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The Man Who Quit Goldman Sachs and Wrote a Tell-All Book Gets Trashed by Corporate Media

Wall Street hates Greg Smith for telling the world of rampant abuse in one of its most prestigious firms.

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Smith was in an area where the opportunity for ripping off clients was circumscribed, so he wasn’t likely to have real dirt. If you listened to the 60 Minutes video, what Smith says, in essence, is that the best profit opportunity lies in selling a really complex product to a naive client. After seeing Jefferson County, German Landesbanken, and Australian town councils as world famous stuffees, this should comes no surprise. Smith does provide further confirmation in hinting hard that client who are so trusting that they “don’t know how to ask questions” are well represented in Goldman’s top 25 clients (by profits) list.

Ishikawa who was in the middle of precisely that type of rape and pillage activity (for instance, he was on the team that marketed the Abacus CDO that was subject to a $550 million SEC settlement). By contrast, Smith was selling fairly simple derivatives to pretty savvy clients. From Craig Heimark, who has been in the OTC derivatives business from its early days:

The profile and expertise of buyers of equity derivatives (and equity products generally) are quite different from the profile of fixed income. Obviously, the fixed income buyers are more conservative and looking for a safer, more guaranteed investment product. Because of this, their independent skills to evaluate the investment product sold to them are far lower than buyers of equity. In more formal terms, not only is their utility curve different than equity buyers, their expertise to understand complex products is much lower. Recognizing the skill set differential is important – because one of the standard mantras – to which I subscribe, namely transparency – addresses information asymmetry, but not expertise asymmetry.

The fundamental assumption that institutions are sophisticated enough to fend for themselves simply does not work in this age of infinite complexity. So your guess that Greg Smith might have a restricted view of abuses is consistent with my observations, and originates with three factors. One – the equity side has fewer abuses because of the nature of the buying segment. Two – Greg may be using a wholesale definition of what is the responsibility of the seller – i.e does it comply with all rules to be a proper product, versus a consumer view ie is is safe for this customer to consume. Three – many of the customers don’t know they are getting fleeced because of the opaque market structure of OTC derivatives and complex structure products (this is more an excess margin to the financial supplier than and product design issue, but it is a market failure nonetheless, because perfect competition assumes perfect information – and we are VERY far from this in OTC and Structured products)

Wholesale market regulation needs to be completely overhauled as a result of several factors, but the most important is technology. Complex product design is fundamentally related to IT systems capacity. Far too much of the blogosphere focuses on greed. People are just a greedy now as ever, but financial products have gone from something that a person of reasonable intelligence and a college education could understand to something that requires at least a specialist degree in financial design from Wharton or perhaps an advanced physics degree. So financial products have become very sophisticated embodiments of Intellectual Property. In the pharmaceutical industry we have elaborate FDA safeguards to ensure the products produced are fit for consumption. The financial market has yet to adjust is regulatory principles to the current set of technologically sophisticated products.

Smith doesn’t get, and therefore couldn’t articulate, the implications of Goldman’s cultishness. Just the way fish don’t recognize that they are swimming in water, Smith likely does not appreciate how insular and inward looking Goldman is. The aggressiveness of Goldman’s response isn’t just to protect its external reputation; it’s also because, on some level, people at Goldman really believe their PR. Look at how remarkably thin-skinned Wall Street employees have been in the wake of the crisis, how utterly unwilling the overwhelming majority are to take any responsibility for blowing up the global economy. Goldman, with its exaggerated sense of righteousness, is even less willing to hear even a very watered down version of reality.