All Goldman-Deal Gamblers Knew the Score

Bill Fleckenstein MSN Money April 26, 2010

The players on both sides of the trade that the SEC has targeted knew the risks and knew one side was bound to lose. It's far from the worst sin of this mess.

Goldman Sachs. John Paulson. Those are hot-button words that have dominated business news lately, with many of the reports biased toward a black-and-white supposition: guilty.

This column, however, wouldn't live up to its name if it didn't take a contrarian view. Not surprisingly, I'm going to discuss the Goldman/Paulson flap from a slightly different perspective.

What I believe may have happened -- at worst -- is that Paulson, a hedge fund manager, identified various bits of mortgage flotsam he wanted to short, betting they would go down. Then he might've gone to Goldman Sachs (GS, news, msgs) and asked something like, "Hey, would you put a basket of this stuff together?"Msn.Video.createWidget('PlayerAd1Container', 'PlayerAd', 304, 314, {"configCsid": "MSNmoney", "configName": "player-money-4x3-articles-inline", "player.vcq": "videoByUuids.aspx?uuids=3524b2bc-dda8-4f24-b718-0d47a54a70e7,a2982f18-9177-446d-b29f-a091aca71fc4,8311e401-2140-4ebf-8e0b-d8c16753248c,6283b3ec-6859-41fc-9fa6-5a1a416a8822,f828a090-e826-4137-9fc7-8d1940218dfd,9ad22bc1-dada-48a6-851a-5c1893ca184a,399c6388-5d01-4395-ae19-645553785a8b,b3c9c172-6c31-4ce9-becd-092211c7b851,5dbd6b14-1b1a-4a35-9dc3-44ea67688aa1", "player.fr": "iv2_en-us_money_article_Investing-ContrarianChronicles-inline"}, 'PlayerAd1');Msn.Video.createWidget('Gallery4Container', 'Gallery', 304, 150, {"configCsid": "MSNmoney", "configName": "gallery-money-articles", "gallery.linkbackLocation": "bottom_left", "gallery.numColsGrid": "3", "gallery.categoryRequests": "videoByUuids.aspx?uuids=3524b2bc-dda8-4f24-b718-0d47a54a70e7,a2982f18-9177-446d-b29f-a091aca71fc4,8311e401-2140-4ebf-8e0b-d8c16753248c,6283b3ec-6859-41fc-9fa6-5a1a416a8822,f828a090-e826-4137-9fc7-8d1940218dfd,9ad22bc1-dada-48a6-851a-5c1893ca184a,399c6388-5d01-4395-ae19-645553785a8b,b3c9c172-6c31-4ce9-becd-092211c7b851,5dbd6b14-1b1a-4a35-9dc3-44ea67688aa1;videoByTag.aspx%3Ftag%3Dmoney_dispatch%26ns%3DMSNmoney_Gallery%26mk%3Dus%26vs%3D1;videoByTag.aspx%3Ftag%3Dbest%2520of%2520money%26ns%3DMSNmoney_Gallery%26mk%3Dus%26vs%3D1"}, 'Gallery4');It seems to me that Paulson did nothing wrong. (I myself constructed a few "put baskets" of stocks I hated back in the late 1990s. At that time, the player on the other side of my trade was a brokerage firm.)

If that's what occurred, Goldman probably didn't want to take the other side of that trade. So, it would've gone out and found some suckers -- I mean, buyers. But what is most important to understand is this:A buyer-beware market This is not a mom-and-pop market of innocents. This is a sophisticated, buyer-beware "upstairs" market. All participants have ISDA (International Swaps and Derivatives Association) agreements -- and the mountains of supporting data that go with it. Nobody unsophisticated operates in this derivatives market. Furthermore, every participant knows there is a short-seller on the other side of every purchase.

I am particularly annoyed that so many people seem to feel that Goldman should have disclosed that Paulson was somehow involved in the selection of securities in the Abacus collateralized debt obligations in question in this case, when it appears that another company, ACA, had the final say. (In a bit, I'll spin out a scenario to bolster my point.)

Find a broker who's right for you

Even if Paulson had complete discretion over the selection, I doubt the buyers would have cared. His reputation was not what it is now, after making a fortune shorting subprime, so his opinion on any given security was nothing special. And remember, few people believed the bears back then when they said housing was in trouble.

What's a CDO, anyway?

In fact, some very smart people were bullish on the subprime/Alt-A sector. For example: David Einhorn, who later predicted the collapse of Lehman Brothers, was the largest shareholder of now-collapsed lender New Century Financial -- his fund owned more than 10% of the company -- and he was also a director. I knew then that he was a very smart fellow, but for the life of me, I couldn't figure out what he saw in the company that I didn't.

Einhorn's position did not stop me from being short the stock (though it might have caused others to feel better about the company than they should have), and it ultimately went almost to zero. My point: Among professionals, the fact that somebody else has a different opinion usually isn't enough to change one's viewpoint. Bona fide garbage foisting Here's an example of what the unwashed masses think Goldman Sachs was trying to do, i.e., foist garbage on unsuspecting buyers:

In spring 2007, Goldman filed for an initial public offering for Everquest Financial (which made it through the Securities and Exchange Commission). The idea was to take some of Everquest's mortgage products in the Bear Stearns hedge fund managed by Ralph Cioffi -- which were causing it so much grief -- and let the public in on the deal. Fortunately for the public (and what little might be left of Bear Stearns' reputation), the deal never made it out the door. The markets unraveled so fast that it couldn't be done.

By comparison, it's quite clear how large the difference is between what Bear Stearns wanted to do and what Goldman Sachs is alleged to have done. (To learn more about Everquest, see this March 2007 BusinessWeek story.)

Continued: How the case is aided by hindsight More from MSN Money

He got rich -- and they lost their homes

The 'easy mortgage' era won't last

Inflation won't be invisible for long

Inflation warning etched in steel

SEC probing other banks' mortgage deals

1 | 2 | next >

Rate this Article Click on one of the stars below to rate this article from 1 (lowest) to 5 (highest). LowThank you for rating.UGR('ratCntrl')High var avgRating=0;avgRating=8.368421; if(avgRating!=0){avgRating=avgRating/2;avgRating=Math.round(avgRating*100)/100;var sDisplayText="Average rating: " + avgRating + " from ";var usersCount=114;sDisplayText = sDisplayText + usersCount;if (usersCount==1)sDisplayText=sDisplayText + " user";else sDisplayText=sDisplayText + " users";avgRatingElem=document.getElementById("averageRating");avgRatingElem.innerText=sDisplayText;} View all top-rated articlesE-mail us your comments on this article Discuss in a message board MSN Money InsightNew Investor CenterMarket DispatchesJubak's JournalTop Stocks blogCompany FocusContrarian ChroniclesSmart Spending blogFast AnswersDecision CentersStart InvestingMutual FundsFind Hot StocksSimple StrategiesPower ToolsInvesting for IncomeReal Estate InvestingRecent Contrarian Chronicles ArticlesThe 'easy mortgage' era won't last 04/16/2010Inflation won't be invisible for long 04/09/2010Inflation warning etched in steel 04/02/2010More . . .Contrarian ChroniclesAbout Contrarian ChroniclesLearn the Contrarian Chronicles lingoSubscribe to Market Rap on Fleckenstein CapitalFund data provided by Morningstar, Inc. © 2009. All rights reserved.StockScouter data provided by Gradient Analytics, Inc.Quotes supplied by Interactive Data.MSN Money's editorial goal is to provide a forum for personal finance and investment ideas. Our articles, columns, message board posts and other features should not be construed as investment advice, nor does their appearance imply an endorsement by Microsoft of any specific security or trading strategy. An investor's best course of action must be based on individual circumstances.Msn.Video.createWidget('Gallery8Container', 'Gallery', 500, 230, {"configCsid": "MSNmoney", "configName": "gallery-money-article-site-wide"}, 'Gallery8');msft.msn._ic.cid='3xmm3g08tu7mt8p9hfrwpfgq9w0gtjkf';msft.msn._ic.pst=false;msft.msn._ic.pgn=1; Join the discussion!Add a commentShow commentsSort by:Newest firstOldest first_uc2f12('iucGo');1 - 10 of 10PreviousNextLynn X #1Friday, April 23, 2010 9:28:06 PMI am particularly annoyed that so many people seem to feel that Goldman should have disclosed that Paulson was somehow involved in the selection of securities in the Abacus.

Bill Fleckenstein

I am particularly annoyed that nobody seem to want to take responsibility for this gigantic mess.

Lynn X

ReplyReport Abusewordfrominside #2Saturday, April 24, 2010 12:47:53 AM

Fleckenstein is a very wealthy man. His position is the same one taken by most wealthy and powerful people: we would like to continue to fight our "wars" against each other and the collateral damage that we do to others, well, those things are just the price of growth and prosperity. This is what I often refer to as "how many angels on the head of a pin" argument. The argument itself is just plain stupid and it accomplishes nothing. And, while they argue over legal, accounting and mathematical minutiae, the Titanic sinks. There is a complete disconnect between their concerns and that of the rest of the nation (or the world for that matter).

The real issue at hand is that these people damaged the world. And, they did not do it in some small fashion or by some accident. Worldwide, they wiped out the equivalent of three times the GDP of the United States in global wealth in less than 18 months. They aided in the destruction of more than 8 million jobs in the U.S. (and similar numbers in Europe and Japan) plus tens of millions more in less developed parts of the world.

Yes, they were not the only bad actors (e.g. the govermment spent too much, regulators were asleep at the switch lulled by their "magnificent" economic and market "theories" and Americans not having seen real calamity in a generation just became lazy and stupid) but that does not excuse their roles in what has happened. In this way, as individuals, if they did not commit a crime, they were accessories to the crime.

I really don't understand how the minds of these people function. They really do seem to be missing a self-reflective circuit that most people have naturally. They can excuse anything as long as it benefits them personally. I don't know if this is something they have always had or it is something that developed as a matter of years of practice in making excuses for themselves.

The Goldman situation (and I am sure soon to be revealed at many other institutions) just shows how they can walk that fine line between selling and lying, between investing and gambling or between "being smart" and fraudulent. I would think that would change a person after years of doing it. For the moment, they can hide behind their elaborate personal security, phalanx of lawyers and cocoon themselves in their mansions and private clubs. But the longer this disconnect persists, that may not be enough.

ReplyReport AbuseJoe Consumer #3Saturday, April 24, 2010 12:29:55 PMDismal......since Goldman Sachs controls DC not much will get done to prevent future schemes like this imo.Sad to see our Nation go downhill like this ...a victim of unbridled (and unregulated) greed.ReplyReport Abusesarenjo #4Saturday, April 24, 2010 1:18:17 PM

Does the Goldman lawsuit make you less willing to invest in the stock market?

I'm conducting research on how the stock market's volatility has impacted household portfolio allocations over the past two years. The link below will take you to a brief survey. Once you have completed the survey, you will see a graphic of the average portfolio allocation at 3/31/2010. https://www.surveymonkey.com/s/investments1

ReplyReport Abuseautoey92702 #5Saturday, April 24, 2010 6:25:45 PMI agree with some of Bill's points, and I agree that Congress has abdicated to this mayhem in the markets. Nonetheless, there needs to be more regulation and less leverage. Goldman participated in a massive con, in my opinion, in that it had more information than it would have been normally thought to have had by the counterparty to Paulson (ACA). Also, generally, there is simply too much outright gambling going on here-and with this outright gambling, the Federal government is then expected to go in and backstop this insanity. It's outrageous. Is Paulson a genius or is he someone on the inside with a mind not to investment but odds making, and one with access to the mechanisms to play his gambles? Was the management of GS genius in their purchases of insurance from AIG, or did GS, in fact reap billions ONLY because the US Government decided to honor AIG's commitments to GS? I call it audacious luck, and poor management by the US government, not genius on GS or Paulson's part.ReplyReport AbuseRocco Fugaro #6Saturday, April 24, 2010 7:20:05 PMso, has anything changed? No. G.S. will get a slap on the wrist. The Congress will rattle its legislative sword. The SEC will do its Chinese Fire Drill. The media will all go home. Business as usual. Oh, yes, the American People get schrewed once again.ReplyReport Abusewordfrominside #7Sunday, April 25, 2010 1:37:42 AM

Oh, Goldman and the other players in this scam knew the score; they knew the rating scores:

Rating Agency Data Aided Wall Street in Mortgage Deals

http://www.nytimes.com/2010/04/24/business/24rating.html?th&emc=th

ReplyReport AbuseFIRSTCALL #8Sunday, April 25, 2010 2:48:51 AMPresident Bush and Treasury Sec. Paulson should be investigated, indited. Back in 2005, give or take a year, if a little dummy like myself was questioning the destructive outcomes of sub-prime, liar loans, no income mortgages, 120% of value mortgages and so on, that the Bush boys should have been questioning the idiocy that was going on? IT WAS NOT A SECRETE THAT THIS WAS GOING ON. They closed their eyes because it was juicing up the economy during an unpopular war. What Goldman did was just a repackaged con that they are the masters of.ReplyReport Abusewordfrominside #9Sunday, April 25, 2010 12:26:34 PM

I am quoting this from a NYT editorial. Yes, I know NYT's political leanings but what it is said is true nevertheless. People who focus incessantly on the legal details and arguments of the Goldman case (or any other cases that come along) completely miss the point of the entire enterprise and why the country is in such dire straits. Although the size of the asset pool has recovered somewhat with the recovery of the stock, bond. commodities and currency markets, the wrenching effects of the financial crisis has resulted in the largest wholesale transfer of wealth in the ENTIRE history of the world.

The quote:

Those same people also make smart decisions without transparency — smart for them, if not the country. Even if the reform bill does bring stringent regulation to derivatives — a big if — that won’t rectify capitalism’s worst “innovation” in our own Gilded Age: the advent of exotic, speculative “investments” that have no redeeming social value and are instead concocted to facilitate gambling for its own sake. Such are the Goldman instruments of mass financial destruction that paid off for John Paulson. In 2007 alone, according to Gregory Zuckerman in his book “The Greatest Trade Ever,” Paulson’s personal take amounted to over $10 million a day, “more than the earnings of J. K. Rowling, Oprah Winfrey and Tiger Woods put together.” That “financial alchemy,” as Zuckerman calls it, explains why the finance sector’s share of domestic corporate profits, never higher than 16 percent until 1986, hit 41 percent in the last decade.

And, let's not forget, Goldman is not the only company under investigation. There is the convenient corpse of Lehman Brothers and the weapon of the 85% government ownership of AIG with which we can perform an autopsy to see what had happened before the crisis hit its crescendo.

Here's another fact: the 6 largest financial institutions now manage 61% of all financial assets in the country! Given the personal faults of the people that created the crisis, do you think it is wise to allow these people to access that much of the country's wealth?

ReplyReport Abuseholland3 #10Sunday, April 25, 2010 12:48:49 PM

I am surprised that no one is investigating how much money/ gs stock the former treasury secretary Paulson made from his decisions when we were all told there would be a financial crisis. Were there no other senior economists in our government who had an opinion on how to spend billions of american taxpayer dollars ? As a taxpayer, I am annoyed that there are so many business schools/ MBA programs in our country ,and economists working on the taxpayer dime, and we are not getting competence in terms of the best usage of taxpayer money. Will someone in the business community please start speaking up more loudly about the damage that has not only been done to the american taxpayer in terms of not getting their tax dollars used to build infrastructure, small business loans to create local jobs etc, but also to the reputation of our country as a capitalist society in the global arena. If I was a pension manager in some other country, I may think twice about doing business with an American firm due to concern over poor regulation.

I have no business degree, but could understand housing prices were getting too hot. I have no business degree, but can understand if a few investment banks go out of business, there will be other investment banks who will jump at the opportunity to gain market share. Is that not what capitalism is all about? Did the decisions of Secretary Paulson help some firms more than others ? Even I could borrow money at less than 1% interest rates and make money by buying stocks/bonds etc that pay 3-5% interest and dividends if the government was so generous with individuals as they are with the banks. How could our government allow some banks to over leverage themselves to the point they can supposedly threaten the entire US economy ? The incompetence and buddy boy system in Washington is destroying the foundations of our country. I am not thrilled with republicans or democrats , and look forward to a day when there will be real third party options to vote for.

ReplyReport Abuse1 - 10 of 10PreviousNext_ucf13('0'); _iuc2Om1('MSNPortalInlineComments','Initial_Load_Comment_View','http://articles.moneycentral.msn.com/Investing/ContrarianChronicles/goldman-deal-gamblers-knew-the-score.aspx?','en-us');Are you sure you want to delete this comment?Report AbusePlease help us to maintain a healthy and vibrant community by reporting any illegal or inappropriate behavior. If you believe a message violates theCode of Conductplease notify us using the Report abuse form below. We will investigate your report and take appropriate action against offenders. We report all illegal activity to authorities.CategoriesSpam or advertisingChild pornography or exploitationProfanity, vulgarity or obscenityCopyright infringementHarassment or threatOtherAdditional comments(optional)100 character limit To add a comment, pleasesign in/*MSN PrivacyLegalAdvertiseRSSHelpFeedbackSite mapAbout our ads© 2010 Microsoft/*