I'm a sucker for comedy. Growing up watching old Mae West, WC Fields, and Marx Brother movies or listening to records with the young Bill Cosby asking "Why is there air?". Later I was hooked by Monty Python's Flying Circus, Mel Brooks, Firesign Theater and just last year I was jolted by an hilarious comedy I never saw coming, "The Hangover". But when it comes to outright belly laughs it's hard to beat a Boston Globe editorial!
In yesterday's editorial on the SEC case against Goldman Sachs (04/24/2010) the Globe rails against Goldman's "financial folly" and, since the Globe's editors sit at the right hand of the Father (or on Olympus) and are spoken to by the deities, declare that "The transaction in question wasn’t an investment; it was a form of gambling." Well ... thank you, I'm glad you clarified that for us "regular folk". But, sometimes, even those of us that aren't as enlightened as Boston Globe editors have a few questions ... and sometimes they're good questions. Better yet, sometimes we are actually presumptuous enough that we'd like to have them answered.
I'd like to start with those first statements. How is the Globe defining investment, gambling and folly. Any person who thinks they can open a restaurant and pours their own (and frequently borrowed) money is, in fact, gambling. Since most new restaurants (not chains or parts of larger restaurant groups) fail with astonishing regularity (about 90% in 5 years), is opening a restaurant and investment, gambling or "financial folly"? In fact it can be all, folly for those that fail, and an investment or a "successful bet" for the successful.
I'm not trying to split hairs or "count the angels on the head of a pin", or even determine how you define the word "is", just to point out that ALL investment involves the risk of failure. The very reason there is a potential for reward is BECAUSE of the risk. If all the sides of 2 dice had only one spot, the number that would come up when rolled would always be 2 and betting 2 you would always be a winner, but there would be no reward because of the lack of risk!
The Globe's editorial board also skew the particular Goldman/Paulson transaction by failing to place it into context. Yes, investor John Paulson, etal did ask Goldman to assemble the Abacus financial instrument but Goldman (and other investment banks) were assembling and had assembled hundreds .. perhaps thousands of similar mortgage based securities involving Collateralized Debt Obligations (CDO), credit default swaps (CDS) and other investments. Abacus was hardly unique.
Investors that thought any particular investment would fail could avoid them, those that thought they would be a successful investment (or bet) bought them, and those who bought them could buy a form of insurance against losses in the form of the CDS's. So the Abacus investment was just like many others with just one difference, Paulson, etal were so sure the real estate market was going to tank that they didn't care about anything but the low cost CDS's who's value would skyrocket if the mortgages backing the securities failed. (For an analogy to help explain Credit Default Swaps see the addendum below)
But again, failing to place the Abacus investment in context, this was not the first purchase of CDS's for Paulson. After they became convinced the market would tank and foreclosures would rise, they set out to buy low cost CDS's from others and did. But that means that those that held these CDS's were of the opinion that defaults would not rise, the value of the CDS's would not rise, so they sold them to Paulson for a low price. Paulson, etal were already betting against the real estate market BEFORE Abacus but, they were so confident everyone else was wrong, they asked for specific deals they could specifically bet against, by investing in the swaps. So, Boston Globe, to me it appears that those who held, but sold, the swaps to Paulson were wrong. You might argue that they committed "financial folly" ... but who is it that decides, especially looking forward?
Further, the Globe (as it frequently does) leaves out information that might undermine it's arguments. The Globe leaves out that, to avoid any conflicts, Goldman brought in a company that specialized in assembling mortgage backed securities, ACA Financial Guaranty Corp., a New York firm that helped Goldman assemble the investment and then bet that it would gain value. (Italics mine) So confident was Goldman of ACA's ability to put together successful MBS's that persons in Goldman repeatedly told Paulson, etal that they were wrong and that Goldman was confident with their models. So confident that the instrument would be a success, Goldman put some of their own money in the investment!!
Yes, Goldman earned $15 million for assembling Abacus for Paulson but they also LOST $90 million of their own money when the loans went bad. If Goldman Sachs committed fraud, then they must also be guilty of having defrauded themselves out of $90 million!!!!! Is that why the Globe left this information out of the editorial?
And last, the Globe fails to point out the type of investors that lost millions and whom were allegedly defrauded. These investors weren't retirees or young people investing for their future, the banks at the heart of the Abacus episode are major investment banks. These are banks with thousands of employees and layers of risk analysis to determine whether or not any particular investment (or gamble to the Globe) is worth the risk. I think everyone agrees that the rating agencies blew it but, regarding these investment banks (German banks IKB and Deutsche Bank), they did (or certainly SHOULD have done) their own risk analysis of their Abacus investment, and decided it looked good. So, is it the role of the SEC to protect these banks from their own mistakes and from risk and potential losses??? I hope not because that would imply that the SEC's job is also to protect them from risk and potential gains!
And what if Paulson was wrong, as most of Wall Street thought he was? He would have lost millions on Abacus, Goldman would have made millions and we wouldn't be having this conversation now.
Ironically, while the Globe berates Goldman Sachs and Paulson, etal, it continues to go soft on those institutions that also "gambled" and lost and clearly exercised "financial folly", but with whom the Boston Globe editorial board agrees. The failure of FNMA and FHLMC have cost the taxpayers more than $125 billion so far and they are hemorrhaging more money every month. Even worse, since the government has nationalized the two, the taxpayers are now on the hook for guaranteeing about $1.5 trillion (that's right, with a "T") of loan guarantees issued by them!!! Fannie and Freddie also used the same sort of MBS's, CDO's and credit default swaps used by Goldman, Paulson and others and lost in a scale not yet seen on Wall Street! When will we see the SEC bring fraud charges against Fannie and Freddie?
Yet, one of the Globe's favorite congressman Barney Frank, pushed Fannie and Freddie to gamble with the American housing market and the world's bond investments. Where was the Globe criticism when Congressman Frank prodded Fannie and Freddie into more risky mortgages? When Mr Frank stated in 2003 that, " These two entities -- Fannie Mae and Freddie Mac -- are not facing any kind of financial crisis. The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing.'' Has the Globe tarnished him for being astonishingly wrong?? And did the Globe ever condemn him for gambling on the housing markets when he famously claimed that, " I do think I do not want the same kind of focus on safety and soundness that we have in OCC [Office of the Comptroller of the Currency] and OTS [Office of Thrift Supervision]. I want to roll the dice a little bit more in this situation ..."? Where has been the criticism of Mr Frank when he looked for LESS "safety and soundness" at Fannie and Freddie than what is applied to other banks and lenders? That's not "financial folly" ?? And "roll the dice" (his words), doesn't the Globe think that sounds like, oh ... I don't know .... gambling?
And last, where is the criticism of do-gooders like MAHA, NACA, ACORN, and others who, at the top of the real estate market, were encouraging low-moderate income (largely minority) buyers to buy expensive homes with mortgage programs that were referred to as "affordable". These "activists" were betting that the Dorchester and Roxbury real estate markets would stay expensive (if they thought at all), but they were betting, not with their own money, nor with the money of large investment banks, but with the money and finances of persons who have, by definition low and moderate incomes. They're NOT RICH!!!
My favorite is the three decker that an Hispanic family purchased on forgettable East Street in Dorchester for $605,000 on 06/17/2005 with an "affordable soft second" mortgage product. The next most expensive three family home sold on East Street since sold for only $370,000. If what Goldman/Paulson did was fraud, what the do-gooders did to low-moderate income (largely minority) home buyers should be a capital offense. But we hear NOTHING from the Globe.
I started off stating that Boston Globe editorials were frequently funny. The carelessness they exhibit SHOULD be comical. But when you consider how many people have gotten hurt, and the Globe STILL doesn't get it ...... it's just sad.
(A quick analogy about Credit Default Swaps. In Florida during hurricane season insurance companies WILL NOT allow you to close on a house purchase if there is hurricane or tropical storm within a certain number of miles of the state. The reason is that, with a storm that close, the potential for loss is so much greater that, at any price, the insurance company is still taking too large a risk. If a MBS is thought to be well constructed the risk of loss is low and the cost of the CDS's are low, but if the mortgages start going bad the value of the CDS's rise and THAT was what Paulson, etal were counting on.
I would ask the Globe, are the home insurance rules in Florida a form of gambling or a method for managing the risk of an investment?)
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