A few days ago, I presented you with an analogy that Rachel Maddow came up with to explain the Goldman Sachs fraud mess. Aaaaaaand you didn’t like it very much, which is fair since it was a little too oversimplified. (If you’re curious, I added some more detail in the comments of that post.) But I have to admit that it’s not as bad as the analogies that some others have come up with…*cue Daily Show montage*
Oh man. First off, what on earth was Jim Cramer thinking regarding that costume? Second, apparently decent analogies to explain things like potential large-scale bank fraud are harder to come up with than I would have initially thought.
|The Daily Show With Jon Stewart||Mon – Thurs 11p / 10c|
|These F@#king Guys – Goldman Sachs|
Dear CNN: Your attempted used-car analogy should have been a slam dunk, since the Goldman Sachs situation is a near-perfect example of the lemons problem. How did you go so wrong on this? (Sidenote: I fully expect you to tell me if any of my analogies or explanations are this bad. Seriously.)
Personally, I appreciate Jon Stewart’s recommendation: “I got an idea- why don’t you explain it like you’re news shows and your audience had *not* suffered a traumatic brain injury.” Unfortunately, I disagree with much of Stewart’s (fake) analysis from that point on…
It’s not “terrible” to sell a risky product if people in fact know that it’s risky or damaged or whatever. At the risk of making another terrible analogy, investing in these products with the proper information is like buying a pack of irregular socks- you get them at a significant discount, and they may turn out of be crap, but they could also turn out to just have the wrong color stitching on the toe or something. If the market has full information, then the prices of these products should reflect their risk, and people get what they pay for. Would you prefer the law take away your ability to buy the irregular socks at a discount because they might not work out for you?
At about 4:15 in the video, the news source said that Goldman Sachs labeled the financial product in question as a good product and said that the hedge fund had in fact invested in the product. Well, that second part, if not true, is clearly problematic. The first part is also pretty crappy, I will admit, but on a somewhat different point on the reasonableness/legality spectrum. To provide another potentially terrible analogy, I present some comments from the previous post:
Warren // Apr 18, 2010 at 5:20 pm
“Simply put, if you have a really smart guy trying to sell you something that he owns, he’d better have a good reason for needing to sell it, since otherwise you’re probably getting taken for a ride.”
Hmmm. Sounds a lot like the reason I won’t by gold from people telling me what a great investment it is…
econgirl // Apr 18, 2010 at 6:20 pm
@ Warren: YES! If you think that gold is such a good investment, why are you spending money on this commercial as opposed to using that money to, oh, I don’t know, BUY GOLD????
Basically, I’m trying my best to keep things in perspective here. Yes, Goldman didn’t let on that this hedge fund guy designed the product to be crappy, but if people could see what was in that product why should it matter? I could make sandwiches out of week-old bread and moldy cheese and they could be sold at a supermarket and the customers would balk at the idea of purchasing them as long as they could tell what they were made of, even if the supermarket went around saying how great they were. Should they have to tell their customers that I specifically made the sandwiches out of things that I wanted to get rid of in the kitchen? This doesn’t make the supermarket look good, but it also isn’t particularly problematic from a market perspective. The problem comes in if the sandwiches are wrapped such that the customers can’t examine them and then the store refuses to give a refund once the customers open them up and find them to be inedible. See the difference?
Based on the above, we’re finally honing in on where the underlying problem could be- did investors have all of the information that they needed to make an objective, informed decision? In other words, if investors knew what they were buying, knowing who constructed it becomes mostly irrelevant. I mean, no stock broker really has an obligation to tell me how Warren Buffet currently feels about the security I am about to purchase, even if he had a hand in shaping the company, right?
This all brings me to the coolest part of this that I have read about so far. Apparently these products are so complex that it might be computationally impossible to sniff out the lemons in them:
The paper (Arora et al., “Computational Complexity and Information Asymmetry in Financial Products”) argues that the complex structuring of derivatives can create “computational intractability.” In layperson terms, finding the “lemons” can become an inordinately difficult mathematical problem. Unless an investor has unlimited computational power, it may not be able to “solve” the problem and detect the lemons. It’s the same problem that occurs with trying to decode computer messages protected with a certain level of encryption. The structuring of the deal functions as a kind of encryption to camouflage the bad assets.
This means that the party that both selects the collateral and structures a complex derivative (like a synthetic CDO) has a potentially insurmountable information advantage over its counterparties. … (In an amusing twist, the paper argues that “even Goldman Sachs” wouldn’t be able to detect the lemons).
My nerd meter is so off the charts right now. If this is true, then investors aren’t able to fully investigate and understand what’s in the product, and they got the financial equivalent of the wrapped and unreturnable sandwich. Legal or not, this doesn’t look so good for the grocery st…er, Goldman Sachs. I will try to stop with the bad analogies now.