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Roger Martin
Dean/Scholar

Roger Martin

Roger Martin is Dean of the Rotman School of Management at the University of Toronto and author, most recently, of The Design of Business. His website is www.rogerlmartin.com

The business of fleecing others

Q: Goldman Sachs promises to put customers' interests first. At the same time, Goldman was able to avoid serious financial trouble by hedging positions in ways that placed bets against clients. Do Goldman's leaders need a new business strategy, or do they need to just do a better job at explaining their business to regulators and the public?

Sadly for Goldman, the latter is not an attractive option. The better job Goldman Sachs does in explaining exactly what its business is, the more outraged regulators and the public will be. The only reason that Goldman has avoided negative publicity for so long is that the public has had no idea how far its business model has changed from one that the public could reasonably understand. Even the regulators are largely flummoxed.

Goldman Sachs, not that long ago, was a firm that raised capital for companies who wished to grow and advised companies that wanted to buy another company or sell themselves to another company. These are now minor sidelines for Goldman. The overwhelmingly large portion of its revenues and profits come from trading. And to be clear, this is not brokerage whereby a firm executes trades on behalf of someone else. This is trading on its own account for its own benefit.

Goldman should no longer be thought of as a professional service firm, providing professional services to a clientele. It is now (principally) a trader that lives to find people who are dumber than it is and take advantage of its intelligence advantage to enrich itself and impoverish its trading partners. So it is hard to argue that it serves a particularly useful purpose for society. It exists to serve its own interests which can only be served by causing a disservice to its trading partners. If the public really understood that business model, Goldman would have a much bigger problem than it has now.

That is because the public would start to ask: "If markets are supposedly perfect, and everyone has access to the same information, how can one firm consistently, without fail, win huge in its trading operations?" (And remember, its trading business is hugely profitable even after paying out stunningly high bonuses to the traders.) "Is anybody that smart that they can, day after day, week after week, month after month, year after year, find more suckers with whom it can trade and, in the process, fleece? How is that possible?" Then the public would quickly go to the current Goldman-Paulson scandal and say: "Oh, I get it. That is how. You rig the trade before making it. Yup, that works."

Goldman would be foolish to increase the transparency of what it does. What then should it do? That is a toughie. The business of fleecing naive trading partners is so incredibly profitable that it would be difficult to change the business model to one that is at least marginally good for society. My guess is that Goldman will point to how it makes the world a better place by exporting its leaders to the political realm, giving more to charity, firing all of its 'rogue traders' and keeping on doing what it is doing, but more discreetly.

By Roger Martin

 |  April 26, 2010; 2:23 PM ET
Category:  Economic crisis Save & Share:  Send E-mail   Facebook   Twitter   Digg   Yahoo Buzz   Del.icio.us   StumbleUpon   Technorati  
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First Levin establishes Goldman sold a product they thought was in their own words "sh*tty". Then he asks whether it is ethical, the reply "currently it is not an obligation." Levin "Thats why we need regulation." Time to pay the rating agencies from a fee on rated transactions from the exchanges themselves. The system should not allow gaming by Goldman nor anyone else.

Posted by: jameschirico | April 28, 2010 12:05 AM
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Professor Martin may have hit the nail on the head but many realised this when derivatives were being sold to people who did not understand what they were buying or the risks that attached to those purchases.

Goldman Sachs (and its fellow investment banks) looked for investors people who did not understand what derivatives were, how they worked and why the market was speculative. Thus, they required the assistance of others to manage their assets (derivatives).

GS had an attitude that was contemptuous of its clients. GS got their money and these poor suckers got the risk.

Posted by: robertjames1 | April 27, 2010 11:48 PM
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We do not allow pro athletes to bet on their games, why are professional trading firms allowed to bet on the markets they make?

Posted by: Dpete1 | April 27, 2010 11:07 PM
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Those packaged mortgage debt had NO business being rated that highly. If the ratings companies had done their jobs and rated the debt as the junk that they were, nobody would have bought them regardless of what Goldman Sachs said or didn't say about them.

Posted by: bendan2000 | April 27, 2010 10:52 PM
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This article has the right idea, it's a shame that the venom and inaccuracy undermine the argument.

- Goldman Sachs is, by their own description, "one of the leading Designated Market Makers for stocks". As such, they not only take a piece a a large share of stock trades. They also have information about a large share of trades, and exploit that information in their trading. As you pointed out in an earlier article, the closer to illegal the information is, the more profitable the information is.

- Therefore, Goldman isn't just rigging trades with "naive traders" - they are exploiting a large chunk of the nations investors, of all types.

Posted by: pilgrim1629 | April 27, 2010 8:00 PM
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Goldman Sachs is a member of the American Gaming Association, the lobbying group for gambling interests. Looks like Goldman Sachs began identifying itself more with the illusionary spin of the gambling interests rather than that of a financial institution which valued its own honesty and transparency. Guess if you sleep with dogs, you really do get fleas!

Posted by: DMBerlin | April 27, 2010 7:52 PM
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Why does Goldman, broker/dealers, supposed market makers, and investment banks have access to essentially free money from the Fed, the Treasury and the taxpayers so they can all either trade against their own customers, or acquire business' with their tremendous access to capital.

The solution is simple - stop the free money parade - the only institutions that should have access to Fed money are banks and credit unions - depositories - that have no direct or indirect ownership in the other types of financial organizations.

But the, the Politicals would not have access to unlimited money for their campaigns.

Looks like we are the stuckees.

Posted by: bestmoneyguy | April 27, 2010 7:29 PM
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Goldman has made very clear their opinion of "ordinary people", which includes the 8 million or so that were financially decimated by Wall Street and the hedge trader's actions during the past two years. They couldn't care less.

Financial Times, USA, Friday, Oct 16,2009

“Goldman’s surging profits appear to vindicate its managements decision not to change strategy despite being forced to ditch its investment banking status and convert to a bank holding company to access government aid last year.

Unlike arch rival Morgan Stanley, which bought most of Citi’s retail brokerage unit, Goldman steered clear of consumer banking, arguing that its expertise lied in serving investors and companies rather than dealing with ordinary people.”

Taxpayers, voters, and other ordinary people should take notice. Who's holding up the senate financial reform bill. To protect "investors and companies rather than dealing with ordinary people" which 150 companies are hiring lobbyists to kill the financial reform bill? It must be good or there wouldn't be such a violent reaction to the prospect of it passing.

Posted by: dtgo | April 27, 2010 6:25 PM
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So what is Soros if not a capitalist in socialist clothing? He makes billions on the principles as Goldman - but he plays nice-nice with Marxist hippocrites who would just as soon kill you (albeit to be green) as to look as you.

Posted by: alecsandertheg8 | April 27, 2010 4:58 PM
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I don't get why they feel they have to lie and pretend they've forgotten stuff. Why not just say they've done nothing illegal, they made a killing on short selling the bad subprime market, and they're proud of it. They're acting like weasels.

Posted by: newsjunkie60 | April 27, 2010 4:12 PM
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To all of you who see Goldman's actions as pure capitalism at work, please remember that a large portion of their recent profits came out of your pockets. And your children's and grandchildren's pockets. And that Goldman counted on you and I to step in and bail out the very counterparties that they deliberately forced to the edge of extinction. In particular, Goldman started the stampede which drove AIG out of business by deliberately undervaluing their bond portfolios. This is not capitalism -- it is thievery.

More importantly, please don't forget that, while ACA may have been a sophisticated investor, IKB was not. They specifically asked Goldman to act as an investment advisor, and Goldman dumped Abacus on them as well. You can argue that ACA should have known better, but Goldman betrayed its fiduciary duty to IKB.

Posted by: jerkhoff | April 27, 2010 4:00 PM
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Watch any of the Senate Hearings on GS today?

The arrogant, superior, snotty brats, their
stalling, their "stuff" the answers that
evade...

and we have to hear how that poor little WS firm is being unjustly accused?

EVERY SINGLE CLICHE OF WALL STREET AND IT'S DENIZENS JUMPS OUT.

Posted by: whistling | April 27, 2010 3:57 PM
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It would have been stupid Not to profit of stupid partners, since it was legal.

After all these are too big Not to bail out.

Leave WS alone!

Posted by: mahassan_us | April 27, 2010 3:45 PM
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This is standard practice and has been for the better part of the past 10-15 years. All we have he is a bunch of DEMS trying really hard to distance them selves from the mess. They we're all a part of the problem. What we need is criminal trials indicting Congressman for their role. Letting them investigate this is the same as asking the fox to guard the hen house. Anyone that doesn't see this is just a dumb@zz.

Posted by: askgees | April 27, 2010 1:14 PM
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You have defined Capitalism, to capitalize on the weaknesses of others.

Posted by: deadkoz | April 27, 2010 1:10 PM
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Well said. Goldman Sachs is institutionalized fraud. It is a nothing but a parasite on the national and global economy. GS and every company like it should be destroyed, root and branch, and their "leaders" locked up for life.

Posted by: bigbrother1 | April 27, 2010 12:33 PM
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If any individual did what Goldman does, he or she would be up on fraud charges. When a company can do that year after year, and is then hailed as a leader and a winner, it understandably leaves the public feeling like victims.

Posted by: gce1356 | April 27, 2010 12:24 PM
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"First off, Goldman (like other such firms) is not merely a single business. It is a collection of multiple businesses, and yes, they do not always behave consistently with each other."

A good reason to take an anti-trust axe to the company, and divide it into the smaller compaines that it really is. Only when it is too large to behave consistently and protect their clients, should it be cut into smaller portions.

Posted by: LeeH1 | April 27, 2010 12:21 PM
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An amazing critique from someone who should know better.

First off, Goldman (like other such firms) is not merely a single business. It is a collection of multiple businesses, and yes, they do not always behave consistently with each other.

Second, Goldman's trading operations as a market maker *should* make a profit, and very consistently. It's essentially just like being a grocery store - you buy inventory at a low price, mark it up a little for retail, and pocket the difference. This is not the same thing as taking an investment position.

Goldman's investment arm (not the same as the trading arm) makes and loses money with a lot more variation.

Third, Goldman wasn't fleecing anyone. They basically facilitated a trade where one side picked some mortgages that a lot of people thought would fail. Then they found someone else who thought they wouldn't. All parties involved were big banks in their own right and themselves part of "Wall Street". One side bet the right way, the other didn't. Goldman's underwriters made money by brokering the deal. Goldman's compliance folks even told the investment arm they should hold a more neutral position.

This is much ado about nothing, told by people who know no more about this than they do about brain surgery.

Posted by: JeffRandom | April 27, 2010 11:53 AM
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I prefer this article:

http://www.nytimes.com/2010/04/27/opinion/27mclean.html?ref=global-home

Posted by: rachelle1 | April 27, 2010 9:56 AM
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Sorry, don't agree. The person dumber than Goldman Sachs is an equally sophisticated banking institution. The attempt to make Goldman scapegoat for the bubble just won't fly.

Posted by: Nemo24601 | April 27, 2010 8:57 AM
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Goldman Sachs is not a legitimate company. It should be out of business -- the sooner the better.

Posted by: mnjam | April 27, 2010 8:43 AM
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