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drama drama drama.. but what's my role?

by on April 30, 2010


For those of you who haven’t heard about the SEC vs Goldman case, I’m not sure as to where you’ve been for the last week. For those of you who have heard about it, how many of you actually understand what’s going on here? Article after article just talk about finger wagging, scandalous emails and a poor Frenchman nicknamed the Fabulous Fab. But mind you, we’re talking about a 2 billion dollar “scandal” here and far overreaching consequences such as a conspiracy to hide Greece’s debt problems to the fact that UK government now owns a majority share of Royal Bank of Scotland.

To get the facts and to continue on my journey of financial understanding, I attended an event hosted at Stanford University titled “GS vs SEC”. After much discussion by Darryl Duffie from the GSB and Joseph Grundfest from the Law School, I came to realize that this is nothing more than a company, ACA, who was on the wrong side of a bet crying for vengeance and an overzealous government agency trying to make a point. The heart of the matter is that Paulson and ACA entered into a bet – Paulson bet that the housing market would crash and ACA bet that it wouldn’t.The size of this bet was a staggering $2 billion and the market ended up crashing (as we all know). ACA couldn’t hold up their end of the deal and could not pay up. ABN Amro was the company that was supposed to back up ACA in case ACA fell through. ABN Amro was acquired by Royal Bank of Scotland. Most of us know how that went – RBS was bailed out for $50 billion by the UK government.

So, now I’m wondering as to why there’s all this hype about ACA not knowing that Paulson was on the other side of the deal or not. It’s a bet! Isn’t it common sense, that if you’re betting that something is going to go up – there has to be someone betting that it’s going to go down! And if you’re betting $2 billion, you sure as to have someone on the other side betting exactly $2 billion against you. Whether it was Paulson (who, by the way in 2007 was pretty much a no-name) or anyone else, the amount would still be the same and the bet would still be against you. That point is clearly moot.

Now Goldman is also being blamed for fueling the financial crisis by selling and marketing these vile complicated options to innocent parties. But, I can’t buy a CDO and neither can the average person. According to the SEC, only “sophisticated investors” can even get close to these kinds of options and actually trade them. In this case, ACA was a sophisticated investor who just made a stupid call. A very stupid call.

It makes me wonder if the drama that has been unfolding over the last couple weeks has been nothing but a way of the SEC to flex some of its severely underused muscles, if you could even call them that. After years of under-regulation of the financial market, the SEC is again making a huge mistake by entering into a case where it has no idea of how the synthetic CDO market works or is even structured. Sure they can bring Goldman employee after employee to the stand only to find them painfully arrogant yet, not wrong.

In my mind, save the tax payers’ dollars and figure out a solution to the problem. The problem here is that there was too large of a bet made by people who clearly were not capitalized enough to make the bet. So, the easiest thing would be to set up a clearing house and make everyone who wants to make such bets post collateral. Think of collateral as a down payment – if ACA had posted say, $500 million on the bet that it made, they probably wouldn’t have been in such a bad situation when they lost the bet. As the old saying goes, put your money where your mouth is.

Mostly I’m irked because my portfolio has been wildly fluctuating because of all this unnecessary drama. Also, I’ve come to realize that sadly, my only role is to be nothing more than a bystander as this case unfolds. Initially I was a victim of the financial crisis and now I can only hope that the SEC has enough sense to overcome its bruised ego to actually make effective policy changes. One can only hope…

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3 Comments
  1. Robin permalink

    To get to the route of the problem–check out Freddie and Fannie.
    To make an impact–vote.

  2. I completely agree about Fannie & Freddie – maybe a future blog post? Anyhow, Buffet seems to be on the same page as me: http://online.wsj.com/article/SB10001424052748704608104575218071029226354.html?mod=wsj_india_main

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