The Goldman defenders

By Felix Salmon
May 4, 2010
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Is it just me, or are the defenders of Goldman Sachs becoming more vocal and more numerous these days? Andrew Ross Sorkin today seems to come down squarely on the side of Warren Buffett and Bill Ackman, defending Buffett from accusations that his stance on Goldman is self-serving (“his stake in Goldman is more a loan than an investment, so he’ll no doubt be paid no matter what happens with the Abacus suit”) and agreeing with Buffett that there seems to be something of a witch-hunt going on:

With so many easy targets of the financial crisis — Fannie Mae, Freddie Mac, A.I.G., Bear Stearns, Lehman Brothers — it does seem odd that the government, and the public, has chosen to vilify one of only a couple of firms that made fewer mistakes than the rest.

The problem is that this makes no sense. Does Sorkin really believe for one moment that the other firms on his list haven’t been vilified? After all, he himself wrote a column last year explaining that that the vilification at AIG was so bad that you wouldn’t want to work there for less than $3 million a year.

More invidiously, Sorkin twice plays the cunning game of stating the SEC case against Goldman in ways that makes it easy to criticize. “The S.E.C. has accused Goldman of not disclosing that the Abacus instrument was devised in part by a short-seller, John Paulson, who stood to gain by betting against it,” he writes, accurately enough, and then lays out the opposite case:

“For the life of me, I don’t see whether it makes any difference whether it was John Paulson on the other side of the deal, or whether it was Goldman Sachs on the other side of the deal, or whether it was Berkshire Hathaway on the other side of the deal,” Mr. Buffett said…

One Berkshire shareholder who has been a regular in Omaha is Bill Ackman…

In recent days, he has gone even further than Mr. Buffett in his defense of Goldman, suggesting it would have been unethical for the firm to disclose Mr. Paulson’s position in the Abacus deal. He says that Goldman, as the market maker, had a duty to protect the identity of both sides of the transaction.

He agrees with Mr. Buffett that as an investor, he would not have considered it necessary to know that Mr. Paulson had helped select the securities.

But this is a bit of a straw man, as Sorkin well knows. The heart of the SEC case is not that Goldman failed to disclose Paulson’s name. It’s that Goldman failed to disclose the fact that the sponsor of the deal, the fund which was paying Goldman $15 million to put it together, was going short the entire thing. The Magnetar disclosure, for instance, which the SEC presented to Goldman as an example of what the bank should have done, never actually reveals Magnetar’s name or identity. But it does make it clear that the Initial Preferred Securityholder might be shorting the deal and that its interests are not necessarily aligned with those of the investors.

What’s more, Buffett and Ackman have made their careers, and become extremely wealthy, by analyzing and picking individual securities. That’s what they’re especially good at. Neither of them in a million years would invest in a CDO managed by someone else, like ACA: they compete with the likes of ACA. IKB, by contrast, specifically asked for an independent CDO manager, and said that it would not be happy with Goldman itself selecting the contents of the CDO. That’s not the kind of action that you’d expect from someone who thinks that a simple list of reference securities comprises “all the relevant facts that any investor would need”, in Sorkin’s words.

ACA, here, is a bit like a mutual fund manager, and IKB was an investor in that fund. The argument from Buffett and Ackman is essentially that so long as fund investors know what their fund manager is investing in, they shouldn’t really care who that manager is. It’s silly, especially coming as it does from two men who have made a fortune by setting themselves up as great stewards of other people’s money.

John Gapper is much more sensible on the whole affair, throwing prior Buffett statements back at him, especially the one from 2002 where he complains that derivatives are nearly always mispriced until it’s far too late. He says that “the shareholders of Berkshire Hathaway were disappointed by Warren Buffett’s defence of Goldman Sachs”, while Sorkin prefers to say that “by the end of Berkshire’s annual meeting, at least some of the 40,000 shareholders in attendance who had been skeptical of Goldman” had come around to Buffett’s way of thinking. I suspect that Gapper’s characterization is the more accurate.

But it seems that Goldman is drumming up a certain amount of what it likes to think of as “third-party validators” these days, including this astonishing statement from law professor Richard Epstein:

At the time of the ill-fated Goldman transaction, no one in the CDO market thought they were governed by any full disclosure regime. It was everyone for himself, and for good reason.

Hm. I wonder, in that case, why there was a 196-page prospectus for the deal, full of dense, disclosure-filled legalese.

32 comments

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Let me get this straight:

1. BRK buys from GS preferred shares with a 10% annual dividend – I assume that, if GS loses money, this dividend is not paid on time

2. BRK gets from GS options to buy stock at $115 until 2013, so the higher the actual price the better the return BRK gets

And Ross Sorkin wants me to believe that Buffett is not invested in GS’s financial performance going forward?

I can agree that the SEC case is far from bulletproof. But the key issue is that GS failed to provide useful (vital?) info from the Abacus deal to the long side, and that is, to say the least morally reprehensible. I don’t know how Buffett can defend that, unless you understand that, by siding with GS, Buffett is just fueling the return on his GS investment (not a loan, btw).

Posted by lgg | Report as abusive

Felix,

Don’t ignore one of the more obvious items: It’s very sad to say it, but one of the reasons people hate this firm is the ethnic background of the ‘partners.’ As Jews, I think we are well aware that anti-antisemitism is alive and well in today’s USA.

Posted by MarkWolfinger | Report as abusive

Getting through Sorkin columns of this type (such as a “Blackstone are really terrific guys” example I recall from a while back) is sort of the price you pay for finding out who swore at whom in the most colorful fashion during Great Moments In Financial History.

Posted by gringcorp | Report as abusive

All enforcement is selective. In this case, the government lawyers likely felt that:

a. It’s important to affirm the standard that a blunt disclosure law can’t be avoided for profit and that claims of “sophisticated investor” don’t vitiate disclosure obligations under law.
b. Since the end clients are public, meaning pension fund investors and the like, there is a public interest in encouraging companies to adhere to the law.

My guess is that if the end client was really just another financial company that the government would have little to no interest in this matter.

Posted by jomiku | Report as abusive

@MarkWolfinger,

I hate GS with the utmost vitriol but until you brought ethnicity into the conversation, I wouldn’t have been able to tell you the ethnicity of anybody involved with the company (because I don’t care). Jew, Swede, Italian, Asian, African, or Canadian, GS presents itself as a beacon of condescension and self importance that personifies the class war in the United States.

Middle America is squeezed from all sides while institutions like GS, AIG, et al. are bailed out with our tax money that is then used to pay out massive bonuses. And then on top of it all, these corporations turn around and tell us that it’s for our own good (as if we had a choice anyway) with not a hint of humility. I mean really, you don’t think that there is enough there to hate without bringing race into the picture??

Posted by spectre855 | Report as abusive

Felix,
If your view is the right one, why isn’t IKB suing ACA and/or Goldman? Why isn’t ACA suing Goldman? The SEC’s case doesn’t make sense to me until I see the private suits filed, where those entities specifically lay out how they were misled. It makes no sense to me that the SEC is doing this on their behalf.

Posted by Beer_numbers | Report as abusive

there is no doubt Buffet is talking his own book – he’s a pro at that. remember, it was his op-ed about being long America that sparked the equity rally in the first place!

however, i do believe that HE believes what he’s saying about GS’s role in all of this..

Posted by KidDynamite | Report as abusive

Most of the “dense legalese” in this document pertained to elements of the deal, not disclosure. Only some five pages or so are given to some boilerplate disclaimers about agency that GS detractors still pretend isnt there.

“It’s important to affirm the standard that a blunt disclosure law can’t be avoided for profit ”

I’d be interested to see the specific parts of derivatives law that require market makers to disclose their clients’ positions to one another, especially among those with directly adverse interests in a zero sum structure.

“Since the end clients are public, meaning pension fund investors and the like”

Do you mean the pensions invested with Paulson? Or those with Goldmans? Who is the “end client” in your conception of this trade?

Posted by AEinCH | Report as abusive

@Beer_numbers –

IKB probably isn’t suing for the same reason that many others aren’t suing. They didn’t exactly cover themselves in glory on these deals. If you managed to lose hundreds of millions being the patsy in a scam it looks much worse than if you lost it in a ‘general market crash.’ For all we know, the managers of IKB may even have exceeded their mandate in chasing yield.

Lots of banks and funds are quietly nursing their wounds and would rather it not be known to their investors and clients how their lost so much money. Buffett is engaged in bullying tactics to label these counterparties as incompetent fools in advance to scare them away from suing. He sure is loyal!

Posted by DanHess | Report as abusive

I thought the “end clients” here were whoever IKB was going to (or did) sell on to, whether that’s German pension funds, or directly to individual German dentists/engineers/widows/orphans and the like.

Posted by SelenesMom | Report as abusive

Felix is right that in the narrow legal sense, GS should have disclosed Paulson’s role in the transaction, or at least put a disclaimer in like Magnetar. Still, IKB knew full well it was a zero-sum bet, and at least in the legal sense, a sophisticated investor. And wouldn’t GS have hedged the entire transaction beforehand had they believed the price would collapse (given Paulson’s role, and their knowledge thereof)?

Posted by Abulili | Report as abusive

Selenesmom, IKB didn’t sell the “securities” on, one of many reasons why this case smacks of baloney. IKB was buying them on behalf of its own offshore regulatory avoidance vehicle called ‘rhineland conduit.’ see here eg for more:
http://www.nickdunbar.net/?page_id=146

Posted by AEinCH | Report as abusive

DanHess,
IKB would rather look good than recover money? That seems to be a pretty direct fiduciary failing. I’m with Buffett on this one.

Posted by Beer_numbers | Report as abusive

Folks are with Buffett because IKB is skuzzy and unsympathetic?

That doesn’t change the fact that the law, at least in a narrow sense, seems to have been broken.

Posted by DanHess | Report as abusive

“ACA, here, is a bit like a mutual fund manager, and IKB was an investor in that fund. The argument from Buffett and Ackman is essentially that so long as fund investors know what their fund manager is investing in, they shouldn’t really care who that manager is. It’s silly, especially coming as it does from two men who have made a fortune by setting themselves up as great stewards of other people’s money.”

Do you mean Paulson was the fund manager?

And what do you really mean, “like a fund manager”? ACA was exactly like a fund manager, except they couldn’t buy or sell (manage) for the fund. If I bought a mutual fund whose portfolio was set in stone before I bought, then I personally would care about the portfolio, but not the “manager”. Would you approach it differently.

Posted by Despistado | Report as abusive

It’s far from certain that IKB wouldn’t sue GS, only that it has not yet done so in stated deference to SEC’s titular priority. Same applies to the respective governments of Germany and the UK, and of course RBS. On the other hand, there’s that County in Washington State amid numerous other domestic suits coming at GS right now.

Maybe it’s a European thing to give the institution of record the first crack at getting its house in order but, whatever it is, it’s something Warren Buffett in his dotage would do well to emulate.

This goes double for all local Goldman sycophants (Wolfinger please note: of whatever religious tendency) who are digging themselves into a credibility gap so deep it may never stop festering, never mind completely heal over.

Posted by HBC | Report as abusive

Any international aspirations Buffett may have had just took a hit to the gut while he was running off at the mouth, running interference for the cutpurse home team. That his was a poor choice of words and an even worse choice of timing to express them hasn’t escaped the attention of American shareholders either. If reputations count for anything, his just sank a good several notches.

Worst of all, Sorkin is deluding himself to think that this will all be over once Goldman’s situation has been legally illuminated. All the others he mentions have it coming too, in short order.

Posted by HBC | Report as abusive

Despistado,

The manager really does matter in this case.

Unlike the stocks in a mutual fund, CDOs are information asymmetric. Its much easier to stuff them full of crap than it is to discover that they’ve been stuffed full of crap. That’s why IKB demanded a neutral party select the underlying securities – it is, in fact, similar to a manager because they’re relying on ACA’s neutrality.

Posted by AnonymousChef | Report as abusive

1. Does anyone else think one day soon we will wake up to find out that Sorkin has taken a job working for a financial institution?

2. Goldman may not have been required to make any disclosures in this unregistered deal, but once it made any disclosures it was required by law to make sure those disclosures were materially complete and accurate.

Posted by Snyderico | Report as abusive

Buffett’s explanation of Abacus has not been presented in full. He was asked the
same question and his explanation was neat.

Here is the exact explanation:

BECKY: Now, Goldman was obviously one of the huge headlines here this weekend. There are — right now the SEC considering these charges. And a lot of concern about whether Goldman not only followed the letter of the law, but the spirit of the law. What do you think?

BUFFETT: Well, from everything I’ve seen of the Abacus transaction, which was the one the SEC put out the complaint on, I do not see a problem with that transaction. We’re a bond insurer, ACA was a bond insurer, MBIA, FGIC, Ambac, and all those companies started out insuring municipal bonds and then the profit margins got squeezed in the municipal bonds and they started drifting over and insuring other structured deals and so on.

ACA had probably dozens of people analyzing bonds. Many of the reports don’t even explain that they were bond insured, but that was their job. Their job was to look at credits and stick a proper premium on if they wanted to insure them. If they didn’t know what the proper premium was, they should have skipped insuring them. And almost all of the bond insurers got in trouble during that period because they drifted over into areas where they really weren’t that good.

BECKY: But the SEC complaint focuses on fraud and says in large part it’s because Goldman, the SEC alleges, did not let on that John Paulson was on the short side, betting against this, and he was helping structure the deal.

BUFFETT: Becky, we had many deals presented to us. But, for example, there was a municipal bond deal that was presented to Berkshire. And 8 billion of municipal bonds and a Wall Street house came to us and they said, “We’d like you to insure these bonds.” And we said, “We’ll do it for $160 million.” And you’ll see that the state of California is a couple of hundred million and Texas is a billion. And when that firm came to us, it happened to be Lehman Brothers two years ago, and we were to insure these bonds for 10 years. There were four possibilities. Lehman had these bonds and was hedging them. Lehman had an opinion that municipal bonds were overpriced and they were shorting them. They had a customer on the bonds that was hedging them, or the customers were shorting them.

Posted by raghuveern | Report as abusive

How could GS put a Magnetar like disclosure in the Abacus document? Magnetar was long the equity; Paulson wasn’t. There was no initial preferred security holder in the Abacus deal…

They did disclose that GS was the counterparty on the swap and GS may in fact engage in an offsetting transaction with other parties, which they did, (partially) with Paulson.

Posted by TinyOne | Report as abusive

“Unlike the stocks in a mutual fund, CDOs are information asymmetric. Its much easier to stuff them full of crap than it is to discover that they’ve been stuffed full of crap. That’s why IKB demanded a neutral party select the underlying securities – it is, in fact, similar to a manager because they’re relying on ACA’s neutrality.”

AnonymousChef,

Define “information asymetric”. The SEC makes no claim that GS or Paulson had any information about the underlying securities that the rest of the world didn’t have, except that Paulson wanted to short them

Posted by Despistado | Report as abusive

Sorkin is a naive apologist for Wall Street. He has traded his forum in the NYT for access. He is willing to parrot whatever he is told by experienced professionals, and is unkowingly playing the fool.

Posted by julianbradley | Report as abusive

I still don’t get the fuss. Paulson has one economic view of the securities in the CDO. ACA and IKB clearly had a different one otherwise they would not have invested.

If as the SEC and random people allege that the CDO was stacked to fail then the people who failed in their fiduciary trust:

1) ACA who selected the portfolio but despite their years of experience as boasted on their site failed to notice the reference entities were “bound to fail”. Also believed that Paulson was long the equity slice in a deal with no equity slice.

2) IKB, who again despite their years of experience failed to notice the portfolio was “bound to fail”. Of course given they were stuffed to the gills with the same investments I guess they were kinda of screwed anyway if the investment went south so they were motivated to keep rolling the dice.

3) ABN Amro, who failed to do a proper hedge and proper due diligence but who where making tons of money from this deal and in large part due to exactly these deals were able to sell themselves as a hugely inflated price so in terms of realising shareholder value they did a good job.

But i guess suing these guys doesn’t generate the right sort of headlines – “Dumbass investors lose money” – not really whats going to get a poorly thought-out, knee jerk fin reg bill passed now is it?

Posted by Danny_Black | Report as abusive

AnonymousChef, in the prospectus was a full list of the reference bonds. Exactly what relevent information did GS have that IKB and ACA didn’t? That some guy that had exactly the same information thought these bonds were duff? If I go short IBM on REDI and you buy my short then the fact REDI doesn’t say so makes GS liable?

Posted by Danny_Black | Report as abusive

DanHess, they didn’t lose “hundreds of millions” they lost billions on a ton of transactions exactly like this and ended up being bailed out by the german government. They had a chance to cut their losses on this and other deals but decided to ride it down to the bottom.

If the SEC were honestly interested in rooting out bubble-generating behaviour and breach of fiduciary trust they’d be suing ACA and IKB but that wouldn’t serve their actual purpose.

Posted by Danny_Black | Report as abusive

HBC, the real reason IKB aren’t suing is because there is no case against GS and they don’t have a political agenda to drive that the democrats do. IKB also can’t just keep releasing embarassing emails forever as a “legal argument” or threaten the full might of the government. If GS does settle then they might piggy back on that.

FSA suing also has zero chance, just a pathetic attempt by our useless PM to fob off his guilt at running a great country into the ground, not even the UK press were dumb enough to buy that one. RBS is going to sue because it bought ABN at the top of the market who was insuring CDOs at the top of the market? Good luck with that one.

Personally I will wait until GS settles then sue everyone i made a losing trade against on the basis that they didn’t disclose that in the future that trade would lose me money.

Posted by Danny_Black | Report as abusive

I don’t know this Danny_Black guy, but I totally agree with him.

I think John Coffee comes closest to a sensible blaming of Goldman Sachs:
http://dealbook.blogs.nytimes.com/2010/0 5/04/debate-flares-on-goldmans-role-as-m arket-maker/

But in the end, I think Buffett’s description of this transaction is accurate.

Also love the comments I’ve seen about Buffett talking his book (e.g., KidDynamite), which seem ignorant of the fact that Buffett slammed Kraft’s management within about 4 seconds of complimenting Goldman.

Posted by Beer_numbers | Report as abusive

Danny_Black I don’t think anyone knows what “information asymmetric” means. Neither Paulson nor GS is psychic, and yet this is the only way their opinion on instruments priced at market could constitute a “material disclosure.”

Personally I’d like an explanation how a synthetic CDO can be crafted or priced *without* consulting some universe of shorts (through RFPs on component CDSes perhaps — isn’t this roughly what Paulson was doing for ACA?)

Posted by AEinCH | Report as abusive

If it were only the big investment companies swindling each other of their own money, this would all be moot, but in the end it was the public who took more risk then they would be willing to take.

In the end, these deals caused huge shudders throughout the world because it is paper snd debt, smoke and mirrors and the transactions more then a little suspect throughout.

@AEinCH, Personally I would like to know how Synthetic CDOs can be crafted at all, as though it were some big win in a high stakes lottery and you hold the ticket on paper. Being the money collected was the prize and there was no actual entity as a prize, I think initial investors have the right to ask that question.

Is “are you willing to take ridiculously high risk to buy into high risk/high yield winner takes all schemes?” now one of the questions the investment companies ask their clients? You would find, if asked, most would not wish to have their investment funds used in a lottery scheme.

Money maker= book maker

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