Goldman Under Fire

By Brad Thomason, CPA


A couple of days ago (4/16) the government filed criminal charges against several parties alleging fraud related to securities involved with the housing and credit meltdown.  Among the parties was Goldman Sachs.

In the weeks to come the facts of the case will likely find the light of day, and people will be in a better position to judge what actually took place.  Perhaps the evidence will exonerate those who have been charged; maybe it will hang them.  Wrongdoing either took place or it didn’t.

I find this case troubling though because I think its basis is a very slippery slope.  If it turns out that one party wronged another, then that will be too bad.  But that’s hardly a new story.  People have been perpetrating awful things on other people for as long as anyone can recall.  So as unfortunate as that would be, it doesn’t represent the kind of system level problem that I’m concerned about.

What bothers me is that the allegations as they stand, the actions that were supposedly fraudulent, bear close resemblance to legitimate activities which have been daily occurrences in the financial industry for decades.  Far from being criminal acts, these things are widely understood to be business as usual.  Consider the following:

  • Investment firms simultaneously take long and short positions on the same asset or circumstances all the time.  It’s called hedging, and stems from the fact that you may know that something is going to move, but you might not know in which direction.  Hedges, or “paired trades” limit exposure and insure that if the move is a big one, there will be a net profit either way.
  • Every business in the world purchases insurance, in myriad forms, when its basic activities cause it to have exposure to a risk that the managers are not comfortable bearing alone.  The vast majority of the time people buy insurance because they hope X doesn’t happen.  Much more rarely are they hoping that it will.
  • Engaging in an activity that has less than a 50% chance of success is sometimes still worth pursuing if the potential gain is big enough.  Obviously that’s not the way most businesses operate, but there’s nothing that says that operators who are willing to accept the risks should be precluded from doing so.  Just think about how difficult it would be to establish limits, much less regulate them, if such were not the case.

Bottom line is that engaging in risky behavior and putting countermeasures in place to limit exposure to unexpected outcomes isn’t by itself an indication of fraud or any other kind of wrong doing.  It’s the opposite: sound business and prudent protection of resources.

The risk here is that the investigators will ignore the nuances of the case, ignore the facts that don’t fit with their theory, and in the end drive to a conclusion that is more simplistic than the situation calls for.  If they do, then precedent will have been furthered, and all the sudden what started out as a single case against one small group of people becomes an indictment against long standing, legitimate, rational business activities.

Even if the parties who have been charged did something wrong, by misusing the common tools of the trade, that doesn’t mean that all of the other tool users are guilty too; or that the tools themselves are somehow inherently evil.  If someone breaks out a windshield with a baseball bat, reforming the game of baseball is clearly not the right move.  Let’s hope that it’s just as clear to everyone involved with this case too.

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