Goldman success doesn't smell right

By DAVID MOON, Moon Capital Management, LLC
May 16, 2010

If you needed any proof that the market is rigged to favor firms that both serve clients and invest the firms own funds – but not necessarily in the same way – look at the first quarter trading results of Goldman Sachs.

The firm’s traders made money every single day in the first quarter. They may have lost money on certain individual trades, but taken as a whole, everyday produced a net profit. That is akin to pitching 5 or 6 consecutive perfect games in baseball.

Although Goldman trades worldwide, there were 61 trading days in the US during the first quarter. The Dow Jones Industrial Average increased on 39 of those days. Goldman traders have the freedom to take short stock positions, which they might have done on the 22 days the US market declined. Or they might have been invested in Malaysian bonds. Or pork belly futures. Or Peyton Manning trading cards.

I wonder how many Goldman clients made money every day last quarter?

As I wrote two weeks ago, therein lies much of the problem on Wall Street. Firms are often on both sides of transactions. Brokers in one division of a Wall Street firm might be advising their clients to do one thing while dealers or traders in another division are doing the exact opposite.

And although there are theoretical safeguards to discourage internal sharing of information, traders often know what the firm’s clients are buying and selling, giving them a distinct short-term investment advantage over anyone without that knowledge.

Some people argue that the market is efficient – that all knowable information is factored into stock prices. The efficient market hypothesis makes for excellent academic discussion. It lends itself to wonderful charts and formulas. Advisors can use it to impress otherwise unknowing clients about co-variance, standard deviation and capital market lines.

But it doesn’t explain the real world. The traders at Goldman Sachs would laugh at the notion of an efficient market – laugh all the way to the bank.

Goldman Sachs has a reputation as being somewhat of a teacher’s pet with respect to federal executive branch officials. Stephen Freidman, the Chairman of the New York Fed in 2008 (the depths of the financial crisis) was a former Goldman director. He was buying Goldman stock about the same time Goldman converted to a bank holding company – placing it under the regulatory authority of the Fed.

Not long afterward, he resigned under pressure.

Goldman then received billions in government aid, both directly and, less known, indirectly as a counterparty to derivatives contracts with AIG. Much of the bailout money paid to AIG actually flowed through the company and was ultimately paid to third parties, such as Goldman.

It just doesn’t smell right.

It’s hard to know if somewhere far removed from your specific advisor there is a division of his employer that is betting that your investments fail. But you can test whether your specific advisor is committed to the success of your investments.

When he recommends that you buy something, ask how much of it he owns.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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