After watching our teevee news anchors struggle mightily to explain the Goldman Sachs suit to middle America (okay...after watching The Daily Show’s recapitulation of news anchors struggling mightily to explain the Goldman Sachs suit to middle America)it is clear that even a lay person who has never set foot on Wall Street could do better. So here it goes.
I imagine the deal went down like this. A guy, a rich guy, a guy who runs a hedge fund, let’s call him JohnBoy, goes to his Investment Bank, let’s call it Goldman, and says something along the lines of...
I’ve got a plan to make us both a lot of money. I am talking about a really enormous, mind blowing, amount of money. I’ll make more than you, Goldman; but still, you will make out like a bandit – heh, that’s pretty funny. Is this a great country or what? Anyway, here’s the deal. You see this? (JohnBoy lays a sheaf of papers on the table.) This is a Big Steaming Pile of Crap. I know for a fact that it is a Big Steaming Pile of Crap because I’ve picked it out personally, turd by turd. It is designed to be a Big Steaming Pile of Crap. What I want to do is place a bet, a huge bet, maybe even a series of huge bets that this is, in fact, a Big Steaming Pile of Crap. When the bets pay off, and they will because, after all, this is a Big Steaming Pile of Crap, it will be just like winning the lottery.
It sounds simple. What could be better than a chance to bet big on a sure thing? But as anyone who has ever made a school yard bet knows; you can’t place a bet unless you can find someone to take the other side of the bet. And if you want to find someone who is willing to bet against a sure thing, you need to find a sucker. It seems to me that Goldman’s job was to find the suckers.
Goldman’s first task was to take the Big Steaming Pile of Crap and put it in a pretty box. I think they call these boxes "securitized investment vehicles." Then they name the investment vehicle something irrelevant but respectable sounding like "Abacus." I am going to call this one "Abracadabra."
The next step was for Goldman to peddle shares of Abracadabra to "sophisticated investors" on the theory that it is legal to sell crap to sophisticated investors because they should know better. Of course, not even a sophisticated investor is going to want to buy a slice of an investment vehicle that only owns a Big Steaming Pile of Crap, so Goldman would have to convince buyers that Abracadabra owned a Pile of Gold Coins – something with a good return relative to its risk. They would have to acknowledge that there is always some risk that mixed in with all those gold coins there might be a few silver or bronze coins, or even a few worthless old subway tokens. But the good news was, as Goldman or its rating agency might have told investors, Wall Street had solved the whole risk problem. It turns out that risk is nothing more than a really hard math problem. Who knew? This math genius, from MIT or somewhere impressive like that, Chinese dude...scary smart, had solved the whole thing. He’d proven MATHEMATICALLY that as you approach the event horizon of a really large pile of debt, all known rules of finance break down, and risk just disappears – like magic! Really, there's a mathematical formula out there called a Gaussian copula function that Wall Street used to make risk disappear.
Because Goldman got investors to buy the Big Steaming Pile of Crap, now known as Abracadabra, JohnBoy was able to place his bets that Abracadabra was nothing more than a Big Steaming Pile of Crap. And when the bets paid off, it WAS like winning the lottery for JohnBoy...only better. Lottery winnings are taxed as ordinary income, just like the W-2 income earned by schlubs like you and me. But JohnBoy probably ran his 1 Billion (yes, with a B) lottery winnings through his hedge fund and Congress has decided that hedge fund managers are super duper special and that their income shouldn’t be taxed as highly as ordinary Americans. Instead Congress has decided that hedge fund managers should only have to pay tax on most of their earnings at the much lower capital gains tax rate. It pays to have friends in Congresss.
And what was in this for Goldman? I’m guessing that they got paid money to put the Big Steaming Pile of Crap into the pretty Abracadabra box and that they made money every time they sold a slice of Abracadabra and that they made money when JohnBoy placed his bets and that they made money when the bets paid off and that they may have even placed a few bets of their own against Abracadabra. I suspect that every time they thought about or touched the Big Steaming Pile of Crap they made money.
I may not have all the details right and I am sure it is way more complicated in reality – but I am betting this is more coherent than anything Rick Sanchez had to say about it...