What Goldman Teaches Us about Investment Banking Ethics

Steven Pearlstein is a Pulitzer Prize-winning columnist for the Washington Post. Recently, he answered a rather lengthy series of questions from online readers who were trying to figure out what the whole Goldman Sachs mess means. Some of the nuggets included:

Are collateralized debt obligations (CDOs) really just a form of gambling? Perhaps in some cases, they are. Pearlstein thinks we should say goodbye to hedging instruments that people don’t own or control. In other words, no more “naked” hedges or shorts. This would keep the system intact for people with legitimate needs for hedging but wouldn’t allow the market to get distorted by frothy speculation.

Did Carl Levin (the Michigan Senator and head of the public inquiry into Goldman’s dealings) and the other senators truly understand the inner workings of Wall Street well enough to question Goldman’s dealings? Pearlstein says that few of them comprehended that Goldman really has two different types of businesses operating at the same time. One is the traditional underwriting business, creating and selling securities. The other is trading these and other securities on the secondary market, often for the firm’s own account.

This practice has brought the firm enormous profits, and it’s one they are unlikely to change. First, because it’s not illegal. Second, because this is the way modern investment banks work. Modern investment banks have several lines of business and their goal is to find the ones that generate the most profits. Anyone who complains about this just doesn’t understand the business.

In one famous email, held up by Levin, a Goldman trader labels the security’s quality with a four-letter word. But in the take-no-prisoners ethos on Wall Street, that doesn’t mean Goldman shouldn’t sell the security. It simply means they think its value will go down. There is no “good” and “bad” in this scenario. Every security simply has a price, writes Pearlstein.

Pearlstein offers other insights in a rather lengthy question-and-answer session. Such as details about the Fed’s “dirty little secret” of allowing big banks to borrow money at near-zero Fed rates and earn big profits on essentially no-risk transactions in longer-term government paper.  Or whether the SEC charges against Goldman will open the floodgates for lawsuits from Goldman clients. And much more. You can read the full story online at the Washington Post.

What’s your take? Do you think Goldman was acting in an underhanded fashion, creating and betting against subprime CDOs? Or was it simply “caveat emptor”, let the buyer beware, and business as usual? Add your comments below.

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{ 1 comment }

William May 8, 2010 at 2:39 am

One more example proving that greed overrides ethics and common sense. Maybe, government regulation itself was the main problem behind this. Blankfein says that he wants Goldman to “be the leader in things like ethics, in putting clients first.”

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