Goldman Sachs and the Apple structured bond deal
tech.fortune.cnn.com
tech.fortune.cnn.com
As a lawyer, we have detailed guidelines about who we can and cannot take on as a client because of conflict of interest. On rare occasions lawyers can represent a client where there is a conflict of interest provided it is spelled out in writing and signed by both the lawyer and client. On the other hand GS lives off of conflicts of interest and exploiting them.
For example, just before the real estate bubble, GS owned a bunch of "toxic" real estate backed assets. GS sent internal emails throughout the firm to sell these assets to clients before they became worthless, and even offered additional incentive compensation for dumping these toxic assets off on their own clients. When certain GS clients lost everything and these emails were leaked a congressional hearing was held, see here: www.c-spanvideo.org/program/293196-3
When asked about the GS conflict of interest and dumping self-owned toxic assets on their clients that GS acknowledged would become worthless, the CEO responded by saying just because those assets were no longer in GS's best interest, does not mean they were not great deals for their clients, nor did GS have any duty to disclose that GS itself was dumping the same asset it was trying to sell to its own client.
Be warned: This can and will happen again, despite the passing of The Wall Street and Financial Reform Act to make sure the 2008 financial crisis will not repeat itself, GS and other special interest groups made sure that prohibitions/disclosures of this type of conflict of interest were not included in the reform.
In the prospectus filed with the SEC[1], Goldman disclosed that "...with regard to your notes, from time to time, we and/or our affiliates: (1) expect to acquire, or dispose of positions in listed or over-the-counter options, futures or other instruments linked to the index stock, (2) may take or dispose of positions in the securities of the index stock issuer itself, (3) may take or dispose of positions in listed or over-the-counter options or other instruments based on indices designed to track the performance of the New York Stock Exchange or other components of the U.S. equity market, and/or (4) may take short positions in the index stock or other securities of the kind described above — i.e., we and/or our affiliates may sell securities of the kind that we do not own or that we borrow for delivery to purchaser."
Let me paraphrase Warren Buffett: if you're playing poker with the big boys and you don't know who the patsy is, you're the patsy.[2]
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[1] http://www.sec.gov/Archives/edgar/data/886982/00011046591300...
[2] Buffett's original quote: http://www.goodreads.com/quotes/29147-if-you-ve-been-playing...
If they do not guarantee any return on whatever investment they sell then they are under no obligation to look for their clients best interests.
It happened during the subprime mortgage crisis where banks would sell derivatives to their clients and short the same clients because they knew the products were bad. And it is totally legal.
So who is to blame ? the banks ? or the elected representatives that made these things legal ? in the end the people is , for electing people that serves bank interests.
http://www.nytimes.com/2010/07/16/business/16goldman.html?_r...
However, it is worth noting that after Goldman agreed to pay the fine their stock price rose. This indicates that the stock market believed they got off lightly, so while officially illegal it does appear to be a reasonable business model.
This is indeed true.
>in fact , that's how they make most of their money
This however requires some proof. They do make money this way but to say that this is how banks make "most" of their money is way off by my understanding and I work in the industry.
In many ways it's no so different with the managing agents my building co-op appoints. We know they're screwing us every year, but at least we know how they're doing it, while with a new agent we'd have no idea!
From my understanding Goldman Sachs typically makes money selling these kinds of derivatives through sellers fees. i.e. They are not actually backing the debt behind the derivative, they are just selling it and collecting a fee (typically, around 0.3%).
If this is true then the deal simply looks like a bad one for the buyers, but not in any unusual way. They purchased derivatives linked to Apple's stock price the day before the earnings were made public. They bet of good news and they lost.
The Goldman deals that were fraudulent were around Goldman recommending their customers buy derivatives they themselves owned and were furiously offloading. Or they were selling derivatives and then betting against those derivatives through AIG.
This article would make sense if we could demonstrate that Goldman actually stood to gain from Apple's precipitous stock price fall. But that connection isn't obvious to me.
I would love to hear from someone with real knowledge about these things. Also if anyone can pick holes in what I wrote about I would appreciate that too.
1) For some reason, they have an outsized position that they want to reduce. Circumstances include:
- Proprietary trading group wants to liquidate a position without having to go to the open market
- Firm obtains a large position as part of a block deal.
In this case, I suspect they engaged in a deal with a hedge fund that had a large exposure to AAPL and wanted to get out. GS would have acquired the position at a significant discount (say, 5% below market price).
2) They need to find clients to soak up the exposure.
To do this, they construct investment products that allow them to offset the exposure without having to directly move the inventory. Offering shares directly would have to be essentially free, but products can be sold with some extra fees.
To summarize, they have a long position in AAPL and taking the opposite side of a derivatives trade helps balance the net position.
Note that if the clients made money then you wouldn't hear about the deals. It's only because clients lost that we are hearing about this.
Further, the fact that a GS analyst said something is irrelevant. The analyst is an independent adviser to GS's brokerage clients, and is not informed what the prop trading dept is doing. In fact, it would be illegal for the prop traders to tell Bill Shoppe what they are doing, or for him to give them advance notice of his analysis.
Besides, you really don't need a lot of shares to hedge this type of product. You need options that are typically (at least initially) deep-ish out of the money and so have little delta.
Buying a put option requires an upfront payment but you will receive money if the price falls below a specified price (the "strike price"). On the other hand, you receive money when selling a call option but may have to pay later (or hand over your shares) if the stock price jumps above the strike.
The problem is that this mechanism only works because there's a counterparty willing to do the trade. You can see the option premium (cost) for a variety of strikes on most financial sites (e.g. https://www.google.com/finance/option_chain?q=NASDAQ%3AAAPL)
As more people buy put options, the price of the put option goes up. As more people sell calls, the price of the call option goes down. If you have a small position (say, 1000 shares), your trade wont move the options market much, but if you have a large position your trades will affect the market makers (they also have a book and are looking to reduce their exposures profitably as well)
Remember, just because the MM would buy or write one contract doesnt mean they'll buy or write tens or hundreds of thousands of contracts at the price.
What I'm saying is that trying to get rid of a lot of shares through $30MM worth of a reconv is very ineficient, if not downright stupid.
edit: changed to non-paywall link (thanks "mef")
If you read through this you see: Goldman published that they thought Apple would do well; Goldman sells a derivative linked to Apples stock price and collects a sales fee; people bought into that derivative; Apple released their earnings; the value of the derivative went down; Goldman published a revised estimate on Apple.
Where's the scam? It looks to me like people bought something that went down in value, and suddenly it's the sellers fault!
Is this just the good old put Goldman in the title and people will read it?
These are very generic products, and many investment banks issued dollops of them (especially tied to Apple) in the past few years.
Basically, they look like bonds that pay a higher-than-average coupon, the catch being that if the equity the note is tied to declines in value, you lose part of your capital. Company treasurers tend to like those because of the high headline return rate (i.e. assuming the underlying equity doesn't tank).
Now, the banks do not take the reverse position. They hedge it (probably not perfectly, but very closely) using a combination of cash deposits and equity options (which is really what these products are about). There is little to no trading PnL on these things. They make money by selling the note $10 when its intrinsic value is $9.50.
It's a bit much to label it a scam based on the evidence in the article itself. The target price of an exchange traded share is far more public and published compared to a complex financial instrument. If people bought millions of dollars of bonds based on nothing more than Goldman's analyst's stock target price then they are a fool.
what I would like to find out is whether they were market making and hedging what they were selling to their clients or rather taking short positions and selling clients long positions. They stand to gain little if they were just market making -- I suspect they must have taken some middle ground to make a profit.
[edit=elaboration] I really wonder who buys bonds from a bank when all of this is true:
a) I can only make profit when the bank loses
b) The bank's analyst predicts that I willmake profit
There are only two possibilities:
1) The bank does not know how to earn money
2) The bank tries to screw you over
As Goldman Sachs has a pretty good track record at making money, 1) is bloody unlikely.
Usually your local education board or city council (A) has some money to invest or some income to smooth out. 1. They talk to financial advisors (B) who give advice. 2. The advisors get commissions if they sell certain types of products. 3. The inexperienced financial staff in A believe the advice given by B. 4. The taxpayer shoulders the risk.
People that lose their own money on these scams can't expect sympathy for being greedy from me.
The people dealing with GS are dealing with "other people's money"
They are people who don't get penalised when a deal goes bad BUT they do get massive bonuses when a deal goes very well. Hence they are willing to deal with GS.
Can a HN mod please change the title/link bait?
Is the apparent increase in lawsuits real ?
It's mostly scapegoating as far as I am aware, the banking sector collapsed, and people want to blame someone!
Well actually you can, but we are in a massive period of transition, where technologically based unemployment is chucking middle income earners onto the fire.
The sensible response to temporary unemployment is to borrow to cover the down period and pick up with a new job - but for millions there is no job
So debt was take. On massively across the board - and debt is what was revealed in the 2008 bust up - there was no where else to hide the debts and bang
Not sure if its coherent analysis but interesting (read race against the machine)