As the resident finance geek in my circle of friends, I had to field several questions about Wall Street megafirm Goldman Sachs, which was sued by the Securities and Exchange Commission last week for allegedly defrauding its investors.
Of course, the danger I encountered while trying to explain what Goldman did was in getting bogged down in financial terminology. After all, a person can only hear so much about synthetic CDOs, equity tranches and credit default swaps before going insane.
I think the best way to explain these matters is to remove them from the arcane language of finance and put them into more familiar territory. For our purposes, let’s pretend that Goldman Sachs isn’t a major investment firm and is instead a small business based in rural Georgia called Honest Lloyd Blankfein’s Used Auto Emporium. And instead of selling mortgage-backed securities, let’s say that Honest Lloyd sells (you guessed it) used cars.
Our story begins with Honest Lloyd walking through his dealership lot and coming away appalled by the low quality of cars he has for sale. One truck has a nest of possums living in its engine; another has triangular wheels; yet another has sparks shooting out of its gas tank; and so on. Honest Lloyd barges into one of his salesman’s offices – let’s call him Fabrice Tourre – and pops off about the crappy stock on his lot.
“Goldurnnit, Fab, how in all tarnation are we gonna git ridda these things?” fumes Honest Lloyd. “We done got the sorriest damn cars in alla Georgia!”
Tourre, who can talk smooth with the best of them, tells Honest Lloyd to relax – he’s got a plan. Tourre has already put in a call to John Paulson, a clever local mechanic who has come up with a brilliant way to make Honest Lloyd’s car stock look better. Basically, Paulson will remove all of the worst parts from each individual car – from the possum-infested engine to the exploding gas tank – and swap them out with the working parts of another car. This means there will now be one car on the lot that has all of the horrific defects of the entire lot.
“However will we repay you for your incredible work?” asks Honest Lloyd to Paulson after he finishes up.
“How about this?” Paulson says. “Just give me the Social Security number of the dumb chump you sell the vehicle to so I can take out a life insurance policy on him. Sound like a plan?”
The two men shake hands.
This is pretty much what Goldman Sachs allegedly did when it hired hedge fund manager John Paulson to pick out the absolute worst mortgages on Goldman’s books and repackage them into a new synthetic collateralized debt obligation that would be sold to some hump investor. The government alleges that Goldman knew the new CDO was likely to blow up on whoever bought it and that it misled its investors by not telling them the assets in the CDO were handpicked by Paulson.
OK, so back to Honest Lloyd. Now that he’s put all of the worst defects into one vehicle, he still has to find some sucker who’s willing to buy it. So he calls up one of his dopiest customers – let’s call him Johnny Pension Fund – and lets him know he’s got the deal of a lifetime for him. Johnny, an affable sort who has always trusted Honest Lloyd strolls down to the lot and looks in horror at Honest Lloyd’s Frankenstein car, which has now been rebranded the Chevy Abacus.
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