As the Goldman Sachs issue continues to draw attention from the public, the media and the government, several facts are coming to light that show the murky side of high finance. Questions are being raised about the ethical standards of financial companies and the dubious dealings they indulge in.
Many other aspects are also coming to the fore, which point to some fundamental issues and risks associated with financial instruments similar to the ones issued by Goldman Sachs.
The crux of the Goldman Sachs case is that the company promoted some dubious investments in the form of mortgage bonds and collateralized debt obligations (CDOs). The mortgage bonds were based on sub prime loans where the possibility that the borrowers might default on repayments was visibly high.
The buyers of such bonds typically get the advantage of higher interest but also bear a higher risk of default. These bonds are sometimes used to create a CDO in conjunction with other bonds. These CDOs are then sold to investors, who find them attractive because of the higher interest payout that they offer.
Several doubts are being raised on the legality and fairness of such instruments. Critics say that there is no justification for regulatory authorities to allow such high risk investment products in the market at all. In fact, these instruments are being compared with gambling.
In the case of Goldman Sachs, there is reason to believe that the CDOs were made for failure. Hedge fund manager John Paulson allegedly chose the bonds which would make up the CDO, and at the same time he was betting on their failure. Goldman Sachs’ complicity in allowing such a selection by an interested party and not revealing the same to investors is the main allegation against the company.
The company is making a defense in the case, justifying its actions by stating that the instrument was never designed for amateur investors or ones with limited knowledge of the markets. It says that the CDO was aimed at investors who are highly proficient with financial market nuances and more than capable of judging the instrument’s risk. The fact that Paulson’s influence was not disclosed has no bearing on the case, company sources maintain, as proper risk disclosures had been made.
Whether Goldman’s argument holds water or not is yet to be seen, but investors should learn a valuable lesson from the fiasco – doing their homework before investing.