Roger Martin is dean at the Rotman School of Management at the University of Toronto. He writes extensively on corporate strategy, executive compensation and governance, business design and integrative thinking. His most recent book is The Design of Business: Why Design Thinking is the Next Competitive Advantage (Harvard Business Press, 2009). Read more on his website at www.rogerlmartin.com.
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Great piece. The one element in this whole Goldman fraud is in the phrase "clueless, deep-pocketed fiduciary institutions", for obviously there are such institutions around. The key word is "clueless" - what precautions did they honestly take to check the viability of the investment? I suggest that the average used car buyer does a more extensive 'due diligence' than was done in these circumstances.
I wrote about how they did a year ago and commented on Huffington Post. Then went on to write a book about it. Soon you will get the rest of the story: Corporations and individuals are hiding assets and money in European tax havens using an obscure loophole called 'Hidden Treuhand', a form of hidden trust, to hide beneficiary identity. And what does this have to do with the financial crisis in America? Individuals can create corporations embedded with a hidden Treuhand to hide their identity, then the very financial experts that engineered the housing crisis, can profit without the slightest transparency from their deeds by short selling the over valued assets they sold to others offshore, escaping income tax in the process. Tax havens have created a boom in offshore finance. These corporation and individuals are exploiting grey areas in tax avoidance that has led to downright tax evasion. Derivative short selling plus hidden Treuhand plus bank secrecy equals financial meltdown. Americans do not understand the role offshore tax havens play. As an expat living in banking secrecy paradise, I can tell you that the American problem cannot be fixed until you understand the impact of hidden Treuhand in this crisis. A red thread runs through the problem that besets American fiscal health to European banking secrecy; think Senate investigation concerning the role of the Deutsche bank to whom bailout money was transferred to because of debt obligations, as Tim Geithner puts it, and the role of the UBS bank in hiding 52,000 American accounts with an estimated US$15 billion in bunkered assets. The surge by the US government to tackle tax havens and the bank transfer to the Deutsche Bank have not yet been properly connected to the financial crisis by the mainstream press. At least a few agree with me: According to Prof. Dr. Sol Picciotto, emeritus professor at Lancaster University and a senior advisor to the Tax Justice Network, there is a close link between tax avoidance dealings in offshore tax havens and the speculation that has fuelled the current financial crisis. He states: "large multinationals are as much financial as business entities, they have freedom to devise complex financial structures and financial institutions, such as banks, even more so: in recent surveys by the US Government Accountability Office and the Tax Justice network, the largest user of tax havens in every country was a bank".
Nonsense - Lack of moral hazard = financial meltdown. When institutions know or think they're too big too fail and that their principals are essentially immune from prosecution than the system melts down. Secrecy has little if anything to do with it.
Is this your real name, ?You are a brain, a wizard and a genius.I rant, I am always upset, I complain, I guess,those who have no way to be heard,express how they can.The most fabulous country, The dream and Envy of the world, Has been totally and continues to be raped and ravaged. the poor working average american has a few years of any growth. Since the mamoth growth abroad, is going to consume everything. Well I say this all the time, but let me add to your thesis, The politicians, leaders, and legislators and agencies we have had ,Have no concern or care,or interest in their mainstream.The past 20 years,greed has filled all their pockets, .Besides, their moral fiber,as arois states,has been long gone.Nobody will pay anything, too many cover up each other, and people desperate, to work,survive, grow, pay taxes, pay towards the economy, will continue to be raped and ravaged. We do not need reforms, we needed everyone to do their jobs. Enough government, agencies, of sitting on their behinds.We have a wonderful, charismatic, man, for President.But something continues to go wrong daily in this country.We had a horrible, hurricane, years ago, I remember all the wealthiest families got the new homes.Not the poor, broken roofs, No, those who damaged their homes. on purpose, collected.Moral, Fiber,Long Gone.
Hi Shelly, Googled Treuhand and up came your book and a bunch of other stuff. Not surprisingly, there was a big fat Haliburton story right on top. So, did the UBS issue touch any of the funds protected by tueuhand laws? Do you have a blog somewhere? Thanks for sharing this information. BTW, I am buying your book.
Clueless? No way! Economists claimed the financial meltdown to be both inexplicable and unforeseeable, but many legalists were not surprised by these events; many even predicted them. Google Hidden Treuhand and Tax Justice Network.
No historians were surprised by the most recent meltdown, either. We expected it sooner or later just because the same economic policies as the Gilded Age and the 1920s had been revived in the 1980s and 1990s. It's a familiar cyclical pattern in American history.
Well,said Dak Lak, Maybe we do not need reforms. we need people, legislators,agencies, those who lead this country to do their jobs. Meanwhile, all these bankers with a whole entourage behind,them,wallstreeters,incompetent,overseers,it makes you wonder?But while they all made fortunes with the sub-primes, the average Joe is broke. nothing was done to fix, release,and solve their problems.It was said, in a TV program, Is not Repub nor Democrat,Its those who have and thosewhoHaveNot
Goldman won't pay a dime, or lose the suit. Everything they did is covered in the prospectus that go with any sale. Full disclosure. They pay lawyers a good $billion a year to print them, the prospecti, in iron clad risk free form. The question is, I suppose, did Goldman's and it's brethern cause the financial collapse in favor of their levered bet against the system? Once a position is staked, all levers are brought into play to optimize it. Did a cabal of traders crush the market for mad gain? Oh yeah. The problem being that they we're too big, too clever, and too powerful. That being said, they flushed the system pretty good, from I can see.
A little digging into Goldman Sachs reputation shows why the S.E.C. probe was no surprise. http://blog.vanno.com/
Zero sum game? Capitalism? Oh golly gee. Destroying the value of capital is going to lead to a crash if it can't pull back up. Capitalism in a way destroys itself, you don't need a violent revolution to destroy it. It was predicted the bankers were going to play a huge part in it. If you read volume three of Capital (as Accounting theory not as a political manifesto) the danger of derivatives was even discussed but it was described differently, but it was still futures that pulled the industrial complex up, on the backs of the poor, sadly. The surplus is what pulls us up, and the diminishing returns pulls us down. Bonus! Like taking a person's last $40 for having Not Sufficient Funds. That is Sum Zero all right. Waiting for the risk to be disclosed, is playing behind the eight ball.
Well, it's not that they were entirely clueless, more like, they mainly relied on stock market analysis when thinking over what stock to buy. Since that's a derivative of how well the stock is doing in the first place, it's sometimes wrong. That does require that _all_ investors are fooled, of course - but that can basically turn the rigged investment into a ponzi scheme, if it is, indeed, impossible for an investor to find out the actual value of his investment by other means than the stock market. As we all know, ponzi schemes eventually fail - and ingeniously, goldman could then take out insurance against it. But for all this to work, there has to be a whole lot of people who don't actually know what's what, and I agree, that can only come about by the cluelessness of managing othe peoples monies rather than your own. However, aren't all these people criminally liable? Aren't they _supposed_ to not buy stock in something they don't understand themselves? And if they think they understand it because of illegally bad advice - shouldn't goldman be liable? There has to be liability somewhere in the system when someone was lying and cheating! right?
I think a lot of these "clueless" investors were likely misled because they trusted the big three rating companies (S&P, Moody's, and Fitch), Aemsere. The rating companies get paid for rating securities issued by companies like Goldman. Given the competition among the rating companies, Goldman could easily shop around to get ratings above (perhaps far above) what the securities should have been given. I wouldn't be surprised to find cases of collusion and outright bribery too. There is certainly a lot of room for corruption in this rating system, and it should be changed to require buyers (not sellers) to pay for ratings.
Totally agree. The rating company should share the responsibility and punishment for this mess.
reminds me of the old saying about playing poker: if you sit down to a poker game and you can't identify who the mark is, you are the mark. these 'clueless' investors did not remember that rule.
Really this is an inane column. I am surprised. And by the way, as a small example of its lack of quality, it should be "loses" rather than "losses" in the third paragraph. Yes I believe Goldman is at fault here, and deserves to have the book thrown at it. Martin's inanity is in his assertion that "trading" is only a zero-sum activity, that pension managers are obtuse, capitalism is destructive, and so on and so forth. How was this person ever appointed a dean of a school of management? To take just one example, trading is never zero-sum, it is rare to take someone's dollar and make it yours, it is more like you take 1,000 people's 0.1 cents. To be a good trader is about having an edge, a hunch, something that brings you closer to the 51% divide. And Goldman is at fault here not for conducting its primary line of business but in rigging the system to fool the poor rubes who bought these products. What is wrong with this column is Martin's assertion here that any client of any financial services company is similarly exploited - quite plainly, that is an exaggeration, and he would be laughed out of any academic conference where he tried to make such a case. Less is more. Broad assertions and exaggerated generalizations of this sort are not helpful at a time when it is clear there are real flaws in the system that need to be fixed.
Mepnyc1, Sir: you have it absolutely correct. There have ALWAYS been the element of greed in these trading activities, ALWAYS. Someone thinks they are going to make a buck on someone else's loss. Greed drives a person to place his money or bet of money on a product. This is even true in trading Toyota stock. When you have government sticking its own fouled nose into it, the problem gets worse. With the current crowd of tax cheats and worse in Washington at this time, we are in for a rough ride. This article is no more than a simple minded suckup to the socialism plans of the current socialist leaders.....till November 2010.
Nonsense. It's the lack of government sticking its nose in it that created this monster. As Hyman Minsky said: "Unless somebody can find a way to change human nature, we will have more crises." Until that time we can change human nature, we need regulations and oversight. I certainly understand why Wall Street doesn't want oversight. I suspect bank robbers would like to have no laws against robbing banks too. How about we remove all stop signs from our streets? There's really no difference. Stop signs are merely a way to sanely regulate traffic flow to avoid crashes. It would be nice to reestablish financial stop signs to avoid Wall Street crashes as well.
Gordon Gecko, we haven't heard from you in a while. I heard you had a new movie coming out. Greed is good, right Gordo?
They've ALL been doing this. No one who is even slightly familiar with the history of Wall Street should be surprised that a bunch of corrupt insiders have rigged the whole game in their favor or that the smaller investors get screwed over. I know this history, which is why I have never invested a dime with them and never trusted them or believed a word they said. Nor have I ever taken out a mortgage or owned a house because I knew that whole system was crooked as well. In short, I never bought into all the propaganda about free market capitalism that has been shoveled at us since the days of Reagan--another guy who I always thought was just a smiling crook and con artist who could not be trusted. I knew too much history to ever believe in that system, and I also knew that it would end up in another depression sooner or later, like the 1890s or 1930s. Those who did just got taken to the cleaners, as I always knew they would. That's just the nature of capitalism, to have a big depression every 30-40 years, although crooked insiders on Wall Street know this better than the little people and can profit even from their misery. Naturally, the government does nothing to protect the common people from the sharks, since both major parties are bought and paid for by the big capitalist interests. Obviously the Republican Tea Baggers are too dumb to know this, despite all the evidence that is right in front of them all day, every day. They think they are being led by Paul Revere or something instead of a bunch of crooks. So yes, the Republicans and Dems are both crooked and deceitful, and politicians like Slick Willie are no more honest than Reagan and Nixon. That's our system in America.
Mcmchugh: May I offer a slightly different take. Truly it is not free-market capitalism that has failed. It is the greed of the people who run the systems that facilitate capitalism that have brought on the cyclical failure to which you refer. It is not so much a cycle as it is an acceleration of greed. The rate of return is the key. Where it gets totally insane is towards the end of the life of the bubble. On the front end, a 5% return is very nice. There is no legitimate reason this should not outstrip the inflation rate, thus there is a genuine reward for the risks inherent in lending. As the bubble increases in size, the amount of cash necessary to produce a 5% return increases. The frenzy accelerates when 5% is no longer enough for the sharks. ALL bubbles are the result of greed. Capitalism is merely the vehicle by which they extract their cash. As for Reagan, he was not so much a smiling crook and con artist as he was a shill. He was a very likable and grandfatherly-type shill. That's why Grampa Ron gets a free ride in spite of the fact that his budget increases exceeded any previous president. As Governor, this is the guy who introduced income tax withholding in California. That's why he is forgiven/forgotten as the top guy at a union (Gasp!!!!!; a socialist institution known as the Screen Actors Guild.) Talk about having it both ways! American government, almost from the day it came into being has been in bed with moneyed interests. How could one expect anything different from its creators - a group comprised solely of men over the age of 21, who were free, white, and landed. (I wonder if the women of the TEA Party really want a return to THAT Constitution.) I have pointed out this before. It was Senator Dick Durbin who pointed that that the Senate was owned by the banks. He's been rather quiet on that point lately. What's really disturbing though, is that McConnell and Boehner advertise the fact.
Talentless hacks whose only actual skills are fast talk and the art of the con. Something they probably all learn at Haaarvaarrd or Yale or one of those other big finance schools that spit out these drains on society...
Now that the world has been put on notice that the SEC will no longer be taken for a joke a whole lot of risky asset classes have suddenly began falling out of bed when it was announced that Santa Claus was no longer happy with his nephew Goldman Sachs. Even gold the first thing that everyone flocks to in times of distress fell down and hurt its knee. But there's more reason to worry, because this now gives the government the right to suddenly impose transparency in the nebulous world of derivatives trading that normally happen in cubicles 3 miles into the air. That of course is a bad idea, because it means not everyone will be allowed to get shit faced anymore or call up the government for a hand out when things backfire. It also means the end of cowboy trading and gaming the system and the American public, and any capitalist will tell you the best way to make lots of money is to give the public what they want or what they should think they want. Of course the government will be closing the bar early going forward and that can only mean one thing going forward- it's going to be a rocky retreat back to gravity, especially when we're all sober now. http://scallywagandvagabond.com/2010/04/greed-is-good-why-wall-st-is-get ting-ready-for-a-bath-2/3/
Sorry Christopher.....It is merely using the SEC to formulate a new version of Socialized government control. Greed works even in obama's cabinet with those tax cheats. That too was greed. Where was their Utopian thoughts when they cheated all of America on their tax forms. NO, NO Christopher, you can't get off that easy. This is just another attack on America's freedom.....to get rich....to go broke.... and to be free of government oppression. To be sure, this action is a fringe attack, but attack it IS.
You really need to get on meds, Jakeson. Your paranoia is getting too blatant.
We know this already regarding the Bank Institutions, but the biges problem is with Congres and Wall Street, Bernanke and Geithner don't know anything about this right ?, now are we dealing with more International economical problems isn't the market flooded with these types of issues,"but don't worry" Obama will show up to save some fellows from his team, everything will be take care no problem.
Who knew "doing God's work" involved defrauding people to enormous personal profit? Apparently Lloyd Blankfein did!
God's work is making the rich even wealthier, Danbury. If you don't believe me, just ask any Republican / conservative. How could you possibly misunderstand this?
Alan your D is on too tight, these are the big "O"s bankers, they were only trying to make a buck....sheez!
Johnny, I think you'll find that most of these bankers are Republicans. And you must have missed this recent tidbit (isn't bribery fun?): Senate Minority Leader Mitch McConnell (R-KY) and National Republican Senatorial Committee chairman Senator John Cornyn (R-TX) went to New York City last week for a private meeting with about 25 elite hedge fund managers and other Wall Street executives. They wanted to enlist Wall Street's help in funding Republican campaigns in the fall and killing any tough financial reform. See: http://www.foxbusiness.com/story/markets/industries/government/street-ex ecs-pols-earful-financial-reform/ (Remove any spaces if you copy and paste this link.)
Goldman Sachs gave the second most amount of money, $995,000 in donations to 0bama duing the 2008 campaign. and sheep like AlanR2D2 continue to spout that republicans are in wall streets pocket.... maybe 0bama will return the money...yea right. http://www.opensecrets.org/pres08/contrib.php?cycle=2008&cid=N00009638
How could Goldman have committed sure fraud all alone? There are still more of Lloyd still elusive.
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