In 2006 the investment bank Goldman Sachs was approached by amajor hedge fund that was
pessimistic about the outlook for house prices. Goldman helped thefund to construct a complicated
deal that would pay off if a $2 billion package of low-graderesidential mortgages declined in value.
Goldman then approached some banks that it knew were optimisticabout the prospect for house
prices and who might therefore be prepared to take the other sideof the bargain.
In the event, house prices slumped, many of the house ownersdefaulted on their mortgages, and
the hedge fund made a profit of around $1 billion. The banks on theother side of the transaction
lost heavily. Goldmanâs role in the transaction subsequently camein for heavy criticism. One
criticism centered on the fact that Goldman shared the hedge fundâsconcerns about the housing
market and in 2007 had circulated internal warning memos to itstraders. Some therefore
questioned whether it was ethical for Goldman to take a pessimisticview on housing in its own
trading positions and at the same time continue to sell what itregarded as overvalued securities to
its customers. There were also questions about what Goldman waslegally and ethically obliged to
reveal. Although one of the banks was heavily involved in choosingthe package of mortgages and
rejected many of the suggested contents of the package, none ofthem was aware that the
mortgages had originally been proposed by the hedge fund managerand therefore could be
particularly toxic.
A senate subcommittee that investigated the deal lambastedGoldman for âunbridled greedâ and
suggested that the firm had operated with âless oversight than apit boss in Las Vegas.â When the
SEC announced that it was charging Goldman with fraud and materialomissions and
misrepresentations, the market value of the bankâs stock declinedby about $10 billion, far more
than any penalty that Goldman might be expected to pay. Investors,it seemed, believed that the
damage to Goldmanâs reputation was much more important than anyfine. Three months later the
bank admitted that the marketing material linked to the package ofsubprime mortgages was
âincompleteâ and agreed to pay a $550 million fine.
The event raised several difficult ethical questions. When aninvestment bank is employed to give
advice on a new issue or a merger, it is essential that the clientcan trust the bank to give an honest
and impartial view. But the situation becomes less clear-cut whenthe bank is acting as a middleman
or trading securities. Much of the debate on the Goldman dealtherefore centered on whether the
bank was simply an intermediary between sophisticated traders orwhether it had deeper responsibilities. *
Ethical behavior of managers is the key for the shareholders.Please read the article: âGoldman Sachs Causes a Ruckusâ thatdescribes the controversial involvement of Goldman Sachs in amortgage-backed securities deal in 2006. When this involvement wasrevealed, the market value of Goldman Sachsâ common stock fellovernight by $10 billion. This was far more than any fine thatmight have been imposed. Explain. Can you comment on other examplesfrom the real life about the unethical behavior of managers and theits consequences?
In 2006 the investment bank Goldman Sachs was approached by amajor hedge fund that was
pessimistic about the outlook for house prices. Goldman helped thefund to construct a complicated
deal that would pay off if a $2 billion package of low-graderesidential mortgages declined in value.
Goldman then approached some banks that it knew were optimisticabout the prospect for house
prices and who might therefore be prepared to take the other sideof the bargain.
In the event, house prices slumped, many of the house ownersdefaulted on their mortgages, and
the hedge fund made a profit of around $1 billion. The banks on theother side of the transaction
lost heavily. Goldmanâs role in the transaction subsequently camein for heavy criticism. One
criticism centered on the fact that Goldman shared the hedge fundâsconcerns about the housing
market and in 2007 had circulated internal warning memos to itstraders. Some therefore
questioned whether it was ethical for Goldman to take a pessimisticview on housing in its own
trading positions and at the same time continue to sell what itregarded as overvalued securities to
its customers. There were also questions about what Goldman waslegally and ethically obliged to
reveal. Although one of the banks was heavily involved in choosingthe package of mortgages and
rejected many of the suggested contents of the package, none ofthem was aware that the
mortgages had originally been proposed by the hedge fund managerand therefore could be
particularly toxic.
A senate subcommittee that investigated the deal lambastedGoldman for âunbridled greedâ and
suggested that the firm had operated with âless oversight than apit boss in Las Vegas.â When the
SEC announced that it was charging Goldman with fraud and materialomissions and
misrepresentations, the market value of the bankâs stock declinedby about $10 billion, far more
than any penalty that Goldman might be expected to pay. Investors,it seemed, believed that the
damage to Goldmanâs reputation was much more important than anyfine. Three months later the
bank admitted that the marketing material linked to the package ofsubprime mortgages was
âincompleteâ and agreed to pay a $550 million fine.
The event raised several difficult ethical questions. When aninvestment bank is employed to give
advice on a new issue or a merger, it is essential that the clientcan trust the bank to give an honest
and impartial view. But the situation becomes less clear-cut whenthe bank is acting as a middleman
or trading securities. Much of the debate on the Goldman dealtherefore centered on whether the
bank was simply an intermediary between sophisticated traders orwhether it had deeper responsibilities. *
Ethical behavior of managers is the key for the shareholders.Please read the article: âGoldman Sachs Causes a Ruckusâ thatdescribes the controversial involvement of Goldman Sachs in amortgage-backed securities deal in 2006. When this involvement wasrevealed, the market value of Goldman Sachsâ common stock fellovernight by $10 billion. This was far more than any fine thatmight have been imposed. Explain. Can you comment on other examplesfrom the real life about the unethical behavior of managers and theits consequences?
