Investment bank Goldman Sachs has just been fined US$550 million for its handling of CDOs (Collateralized Debt Obligations) during the credit crisis. Specifically, the allegations were that Goldman knowingly sold these bad investments to clients as they then proceeded to short them themselves (bet against them). In fact, Goldman had hired Paulson & Co. (who run one of the largest hedge funds in the world) to help select securities that would be inside these CDOs. Paulson & Co. shorted the CDOs, and apparently Goldman did as well. Goldman Sachs contends they shorted the securities as a hedge against their own losses. Paulson & Co. made an estimated $1 billion on this short, the actual investors lost about $1 billion.
Here is the actual pitch-book used to promote these investments to investors (66 pages long).
While Goldman was fined $550 million, the stock was up $800 million in market cap on the day. This means even Wall Street thinks they got off too easy.
So just because you sold a certain financial product to a client, that means no trader in your firm can short any component of that product? That seems fairly arbitrary and restrictive. If GS’s quants later determine that the risk premium is higher than the initial underwriter and Moody’s thought, what’s stopping them from using this information to make a prop trade that supports it? I suppose the question is: How long after the initial sale did GS open the short position?
The difference between “trade of the century” and “lost your shirt to a charlatan” is which side of the trade you were on. If Paulson had instead selected CDOs to short, and subsequently Paulson and GS took a long position in these same CDOs, would you be feeling bad for those guys when they took the loss, and trying to fine them even more?
Hey, I’m as cynical as the next guy, but just because the stock price went up in response to this news doesn’t mean investors think it was an unjustly small fine. It only means the fine was less than expected, and/or the risk inherent in an unknown fine has now passed and the risk premium has disappeared.
The half-billion fine is small potatoes compared to the 80 billion the US government paid Goldman via the now failed AIG. They got dollar for dollar in their investments with a failed company.
So how much of this fine will be going to the individual investors who were wronged?