Big Money: Debunking the myth of the sophisticated investor’
Washington Post
By Heidi Moore
May 2, 2010… Let’s examine what happened with Goldman and Paulson. Goldman Sachs stands accused, in part, of giving favored financial treatment to Paulson’s firm, allowing him to advise on the creation of a security, Abacus, that he wanted to fail; Goldman later sold it to investors who wanted the security to succeed, but it didn’t tell them Paulson had played a role in creating the thing and shorted it to bet it would fail. To sell the deal, Goldman apparently withheld information about Paulson’s involvement from the buyers, including Royal Bank of Scotland and Germany’s IKB Deutsche Industriebank. The buyers lost about $1 billion on the deal, according to the Securities and Exchange Commission…
Economists call this "informational asymmetry." Everyone else calls it "not telling the whole story." The hitch is that America’s securities laws require disclosing all warts to potential buyers, and banks pay lawyers millions of dollars every year to comply.
Informational asymmetry is also contagious: Once it’s started, it becomes easier and easier to withhold information that buyers need in order to make decisions. And if it’s done to one client, it can be done to any. Most of those clients can put 2 and 2 together and recognize that what happened in the Abacus deal is probably not an isolated incident; in Wall Street parlance, there’s never just one roach. That’s why Goldman and Paulson started assiduously groveling to their other clients after the SEC announced its case, hoping to ease those clients’ predictable fears that the bank and the hedge fund could have treated them the same way they treated RBS and IKB.
It’s not just the big clients, however, that get hurt. What Wall Street would like to ignore when it is taking bets in its casino is that a big pile of chips on the table come from regular consumers – from their bank deposits, retirement accounts, credit-card balances, car loans and mortgages. That’s why the distinction between these sophisticated investors and everyone else is nonexistent. When Wall Street banks omit information and draw profits from "institutional investors," that means they are taking money from your pension funds, your school endowments, and your city and state governments. Other sophisticated investors include hedge funds, which take money from those pension funds, or private-equity funds, which own companies that employ 10 percent of all Americans.
Pension funds, for instance, are considered "sophisticated investors" on Wall Street. But those are just pools of retirement money owed to workers. The pension funds, looking to expand their stash, invest in stocks and bonds sold by Wall Street. These pension funds also give their money to other funds, such as hedge funds and private equity funds, that invest that money in riskier investments, perhaps troubled companies or distressed mortgages. Pension funds play the Wall Street game to score a healthy return – but when they lose, the money lost belongs to regular people.
Consider synthetic collateralized debt obligations – which describes bets made on a bundle of securities tied to home loans – like Abacus. Banks would need to lend $50 billion of mortgages to regular people in order to create a $1 billion CDO like Abacus, according to Michael Lewis in "The Big Short." These deals didn’t cause the greatest financial crisis since the Great Depression; what they did was far worse.
They took the basic subprime losses and magnified them to a point at which no one – not banks, not investors, not entire governments – could bear the cost of the massacre that followed. It cost only $35 million a year to buy protection against the failure of billions of dollars of assets. When these assets failed, the insurance holders didn’t get $35 million a year; they received many multiples of that. Banks nearly collapsed trying to scrounge together the money to pay back these insurance policies. The two banks that bought the Abacus deal both received multiple bailouts from the taxpayers of Germany and Britain. Yet Goldman and Paulson insist their deals concerned only sophisticated investors. Tell that to the foreign governments…
As a result of the bank closings and the already devastated economy, public confidence in the U.S. financial structure was low. In order to restore the banking public’s confidence that banks would follow reasonable banking practices, Congress created the Glass-Steagall Act. The act forced a separation of commercial and investment banks by preventing commercial banks from underwriting securities, with the exception of U.S. Treasury and federal agency securities, and municipal and state general-obligation securities. More specifically, the act authorizes Federal Reserve banks to use government obligations and commercial paper as collateral for their note issues, in order to encourage expansion of the currency. Banks also may offer advisory services regarding investments for their customers, as well as buy and sell securities for their customers. However, information gained from providing such services may not be used by a bank when it acts as a lender. Likewise, investment banks may not engage in the business of receiving deposits.
Actually, I wouldn’t even object to the Derivatives Markets continuing if they blocked using our personal money to bet with. If rich people want to give John Paulson their money to mess with, that’s fine with me. I just don’t want our Banks insuring their antics with what they call "institutional money" – namely, my retirement plan or whatever they garner from government bailouts. If they want to give it to Bernie Madoff, it’s okay with me too. Just don’t ask us to back them up involuntarily.
Sorry, the comment form is closed at this time.