Rethinking the Goldman case

Larry Ribstein of the University of Illinois seems to think the SEC has Goldman by the you know what according to this piece in Business Week. He called Goldman’s behavior “fishy” and said the bank has a lot of explaining to do.

But what Ribstein seems to miss is the role Goldman is supposed to play in the capital markets: they are an intermediary between buyers and sellers of securities. That is what they are in business to do. Anyone who calls them up to buy a stock, perhaps shares in Apple or IBM, knows that Goldman will be selling them stock they have in their own inventory or that Goldman will find a willing seller.

By definition the buyer must understand that Goldman or the seller Goldman secures for the trade think that it’s worth getting rid of the stock at the price agreed upon.

Goldman or the seller presumably think the stock will decline in value or else they would hold on to it or charge a higher price.  Of course there are always traders who need liquidity. But the main point is clear – there is in some sense always a short or a long on each side of any trade. And the Goldman’s of the world are in the middle.

Did Goldman do any thing different in the ABACUS trade that the SEC has targeted? Yes, Paulson & Co. was involved in setting up the CDO vehicle so they could buy CDS protection. But IKB, the German bank that was on the long side of the transaction, knew this was a synthetic CDO which by definition means someone is buying CDS protection to pay off in case the underlying securities default.

Does the SEC need to step in to protect investors who bought into the idea that housing prices never fall?

Goldman SEC Case May Hinge on Meaning of ‘Selected’ (Update1) – BusinessWeek.