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According to the Collins English Dictionary 10th Edition fraud can be defined as: "deceit, trickery, sharp practice, or breach of confidence, perpetrated for profit or to gain some unfair or dishonest advantage".[1] In the broadest sense, a fraud is an intentional deception made for personal gain or to damage another individual; the related adjective is fraudulent. The specific legal definition varies by legal jurisdiction. Fraud is a crime, and also a civil law violation. Defrauding people or entities of money or valuables is a common purpose of fraud, but there have also been fraudulent "discoveries", e.g. in science, to gain prestige rather than immediate monetary gain
*As defined in Wikipedia

Sunday, January 9, 2011

Goldman Sachs Knows How to Win at Market Making

The following post from Bankwatch talks about an interesting comparison between CDOs and the Facebook deal that Goldman Sachs made. The deal is a win-win for Goldman Sachs: If Facebook takes off, GS wins; if Facebook comes a cropper, GS still wins by selling its own stake and collecting fees (and bonuses). Nice.

The Bankwatch

Tracking the evolution of financial institutions

The Goldman Sachs Facebook deal builds the wrong kind of value and will be bad for FaceBook as a company

Nomi Prins worked at Bear Sterns, then Goldman Sachs until 2002. Her background was CDO (Collateralised Debt Obligations) which later (after she left) became tarnished with sub prime mortgages and were at the centre of the banking crisis. Goldman Sachs were fined $550 million by the SEC for insider trading regarding CDO.

Nomi compares the FaceBook deal to CDO. Her central point is that Goldman Sachs have better information than their customers and are in effect ‘making the market’ in FaceBook. By making the market they provide several opportunities to make large fees and will make those fees no matter which way the market goes. Meantime the investors are forced into an illiquid position until 2013, except for Goldman Sachs who can exit any time. Also check out the fees. Investors are down 10% from the outset – your $2 million is worth $1.8 million on day 1. Its a great deal for Goldman Sachs.

Goldman’s Shady Facebook Deal | Daily Beast

If you’re one of those investors, here’s the deal in a nutshell: You get to buy shares, forking over 5 percent of any possible gains, on top of a 4 percent placement fee and a 0.5 percent expense reserve fee (so you’re down 10 percent before the game starts) in a private company that doesn’t have to disclose any pertinent financial information to you or any regulator for 15 months. For the privilege, Goldman gets its eight-digit windfall.

Article - Prins Goldman Facebook

Forget their fees for a moment, though. Recall that what killed the CDO market, aside from the crappy deals, crappy collateral and overall shadiness: lack of liquidity. Investors stopped buying CDO pieces, and trading desks stopped making markets in them. Game over. That’s why this deal, albeit in something with more potential than a basket of subprime assets, is worse than a CDO: Investor illiquidity begins on day one. The rich Goldman clients who must pony up a minimum $2 million investment aren’t allowed out until 2013. No exceptions. Ditto Facebook employees (although they were allowed to cash out about $100 million last year). But Goldman is. Whenever it wants "without notice to the fund or investors in the fund."

She goes on to compare the FaceBook arrangement to CDO in more detail.

CDOs were private, unregulated, overvalued, disclosure-lite, fee-intensive deals. The Facebook deal is private, unregulated, overvalued, disclosure-lite, and fee intensive. CDOs sold like mad— until they didn’t. That can happen here. At the end of the holding period, there may be no bid for Facebook shares anywhere near the price paid. Plus, by that time all the enthusiastic global users of Facebook may have dropped it for taking the advertiser money along with them.

Finally the ultimate telling message. As a raw investment, Goldmans own fund declined to participate. This further promotes Nomi’s point the Goldman Sachs are doing this deal to extract large fees from their accredited investor (rich customers, who are the only ones that can participate) customers while they (Goldman) build a market for FaceBook shares. This is all in complete contrast to the Google IPO which promoted fairness and equal opportunity and it did that by bypassing Wall Street. Gordon Gekko is alive and well.

The Facebook deal sucks so badly that one of Goldman Sachs’ own funds didn’t want a single share of it. Richard Friedman, who runs the money for past and present Goldman partners, among others, said, thanks, but no thanks. That should tell everyone something.

Relevance to Bankwatch:

Its not that I mind people becoming rich. The larger issue here is that opaque deals with extreme fee structures benefit investment banks, but do little for the larger economy. They create false value that contributes to bubbles and that always end in crashes like we just saw in 2008. And after the crash the ones holding the money are the same ones who got the up front fees and bonuses. This is the opposite of creation of sustainable and manageable value that benefits the broader economy and people at large. It also means FaceBook as a corporation will be entirely focussed on working to Goldman Sachs pace and not to the benefit of the company’s long term success.

Read the article here


Anonymous said...

Today’s most dangerous government sponsored enterprises are the largest six bank holding companies: JP Morgan Chase, Bank of America, Citigroup, Wells Fargo, Goldman Sachs, and Morgan Stanley. They are undoubtedly too big to fail – if they were on the brink of failure, they would be rescued by the government, in the sense that their creditors would be protected 100 percent. The market knows this and, as a result, these large institutions can borrow more cheaply than their smaller competitors. This lets them stay big and – amazingly – get bigger.

This is not a left-right issue – again, look at the list of people who co-signed Professor Admati’s recent letter to the Financial Times. This is a question of technical competence. Do the people running the country – including both the executive branch and the legislature – understand economics and finance or not?

Anonymous said...

You don’t have to protest and march. You don’t have to go on a hunger strike.
All you need to do is temporarily DEACTIVATE your FACEBOOK account and tell others that you know. When you Deactivate, it won’t permanently disappear, but it will send a message in a data format, saying that the VAMPIRE SQUID (Goldman), has got to be stopped. After all, we ALL KNOW people who lost their jobs, and WE ALL USE FACEBOOK. So by using Facebook aren’t you simply agreeing with GOLDMAN’s practices ? Like I said, I know people are busy, but this is the easiest and most direct way (not to mention the media would eventually get a hold of it) to protest Goldman’s (one of many in the Wall Street greed nest) lack of care towards society. This isn’t just America, this had effects globally and this would be a way to send a message.

Joyce said...

The Bill Daley appointment points out the biggest weakness in Obama's leadership: he seems to know nothing about finance and depends on his appointees for his information. If he sought some information outside of Wall Street, he would perhaps get a clearer picture of what must be done.

I closed my Facebook account permanently yesterday.

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