In 2008, the Libyan Investment Authority entrusted Goldman Sachs with $1.3 billion dollars. By 2010, that investment was worth $25 million. How does that happen? How does a “sophisticated” investor lose $1.275 billion – 98% – on a single trade? There are a variety of legitimate answers (e.g., it was a hedge), but Greg Smith’s disgruntled resignation letter in yesterday’s New York Times offers some pretty telling insights into how this may have happened. This is how he describes Goldman’s philosophy of dealing with its clients:
“...get your clients — some of whom are sophisticated, and some of whom aren’t — to trade whatever will bring the biggest profit to Goldman... I attend derivatives sales meetings where not one single minute is spent asking questions about how we can help clients. It’s purely about how we can make the most possible money off of them... It makes me ill how callously people talk about ripping their clients off. Over the last 12 months I have seen five different managing directors refer to their own clients as ‘muppets.’”
Was the Libyan Investment Authority a Goldman Sachs “muppet”? Was it convinced by unsavory Goldmanites to buy a basket of options that it had no business even getting close to? I don’t know. That's for others to decide.
Anyway, despite what you may think, I have no intention of piling in on Goldman – even if the company deserves some of what the media is giving it. Nor am I going after Greg Smith, who was almost certainly driven as much by a mid-life crisis as he was by what he saw going on around him. I get it. I bailed on Wall Street, albeit with much less pizzazz.
Actually, I’m too mad to do any of that – or I should say, I’m reminded of how mad I’ve been for a decade. What am I so mad about? That, in Greg Smith's words, the “muppets” are still being “muppets”. It’s so, so frustrating. And paragraphs like the one below give me the desire to throw something, like my laptop, through a window:
“If what Smith is saying today is true, then the biggest problem remains the “muppets.” Not Kermit or Gonzo, but the investors that Smith claims continue to buy garbage from Goldman. Until those clients start to take responsibility for themselves, Goldman will remain incentivized to sell stuff to them.”
To start, I take issue with the notion that Goldman doesn’t have a moral obligation here (I’ll come back to that). But, darn it, he’s right! The real question is why we are still trying to make the case for more sophisticated operations to the community of institutional investors -- and in particular their Boards and Sponsors. Why is it so hard for the sponsors of institutional investors to understand that they need savvy people at the helm of their organizations to avoid being taken advantage of?
This whole saga is utterly depressing because the clients – the “muppets” – are often played by pension funds, sovereign funds, endowments, foundations and other institutional investors, and these funds are increasingly crucial for maintaining the institutions we hold most dear (e.g., universities, charities, pensions, governments). What happens to University programs, like student aid, when an endowment loses money? What happens to old age income when pensions don’t have enough assets to meet liabilities? As it turns out, these “muppets” matter! In fact, they are some of the most important institutions in our society today!
So – deep breath, Ashby – this media fire storm should be (needs to be) a wakeup call to the people who oversee these funds. What lessons should they draw?
First, they can’t ask their funds to make ridiculous returns (i.e. higher than 7.5%) in order to spare them the cost of an expensive liability. It’s not fair. It pushes the pension managers into asset classes, geographies, and strategies that they can’t possibly understand.
Second, if sponsors are going to ask these funds to make ridiculously high returns, then they have to give them the tools to succeed. They can’t expect these funds to go off into the most sophisticated segments of financial markets without the resources or skills required.