Goldman Sachs: The Long and Short of Opaque

Apr.22.10 | About: Goldman Sachs (GS)

Goldman Sachs’ (NYSE:GS) earnings call was startlingly arrogant in not remaining silent on the SEC fraud charges. Not only did they fail to disclose the Wells Notice in a timely manner, but challenged the SEC for not giving them a chance to settle before the public announcement. Goldman’s PR machine is so poor that Republicans are being forced to work with Democrats on financial reform as I write. Being legally right and morally wrong does not make for good politics or client relations.

Goldman has sustained itself being a firm that all others had to deal with, like it or not. They were smart enough to work within the letter of the law to offset much of their credit risk at major inflection points. Goldman turned up relatively unscathed, while leaving a bloody trail in their wake. Of course this is a bit of exaggeration for a firm with many clean businesses. But the smartest guys in the room are now saying to their clients “buyer beware.”

The main crux of Goldman’s defense is that buyers of the CDO targeted in the SEC fraud indictment were sophisticated investors who had enough information to make a reasonable decision. Goldman’s salesmanship should have played no role. And ACA, the portfolio developer, was sophisticated enough to act independently whether Goldman tried to influence it or not. It appears that both ACA and the banks that bought the CDO were putty in Goldman’s hands.

How sophisticated could ACA be if they agreed to insure items Paulson selected? Was ACA blinded by greed?

While 'sophisticated investor' is often an overstatement for financial institutions, states, cities and pension funds being duped, Goldman’s argument that all investors know there must be a long and a short for all synthetic CDOs bears a closer look.

I will take a nonprofessional stab at it. The CDO is synthetic only in that the trust’s portfolio contains CDS rather than MBS or bonds. Once created, Goldman’s job is to sell it out of inventory to long investors. John Paulson’s short positions on the CDO bond tranches are completely separate transactions. Goldman being stuck with inventory that they could not sell bears no relevance to their commitment to the CDO, long or short.

The only place where balanced long and short positions are relevant is in the CDS included in the trust. Given that Paulson’s CDS were on the CDO itself and not the components, Goldman’s excuses during the conference call fell short. With the exception of ACA, the investors in the CDO could not be expected to know that Paulson used Goldman to build a CDO design to fail.

The long and short of sophisticated investors is that those often flattered with the term are taken advantage of, and the peddlers of ingenious financial products are losing their political influence. “Let the public be dammed”, “screw or be screwed” and “survival of the fittest” are no longer the best business strategies for the rocket scientist of Wall Street.

Finally, rarely are the innocent speared when the sophisticated players rumble. Look at state and municipal governments brought to their knees by Wall Street. Look at the many public and private pension plans and endowments humbled.

I believe that Goldman is in shock that morality now matters. The company that professes not to be a “retail bank” is about to be reformed by retail politics.

Disclosure: None