Goldman vs. Its Clients

At Goldman Sachs, it's always all about the clients. So when the Securities and Exchange Commission charged the firm today with fraud for its role in constructing and peddling a deceptive investment, of course Goldman said it is innocent and will vigorously contest the charges. It was a release terse even by the firm's usual standards.

The company's defense will largely revolve around the fact that Goldman was simply serving its client. At least that's what Goldman, a firm that is ferocious about seeking out its own self-interest, would like us to think. What's the first of Goldman's business principles? "Our clients' interests always come first. Our experience shows that if we serve our clients well, our own success will follow." In the recently released annual letter to shareholders, the word client (or clients) appears 56 times, by my count. To paraphrase Bryan Adams, everything Goldman does, it does it for its clients. "Among the roles we play for our largely institutional client base are advisor, financier, market maker, asset manager and co-investor." Why did Goldman use cheap government-provided capital and government-backed debt to speculate and hedge? "The vast majority of the risk we take and the revenues we generate is derived from trades that advance a client need or objective." Why did Goldman buy credit-default protection from AIG—bets on which the taxpayer later made Goldman whole? "This protection was designed to hedge equivalent transactions executed with clients taking the other side of the same trades. In so doing, we served as an intermediary in assisting our clients to express a defined view on the market."

Goldman is just a puppet whose strings are pulled by all-powerful clients. But on Wall Street there is a thin line between clients and easy marks. And Goldman has been accused of not always acting in the best interest of its clients. Several of the books about the financial crisis have noted that Goldman scaled back its exposure to subprime debt while continuing to peddle subprime bonds and securities backed by risky mortgages to clients. Henny Sender reported this week in the Financial Times  that a $1.8 billion real estate fund managed by Goldman has lost 98 percent of its value since 2005. Yes, Goldman lost money too, because it invested alongside its clients in the fund. But the firm has also collected tens of millions of dollars in management fees for lighting its clients' funds on fire.

And at Goldman, according to Friday's SEC complaint, some clients are clearly more important than others. The case alleges that at the behest of one client, the hedge fund Paulson & Co., Goldman cobbled together a CDO (a collection of mortgages) that it would then sell in pieces to other customers. Paulson wanted Goldman to create the CDO just so it could bet against it—Paulson thought the mortgages in the CDO would default at a high rate, thus rendering big chunks of it worthless. It's kind of like a developer (Paulson) commissioning a construction firm (Goldman) to build a condominium tower while purchasing insurance that would pay off in case it fell down. But the SEC complaint alleges the scheme went a step further. The SEC says that Goldman worked with Paulson and ACA, a "portfolio selection agent," to ensure that the edifice was composed of defective and subpar materials. The SEC presents evidence that ACA, as Goldman watched, included in the CDO specific assets that Paulson had chosen. Goldman then proceeded to sell condos (slices of CDOs) to other Goldman clients without telling them of the hazardous design. "In sum, GS&Co arranged a transaction at Paulson's request in which Paulson heavily influenced the selection of the portfolio to suit its economic interests, but failed to disclose to investors, as part of the description of the portfolio selection process contained in the marketing materials used to promote the transaction, Paulson's role in the portfolio selection process or its adverse economic interests," reads the SEC suit.

It worked exactly as intended. Goldman collected a fat fee for building and peddling the dreck. One Goldman client (Paulson) made out like a bandit shorting it. And several other Goldman clients (the unfortunate banks who bought pieces of the CDO) got their faces ripped off.

Lloyd Blankfein has said that investment banks like Goldman that focus on serving their clients are simply doing "God's work." Well, yeah, if your God is Mammon.

Daniel Gross is also the author of  Dumb Money: How Our Greatest Financial Minds Bankrupted the Nation  and  Pop!: Why Bubbles Are Great For The Economy.