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April 20, 2010

News & Opinion: The Greatest Gamble Ever

By: Dylan Schleicher @ 10:27 PM – Filed under: Management & Workplace Culture

Gregory Zuckerheim's The Greatest Trade Ever: The Behind-The-Scenes Story of How John Paulson Defied Wall Street and Made Financial History tells of how Paulson "realized something few others suspected—that the housing market and the value of sub-prime mortgages we grossly inflated and headed for a major fall." But it turns out that "The Greatest Trade Ever" may have been something very akin to a rigged bet. What the book didn't tell us (because it was unknown at the time) is that Paulson had shaped the portfolio of mortgages—hand-picking the bonds it contained for Goldman Sachs—that he bet against to make his fortune. (This is what is behind the SEC suit being brought against Goldman Sachs we've been hearing so much about.) Instead of explaining this myself (Because I don't know if I really can), I'll defer to The New York Times and the authors they've had weigh in on the situation this week. Yesterday, Too Big To Fail author Andrew Ross Sorking wrote about When Wall Street Deals Resemble Casino Wagers:
The Securities and Exchange Commission, in its suit, says that Mr. Paulson asked Goldman to help create a synthetic C.D.O. of lousy mortgage loans that he selected so he could bet that they would go down and then profit on their fall [...] This kind of high finance can numb the brain, and the legal questions are murky. But when you strip all of that away, this deal was nothing more than a roll of the dice. Try this mental exercise: Imagine if, a few years ago, an influential investor like Warren Buffett, bullish on real estate, had asked Goldman to develop a synthetic C.D.O. made up of undervalued mortgages. Now, imagine if Goldman had found John Paulson to take the opposite side of the trade and, lo and behold, a year later Mr. Buffett turned out to be right and Mr. Paulson lost his shirt. Would you call that fraud? Would you be very upset? Maybe not, but Mr. Paulson sure would be. And he might be inclined to sue over it, especially if he found out that his bet had been rigged against him from the start.
Today, Roger Lowenstein, author of The End of Wall Street, took his turn explaining Goldman's Gambling With the Economy:
Wall Street’s purpose, you will recall, is to raise money for industry: to finance steel mills and technology companies and, yes, even mortgages. But the collateralized debt obligations involved in the Goldman trades, like billions of dollars of similar trades sponsored by most every Wall Street firm, raised nothing for nobody. In essence, they were simply a side bet—like those in a casino—that allowed speculators to increase society’s mortgage wager without financing a single house. [...] The government would not look fondly on Caesar’s Palace if it opened a table for wagering on corporate failure. It should not give greater encouragement for Goldman Sachs to do so.
The Return of Depression Economics and the Crisis of 2008 author and Nobel Laureate Paul Krugman, in his Op-Ed piece about Looters in Loafers on Sunday, explained how these bets made the overall recession worse:
So what role did fraud play in the financial crisis? Neither predatory lending nor the selling of mortgages on false pretenses caused the crisis. But they surely made it worse, both by helping to inflate the housing bubble and by creating a pool of assets guaranteed to turn into toxic waste once the bubble burst. As for the alleged creation of investments designed to fail, these may have magnified losses at the banks that were on the losing side of these deals, deepening the banking crisis that turned the burst housing bubble into an economy-wide catastrophe.
And, though not specifically about Goldman Sachs and the SEC suit being brought against it, William Cohan, the author of House of Cards, took the space allotted him today on the Op-Ed page today to say You're Welcome, Wall Street.

About Dylan Schleicher


Dylan Schleicher has been a part of the 800-CEO-READ claque since 2003. Even though he's stayed on at the company, he has not stayed put. After beginning in shipping & receiving, he joined customer service and accounting before moving into his current, highly elliptical orbit of duties overseeing the ChangeThis and In the Books websites, the company's annual review of books and in-house design. He lives with his wife and two children in the Washington Heights neighborhood on Milwaukee's West Side.