The Fallacy of Blue Skies

Blue skies, nothin’ but blue skies, from now on ……..

If the SEC believed their charges against Goldman Sucks (GS) were solid, verifiable, that they would “stick”, that they would end up in a punishing civil verdict against the investment banking firm, they would have levied a fine against GS to begin with.  These charges have a very good chance of being overturned in favor of GS.

For every security, IPO, or market transaction, there is a buy side and a sell side.  Hedging one’s bets is one of the most common strategies on Wall Street.  The conflict is that when people lose money, all of a sudden they get morality.  There has never been much of that on Wall Street, and certainly  when new products are introduced, any existing morality falls by the wayside in an effort to sell the product.  Read Steven Pearlstein’s article and then tell me that something other than the desire to make buckets of money was the real motivator in the Wall Street debacle.  In fact, the only issue open for discussion should be if GS didn’t pull off this sub-prime mortgage caper, another firm would have.  It is like a house of prostitution: any requested service, regardless of its morality or safety, will be delivered for the right price.  Everything is for sale if the money is there.

GS does not believe they were at fault for not scrutinizing the individual loans in these subprime mortgage packages.  They may have a point.  Do you think that every new issue represents a sound, stand-up entity?  No way.  The IPO is just a method for that company to raise capital and for the underwriter to collect a huge fee.  The real value of the new company and its publicly traded shares is just another way to generate cash across the board.  It is not a statement on the solvency, social worth or morality of that company.  The market will determine the real value of the new company once the shares start to trade.

In fact, if Wall Street finds itself short of sellable products, they will create new vehicles to maintain their steady stream of fees and income.  Thus, derivatives of every size, shape and sort.  The shortcoming that is just as much in play here as the risky underlying securities is the desire for everyone to hop on the bandwagon.  As long as they made money, they never questioned the underlying value of the “security”, underwriters, issuing company and individual investors alike.  However, the entire sub-prime market collapsed, people lost everything and now “morality” becomes the issue.  Sorry: too little, too late.

GS characterizes their role in all of this as that of a middleman, i.e. structuring investment opportunities but not condoning the investment itself.  In fact, how many prospectuses have you read that clearly state that the underwriter is neither condoning nor condemning the sale of the soon-to-be issued securities?  That is why we have a “blue sky” period, right before the shares are released for sale.  This is a quiet period meant to let nature take its course until the market itself can determine the true value of the shares.

Whether GS is just the middleman or the pusher of evil pills will become clearer.  I do understand the nature of the dilemma: is the investment bank really just a conduit for creating new capital or is it intentionally misleading the public by marketing valueless investments in their goal attainment of more revenues?  I think we will not get a definitive answer.  Thus, the SEC will go down along with its charges against GS, who will experience a renaissance revival in structuring even more dubious investments.

I do not know what the answer is.  Will more regulation help?  I doubt it, because new financial instruments will be designed to hedge those exact regulations. Can morality be legislated?  I cannot put my finger on exactly the malfeasance of GS, but I know it is there.  That is the catch.  The SEC knows it and GS knows it.

One answer might be that the blue sky period should be turned into a rip-roaring, rollicking “red sky at morning, sailor’s warning” period.  Instead of forcing a deliberate time for quiet contemplation of the impending offering, perhaps we should designate this pre-offering period as a time for true disclosure.  Investment bankers and brokers should be encouraged to address every aspect of this new issue.  Every rumor and innuendo, as well as the facts and the figures, should be made public.  Loudly and clearly.  That, my friends, would be true due diligence.  It just does not make sense that a quiet period prior to selling new shares is beneficial to all those involved, especially the buying public.  This is the sticking point: the blue sky period is there to benefit the seller of the shares, but certainly not to inform the prospective buyers of possible risks.  Sometimes, the opposite result is actually realized in the place of the desired result.

The saving grace of these charges will be if President Obama can use the ugly facts, figures and deals to influence those Congressmen to vote for financial reform.  It is a wonderful trick of fate to have the Congressional hearings of GS paired perfectly in time with the push for financial reform.  Of course, the next question will be: what shall we reform?  If we cannot articulate what the fault of GS was, how are we ever going to correct it?

As with the blue sky example above, by supporting one side of an issue, the opposite desired result sometimes occurs.  By slamming fiscal reform across the board, the GOP might be shooting themselves in their feet.  Simon Johnson’s article lays out that possibility.

Something stinks in Denmark —- and on Wall Street, Portugal, Spain and Greece.  Unless we get to the bottom of what already happened, we will not be able to issue corrective measures.  But this time, the SEC will lose, GS will “win” and  all the rest of us Americans might reap the benefits of this debacle, in the form of new legislation.  Any takers for investments that securitize risks and rewards of new legislation?  Even if we do get new laws , how about offering derivatives that hedge our bets against the chance of effective policy changes?

Blue skies, nothin’ but blue skies, from now on.


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5 Responses to “The Fallacy of Blue Skies”

  1. NatalieR Says:

    I see this as a CRIMINAL matter AND a civil one too which is what the SEC brought. We are talking not one little investment we are talking about billions of investments and some lives even lost. I do NOT believe in the goodness of human nature. Our nature is greedy, our nature is sexual, our nature is to be gluttonous. Some of these things are recongized which is why there is law about them. Some if you break the law you go to jail if it is serious enough (not for over eating of course!).

    In the instant matter a crime of HUMONGOUS proportions has been committed against innocent people who lost their hard worked for 401Ks or pension funds and more. You may say ALL of that was a gamble and they should have known better. Yes, it is a gamble BUT I look at it a different way even in CIVIL LAW.

    Goldman looked SO bad yesterday. I watched FOUR hours of it!! it was an incredible thing. When they were asked should the customer have faith in the investing institution they gave their money to and those sanctimonious jerks could NOT give a decisive answer. It was hubris and shameful.

    I know from my own experience that I tried through asking the most reputable people I knew to tell me who to go for financial advice. So I took that advice and did I do it because i am so well versed in investments? NO OF course NOT. That’s
    why one goes to an investment firm. I’s almost like going to a psychologist…you trust him/her to make the best calls for your life and you give him remuneration for it. Two parties are SUPPOSED to win and you the client is supposed to get a session.

    Another example perhaps better: You buy a car with the trust that the car will start and get you where you want to go safely. Personally, I think the debacle of Goldman is like an abridgment in tort law and it should be one in criminal law too. One buys a product and one should have the reasonable certainty and expect that the product is what the seller SAYS it is. That’s basic. But no Goldman did NOT even do that. They didn’t sell it thinking it was a good product. They sold it thinking it was a terrible product (shitty as the guy from Goldman said in his email) and that they were going to short it, make a bundle and keep that secret and NEVER tell the ones they sold the rotten product to. AND worse, they kept doing it not once but BILLIONS of times.

    THAT is where the abridgment is. It’s not the bet. Everyone knows that if you go to a horse track and you bet you COULD lose but not everyone knows IF a horse is lame or doped. THAT is illegal.

    It’s the fact that most of the instruments they sold they did so to unsuspecting innocents who had NO way of knowing if the horse they just bought was DOPED. THAT is the issue moral, legal, civil as I see it. To me the remedy is a CRIMINAL one most especially because of the HUGE harm it has caused and is still causing. I want Blankfien and ALL of those who knew about this fraud be indicted, tried, convicted and JAILED. I want them standing next to Madoff sharing stories of the good old days!! If there is not good case law AGAINST this then there ought to be. I suspect there is. I am hoping the best legal brains that can be found FIND it and FAST!

  2. yomamaforobama Says:

    My Dear Nat:

    You might deem GS’s actions as criminal, but the reality is that they probably did nothing that was illegal. That’s the whole catch in this mess. As I said, morality cannot be legislated. In my next post, I will further explain this stance.

  3. NatalieR Says:

    The following is a little better expressed and one which I wrote to a columnist for the NY Post who seemed to take or at least see Goldman’s side. It’s generally what I said before but better written and with a couple of other points:

    I see the Goldman Sachs’ actions as both a CRIMINAL matter AND a civil matter. The SEC, of course, filed only a civil complaint so far. In a civil case we are simply talking about monitory remuneration. A criminal case is really a much more serious matter requiring a proof from the state of, in this case, the breaking of federal laws against most especially fraud by the defendants. I believe what has been perpetrated upon an unsuspecting and largely innocent public is SO serious that not only should Goldman pay monitory damages to their clients commensurate with the perpetration of this fraud but I also believe a criminal case should be brought as well. Goldman’s actions were so heinous and seemingly so illegal that the “I know it when I see it” Supreme Court measure for pornography SHOULD apply to this as well. Someone(s) should pay for these malevolent and destructive acts not only in money but in jail time as well.

    We are, I think, talking about billions of investments, securities, derivatives and other very complex investment instruments which were packaged, cut up into pieces unknown to mortgage holders as well as securities purchasers alike and sold by Goldman and others as sterling products. Customers were in essence duped into thinking this investment was a good thing to purchase when, in fact, these securities were toxic garbage and, I believe, Goldman itself KNEW they were garbage and sold them to their unsuspecting clients. Compensation for those fraudulent investments is more than warranted due to the massive quantity sold and the dire effect it had on the country and, indeed, the world.

    If Goldman’s acts are not criminal then I do not know what criminal is. In the instant matter a crime of HUMONGOUS proportions was committed against innocent people who lost their hard earned 401Ks, pension funds and other heretofore thought stable investments. I dare say lives were lost often by suicide as jobs and even health insurance were causalities of Wall Street hubris.

    I watched four hours of the Goldman Sachs Senate hearing. Goldman testifiers looked SO bad yesterday bobbing and weaving as if they were children being asked if lying about a school yard prank was the wrong thing to do but not really figuring out how to make sure their answer was the right one so they would not be punished. Instead they were asked the serious seemingly simple question should the customer have faith in the investing institution or any institution to which the customer gives its money. Is it a bad thing if an investment firm represents one thing to its customers but in reality knows what they are selling is junk but sell it as if it were gold? Moreover, the firm KNOWING it was selling junk and that the instrument would fail bet against its own sale by taking out insurance (credit default swaps) on those very instruments. The house would win even if they lost. Those sanctimonious immoral jerks before the Senate could NOT give a decisive answer to those simple childlike questions. Goldman was not MERELY a “principle” just acting as a conduit for savvy investors. Goldman sold these junk securities to anyone whether they were savvy or not. That is NOT the point. Goldman’s conduct was shameful, it was immoral and, I believe, it was illegal.

    Compounding the matter was the rating companies like Standard & Poors which were hired by the investment firm itself to rate the securities and were paid by the very firm that was selling the securities. That would be as if I hired an evaluator of my home and gave them instructions to rate it high and sold it off to a buyer who took their word for it. Do I see a conflict of interest here? Emphatically, YES!

    Goldman actions are an abridgment in tort law and it should be one in criminal law too. It is my opinion that the customer of an investment firm relies on that firm in good faith for advice because one often does not have the expertise to do so oneself. If one buys a product one should have the reasonable certainty and expectation that the product is what the seller SAYS it is. In this case Triple A rated investments which were in reality junk. That is basic in tort law. Goldman did not sell the security thinking it was a good product. They sold it thinking it was a terrible product and in fact a “sh*&^%” product (as a Goldman employee said in his email) and shorted it i.e. bet against it unknown to the ones to whom they sold the rotten product in the first place.

    It is NOT the bet here that is the issue. Everyone knows that if you go to a horse track and you bet you COULD lose but not everyone knows IF a horse is lame or doped. If one knew that one would clearly not bet on that horse and, in fact, doping is illegal and if the track bet AGAINST a doped horse well need I say what would happen if found out? If that doesn’t move you maybe the Black Sox scandal rings a bell? Betting is bad enough but when you bet against your own team failing when you KNOW they are going to throw a game? Need I say more?

    Credit default swaps or insurance taken out on bad securities sold to customers by Goldman as good securities should be both civilly negligent and criminally prosecutable. Their actions and actions by many others caused innocent people HUGE harm, probably forever, and still is affecting the country and even the world adversely.

    ALL of those who knew about these fraudulent monstrosities should be indicted, tried, convicted, fined in civil law and tried criminally as well. If there is not good case law AGAINST what these unconscionable excuses for human beings have done then there ought to be BUT I suspect there is. I am hoping the best legal minds that the government can employ FIND it and find it FAST as CLEARLY Goldman’s product was NOT as good as gold!

  4. NatalieR Says:

    One last point I did not make and that is that Goldman itself through John Paulson constructed the very shi*&y instruments itself with I believe Goldman’s knowledge. Forgot to mention that. Silly unsophisticated investor knowledge person that I am.

    Even IF I wanted or had the means to invest with Goldman I wouldn’t. I HOPE others do the same i.e. Boycott Goldman and oh yes, boycott Arizona too! (just thought I would slip that in) 🙂

  5. yomamaforobama Says:

    Yes. Our only effective reaction is to NOT buy products sold by GS. Sorry. Our laws do not ban this kind of fraud, so our only option is to show our displeasure by withholding our business.

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