Understanding Wall Street

Henry Blodget is doing some great reporting and analysis of the specifics of the very weak fraud charges against Goldman Sachs, but I think the general reaction to the fraud charges, i.e., the gut reaction by the man on the street, is that, "Yes, Goldman did commit fraud." This reaction comes from a failure to understand how Wall Street works.

Wall Street is essentially the land of dealmakers where, day in and day out, Wall Street brokers and investment bankers are approached to raise money, or create products. Most of the deals brokers and IB's are approached about are turned down because the brokers and IB's know that there is no one in their network to take the other side of the deal. If, say. Apple approaches a broker to sell some stock, the broker is likely to agree to the deal because he knows that he can sell the stock to his network. If Johnny down the street approaches a broker to sell stock in his company that hopes to someday capture flying saucers and turn them into tourist travelling air ships, a broker might have problems placing the deal, and turn Johnny down.

It's the same with constructing product, Goldman or any other broker is only going to take on the construction of a product for a client when Goldman knows it can place the opposite side of the product.

It might be a great idea right now to create a product that owns land directly under the Icelandic volcano that is erupting and short that product. Goldman isn't creating this product because it knows that no one would take the opposite side of that trade. Who afterall is going to buy land right at the core of the erupting volcano? On the other hand, when Paulson approached Goldman about creating a CDO that could be shorted, Goldman knew it could find investors who would be interested in taking the other side of that trade, i.e. people who thought real estate prices were going to continue to climb higher (Note to the SEC: In 2007, there were a few people who thought real estate prices were going to be climbing higher.)

When Goldman agreed, Goldman was doing what it does every day simply putting a deal together.

Now, the SEC further alleges that Paulson put the deal together. This is not true. Whenever anyone brings a potential deal to a broker or IB, they are going to try and get the best terms they can. When a company negotiates with a broker on the price of an IPO, the company tries to influece the broker for the highest price possible, i.e. one could say the company had input in setting the price.

In the same way, if Goldman is putting together a CDO for Paulson, Paulson is going to, very logically, want the weakest mortgage backed securities in the world in that CDO. There is nothing wrong with this. Paulson can suggest anything in the world. Goldman took it to an independent third party, ACA, to evaluate the securities Paulson wanted in the CDO. They allowed some, and disallowed others.

ACA and Goldman Sachs then bought some of this CDO. Got that? For all practical purposes, Goldman and ACA thought Paulson was an idiot for thinking the real estate market was going down. Goldman and ACA, which let me emphasise again was the independent third party brought in to evaluate the potfolio, bought part of the CDO. This was a regular everyday transaction on Wall Street. As far as Goldman failing to disclose that Paulson was on the other side of the trade, disclosure like that is simply never done on Wall Street. You do your own analysis and you take your chances. It is the only logical way to do things.How could Warren Buffett, for example, ever buy or sell stock if his broker had to disclose to the opposite party, "Hey, you are trading against Warren Buffett."

You would think that Robert Khuzami, Director of the Division of Enforcement at the SEC would understand this. Thus, it appears that the charges are complete grandstanding by the SEC for political reasons. It's feeding Goldman meat to the masses, now that Goldman CEO Lloyd Blankfein dissed President Obama, when Obama called for a sitdown.

Goldman raped America when Blankfein, in cahoots with then Treasury Secretary Hank Paulson, bailed out AIG for the benefit of Goldman Sachs. That was criminal, so it is hard to feel sorry for Goldman, but on the other hand, this charge against Goldman is not about justice, it is about big game politics, and there is not a more evil bunch of people on earth than government officials who will twist facts and situations to fit power agendas. Power agendas must always and everywhere be fought, and this move by the SEC and Khuzami is nothing but a power agenda move. If they get away with this one, the next time they may try it on you.

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