Goldman Opinion
It took a bit but I think I have made my mind up about the Goldman Sachs fraud allegation. Essentially they were simply doing business and the fault actually lies with the people they were doing business with.
As a company they had a responsibility to reduce their risk exposure. They looked at the market, worked out the risk reward ratio of the CDO’s and determined that they would be better off without them than with them. Fair enough.
The counter parties who bought the CDO’s thought they were getting easy money and that Goldman were the losers who sold a good revenue stream.
The problem was these banks who bought the CDO’s didn’t do the most basic of research. The boom in the real estate market was bought about by the Baby Boomers and their offspring being in the market at the same time. When the after boomers had bought their first home the pressure came off and you ended up in a situation where the assumption that real estate would go up forever was no longer true and the sub prime mortgages were no longer covered by a gain in the value of the underlying asset that would have occurred should that demand have persisted.
In other words the buyers of the CDO’s needed to do some basic research about who was in the real estate market, what they were doing and how long would the market last. It would have been fairly simple to bring up a population by age curve and ask a couple of questions about what people in such and such and age group are likely to be doing. In other words marketing 101.
The really scary thing given the millions of dollars these Bank CEO’s learn is that they knew about the demographic distribution. They were in fact targeting the Baby Boomers with reverse mortgages. All the “Unlock The Equity In Your Home” products that abounded. At the same time they were targeting the surge of “First Homer Buyers”. They weren’t making a lot of effort to targeting the mid mortgage people.
The way it works is that any organization has a finite marketing and product development budget. Companies target products and marketing campaigns towards where they can get the most bang for the buck. They targeted these two markets – the “soon to be retired” and the “just married looking for a home to start a family” groups because that is where the population was.
So if we make the assumption that the CEO’s knew that the demographics of the market was not flat across all age groups, then we have a situation where they knew that demand was driven by a surge that would die away once all the first home buyers had filled their immediate demand.
Why then did these multimillion dollar CEO’s make the assumption that demand would grow at a constant rate for ever? Can’t they read a basic graph? Couldn’t they look at their own children to see what they were doing? I definitely remember all the “Home improvement shows” and talk about the difficulty of searching for a home that in time was followed by lots of pregnant bellies around the office, that in turn was followed by lots of prams and doe eyed mothers proudly coming back to work to display their latest creation.
These new mothers were not buying new houses – they had just bought one and were now out of the market. Even if they did have a desire to move to a larger property it requires selling the one they are in. No net gain in demand.
The question is why were Goldman able to work out that the risk in the mortgages was too high and why were the other bankers unable to? Did Goldman simply do better research?
The question of why anybody other than what you would normally call “sophisticated investors” were buying these things is another thing altogether.
May 03 2010 | Market Comment | No Comments »
