Will It Really Help To Investigate Goldman Sachs?
However, more time and research has exposed a group of sinister events that actually took place. It seems that some people knew more about the coming catastrophe than they were willing to let on.
When the credit crisis developed in 2008, everyone blamed the bankers for taking unnecessary risks. At the time, they explained that they simply hadn’t understood the risks and needed to update their risk assessment tools. Investigations since then have revealed a more disturbing reality behind what happened.
Goldman Sachs was heavily involved in producing CDOs—bundles of investments that derived their value from the amalgam of the underlying assets. These might be securitized mortgages or even something as exotic as an airline flight. In theory, CDOs should be quite secure, but many CDOs were based on weak assets. This is where sub-prime mortgages got involved. A number of companies like Goldman Sachs originated CDOs based on these mortgages, assuming that they were more valuable than they actually were. During this period, the originators made a huge profit on every CDO they produced and times looked good. Of course, you know the story—the bottom dropped out of the housing market, consumers couldn’t meet rising mortgage costs, the CDOs became utterly worthless, and the taxpayer ended up carrying most of the bill. When the various stimulus bills were being debated, banks tried to depict themselves as victims along with everyone else. After all, they had lost massive amounts of money too. However, understanding what these banks really did is hardly as simple as reading a forex broker comparison.
However, more time and research has exposed a group of sinister events that actually took place. It seems that some people knew more about the coming catastrophe than they were willing to let on. The basic story is that a few aggressive and highly intelligent hedge fund managers realized that sub-prime mortgages were practically worthless. Advanced knowledge about any part of the market is always valuable, and these managers knew how to turn their understanding into returns. The method was to find CDOs that were doomed to failure and bet against them. Using investments that essentially work like insurance policies, they could reap huge profits as soon as the sub-prime mortgage market collapsed.
First, however, they needed faulty CDOs to bet against. So they put up a small amount of money for Goldman Sachs to originate the investments. In fact, they paid for the core of the investments which is also typically the riskiest part. When other investors saw them take this on, they assumed that something was happening and invested vast amounts of money in the rest of the CDO—expenditures far beyond what the hedge fund paid. When the fund failed, these investors suffered huge losses. Of course, the hedge funds lost their initial investment as well, but reaped a huge profit from their hedging contracts (the financial “insurance” they bought against the failure). Essentially, they worked the equivalent of shorting a stock.
The other agencies that made a profit, at least in the short term, were the originators—financial companies like Goldman Sachs who charged a premium for putting the CDO together. What has now become evident is that Goldman was willing to do an extraordinary thing in that process: they let the hedge funds have a significant say in how the CDO would be put together. Naturally, the hedge fund managers asked for investment assets that were essentially doomed to failure. Goldman let them do it. To make matters worse, it now appears that Goldman never made a full disclosure about the fact that this was happening. In other words, the investors who naïvely bought the rest of the doomed CDO didn’t know that Goldman was working with the hedge funds like this. These investors risked their money in good faith without all of the pertinent information—and later suffered huge losses. As the SEC now alleges, Goldman’s actions were essentially fraud.
This is why the current investigation and allegations are so crucial. The question is whether the regulatory agencies can give Goldman enough trouble to make sure that it doesn’t happen again. In other words, will investigating Goldman really help?
The answer is probably mixed. It is certainly crucial that destructive and misleading financial practices like this should be punished. It is also fairly certain that punishing Goldman for what they did will send a message to other banks and set a precedent for the future.
However, don’t expect this to be the end of problems like this. Fraud will continue for as long as the financial markets exist. In a few years, someone else will commit the same type of fraud with different financial instruments. Worse, the fraud Goldman committed is so widely spread among financial companies, it is impossible for the SEC to deal with it sufficiently. Expect a weak settlement in which Goldman suffers a token penalty that is still less than what they profited. Unless the SEC suddenly becomes more aggressive, the positive results of the investigation will only be partial.
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I surely hope they get Investigated. If found guilty, I hope they pay.