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 Smiths disgruntled resignation letter in yesterdays New York Times offers some pretty telling insights into how this may have happened. This is how he describes Goldmans philosophy of dealing with its clients:
...get your clients some of whom are sophisticated, and some of whom arent 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. Its 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 dont 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, Im too mad to do any of that or I should say, Im reminded of how mad Ive been for a decade. What am I so mad about? That, in Greg Smith's words, the muppets are still being muppets. Its 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 doesnt have a moral obligation here (Ill come back to that). But, darn it, hes 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 dont 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 cant ask their funds to make ridiculous returns (i.e. higher than 7.5%) in order to spare them the cost of an expensive liability. Its not fair. It pushes the pension managers into asset classes, geographies, and strategies that they cant 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 cant expect these funds to go off into the most sophisticated segments of financial markets without the resources or skills required.
Put simply, the current model of public pensions and sovereign funds is a toxic mix of ingredients that puts all the power on the side of the private sector: weve now got unsophisticated investors wading into waters filled only with the most sophisticated players in order to achieve the required returns (to save politicians making tough spending choices). What did you think was going to happen? Stop being a muppet!
The sponsors of sovereigns and pensions and their Boards -- can no longer send under-resourced and under-qualified investors off to Wall Street and London to work with their partners in the private sector. These partners exist to make money. And, when properly supervised and disciplined, thats a wonderful incentive! But when theyre not held accountable by a sophisticated team at the fund the funds end up being muppets. Stop being a muppet!
Let me be even clearer here:
Dear Politicians: Despite what you were told in your legislative and policy meetings (by the private sector), the partnership between the public and private sector the very principles upon which you based the design of your fund has turned out to be a bit of sham. Yes, I know you were told that you didnt need a qualified team at the helm of your fund because all the qualifications you would ever require are right there, in New York. And I know you were told that having firemen or teachers overseeing billions of dollars was feasible thanks to the skills on Wall Street. But all that you now see was BS. And you were a muppet for believing it. Stop being a muppet!
Dear Board: Stop talking directly to asset managers. Start talking to your management team. But first, start hiring a management team that can implement your objectives and deal with the private sector as equals. In a way, fight fire with fire. Stop being a muppet!
Anyway, Goldman Sachs is a lovely villain. But Im targeting my criticism in this post at the folks who design and govern the muppets. Im targeting my angst at the people who think its cool to pay the CIO of a $40 billion pension fund 100 thousand dollars a year. Im sorry, people, thats not OK. Thats how your pension fund becomes a muppet. Stop being a muppet!
I dont want to name names on the muppet side of things in part because I dont want to give some sales team in New York or London a muppet list for cold calls but I do want to give you an example of a sophisticated and well-resourced institutional investor: The Canada Pension Plan Investment Board. On its executive team alone, it has four Goldman alums. Theyre now running the show at CPPIB. Are four Goldman alums likely to be a Goldman muppet? No. Is the CPPIB paying them a lot to be there? Yes. But paying senior staff a few million bucks a year is far better than losing a billion dollars on a silly option trade. Stop being a muppet!
By the way, I also take issue with the notion that Goldman Sachs and its private sector siblings and cousins throughout New York and London have no fiduciary duty to pensions, endowments, foundations, and sovereigns. These private sector firms exist thanks to the capital flowing out of these institutional investors. We in the academy have taken to calling this phenomenon Pension Fund Capitalism: The decision by public authorities to set up pre-funded institutions to manage future spending commitments is what gave life to the financial sectors. So for these same public authorities to be treated as muppets by the financial sector it was instrumental in creating...is infuriating.
Anyway, I actually tried to NOT write this post...but it just happened. It just flowed out of me. And as Ive been writing Ive found myself muttering the same line from the movie the Social Network. You know the line; the one where Eduardo realizes that Zuckerberg just screwed him out of his share of Facebook? You better lawyer up, a$$#0!%! This is an important visceral sentiment. It says that Im going to fight fire with fire. So whats the equivalent of lawyering up for finance? Because whatever it is, the community of institutional investors needs to do that. This isnt a game with monopoly money; this is real. Get serious and take responsibility for your actions. Stop being a muppet!