Fisking Ben Stein on Goldman's 'Wrongdoing'

by: Felix Salmon December 24, 2007 | about stocks: GS    
Felix Salmon

Felix Salmon

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Not content with penning what was probably the most thoroughly fisked column that the NYT ran all year, Ben Stein has now revisited the scene of his embarrassment, only to compound the crime.

Stein has a new charge against Goldman Sachs this week: that it violated the precepts of fiduciary duty when it underwrote mortgage-backed securities at the same time as shorting them.

Stein does a good job of explaining what fiduciary duty is: it's the duty of a professional who is "handling someone else's money". But it's not long until he starts applying this concept to firms which were doing no such thing, like Drexel Burnham or "the bluest of the blue-chip brokerage firms and investment banks [who] placed excessive valuations on companies that they peddled to investors".

Ben, let me explain something to you. If I sell you something - whether it's a car or a house or a stock or a ham sandwich - I have no fiduciary responsibility to you. Caveat emptor, and all that. If I am investing your money on your behalf, then I have a fiduciary duty. Sometimes, investment banks (the "sell side") also own asset-management companies (the "buy side"). But if you're looking for fiduciaries, you're not going to find them on the sell side, only on the buy side.

Actually, while I'm at it, let me explain something else. If an investment bank underwrites a sale of securities, then the bank's client in that transaction is the issuer, not the investors. In an IPO, for instance, the issuer often pays the underwriter 7% of the proceeds. The investors, meanwhile, make their own decisions as to whether they think the stock is a good buy at the IPO price. If you want to get a good idea of who a bank is working for, just look to see who's paying them.

So when Stein accuses Wall Street banks of "betraying their clients' trust," he's simply confused about who the clients are, in these transactions. If I'm an investor and I buy a stock from a broker, then I'm buying it because I think the total amount of money I'm paying is a fair amount for that security. I'm completely agnostic about whom, exactly, I'm buying the stock from: if a different broker has the same security for a lower price, I'll go there instead. And I'm certainly not trusting the broker to assure me that my security will go up rather than down in value.

In fact, at the margin I actually like it if my broker is shorting that stock and thinks it will go down in value - because that just means that I get to buy it at a slightly cheaper level, and it also increases the chances of my benefiting from a short-covering rally.

But here's Stein:

Now, Goldman can spin this as "risk management" and insist that it was doing it to protect its stockholders. (Remember, though, that Goldman's lushly compensated traders and executives get a far larger share of the pie than we pitiful stockholders do.) But selling short the same securities or very similar ones that they were peddling to the clients is extremely hard to reconcile with basic fairness.

Actually, Goldman's compensation ratio is 43.9%, which means that "pitiful stockholders" get $1.28 for every dollar paid to "Goldman's lushly compensated traders and executives". And it's just ridiculous to think that "basic fairness" means that Goldman should be exposed to exactly the same risks as anybody who it sells securities to. Goldman Sachs isn't Berkshire Hathaway, investing money on behalf of shareholders. It's an investment bank: an intermediary between issuers and investors.

Says Stein:

The point is this: Don't expect the securities firms, or the securities laws, to help clients who suffered huge losses.

Yes, Ben, that's exactly the point. If an investor buys any kind of financial security, he's deliberately buying a risk product. He gets all the upside if that security rises in value. But he also gets all the downside if that security falls in value. It's not the job of any securities firm to bail him out.

I do like the way that Goldman (isn't) reacting to Stein's provocations, though:

Goldman asserts that it did nothing wrong in its handling of C.M.O.'s, saying that most of the entities that bought them were highly sophisticated and capable of making their own investment decisions. Goldman declined to show me a list of its large buyers. It also offered no opinion on what its duties might be to small investors who were ultimately exposed to the C.M.O.'s it sold to larger entities.
Goldman emphatically says its short sales and similar trades were normal hedging operations. The firm declined to show me a chart of the scale of its short sales over the past several years.

If only I were capable of the same degree of self-control. But then Stein ends his column with this kind of flourish, and I just can't help myself:

Are we a nation if there is no meaningful restraint on what people can do with an offering statement and a computer screen inside our borders? We surely cannot remain a republic under law if there is no law except the axiom from "Richard II" that "they well deserve to have, that know the strong'st and surest way to get."

Are we a nation? Ahem. Ben, I do understand that you feel aggrieved at the size of the profits that Goldman Sachs made this year. But I can assure you that those profits pose no threat whatsoever to the United States' remaining "a republic under law". If you feel the need to descend into delirious hyperbole, there are lots of places you're more than welcome to do so. Just, please, don't do it in the New York Times.

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This article has 12 comments:

  •  
    Dec 24 08:33 AM
    Having read your defense of Goldman Sachs against the comments of Ben Stein, I must say I am appalled at your cynicism. While it's true that there is no obligation on the sell side to offer good value to customers, there is some obligation not to knowingly cheat them. That is why every police department maintains a "bunko squad." I think it looks very suspicious to most outside observers, for Goldman profit so greatly both ways from the products it packaged and sold to investors, and it simply isn't good enough to say the investors should have known better. They bought in good faith, on the reputation of the vendor and assurances from the ratings firms. Good faith on the part of buyers and sellers is the only thing that keeps the financial markets operating. The credit crisis we are now experiencing is what happens when good faith disappears. For Goldman to have shorted (not hedged) the financial packages it engineered demonstrates clearly the firms lack of faith in what it was it was packaging and selling. When first tier financial institutions start operating like bucket shops our financial markets are surely doomed.
    Reply | Link to Comment
  •  
    Dec 24 09:41 AM
    1. no one at Goldman put a gun to an investor's head and said "buy these CMOs".

    2. Goldman's short position in mortgages was at another part of the bank. It was NOT the part that was giving the investor's exactly what they wanted (ie CMO securitization/selling... - it was a decision that came down from the CFO in looking at the bank's entire balance sheet. It's smart management and the decision itself to short carried..... wait for it:

    3. RISK. The shorts were positions they could have easily lost on were they wrong. Of course, now today, in hindsight, according to Ben Stein and Mr Retail Investor, the shorts were riskless because Goldman "knew" the market was going to crash and when. Riiight. Further, had they a feeling it MAY happen, the timing and magnitude were still very much wildcards and involved, again, risk.

    Ridiculous comments. The only party at fault here were the rating agencies failure to communicate inherent risks, but even then, much blame lies with the investor who did not care to look past the ratings and actually understand the product.
    Reply | Link to Comment
  •  
    Dec 24 10:05 AM
    GS has very high end clients. Both business and individual clients. When these clients demand a product, Goldman has to offer it even if it goes against Goldman's advice.

    These mortgage products were hot, hot, hot and if Goldman did not offer them, their clients would have gone elsewhere. Despite Goldman's own opinion, the clients still wanted them likely due to the hype. That is good business to give the customer what they want.

    However, when it comes to Goldman's own trading and investing, I expect them to do the best they can. They new these real estate investing vehicles were overdue for a dose of reality and they invested accordingly.

    They did not hurt their customers, they were helping them by giving them what they demanded. They did not push these vehicles like a floating interest rate mortgage on a minimum wager. They left it to these customers to make the decision where to invest. Then, Goldman did their own investing. End of story.
    Reply | Link to Comment
  •  
    Dec 24 10:05 AM
    Whoops, Long GS.
    Reply | Link to Comment
  •  
    Dec 24 02:24 PM
    Ben Stein should worry more about his own ethical conflicts of interest and less about what Goldman Sachs did or didn't do for its customers. Most of Mr. Stein's articles in the NY Times and on yahoo Finance seem to slip in recommendations for variable annuities (although the current one does not), without Mr. Stein ever disclosing his financial ties to the life insurance industry. Variable annuities tend to come with very high fees that are not in the interest of the average Mom and Pop investor. Goldman does not go after the Mom and Pop investor. Its customers are mostly institutions, along with some wealthy individuals, who are presumed to be financially knowledgeable. If a county pension fund does not understand the mortgage backed securities it is buying, whose fault is that? The broker's or the management of the pension fund?
    Reply | Link to Comment
  •  
    Dec 24 05:02 PM
    I was confused. I thought all the Wall St. firms existed to help us little guys get really rich, and it just hadn't happened yet because of bad luck.
    Reply | Link to Comment
  •  
    Dec 24 05:54 PM
    The investment banks claim there is a "chinese glass wall" that prevents conflicts of interests.

    On the other hand, the WSJ article praising Goldman's trading prowess clearly mentioned that the short positions in subprime were at the beckoning of the CFO, Viniar.

    Surely, Viniar sees both sides of the wall and his decisions were crucial.

    There IS a conflict of interest always at higher management in these companies. And it can only be eliminated by telling the banks either to have, or eat the cake.

    It is about time this "chinese wall" fraud was stopped by the government.
    Reply | Link to Comment
  •  
    Dec 24 09:51 PM
    Buy side,sell side, whatever. Apparently Mr. Salmon doesn't realize that they are part of the SAME FIRM.
    Reply | Link to Comment
  •  
    Dec 24 09:58 PM
    Actually I think Mr. Stein's concerns well reflect "the rest of America" Wall Street has for over a century operated at the expense of the average American in many complex and sometimes hidden ways. Did Goldman just manage to outmaneuver the other IBs at a dirty game on this go around? We don't know, and we can't really know because the information is private, but the question is should such information be private, and I think that's a valid question since what we're really talking about is the aggregated livelihood of a lot of people who work to produce the nation's wealth.
    Reply | Link to Comment
  •  
    Dec 25 01:12 AM
    NOTE FROM SA EDITORS: This comment has been removed because it contained abusive language aimed at an article contributor or other commenter. The author of the comment has been placed on watch for removal of commenting privileges.
    Reply | Link to Comment
  •  
    Dec 26 04:59 PM
    No one bought Golman bonds. They bought a group of mortgages written by someone else. Goldman administered the sale and got a fee. You provide a service, you earn a fee. The reason for selling mortgages to some is that you don't want them anymore. These could have been written by Countrywide or any lender, more likely a behind the scenes 20 person shop that wrote loans and sold them. They had an agreement with GS and probably others to sell the loans. Any buyer would understand what it is buying. GS is not in the business of writing mortgages, only faciliting trades. This is not a confusing issue. Anyone who tries to confuse you is lying and being to emotional. They are probably either short or long GS. What GS does with its equity has nothing to do with it facilitating two interested parties in making a trade. Thank you and good night.
    Reply | Link to Comment
  •  
    Jan 07 01:37 PM
    First let's start by saying that Chinese walls are a joke. Secondly, you are right Felix; this is not breach of fiduciary duty, legally it is called misrepresentation. Caveat Emptor applies to you not actually having to tell a client if there is a problem. Actively marketing a product you know to be flawed (as proven by shorting it) is nothing short of lying. And yes, there it is a crime, it is called misrepresentation. Pardon Ben Stein, he just misused the correct legal argument for what is essentially a plain cut moral question.

    I guess Goldman's 14 Principles are just another of the things it keeps for show. While we are add it. Let's get serious. Goldman has $40 Billion in level three assets and no significant losses... Are their problems really that serious that they refuse to even open the box?

    Best,

    Reply | Link to Comment
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