Ode to the ‘Vampire Squid’

By now, everyone in the financial press has come across Rolling Stone political reporter Matt Taibbi’s comparison of Goldman Sachs’ business practices to the habits of the deep-sea vampire squid. Like many industry observers, I found the metaphor inappropriate, insulting, and inaccurate, to say the least.

After all, when was the last time a vampire squid made an astronomical profit betting against the US housing market and then awarded itself equally astronomical bonuses following a multi-billion dollar taxpayer bailout?

To top it all off, Goldman now faces a fraud investigation by the US Securities and Exchange Commission (SEC) regarding a mortgage security investment vehicle the bank created with unmentioned assistance from hedge fund manager John Paulson in 2007. According to The New York Times reports and SEC statements, Paulson selected mortgage instruments likely to lose value for inclusion in the vehicle, which was then sold to pension, insurance and other investors that stood to profit only if those instruments increased in value. When the portfolio tanked, those investors lost more than $1 billion while Paulson made off nicely.

Robert Khuzami, director of the SEC’s enforcement division, declared that “Goldman wrongly permitted a client that was betting against the mortgage market to heavily influence which mortgage securities to include in an investment portfolio.” 

Whether Goldman’s actions in this case were illegal or just cutthroat remains to be decided in court. The sleight-of-handiness employed by the bank should, at any rate, raise the hackles of institutional investors expecting more propriety from their counterparties. But perhaps we should neither praise nor bury this particularly well-heeled Caesar.

As unsavory as Goldman’s mortgage-related activities may be, legal or not, one should not assume that the banking giant is alone in these practices. Goldman may have proven itself the most adept at profiting from the housing market collapse, but focusing regulatory ire too exclusively at the biggest bilker on the block would do little to clamp down on activities at other financial powerhouses—unless the Goldman lawsuit serves as a deterrent. In other words, in the SEC’s investigation of mortgage-backed shenanigans Goldman may be the Commission’s biggest target, but it should not be the only one.

But that assumes, of course, that there’s something worthwhile to investigate. Goldman’s actions involving Paulson may ultimately be deemed underhanded but technically legal, and some financial heavyweights not usually in the habit of rallying to the defense of the bulge-bracket banks are already questioning the soundness of the SEC’s case.

The New York Times’ Andrew Ross Sorkin recently reported that the oracular Warren Buffett himself sees little substance behind the SEC’s allegations. “To him, investors should make their investment decisions based on the quality of the securities, not on who helped put them together or who else was betting for or against them,” Sorkin writes. Quoting Buffett, Sorkin continues: “‘I don’t care if John Paulson is shorting these bonds, I’m going to have no worries that he has superior knowledge. ... It’s our job to assess the credit.’”

Therein lies the rub: Regardless of Goldman’s methods or intentions behind the mortgage-backed vehicles it sold to investors, those investors were obligated to ensure they knew what they were buying. In many mortgage-related cases that is a little like blaming the victim, considering how cozy the rating agencies had become with their investment bank patrons. Who wouldn’t have been misled if Moody’s or Standard & Poor’s awarded AAA status to what in hindsight was junk? 

But that fact doesn’t get the investors who lost money with Goldman entirely off the hook. Better internal analytics and due diligence are always a good idea, and the credit crisis showed that at many investment managers these tools proved sorely lacking. All the cephalopod analogies in the world won’t change the fact that as below-board Goldman’s practices have proven, investors nonetheless need to do a better job with their homework.