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One Firm That Took Advantage of the Subprime Market

By JLP | December 14, 2007

According to today’s Wall Street Journal, Goldman Sachs made bets against the subprime market ($) and made lots of money:

The group’s big bet that securities backed by risky home loans would fall in value generated nearly $4 billion of profits during the year ended Nov. 30, according to people familiar with the firm’s finances. Those gains erased $1.5 billion to $2 billion of mortgage-related losses elsewhere in the firm. On Tuesday, despite a terrible November and some of the worst market conditions in decades, analysts expect Goldman to report record net annual income of more than $11 billion.

That’s pretty incredible. Of course, there is some controversy involved because while Goldman was underwriting colateralized debt obligations (CDOs) that were sold to investors, they (Goldman) were shorting the market. The WSJ article asks:

Why did Goldman continue to peddle CDOs to customers early this year while its own traders were betting that CDO values would fall?

My answer: money! Goldman Sachs’ goal is to make money. They were simply insuring against losses. Call me crazy, but I don’t really see anything wrong with what they did. I do think that people should realize that just because a brokerage firm will sell something to you doesn’t mean it’s not crap! In other words: don’t expect the brokerage firm to look out for your best interest.

Topics: Credit, Housing Market, Mortgages | 10 Comments »


10 Responses to “One Firm That Took Advantage of the Subprime Market”

  1. No conflict of interest Says:
    December 14th, 2007 at 11:50 am

    I believe they have a Chinese wall in place so there isn’t a conflict of interest as you present it to be.

    http://en.wikipedia.org/wiki/Chinese_wall#Finance

    If someone more knowledgeable than I could confirm my suspicion that would be great.

  2. dave Says:
    December 14th, 2007 at 12:03 pm

    Frankly, I’m surprised more banks didn’t do this. Even if they didn’t think that CDOs would collapse like they did, it makes sense to hedge against potential losses whenever you can. If I had billions of dollars of exposure to *any* type of asset (stocks, bonds, CDO’s, currency, oil, timber, whatever), I would certainly be looking for ways to hedge and reduce my potential losses.

    More evidence that lots of financial “experts” and professionals don’t really know as much as they seem to think. It’s the ones who make money regardless that are worth watching. Some old saying about a rising tide comes to mind…

  3. JLP Says:
    December 14th, 2007 at 12:09 pm

    Dave said:

    “More evidence that lots of financial “experts” and professionals don’t really know as much as they seem to think.”

    That’s EXACTLY what I was thinking. Surely some of these firms had to catch on that the mortgage market was headed for disaster. I guess they were so busy making money that they didn’t see it coming.

  4. plonkee Says:
    December 14th, 2007 at 1:44 pm

    As soon as I started to read this I just assumed it was a hedge position. With big companies, sometimes you don’t even have to create a Chinese wall, they already live in silos.

  5. shortquestioner Says:
    December 15th, 2007 at 9:09 am

    In light of this WSJ Im sure there will be more investigation to the actions of Goldman Sachs. Given the precarious nature of the illiquid markets that these Goldman traders had full knowledge about, this could be a case of market manipulation. If the total size of these markets is examined against the size of the Goldman positions taken, one could determine if their positions pushed or manipulated these illiquid markets.

    These markets are almost 100% institutional, however, either used by or involved solely with institutional “players”, these markets are having a dramatic effect on Mr. and Mrs. Retail. This link will surely drive regulators, statesment, and the average Joe to seriously question if not boycott GS.

    Goldman may just have “pushed” a bit too far this time.

  6. Gayle Says:
    December 15th, 2007 at 1:58 pm

    If you as a financially astute consumer can’t figure out why on earth you would sign up for one of those wacko mortgages why would you as an investor want to buy something backed up by same? Oh I remember, there’s one born every minute. Nuf said.

  7. Kirk Says:
    December 15th, 2007 at 3:20 pm

    This is common practice on Wall Street. There is a debate going on at the SEC about principal trades. These are trades where the brokerage house/investment bank is selling positions on their books to their clients. Many people don’t realize that the big brokerages own a portfolio just like you and me. This was a real problem when companies like Worldcom and Enron were tanking. Some firms were disciplined for selling the stock and bonds on their books to unsuspecting clients.

    So why would it be any different with subprime mortgages. They probably off-loaded their inventory to individual investors.

  8. » Roundup: My Fiancee and I Are Starting a Rock Band on Blueprint for Financial Prosperity Says:
    December 16th, 2007 at 9:51 am

    [...] JLP shares one good story out of the subprime bust, Goldman Sachs bet against it and pocketed a cool $4b that help offset the other bets. Hedging rocks! [...]

  9. Ricardo Bueno Says:
    December 19th, 2007 at 6:26 am

    Warren Buffett and his company, Berkshire Hathaway, see this as on opportunity to enter into the Bond insurance business.

    With an excess of $45 billion in cash in addition to “triple A” credit rating and the company’s experience in insuring against risks that nobody else seems to want to take, well…it’s Warren Buffett.

  10. MetaMommy Says:
    February 7th, 2008 at 4:16 pm

    Any company with a big enough portfolio is going to take advantage of shorting what they have. It’s just another source of income for otherwise inactive equity. And if Goldman was shorting, I’d find it pretty hard to believe the other firms weren’t, too.

    Oh, I can assure you that yes, a lot of people managing “our” money don’t know anywhere near what they pretend to. They’re just really convincing at playing the role.

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