Tag Archives: hedge funds

Goldman Fraud and John Paulson

Finally, more than a year after the financial crisis began, the first legal action took place with the SEC charging Goldman with fraud. I don’t have much to say about the actual fraud charge, except that in prior cases like this, the first charge is rarely the last. Once discovery begins and subpoenas start being issued, all the dirty documents and emails start to come out, and the dominoes begin to fall.

I do want to talk about John Paulson’s role in this affair. Paulson was not charged with fraud, and rightly not: he didn’t misrepresent anything. From a legal standpoint, Paulson didn’t do anything wrong. But what he did – paying Goldman to create a security purely so he could bet against it – just feels wrong. As Daniel Gross of Slate put it, this is like paying a construction company to build a shoddy high-rise so that you can buy insurance that pays off if the high-rise collapses, which you know it will, because you built it out of crappy materials. I was discussing this with my friend Bark for Daddy yesterday, and I fully admit that I can’t logically make a case for why Paulson was wrong. But there is just something unseemly about it.

Although not only do Paulson’s actions feel wrong, but if you take a step back and look at the big picture, a case can be made that they really were wrong. Paulson, as much as anyone on earth, knew that we were in a housing bubble; that’s why he was betting so hard against mortgage securities. So when he paid Goldman to create a $1 billion security made up of mortgages, he was adding to the bubble, and he knew it. He knew investors were going to lose an additional $1 billion, just so he could make more money.

And make money he did: Paulson took home $3.7 billion in pay in 2007. And speaking of feeling wrong, the fact that hedge fund managers – individuals – are regularly making $1 billion per year is also unseemly. Yes, they are doing so by producing big returns for their investors, and working within the system, but then maybe something is wrong with the system. Scoring $1 billion paydays by simply trading stocks, compared to entrepreneurs who get rich by building companies, again, just feels wrong.

Where Does Wall Street Add Value?

I had lunch today with a guy I share office space with. He is a partner at a small investment bank and has spent his entire career at various investment banks, helping companies raise capital. He is part of Wall Street, and Wall Street pays for his house and his kids’ private schools. And yet even this insider, when our conversation turned to proprietary trading and hedge fund, he remarked “What do those guys really add to society? They don’t build anything. They don’t allocate capital. They just make money from gaming the market.”

It’s true. When we discussed Renaissance Technologies’ 45% annual return since 1988, I noted that there are 90 PhDs, mostly in physics and computer science, working there. Think of the great things those guys might invent if they were trying to grow something other than their bank accounts.