Performance Perspectives Blog

Isn’t there always the other side?

by | Apr 17, 2010

I, like many others, was surprised by the revelation that Goldman Sachs has been charged with defrauding investors. While my research into this is somewhat limited at this time, I couldn’t help but be struck by a statement in today’s Wall Street Journal front page article on this topic:

 “Regulators say Goldman allowed Mr. Paulson’s firm, Paulson & Co., to help design a financial investment known as a CDO, or collateralized debt obligation, built out of a specific set of risky mortgage assets – essentially setting up the CDO for failure. Paulson then bet against it, while investors in the CDO weren’t told of Paulson’s role or intentions.”

Excuse me, “setting up the CDO for failure”? In retrospect we can see that it failed, but at the time many investors were willing to bet that these CDOs were going to pay them great returns. And why would Goldman tell the purchasers that Paulson was on the other side, betting against the CDOs? Isn’t there always someone on the other side? Wouldn’t that be improper for Goldman to identify the other side of the trade? Shouldn’t the investors have realized that someone might hold the opposite position? Didn’t the investors in the CDOs recognize that there were risks with their investments? There was a housing bubble and these investors expected there to be no problems with the markets (just as countless many others did). Okay, their investment failed; they took a bet and it didn’t work out. Now Goldman is charged with fraud?

Many, many individuals felt that Paulson was tilting at windmills. That his investments surely wouldn’t work out. Well, they did, and they resulted in billions of dollars for himself, his firm and his investors.

Investing is a zero sum game, is it not? For every winner there’s a loser. Goldman appears to have constructed CDOs (that’s what happens with these instruments, right?; someone has to take mortgages, bundle them together, and create an instrument) at Paulson’s request and they were able to find someone to buy them; Paulson took the opposite view.

Can someone explain how fraud enters into this? It’s not clear to me and perhaps there is a lot more to it, but this doesn’t seem all that horrible. Is the SEC trying to show their power because of their horrendous failure in the Madoff case?

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