Gary Kopff, a mortgage expert and the president of Everest Management, uses the example of wheat. "Two parties get together. One says, 'I think the price of wheat is going up.' The other says, 'I think the price of wheat is going down,'" he explains. "Neither party owns any wheat."
With the Goldman case, of course, the big difference was that investors were instead betting on mortgages. And since the investment products were synthetic, investors were able to place bets on the direction of the housing market without actually owning any physical mortgage bonds.
In arranging these deals, one of Goldman's roles was that of matchmaker. In other words, it was Goldman's job to find some investors who thought that the housing market would stay healthy and others who thought it would tank. Goldman would then pair the two sides up in a transaction.
"Acting as a swaps dealer, Goldman has a commodity. And in order for it to earn a fee for that commodity going out into the marketplace, it has to put together the short side and the long side. So it has to be simultaneously in possession of the names of bona fide longs and shorts," says Kopff. Using a gambling metaphor, he says, "In that sense, [Goldman] has a duel incentive. It wants some people to go short and some people to go long, because it's basically like the house. It's making money as long as it pairs up the longs and shorts."
The question then becomes: When should we blame the house? The most obvious answer is that the house could be at fault when the deck is stacked against some of the bettors.
In the Goldman case, this issue is particularly relevant. Notably, the SEC charged that Goldman let Paulson essentially hand pick mortgage bonds he thought were doomed to fail. Goldman then created a vehicle where investors could get synthetic exposure to those bonds.
Paulson, of course, effectively shorted the housing market by betting against the bonds, but there were also investors on the long side of the deal in question. The SEC alleged that Goldman, in its role as matchmaker, never told these investors that the bonds they were getting exposure to were chosen because a prominent manager thought they were poised to implode. Instead, according to the SEC, Goldman represented that an independent third party had handled the selection.
Goldman was hardly the only firm to package deals like this. As a result, Greenberger sees the SEC's case against Goldman as the first of several that will involve large Wall Street institutions. "The SEC has a lot of other fish to fry," he says. "This is not going to be the only case that they're going to bring."
Still, Zamansky says the settlement sends the wrong message. "If you write a check to the SEC, they go away, and that's not a good message for Wall Street," he says. Sussman takes the middle ground. "I think it was kind of a win-win for both the regulators and for Goldman," he says. "Goldman can move ahead with a lot less regulatory uncertainty, and [the SEC has] landmark dollar figure."
Also curious is the timing of the settlement. The SEC announced the agreement on Thursday, the same day that the Senate gave the key nod to the overhaul of the financial system. "Interesting timing would be my main thought," says Pritchard.
"The goal of the enforcement action was to create publicity that would give a push to financial reform," he continues. "It worked."