Why I Just Increased my Investment in Goldman Sachs

May 3, 2010 by

Although Goldman Sachs is currently under civil and criminal investigation, I am convinced that its actions were neither illegal nor unethical. Instead, I find the behavior of Congress to be questionable. After watching the Congressional inquiry, I have increased my investment in Goldman Sachs.

Goldman Sachs is a market maker. Like a bookie at a casino, it matches up opposing bets and then takes a cut of the pot for its services. Imagine if you wanted to place a bet on the Knicks in their game against the Celtics. To do this, you would need to find a market maker who was able to pair you with people willing to bet on the opposite team. In doing this, you would expect the house to always win. Although you would be transacting with the house, the house would be only transacting with you in a matchmaking capacity. The fact that the house offered to take your bet should not be seen as an endorsement of the quality of the bet.

In the Goldman case, hedge fund manager John Paulson essentially designed what he thought was a long shot horse – the ABACUS 2007-ACI security. Goldman offered to help Paulson find investors willing to take opposing bets on this horse. The bets were risky, but like betters on a heavily unfavored horse, the investors were willing to take the risk. Two things should be noted. First, Goldman Sachs had no fiduciary duty towards the investors. That is, Goldman had never promised them it would look out for their interests. As a result, the investors should have had no expectation that Goldman was doing so. Second, the investors were expert institutions and not naive consumer investors. Since the ABACUS investors were professionals, it cannot be said that Goldman sought to exploit the weak. The investors should have been equipped to evaluate the securities; the fact that they failed to properly do so should not be blamed on Goldman. Furthermore, the failure of the ABACUS security was not guaranteed. While Paulson’s hedge fund made a lot of money by shorting it, the hedge fund could potentially have owed a large sum of money to the long investors had the outcome been reversed. Everyone at the table agreed to take a bet with Goldman as the bookie, and some parties won while others lost.

The real victim here is Fabrice Tourre. This relatively young man has been turned into the figurehead of what appears to essentially be a Congressional witch trial staged to gain support for financial reform. Although he expressed doubts about the prudence of being a long investor in ABACUS, matchmaking was his job, and he knew that his clients were aware of the risks. Likely, the only risk that he had not imagined was that his behavior would be judged by the national media and people with no understanding of the industry, rather than by fellow bankers. Unfortunately, Fabrice found himself in front of senators such as Jon Tester, a Montana man with experience as a farmer and a music teacher. While Tourre’s actions may not make much sense to Tester, Tourre deserves to be tried by a jury of his peers – fellow bankers, and not farmers who would be ineligible to participate in investments like ABACUS. Guilty or not, Fabrice Tourre will likely go down in public infamy, sacrificed at the altar of politics.

If any sort of reform takes place, it will affect all financial institutions equally. Goldman will not suffer differentially from its peers. In the meanwhile, Goldman is being hammered while its competitors are not. Since I feel that the rapid decline in Goldman’s share price has nothing to do with the underlying value of the firm and that its ability to compete will not be modified by this investigation, I have decided to invest more heavily. As of May 3rd, 2010, Goldman’s Price-to-Earnings (P/E) ratio is 6.96. Meanwhile, the P/E ratios of Citigroup, JP Morgan, and Morgan Stanley are 10.16, 8.95, and 8.54, respectively. Goldman Sachs is presently a relative bargain, and I am always looking for a good value.

3 Comments

  1. Manny

    Great Article. I agree with you on this one. The collapse of the sub prime market was not Goldman's fault. Things could have swayed either ways. AIG on the other side of the fence being grilled for loosing money and now Goldman on this side of the fence being condemned for making money. It is like Mainstreet speaks from their mouth and their ass.

  2. James

    I often bet against the news when I think a news frenzy is distorting market prices (hence my stake in TM), but I think GS actually took a significant hit this week. What they did may not have been illegal, but as we saw with Arthur Andersen, your business practices don't need to be illegal to scare away all of your customers.

    GS makes huge profits from the fact that their customers trust them more than they should. Instead of treating GS salesmen as what they are, many investors treat them as advisers. And this week, GS made a very public statement saying, essentially, that their customers should trust them about as much as they trust used car dealers. I would expect this statement to cost them many of their most profitable suckers/customers.

    The question is, will this erosion of their customer base/forcing their dumbest customers to become smarter cost them 20% of their profits? I'm not sure, but add in the fact that the fraud case isn't exactly a slam-dunk for the defense, and 20% off sounds about right to me.

  3. mart

    Great article.. and I agree with you; although I would not go as far as saying that Goldman does not play any part in the collapse of market.. they do contribute equally as other IB

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