Cross of Gold

By Zakaria, Fareed | Newsweek, May 3, 2010 | Go to article overview
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Cross of Gold

Zakaria, Fareed, Newsweek

Byline: Fareed Zakaria

How the rush to crucify Goldman Sachs is clouding our judgment and distorting public policy.

Imagine that you want to make a bet against a sports team, say the New York Yankees. The Yankees have had a strong run, but, poring over the data, you have come to the conclusion that they're going to start losing. So you go to a bookmaker (in a district where bookmaking is legal, of course) to place a bet. The bookmaker now looks for someone to take the other side of this bet. Once the other party is found, the deal is made. That, in essence, is the transaction that took place in 2007 regarding the future direction of the American residential-housing market, in which Goldman Sachs acted as the bookie, and which the Securities and Exchange Commission now charges was "fraud."

There's so much anger and resentment toward banks these days--some of it quite justified--that anything resembling a defense of them is bound to make people angry. But the rage surrounding the Goldman case can cloud our perspective and distort public policy. We're going through a familiar part of America's boom-and-bust cycle. Having been mesmerized during the go-go years, having unduly lionized and feted industries, firms, and people as they rode the wave, we now want to throw these people to the wolves. We need to step back for a moment and try to understand what happened and learn the right lessons.

Let's be clear: all the facts are not publicly available, and evidence may be presented in court that documents specific misrepresentations and false claims, proving Goldman Sachs's guilt. But much of the public debate has struck me as guided more by emotion than careful analysis. Even if some Wall Street practices strike many people as dodgy, even unethical, that's not the same as illegal. I want financial reform, but I also want our system of government to be characterized by fair play and equal justice--even for people making $10 million bonuses.

There are two core claims of wrong-doing. The first is that John Paulson--the fund manager who wanted to bet against the housing market--was allowed to select the securities he wanted to bet against. This is disputed--but even if it's true, so what? Here's what a routine hedge transaction looks like on Wall Street. Somebody decides to place a bet against some set of stocks or securities. That person approaches a Wall Street firm and says, in effect, "Can you find me someone who wants to take the other side of this bet?" And the firm goes out and finds someone who has the opposite view on those securities. This is how large companies offset the risks to their balance sheet from fluctuating currency, energy, or commodity costs. They often choose the instrument they want to bet against.

Both sides scrutinize the securities on which they're betting. In this case, the main institution that took the other side of this bet was IKB, a large German bank that had whole departments devoted to analyzing just these products--departments many times larger than Paulson's entire firm. Did the Germans know that Paulson was betting against these securities? IKB surely knew that someone was betting against them: otherwise there would have been no transaction. Did IKB realize that the other party thought these securities were garbage? Yes--that's why he wanted to bet against them. Disagreement over the value of stocks or securities is what creates the market.

The second charge is that Goldman Sachs designed a product it "knew" would decline in value.

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