May 5, 2010

Investing Is Gambling, by Definition

Justin Katz

The necessary qualifier is that I agree with Mark Patinkin about the immoral behavior of Goldman Sachs. If I had money to invest, I would most definitely invest it elsewhere, and if I already had that money with Goldman, I'd move it. There's a moral obligation to punish companies, in that way, and it's the credulous person, indeed, who can trust Goldman Sachs in particular.

But truth be told, it's a credulous person who trusts Wall Street players more than is absolutely necessary, to begin with. They've been greedy villains in the popular mind at least for decades. Yet, Patinkin writes:

Some have said it's different for Goldman’s individual clients — those who give their personal portfolios to Goldman to manage.

But in truth, there are conflicts even on that level. Goldman doesn't just put such clients into the same mix of stocks and bonds the independent broker down the block might pick. Houses like Goldman are known to push their own in-house funds on investors — including hedge funds. That's a good deal for Goldman, since they charge a few percent in fees on the investor's portfolio value — as well as a staggering 20 percent of profits the investor gets if the hedge fund goes up. You'd think such outsized profits would mean clients, out of fairness, get a break if the hedge fund goes down, or underperforms. Hardly. It's a heads-they-win, tails-you-lose game. If the funds tank, the firms still take percentage fees for their bad work. And worse, clients aren't able to get out of those bad hedge funds for months or more, since the rules lock them in for set periods. So if Goldman's fund managers place stupid bets, as they certainly have in the recent past, investors have to keep riding them downhill.

The heads I win, tails you lose, game was written into the rules from the beginning. The problem, over the past couple of decades, is that we began to persuade ourselves that they were suspended by success. With government backing giving a sense of security to risky mortgages and with the same individual daydream that keeps people funding governments through lottery revenue, we thought we could play the investors' game without real risk, and without the careful bet hedging and self preservation that characterizes the large firms.

If we're to learn from current events, we must not only investigate the factors that kept us from having information that we could have used, but ponder the factors that kept us from acting on information that we already had.

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The most bizarre belief held by Americans today is that there should be a banking system that pays you a steady interest for keeping your money with them and carries zero risk of losing that money. All that system does is institutionalizes the risk so that instead of bad firms failing and good firms succeeding, either everything succeeds or everything fails together (as happened recently, for that and other reasons). I'd rather live in the first system so I at least have a chance to control my own destiny through good decision making, but the egomaniac progressives believe that they can make the right decisions for everyone on the planet if only they are given sufficient power through government to do so.

Posted by: Dan at May 5, 2010 2:14 PM

"The necessary qualifier is that I agree with Mark Patinkin about the immoral behavior of Goldman Sachs."

What immoral behavior? If you've ever invested in stocks, chances are that you've also engaged in the same "immoral" behavior.

Patinkin does a typical columnist trick and fuzzes things over. The people Goldman sold the bad mortgages to were not "clients". They're not clients in the same way that a "client" purchases a car from a car dealership. They were trade partners. In the car sale, it can come out win-win. In the investment trading game, there is always a winner and a loser. After the sale, someone comes out ahead of the other party.

Let me put it to you this way, let's say you own 1,000 shares of IBM, and you pretty strongly believe that IBM stock is going to decrease in price. So you decide to sell off 800 of your shares. You keep a small portion, similar to how Goldman kept a portion of the bad mortgages themselves. We don't see people like Patinkin mentioning that. But to take the comparison another step, not only do you sell 800 shares, but you go out and short the IBM stock by say 1,000 shares. Are you under any legal obligation to tell the person who bought your 800 shares that you are going to short it? If your answer is no, then you're just as immoral as Goldman. That's what Goldman did. They felt those mortgages were garbage, so they sold them off to someone else who thought they'd make money on them. And they weren't selling them to naive companies either, these were people who brag about how good they are in the markets.

So how is Goldman "immoral" again? This sounds exactly what the investment market is all about, no?

And I have yet to see any evidence of Goldman actually doing anything themselves to tank the mortgage market. They were observers that made a ton of money off it. They didn't cause it.

Posted by: Patrick at May 5, 2010 2:49 PM

It now seems like it was right after the Civil War. When I was in college I took a course titled "Stock Market".
The first day the professor announced "The stock market is a casino without the dancing girls".

A bit of a simplification, but "investing" is "betting" by another name. You may have done, or bought, research, there may be known market forces at work, there may been a "head and shoulders" movement; but you are still betting that you are right and other people are wrong.

Posted by: Warrington Faust at May 5, 2010 7:24 PM

As usual, oversimplification for overly simple minds.

Sure, investing always carried risks. Even investing in a T-bill carries the risk of the government defaulting, inflation eating up your gains and/or the value of that bond falling greatly if you have to sell it before it's time.

Investing in equities is as risky or more. However, in an attempt to make the game more palatable, we have these things called "guidelines, rules and regulations" as well as ethics, morals and best business practices.

These state, for instance, that you cannot deal in insider trading - i.e., take the good or bad news you know about from being privy on the inside and trade on it, or have other trade on it.

And, no....every trade is not win-lose.

Faust, you must have been smoking dope when your professor continued and told you about companies which actually DO SOMETHING and produce goods and services which the market needs - and then become worth more. So, for instance, if I bet on Apple Computer at 25 dollars a share and then sold at 200, I made out like a bandit. But the person I sold to may have sold at 275 a week or two ago, and made out well also. Win-Win-Win.

This is VERY different from the predatory practices of GS and many others. The reasons are too long to discuss in detail here, but they involve things like:

1. Lying to or deceiving clients.
2. Betting with the Casinos money (try that at your local poker table).
3. Creating synthetic (note that word) "instruments" which are not backed by anything except shell games built from other synthetic instruments, and using these to bet 100X to 1000x (or more) of what you could bet if you were required to put up your own money!

But, what me worry! They are betting YOUR and MY and the pension funds money...and they lost it all.

"In December 2007, the Bank for International Settlements reported derivative trades tallying in at $681 trillion - ten times the gross domestic product of all the countries in the world combined."

Hmm, talk about betting money you don't have!

And, the amazing thing is that you guys defend this behavior - effectively stealing from everyone to enrich just a very few.

Sad, really. Maybe that is what the Republican Party stands for?

Posted by: Stuart at May 5, 2010 7:49 PM

Posted by: Patrick at May 5, 2010 8:11 PM

Stuart writes:
"Faust, you must have been smoking dope when your professor continued and told you about companies which actually DO SOMETHING and produce goods and services which the market needs - and then become worth more."

Sorry, no dope at my school. But the professor did make some recommendations based on products produced and market trends. One I remember particularly was a recommendation for Blue Bell Corp. "They make bib overalls and when this president is through with us we'll all be wearing them".

Stuart there is some sense in what you say. It is generally referred to as "risk - reward". The very "risk averse" can select T-bonds, or savings accounts. They will provide small, but steady returns. Those with a higher "risk preference" will take higer risks, or "gamble". Your Apple computer buyer "ganmbled" that it was going up, he had no certain foreknowledge. Unless, of course,he was an "insider".

You don't really think "insider trading" has been eliminated? How about banks who shuffle off their "trans Siberian Railroad Bonds" to the Trust Department?

Posted by: Warrington Faust at May 5, 2010 10:43 PM

A lot of these instruments did not exist -until Phil Graham and his wife at Enron made them legal.

People, and Wall Street, will act more responsible if they have to eat their own cooking. That means not burying risk underneath layers of CDO's and CDS's that no one can understand, and then selling them off to others.

I have been through many scary market downturns - the 85 black monday when the market lost 40 percent virtually overnight, the S&L, the dot com bubble, etc.

Those are to be expected.

This was is different due to the loosening up of the regulations which sought to encourage responsible behavior.

That is what we have to fix - and, at the same time, throw those who committed crimes in jail as an example to others.

Isn't it strange that Martha Stewart and Ms. Helmsly got thrown in jail, while the real big wigs just get billions more in bonuses?

The sad reality is that this country has been sold down the pike. A sadder reality is that some are defending that.

Posted by: Stuart at May 6, 2010 11:02 AM


One of the reasons to create derivitives, splits, etc. Is the same as the old days when they sold "stripped" bonds. There is more capital in search of a return than there are conventional investments. New methods of investment had to be sought.

When you here of large sums of money, thinks of this; a stack of 1 million in 100 dollar bills is just over a foot tall, a billion stacked in hundreds is taller than the Empire State Building (1200 feet +/-), a trillion rivals most of the Himalayas.

Posted by: Warrington Faust at May 6, 2010 6:15 PM

Stuart-I napped through economics in college,so I have nothing worthwhile to say here except that I trust investments in companies that MAKE something(or at least produce,like mining companies)or MOVE things,etc than investments in companies wih no discernible product.
Oh Stu-if you want to piss on Phil GRAMM(I can't stand him either)at least spell the guy's name correctly.I mean you want us to think you're the brightest bulb in the room,right?Heh,heh.
BTW-my surgery was supposed to take 1 hour and they ran into hellacious crap they couldn't see from outside-it took 4 hours.Which is why you want a good doctor like I have at the VA when things like this happen,
but the upside is that they were successful even though they had to make 10 incisions instead of 3.It wasn't that bad-I was off pain meds in 16 hours
because I guess I tolerated it pretty well.I was walking around within 4 hours after getting out of the OR but they kept me in house at the VA for a couple of nights.Place was crowded like you wouldn't believe,but the providers were great.I had an old WW2 vet for a roomate-a real gentleman.

Posted by: joe bernstein at May 9, 2010 4:32 PM

Joe! I was starting to worry as we hadn't heard from you. Glad you're home now. Hope you continue to recoup well.

Posted by: Monique at May 9, 2010 6:05 PM

Thanks,Monique-I finally got a diagnosis for an intractable pain condition that had plagued me for 8 years on and off-a first year resident made it after SEVEN other doctors couldn't.(Only two of whom were in the VA system.I got told stuff like"live with it,we can't do anything for you".
the pain would get so bad sometimes I thought I was gonna pass out-then I would start retching or vomiting a clear liquid and it would stop.It came in waves-sometimes 3 or 4 in a row.Tha pain would go to level 8 or 9 at times.One surgeon wanted to take out my gallbladder-it wasn't that at all.It was a hernia and multiple adhesions from a 29 year old splenectomy followed by 4800 rads of cobalt for lymphoma caused by Agent Orange.And it's service connected because of that.I'm just glad it seems to be resolved.
the VA is a government single payer plan that works well,but it has a limited patient base.Also,the general public can't access the system so there are no deadbeats of any significance.Those disabled 50% or more like me have no copays at all.NO ONE has copays for service connected problems.
It's the only hospital I've been in(I'd guess military hospitals are the same)where the patients are generally supportive of each other.We have something in common that trumps race,gender,religion,class,etc,etc.
Many of the providers and other employees are also veterans.It has a homey atmosphere of sorts.
Wow,off topic,but I don't know anything about investments anyway.

Posted by: joe bernstein at May 9, 2010 9:34 PM
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