Friday, December 25, 2009

Fiduciary Duty and The Victim Mindset

I wanted to avoid writing this post because anytime you write a story defending Goldman Sachs you have to deal with uneducated, moronic criticism from members of the Ignorati spouting what they've read on the internet about vampire squid. 

This post is not a defense of Goldman Sachs, it's a defense of Capitalism.  However, it is certainly not advocating a license to say "Caveat Emptor"   as an excuse allowing any seller or provider of goods and services to plug the buyer of said services with crappy quality.  I'm not advocating a society or fiscal system where it's the Wild West in terms of justifying all behavior with "Hey - buyer beware, you should have known"  when the consumer buys a faulty good or an investment that loses money.  I'm not pushing for an Ayn-Randian pure capitalist free for all (not in this post at least!) where the strong devour the weak and leave them to wither and die.

However, what I am advocating, as I've been advocating all along, is a return to the era of personal responsibility - a return to the realization that mortgage holders are not victims, that consumers are not victims, and that we can't just continue to castigate the Big Bad Banks as the cause of all our financial woes if we want to have any hope at all of righting our sinking fiscal ship.

The story of the week, that prompted this post, is the NY Times missive titled "Banks That Bundled Bad Debt Bet Against It, And Won."    Your assignment as the reader is to first read the Times article in its entirety.  Then read Barry Ritholtz's post on the subject, which is pretty neutral, although chooses to use some quotes which are very critical of GS's behavior.  After that, read Felix Salmon's post on the subject, which I agree largely with, and focuses on the point I've been trying to make yet again: that the buyers of these synthetic CDO's that GS sold were sophisticated investors, not retail rubes who didn't know any better.   

What I find frustrating is that the overwhelming response to the article in the comments on the NY Times site, Ritholtz's site, and even Salmon's site is of the "GS is the devil, hang these a-holes by their ankles" populist variety.  I find the well reasoned, logical responses to be the ones that point out that the buyers of these assets that went bad, or ANY assets that go bad, are acting under their own free will, and need not be thought of as victims.  This is NOT the same as saying "Caveat Emptor."  It's important to understand that the buyers we're talking about here are sophisticated, professional money managers.  They have responsibilities to their clients that go far beyond being able to use the excuse "but I bought it from Goldmans Sachs, it must be good,"  or "Goldman Sachs told me it was good, so it must be good." 

I'll quote myself, as I wrote on Barry's thread:

"I’ll leave you with this thought: again, it seems we’re putting the burden back on the Big Bad Banks and absolving the clients as innocent victims. It was the CLIENTS – the pension fund managers who bought this crap – the municipalities – who failed miserably in their fiduciary duties, and we need to stop holding them up as victims."

Felix Salmon expands on this point:

"The 30,000-foot view of what happened here is that there was an enormous amount of mortgage paper flooding the market over the course of the 2000s. Goldman Sachs, as a sell-side institution which manages its risk book on a daily basis and doesn’t want to take long-term directional bets, hedged its mortgage exposure with short positions it created by structuring synthetic CDOs. The buy-side, by contrast, had an enormous amount of appetite for long positions in mortgages, and it was the job of banks like Goldman to feed that appetite: again by structuring synthetic CDOs. Goldman was killing two birds with one stone: no wonder Jonathan Egol, who was in charge of these deals, did so well there.

When the mortgage market started to turn, Goldman was smart and nimble enough to realize that it could make money on the way down as well as on the way up. That’s what traders do, and Goldman is the world’s largest and most successful trading shop.

The real lesson here isn’t that Goldman did anything scandalous. It’s just that if you’re making a bet and Goldman is your bookmaker, don’t be surprised if you end up losing."

Goldman sold these complicated structured products to investors because investors DEMANDED them - pension fund managers were CLAMORING for more exposure to the mortgage market - for more yield.  These synthetic CDO's that GS was selling have the characteristic that for every buyer there is a matching seller.  GS happened to be that seller, but Felix, quoting himself from over two years ago, explains,
"If I’m an investor and I buy a stock from a broker, then I’m buying it because I think the total amount of money I’m paying is a fair amount for that security. I’m completely agnostic about whom, exactly, I’m buying the stock from: if a different broker has the same security for a lower price, I’ll go there instead. And I’m certainly not trusting the broker to assure me that my security will go up rather than down in value. In fact, at the margin I actually like it if my broker is shorting that stock and thinks it will go down in value – because that just means that I get to buy it at a slightly cheaper level."

"If an investor buys any kind of financial security, he’s deliberately buying a risk product. He gets all the upside if that security rises in value. But he also gets all the downside if that security falls in value. It’s not the job of any securities firm to bail him out."

I also think the comment from "fixedincome" on Felix's post really nails the aspect of GS's fiduciary responsibility - or lack thereof - in this situation:
"Many of you are coming at this from the perspective of what one might refer to as a “retail” rather than institutional or at least, qualified, client.

Differentiation between the two is critical because the latter are generally considered to be both sophisticated and sufficiently capitalized to assume whatever risks they’re taking by–knowingly–purchasing securities that are not registered with the SEC and that do not come to market with regulated disclosure requirements. That includes just about every CDO ever built. It is illegal to otherwise sell such securities directly to “retail” investors.

I’m not certain that GS is entirely without guilt, but not for most of the reasons mentioned here.

It’s also critical to differentiate between a broker/dealer (the arm of an i-bank responsible for distributing securities) and a registered investment advisor. The former, in fact, owes no fiduciary duty to its clients (though for retail purposes this is a hotly contested issue in the industry), while the latter decidedly does.
And while GS does have arms of its business that function as RIAs (Goldman Sachs Asset Mgmt, which manages mutual funds, for example) the investment bank and broker/dealer elements responsible for building and selling CDOs do not operate under those registrations and their institutional clients absolutely, positively know that."

Goldman Sachs was not managing money for these clients.  They do have an arm that manages money (GSAM), but that's totally separate and distinct from the branch we're talking about that created these synthetic CDO's and sold them to investors. 

I keep getting brought back to my own summary of the situation.  Any time someone comes up with an argument that places the burden on the banks selling bad assets, I think this quote is applicable.  I'll quote it again, because I think it's simple and concise:

"I’ll leave you with this thought: again, it seems we’re putting the burden back on the Big Bad Banks and absolving the clients as innocent victims. It was the CLIENTS – the pension fund managers who bought this crap – the municipalities – who failed miserably in their fiduciary duties, and we need to stop holding them up as victims."

Once we end the victim mindset, we can start holding the proper people accountable. In this case, the pension fund managers who failed miserably to identify the risks in the assets they bought are certainly responsible, among others, and should be removed from their roles as money managers.  Then we can work on repairing the system to prevent future occurrences.  If we continue to just say "hey - it's the Big Bad Banks' fault, there was nothing we could do," well then, we're guaranteeing that we'll repeat our same mistakes again.

Merry Christmas,



polit2k said...

Futuristic thoughts from David Brin: It is a theory about the sons and daughters of the rich. It certainly fits with my experience that the VC and PE guys I have interacted with as an entrepreneur are brighter bulbs than those in mainstream funds, banks, etc.

Fuel55 said...

well said KD

sedentary state said...

>we can't just continue to castigate the Big Bad Banks as the cause of all our financial woes.

Well can we at least stop letting them mint money by taking Fed money a 0% and buying bills to get 3.5%. If that happen their stock prices would get a 75% haircut and that would be "market forces" doing their rightful job.

And the more bad PR GS gets the better, since they basically act on insider information as standard operating procedure (all those alum in sensitive gov positions).

And the general public DOESN'T KNOW THAT YET. More damaging pr is in order.

Kid Dynamite said...

@sedentary state - sure - i agree that banks are being coddled (and never mind that GS doesn't even take deposits, as you know, so shouldn't even be considered a bank) don't get off topic though - we're not talking about the yield curve, or GS's government influence - I'm talking about sophisticated investors making bad bets and blaming wall street for it.

note, by the way - that no one has to trade with GS. in fact, if investors thing they're getting ripped off by GS, they absolutely should exercise their rights not to trade with them.

Игры рынка said...

Correct, and noone pushes you to go to mcdonalds and drink coke yet zillions of people do not fit into an airplane chair though everybody knows it is no good.

Everybody knows that smoking kills yet people do smoke.

Everybody knows what drugs can do and they are outlawed.

Activities which are harmful should be outlawed and there we are supposed to have government which is supposed to care after everybody including money managers and to punish or at least regulate such activities. Knowing that drugs are bad, coke is bad, and smoking kills is not enough.

tito said...

> This post is not a defense of Goldman Sachs, it's a defense of Capitalism.

Capitalism? If we were in a functioning Capitalist system, GS would have failed last fall.

Perhaps you meant to defend "Oligarchy" which is surely a worthwhile cause, but is so well supported by our current system that it would hardly seem to require your spirited defense.

While your observations correcting misconceptions about market microstructure were surely a worthy service (and originally led me here), this post is misleading at best.

Your preferred bad guys, the pension fund mgrs, surely hold a slice of blame, but that doesn't mean the banks, regulators, rating agencies, et al can be so easily let off the hook with some pish-tosh argument about a "victim mindset".

Season's greetings to you+yours.

Kid Dynamite said...

@tito :

you said this post was misleading at best - can you elaborate? do you disagree with the notion that sophisticated investors should be held accountable for their investment decisions? or are you in the camp that says anyone should be able to write any loss off to "hey - i didn't know THAT was the case" while blaming whomever they bought the product from (like the bank who gave them a mortgage, or the investment bank who sold them the CDO)?

tito said...

No, I don't fit into the boxes you suggest.

And I'm not so much arguing against you as objecting to your *premise* that the phenomena you describe reside within a Capitalist System.

Why should I bother to correct an argument that rests wholly on false assumptions?

Kid Dynamite said...

@Tito -
i'm not asking you to fit into a box, but you described my post as misleading, yet you haven't described anything misleading about it. regardless of your opinions of the validity of our capitalist system, the point remains: there are two basic genres of people - the kind that believes that investors take responsibility for their decisions, and the kind that believes it's ok to blame everything that goes wrong on something else.

It dismays me that the reactions i read (such as those to this GS CDO piece) seem to clearly demonstrate that the majority of Americans are in the latter category, which is clearly a huge problem (in my opinion). as long as you're blaming someone else, you can't get better (Educated) and you can't solve the problem

tito said...

"there are two basic genres of people - the kind that believes that investors take responsibility for their decisions, and the kind that believes it's ok to blame everything that goes wrong on something else."

I don't agree that this is an interesting, useful or complete taxonomy of humanity, but I'll bite and assert that I am of the former stripe. As such, I think that GS and friends should have been hung out to dry in fall '08 when they were saved by Paulson and Co.

That would seem to make me a Capitalist and you some kind of Oligarchist or what have you.

Now, your defense of "Capitalism" is nice but flawed because you're not defending capitalism, you're defending some transactions in CDOs - a synthetic instrument uniquely apt for (designed for?) fraud - made by a company which owes its existence to repeated recent, expensive and unpopular government interventions.

This is not something that can be waved off so easily as you'd like ("regardless of your opinions of the validity of our capitalist system"). If you disagree, you can explain to your readers why we should take your word for it that we have a working capitalist system given recent history. You've got your work cut-out for you if you choose this route... and no argument whatsoever if you don't.

In any case, I enjoy your blog and would agree with even this post if its premise were correct and we did live in a functioning capitalist system.

But the very sad fact is that we don't.

And the corollary is that the things you are defending here aren't worthy of your efforts.

Kid Dynamite said...

ok Tito, i see where you are coming from. my point is that you can't say "the past actions of the administration have rendered capitalism null and void" and just write it all off, and say that GS and all the banks suck balls because of that, even if they do - that doesn't help...

take it step by step... when evaluating if we should hold GS accountable for selling a bag of crap to sophisticated investors whose JOB it is to know that they are buying a bag of crap, it really isn't relevant how GS got to this point. i feel like you're getting diverted by the whole "GS shouldn't exist" argument, even if it may be true.

they DO exist. so lets start there - in this post at least! i happen to agree with you in that i'm also in the first category (responsibility lies with the investor) - and i also don't think that the banks have been bailed out... BUT THEY WERE - so are you now suggesting that EVERYONE be bailed out for the rest of eternity (CDO buyers? people who can't afford their mortgage)? of course not... let's not compound bad decisions. let's get back to the kind of responsibility i'm trying to get at here.

the "GS would have failed if not for the government intervention argument" is possibly completely accurate - but it also doesn't help anything, and only serves to fuel ignorant populist anger that serves no purpose and ends with the easy answer of "The big banks suck and wouldn't be here if not for taxpayer bailouts." Again, although that may be true, it's a red herring - a straw man that is a side issue to the moral of the story

Kid Dynamite said...

ps - Tito, another way of looking at it - let's assume i'd left out that one line about this post being a defense of capitalism - then what would you say? you wouldn't say this post was a waste of time and misleading would you? i hope not...

don't invalidate this entire post, which i think advocates a very valid point, just because you disagree with the phrasing of one little part.

I wrote that line because i know the initial populist response to any post like this is to label the author some sort of GS crony or sympathizer. WHITE ROBES!!! FOIL HATS!!! HANG THE WALL STREET SCUMBAGS! my whole point was that it goes beyond that.

perhaps i should have said that this post was a defense of capitalist VALUES, instead of a defense of capitalism, regardless of how the current state of capitalism has been bastardized in the last 15 months

Anonymous said...

So the real underlying message is one of self responsibility, in a simple capitalistic system an individual obviously values a product and determines the worth to cost ratio, risk to return and so forth. Although I admit I do not have a background within Wall Street, there is an importance to remind you all that even a simple person like myself can understand and value capitalism. I believe that there are two current problems facing capitalism that like hands of an MMA Fighter are choking the air of capitalism into attempted submission.
1. Responsibility and the reality of risk have to be present in order for capitalism to exist. If you make an investment and that investment fails it is your sole responsibility.
Returning to the current post, I will agree with KD in that Investor especially the large pension firms have a large chunk of the blame for investing in the previously mentioned investments in CDOs.
But… no matter how smart the managers of a pension fund may be, it still is the responsibility of the original investor to understand their investments. Granted the average pension holder has no knowledge of their pension investments. They read a statement at the end of a month and either smile or look for someone to blame. But this is not the responsibility of the pension fund nor is it the responsibility of the government to protect these people. This brings me to my second problem.
2. The Realization of loss along with the consequences and the fear of these consequences. When someone makes an investment that fails they MUST feel the pain of the loss and in its entirely.
LET THEM FAIL and by them I mean you, me, everyone, NO EXCEPTIONS, NO BAIL OUTS. If I was too stupid to realize I could not afford a 700k house on a 40k salary, I deserve to fail, I deserve to have my house taken away, I hope everyone notices what a stupid risk I took. This is what I like to call valuable life lesson. And with my loss everyone around me will learn.
Returning to the pension investments, if you are too lazy or undereducated to understand what your investment portfolio has within it, the fault lies only with yourself. It’s your retirement; invest it in things you can at least understand. If you take the risk of letting someone else invest your money without understanding their investment strategies, you deserve to assume all the risk. If you don’t understand these complex investment strategies, either educate yourself or invest in something you do understand.
Capitalism is not broken, and does not need to be fixed; The American people have been taught that they no longer have to be responsible for their actions and are the victims. This needs to be fixed. Americans need to take responsibility and the government needs to stop trying to move, mask and protect us from the hurt. We are Americans we are tough. If we are continually protected and coddled we will forget the values that created this country

-The Bartender

tito said...

>let's assume i'd left out that one line about this post being a defense of capitalism - then what would you say?

Many innocent pixels would have been spared ;^>

Daniel said...

Capitalism doesn't have a conscience. I think the reason GS draws such ire is their connections within the federal government. I don't believe these "public" officials function without regard to their previous loyalty to the bank that paid them their wealth. I believe that there is a tremendous amount of culpability with respect to the buyers of the derivatives. But GS doesn't function in a vacuum. This business of not doing business with them, or vote out the people that appoint former GS wheels to government positions is just nonsense. It's the equivalent of "guns don't kill people, people kill people." That's the extent of the intellectual rigor. Meanwhile I'm going to continue to use the weapon I have available to me, shorting the shit out of these bastards. Shorting AIG, shorting C etc. GS is going to have a very bad year this year, can't possibly be bad enough. I hope it goes to zero. I will do my part.

Anonymous said...

I have some questions about the NYTs article. GS sold the CDOs to people who wanted to go long on housing. When the Federal Reserve purchased the CDO at market value ($27 billion), they sent the checks to banks (GS, BoA, SoGen, etc.). No pension fund got a check from the Federal Reserve when they purchased the CDO in question in the AIG bailout.

Did the banks buy the CDOs back from the actual "victims", or were the banks the actual victims?

The NYTs article says GS and other parties were paying the owners of the CDO $11 million dollars a year for the protection they would get if the housing market soured. The Federal Reserve purchased the CDOs, and tore up the AIG CDS. The Federal Reserve is collecting periodic payments from the group protected by the Maiden Lane CDOs, which the Federal Reserve is confident will pay off the loan they made to the SIE to buy up the CDOs - $24 billion dollars plus interest. According to their audited financial statement, that appears to be happening. Somebody is sending them cash?

Who is doing that?

Janet Tavakoli insists the CDO in question is worth 10 cents on a dollar. It had a par of 62 billion, so she's saying it's worth 6.2 billion.

How can something be valued so low and still be able to pay off a $24 billion plus interest?

Hammer Player a.k.a Hoyazo said...


Loved finding your blog this year and I think you are consistently a good read.

I am however looking forward to some more open mindedness in 2010 about the direction the market is heading in. I do not know you personally and was not reading here back then, but if you are like mostly everyone else I know out there (myself included), then even Dow 10,400 seemed downright cheap-as-shit on the way down a year ago. I know of a crapload of market noobs who can only focus on the lows and the size of the bounce from there, and these are all the guys who have sat out of the market this entire year and are increasingly frustrated as you can imagine.

Believe me I'm not trying to argue that we're going straight to 15k on the Dow like some anuses out there, but I am also amazed at how few people seem to have been able to keep sight of just how cheap stocks got in 2009, and really how cheap they are even now on a long term basis.

Kid Dynamite said...

hoyazo - didn't i play poker with you one night about 7 years ago at Jordan's homegame?

i'm not at all convinced stocks are cheap for the long run right now.

one thing that's still misunderstood is that this IS normal in terms of the economy - what we had the past 10 years was NOT normal...

is a good read

OC bear said...

I agree with everything you said. The point where it all went wrong is when money moved from taxpayers to to private sector. Had this not happened then all the bad actors would have been identified. Instead we must all suffer the consequences and I and my posterity must pay for them.

The rules are simple. When you make a bet you don't get a do-over. The same goes for the economy.

Jon said...

Isn't everyone conflating moral culpability with legal culpability? Or are Yves Smith, Gretchen MOrgenson, and Janet Tavakoli (lots of women hate the squid!) implying that Goldman's actions are criminal?

Goldman Sachs is like porn. Gets a bit sketchy sometimes, and really pushes the boundaries of legality, but it's the price we pay for our system.

Anonymous said...

Just started reading your blog regularly and I agree with a lot of what you say. But I think you are off in one important point: you believe it is the JOB of sophisticated investors "to know that they are buying a bag of crap."

Many institutional investors - and most pension funds, in particular municipal pension funds - are not capable of determining whether a CDO is or is not a bag of crap. Maybe they shouldn't have bought it, but they were looking at the rating on the security and that was good enough for fifty years.

The real problem was that the failure of rating agencies to properly rate the crap and the ability of IBs to manipulate the ratings process.

While I'm not trying to say pension fund managers are blameless, there is more to the story than just pure capitalism at work.

Kid Dynamite said...

anon - you bring up an ESSENTIAL point. if sophisticated investors can't determine that they're buying a bag of crap, the should NOT BUY THAT BAG!

"that was good enough for 50 years" is not an excuse - and it is an excellent description of how bubbles form - because people blindly buy mispriced assets just cause that's how it's been done.

Игры рынка said...

"there was no wild west for XYZ years" so blame yourself when you get killed on the street because it is your and only your problem. you should be sophisticate enough to protect yourself. Police is there just to eat your taxes.

You should rather stop defending them at the expense of general public and put some guys into jail. Either from GS or from rating agencies or from FRB or from SEC or from wherever you like.

Harmful activities should be outlawed and people punished. To my knowledge noone from GS or GS itself was punished.

So good luck on the street next time you face a sophisticated robbery. I hope you will like it and will defend those guys afterwards. But only if you manage to stay alive

Anonymous said...

it is the same thing, just a _slightly_ different perspective.

>"and i also don't think that the banks have been bailed out... BUT THEY WERE - so are you now suggesting that EVERYONE be bailed out for the rest of eternity"<

this is exactly it. you cannot go past that, you have to stop there.

like you, i am not saying this should be the way it is. but, since the banks WERE bailed out en masse (OR were at least perceived to be OR there are certain factions who are trying to load that perception into people's cranial processors ... things get fuzzy in politics sometimes), everybody thinks they are owed a bailout. why should non-banks be "held responsible" when banks "weren't"?

that is all there is to it.

Kid Dynamite said...

to my Cyrillic commenter - what you still fail to understand is a concept Jon voiced in the comments earlier - GS isn't breaking any laws. There is a difference between legal culpability and moral culpability.

our financial markets, ESPECIALLY in products like synthetic CDO's, are manners for big boys to express proprietary views. they can't cry foul when they get out traded or they end up being wrong.

criminal comparisons are good for populist press, but are misplaced.

Игры рынка said...

However what you fail to understand is that AAA and even super seniors is something that is supposed to be super safe. Even safer than USA government. For this safety you get very low yield but you can sleep well expecting to get 100 at maturity. For this task you do not need super-models to estimate actual risk because this stuff is not supposed to collapse within a couple of days. These are not distressed bonds and BBB and below where investors employ PhDs to run their statistical stuff. I am not saying that it is GS who failed their duty but somebody definitely did. However noone apart from investors suffered. And even more, GS was made full on the same stuff while many people lost their retirement savings.So go and enjoy people doing God's work. But I say that somebody should go to prison either from Wall Street or from the government

Kid Dynamite said...

ok - so you acknowledge now that maybe GS didn't fail its duty - that's not what you said before.

in my opinion, in order, the blame lies with the ratings agencies and the pension fund managers WELL before it lies with GS.

i agree with you that someone definitely failed their duty - and i think that someone is both ratings agencies and money managers above the GS's of the world.

i will not, however, accept the "it was rated AAA so it's not my fault that i bought it and it went bad" defense. and it sucks that GS was made whole - but again, that's ANOTHER argument - let's not mix it up in this one.

Hammer Player a.k.a Hoyazo said...

KD -- Wow, had no idea you were there that night at Jordan's. Wish I had known who you were back then and we could have talked about the market back before the shizzle hit the fan a few years back.

Hope I wasn't a douchebag that night or anything. Ha ha.

Игры рынка said...

that is exactly what I said before :)

Alain said...

I'm not pushing for an Ayn-Randian pure capitalist free for all (not in this post at least!) where the strong devour the weak and leave them to wither and die.

Since when is pure capitalism a "free for all" where "the strong devour the weak"!

I'm fairly sure that is not what Ayn Rand meant when she made the moral case for capitalism.

Alain said...
This comment has been removed by the author.
Munchausen said...

And this is now why most regulatory reforms are moving the wrong way... they aim to "de-risk" the securities markets (partially absolving those fiduciary responsibilities) when they should be "re-risking" everything (reinvigorating the forgotten practice of security analysis and due diligence). But we've lost our way (ideologically) - regulators are now charged with the duty to "eliminate" risk altogether. What a terrible misunderstanding of markets...

randy said...

Eye opening essays both this and the follow-up.

KD: you wrote that these sophisticated, professional money managers were 'clamouring' for pieces of Goldman's action: these CDO's. But these new investment entities didn't just appear and charm the pants off the money managers. Goldman promoted these investments; so from a reciprocal personal responsibility it, too, should have been acting with the greatest caution if any thing seemed amiss.

But more important, I think what has the rank and file "retail rubes" pissed off is that it looks like GS knew they had toxic assets and bet against them but at the same time never let that material fact be known.

Had it been stated clearly and explicitly, I think that many would have passed had they known GS was hedging against these investments.

GS has indeed crossed a Rubecon.