Monday, October 22, 2012

At Goldman, unsophisticated investors were 'golden prize'

As reported by the Telegraph, Greg Smith expanded on his definition of a muppet by saying that
The “golden prize” at Goldman Sachs was to sell the most complex financial product to the least sophisticated investor....
The allegation is one of several made by Greg Smith, a former derivatives salesman, who used an open letter in the New York Times in March to quit Goldman in a blaze of publicity. 
“Getting an unsophisticated client was the golden prize,” Mr Smith said in a television interview ahead of the publication today of Why I Left Goldman Sachs. “The quickest way to make money on Wall Street is to take the most sophisticated product and try to sell it to the least sophisticated client.”...
Please re-read the highlighted text as it fits hand in glove with Yves Smith's observation that nobody on Wall Street was compensated for creating transparent, low margin products.

Simply put, Wall Street profits from opacity.

Why does Wall Street profit from opacity?

Because buyers and sellers of opaque financial products are not able to assess the risk or correctly price these products.  At the same time, Wall Street, which has more information, can do a better job of assessing the risk and properly pricing these products.

An example of a opaque financial product where Wall Street had an information advantage is structured finance securities.
In an interview with the US news programme 60 Minutes broadcast last night , Mr Smith recalled an episode in which he and a partner at Goldman met in Asia with the head of one of the world’s largest investment funds. 
The head of the fund, according to Mr Smith, said : “Let me be honest with you guys. We don’t trust you at all. But don’t worry. There’s nothing to worry about. We’re going to keep doing business with you because you’re the biggest bank.” 
Following the meeting, the Goldman partner described the outcome of the meeting as “great news,” Mr Smith said.
Regular readers know that in the financial markets transparency is the foundation for trust.

The investment fund manager's comments simply reflect the manager's awareness that Goldman was selling opaque financial products and therefore could not be trusted.


For readers who might not know, the word 'sophisticated' carries a special meaning when applied to investors.  An individual investor or investment manager is considered sophisticated based on assets and not on their ability to assess the risk of an investment product.

Once an individual or investment manager passes the threshold for sophisticated, the relationship with a firm like Goldman changes.  It is assumed that Goldman or any firm like it is not to be trusted and the individual or investment manager knows this.  As a result, the burden is on the individual or investment manager to do their homework prior to investing.

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