Against my better judgement, I’ve ended up writing a lot about the financial mess that we’re currently going through. If you’ve read that, you know that my opinion is that the mess amounts to a giant pile of fraud.
But even having spent so much time reading and studying what was going on, the latest news from the financial mess shocks me. Even knowing how utterly sleazy and dishonest many people in the financial world have been, even knowing about the stuff they’ve been doing, the kinds of out and out fraud that they’ve perpetrated, the latest news makes them look even more evil than I could have imagined.
Mark not only provides a nice background of how derivatives and credit default swaps created the huge financial mess, he also illustrates the type of fraudulent behavior Goldman Sachs, and probably others, exercised.
It may very well be that Goldman Sachs purposefully created financial instruments that it sold to people, knowing that the value would decrease, all so that other clients of its could make a bunch of money on the failure. From Mark:
What the hedge funds were really doing is making it possible for the investment banks to create CDOs that were likely to fail, and then buying credit default swaps against the top tranches of those CDOs, betting that they were going to fail.
The strategy here is simple. I spend $5 million buy the bottom 5% of $100 million worth of loans that I think are going bad. I’m expecting to lose that: I’m going to be out $5 million. But, I also use another $5 million to buy credit default swaps on $60 million worth of the higher tranches of that pool of loans. Now, if the pool goes bad, I’m out $10 million – $5 million for the crap that I bought that’s now worthless, and $5 million to buy the credit default swaps. But because the whole thing went bad, I get to collect $60 million.
They wanted to crappy loans that were sure to default. Because they could clean them up and sell them to regular institutions as though they were fine. But they could then sell CDS, which are essentially insurance for failure, to hedge funds. By purposefully creating things that would fail, Goldman Sachs got money from the original sale and money from the sale of the CDS. The hedge funds made tons of money on the failure and the losers, who thought they were buying regular safe investments, were left holding the bag.
No wealth was really created. It was transferred (I call it stolen) from the groups that invested in the original loans, not knowing that the financial institutions. were selling them a load of crap.
Let me restate – it appears that institutions such as Goldman Sachs knowingly sold derivatives, that were doomed to fail, to groups who were assured that these were safe investments, all so it and its hedge fund partners could make even more money by betting on the failure.
And they did all this on purpose, knowing it would fail and making money on the failure:
Anyone who honestly looked at the whole CDO thing a few years ago knew perfectly well that the thing was going to collapse sooner or later. The hedge funds knew, perfectly well, that the people that they wanted to buy credit default swaps from were likely to go belly up eventually. So they wanted to be in the situation of being the first ones to collect, before the big insurers backing the CDSs ran out of money.
So they didn’t just find crappy CDOs to bet against. They went to the investment banks, and asked them create CDOs consisting of piles of specific, high-risk loans. They provided specific requirements – complaining when firms tried to put together better packages. They’d only back the true crap. They wanted shit that would go bad, and go bad fast. And most of the big investment banks went along with it. (To their credit, a few refused.)
Both the banks and the hedge funds knew what was going on here: they were creating and then selling CDOs where they knew that the things were designed to lose all of the money invested in them. And the investment banks went to their other customers, and lied! They sold these things to their customers, telling them that it was a safe, profitable investment, even though they knew that they were designed to lose all of the money invested in them!.
It is like betting against the come in craps, only with loaded dice and with the stickman in on the deal.
Then when all this blew up in their face, they went to the taxpayer to get made whole.
If this is true, then all those guys should be in prison along with every other person involved with this fraudulent behavior. It was bad enough that they were using monstrosities such as CDS but to knowingly game the system in order to make money off of the failure,. To think that this was a failure that resulted in the loss of trillions of dollars in value for the people who thought they were buying regular safe investments, is simply jaw-dropping.