April 30, 2010

Another Sh*tty Deal

For the past few days I’ve been following the news surrounding the testimony of Goldman Sachs executives before a Senate panel investigating the investment bank’s role in the financial crisis. Wow! If you haven’t followed this crazy ride, the transcripts from the hearings can be found all over the web and while there are still more questions than answers, it points to a major disconnect in our capital system.

The dialog is almost comical. Certain lawmakers compared the bank’s mortgage bankers to bookies – with the senator from Nevada further expressing his displeasure by saying, “Bookies have more ethics than Goldman.” Senator Carl Levin asked repeatedly why Goldman Sachs sold securities that their internal emails called “really sh*tty deals.” If the frauds perpetrated here weren’t so frustrating and disheartening, the dialog would make Lenny Bruce laugh out loud. Levin used the term “sh*tty” 11 times in one set of questions and began to ask the Goldman executives if they could define degrees of “sh*tty” in the deals they promoted.

Levin also asked Daniel Sparks, who ran the bank’s mortgage unit at the time, “How about the fact that you sold hundreds of millions of that deal after your people knew it was a sh*tty deal. Does that bother you at all?” While there was a great deal of polite posturing by Mr. Sparks, the apparent unspoken answer was not only “No”, but “Hell No!” Other questions related to Goldman’s “moral obligation” or “duty of care toward the best interest of the client” also received a “yeah, not so much…” response - really scary and sickening.

This past Monday I had the pleasure to be in New York for McGraw Hill’s publication premier of Buffett's Bites: The Essential Investor's Guide to Warren Buffett's Shareholder Letters. Buffett’s Bites is a stellar book written by a good friend of mine, LJ Rittenhouse. Rittenhouse has been fighting for transparency and improved corporate communication for years. She helps CEO’s formulate their shareholder letters and has created a very interesting ranking based on the candor, or lack thereof, found in many CEO letters. Rittenhouse recognized that Buffett’s letters are his legacy. As you read these letters, you realize his demand for an appropriate use of capital and you begin to understand the core of his investment philosophy.

Rittenhouse blogged early on about the 2009 Goldman shareholder letter and sensed there was trouble in River City. She was right - but I have learned she generally is. By looking at the word choices and the vocabulary utilized in shareholder letters, Rittenhouse has proven a correlation between the amount of “fog” in a letter and downstream share value.

Later that night at dinner with friends and colleagues, Goldman was one of the topics of conversation - at the end of the night we all shared a collective sigh of disgust and cynicism. The problem is clear. The dollars associated with making the deal are worth more than the value of the deal. Therefore, there is no duty of care or moral responsibility to the investor – and, if it is a “sh*tty deal”, the deal maker just invests in derivatives that bet against the deal so they make money when the deal tanks.

Senator Levin summed it up when he said, “You shouldn't be selling junk. You shouldn't be selling crap. You shouldn't be betting against your own customer at the same time you're selling to them." While not as a direct response, Goldman Sachs CEO Lloyd Blankfein indignantly expressed that clients who bought subprime mortgage securities from Goldman in 2006 and 2007 came looking for risk "and that's what they got."

Although we were at dinner to celebrate Mr. Buffett’s letters, it was another Buffett, Jimmy, whose words we sought for solace. “We need more fruitcakes in this world and less bakers! We need people that care! I'm mad as hell! and I don't want to take it anymore!" ...

Comments

1 Response to "Another Sh*tty Deal"

Andrew Soto said... May 3, 2010 at 7:46 AM

David:
Those of us in the energy industry were equally shocked and outraged over the behavior and language used by energy traders during the Western energy crisis of 2000-2001. I have reviewed the transcripts of Enron traders and have known several traders in "reputable" energy companies, and I continue to be amazed at a culture that rewards not only profit but profit off of the misfortunes of others. I could not be a trader in any industry whether its commodities or securities. I don't have the stomach for it, nor would I be very successful at it. Nonetheless, we all benefit from healthy trading operations in various markets. The price discovery, arbitrage, and liquidity funtions all contribute to rational employment of capital to generate wealth. Is the trading culture a necessary evil? How would you reform it in a way that preserves its beneficial attributes in a capitalistic economy? I don't have a lot of answers here, but I understand your sentiment.

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