NYTimes Op-Ed: Why I Am Leaving Goldman Sachs

"Sophisticated" investors are also themselves often agents--running pension funds, mutual funds, etc.--who don't necessarily have interests perfectly aligned with actual investors.

 

Now THAT is revisionism.

Even last year, there was thought in some corners to be a massive international crisis because of what S&P said about U.S. debt. Now, that turned out to be overblown (as you correctly predicted), but it shows that those agencies hold enormous sway.

There are hundreds and hundreds and thousands and thousands of examples of reliance on ratings agencies. Pension funds, low-risk retirement accounts, you name it, the main requirement on those was that they invested in top-rated securities. That was it. That was the absolute #1 measuring stick. Now, you and a small handful of people in this economy might say now that you've always known the truth about the ratings agency staffing, but the general public did not know that, and the laws and regulations themselves invested an enormous amount of faith in those agencies.

 

No it doesn't. You don't outsource your due diligence.

 

Based on forecasts, Jim Cramer and S & P both rate XYZ a hot triple-A lock. Bob the CEO was choppin' it up with the CNBC Money Honey just last night! Grab it and flip it!

 

That's true. There was one investor in Madoff's funds who held himself out as a "hedge fund manager" with excellent returns.

The guys strategy? hand over all the money he raised to Bernie. (And, the fact that Bernie's funds were "closed" to new investors made this guys "strategy" desirable.)

The guy wasn't a hedge fund manager. He was a sales guy.

So, he failed in his due diligence, but so did the investors in his "fund".

 

And so did the SEC, which had warning of what Madoff was doing eight years before it blew up. If that agency hadn't been turned into a eunuch by the industry it was supposed to govern, Madoff would have been in jail years earlier and investor losses would have been a tenth of what they ended up being.

 

A major problem with rating agencies is not that investors invested in these instruments because they were rated highly, but rather that the ratings allowed for financial institutions to use these to game things like capital requirements. Holding highly rated securities, for instance, requires less capital than lower-rated ones. One thus has an incentive to hold the riskiest assets in any given asset-class--especially if you earn a bonus based on "earnings"--to increase return.

From the FCIC report:

 

But they're also not "sophisticated" investors. That doesn't excuse they're lack of due diligence, but it is an important distinction, I think, because banks often trot out the sophisticated investor argument.

 

"Sophisticated investor" refers to people with a specific income or net worth. You can be dumb as a brick but if you hit the magic number you qualify.

 

Likewise, fund managers may not be able to invest in certain securities if they don't have a certain rating. Even if they should done due diligence, rating agencies still could have been one of the many causes of the crisis, because but-for those ratings, the funds could not have made those investments.

 

Then why in the hell did Goldman and everyone else package up those securities and get the highest ratings on them? Because the rating didn't matter?