# So Goldman Sachs is getting done for fraud, explanation please? **URL:** \ **Category:** Factual Questions\ **Created:** [April 16, 2010, 4:23pm UTC](https://boards.straightdope.com/t/so-goldman-sachs-is-getting-done-for-fraud-explanation-please/536360 "2010-04-16T16:23:42Z")\ **Posts on this page:** 20\ **Page:** 1
**Author:** ![Sitnam](https://avatars.discourse-cdn.com/v4/letter/s/6a8cbe/32.png) [@Sitnam](https://boards.straightdope.com/u/Sitnam)\ **Post date:** [April 16, 2010, 4:23pm UTC](https://boards.straightdope.com/t/so-goldman-sachs-is-getting-done-for-fraud-explanation-please/536360/1 "2010-04-16T16:23:42Z")
I get that Goldman Sachs hired the hedge fund manager John Paulson to pick shit investments that were sure to fail, I get that Goldman Sachs then bundled those together and sold them to investors citing an independent 3rd party organizer. I get that Goldman Sachs then secretly made bets against those very packages (Abacus 2007-AC1 and the like) assured that they would fail. I just don’t get how you bet on something to fail and make money. For Wiki: > [@](#): > > In finance, short selling (also known as shorting or going short) is the practice of selling assets, usually securities, that have been borrowed from a third party (usually a broker) with the intention of buying identical assets back at a later date to return to the lender. The short seller hopes to profit from a decline in the price of the assets between the sale and the repurchase, as the seller will pay less to buy the assets than the seller received on selling them. I just don’t get it. ---
**Author:** ![Rysto](https://avatars.discourse-cdn.com/v4/letter/r/ecccb3/32.png) [@Rysto](https://boards.straightdope.com/u/Rysto)\ **Post date:** [April 16, 2010, 4:30pm UTC](https://boards.straightdope.com/t/so-goldman-sachs-is-getting-done-for-fraud-explanation-please/536360/2 "2010-04-16T16:30:48Z")
The essence of short selling is quite simple. Suppose that currently, widgets are selling for $15. I think that they’re overpriced and the price is due to fall. So I find somebody who thinks that they’re a good deal(say it’s you) and make a contract with you. The contract says that I will sell you a widget on April 30 for the price of $14. The key is, I don’t actually own any widgets right now. On April 30, I’m going to buy a widget and sell it to you. If the price of widgets falls to $10 by April 30, I make a $4 profit. If the price of widgets rises(or even stays constant) I lose money, and you got a good deal on a widget. ---
**Author:** ![friedo](https://avatars.discourse-cdn.com/v4/letter/f/8edcca/32.png) [@friedo](https://boards.straightdope.com/u/friedo)\ **Post date:** [April 16, 2010, 4:52pm UTC](https://boards.straightdope.com/t/so-goldman-sachs-is-getting-done-for-fraud-explanation-please/536360/3 "2010-04-16T16:52:47Z")
Short-selling step-by-step: 1. Let’s say FriedoCorp stock is currently trading at $10 per share and you think the price is going to go down. 2. You borrow a thousand shares of FriedoCorp from your broker and promise to give them back (plus a little interest) later. 3. You immediately sell those shares on the open market. At $10 per share, you now have $10,000 cash. 4. You set fire to FriedoCorp’s main widget factory in Omaha. FriedoCorp stock plunges to $4 per share. 5. You spend $4,000 to buy back a thousand shares of FriedoCorp from the open market, and give these back to your broker. 6. You have $6,000 left over which is profit. That’s the simplest form of betting against a security – a short sale. There are other forms, such as put option contracts, which are derivatives that gain value when the underlying security loses value, and even more complex arrangements, all of which are sometimes referred to as shorting strategies even when they might not actually involve short sales. ---
**Author:** ![Curious\_Mike](https://avatars.discourse-cdn.com/v4/letter/c/f04885/32.png) [@Curious\_Mike](https://boards.straightdope.com/u/Curious_Mike)\ **Post date:** [April 16, 2010, 4:53pm UTC](https://boards.straightdope.com/t/so-goldman-sachs-is-getting-done-for-fraud-explanation-please/536360/4 "2010-04-16T16:53:40Z")
Rysto, yes you did capture the ‘essence’ of the short sale with your description but I believe that there is a subtle difference. Your description sounds more like an option contract with a strike price and expiration date which is a completely different animal. Following your example… you would **borrow** some widgets from a third party and sell them immediately on the open market for $15 each. At some point in the future you would choose to buy widgets on the open market to repay that third party. If you were correct and the price of widgets is lower you can keep the difference less any fees assessed by the lender of the original widgets. Conversely if the price of widgets goes up you would lose money on your short position. ---
**Author:** ![Rumor\_Watkins](https://avatars.discourse-cdn.com/v4/letter/r/d9b06d/32.png) [@Rumor\_Watkins](https://boards.straightdope.com/u/Rumor_Watkins)\ **Post date:** [April 16, 2010, 4:54pm UTC](https://boards.straightdope.com/t/so-goldman-sachs-is-getting-done-for-fraud-explanation-please/536360/5 "2010-04-16T16:54:06Z")
> [@Rysto](#): > > The essence of short selling is quite simple. Suppose that currently, widgets are selling for $15. I think that they’re overpriced and the price is due to fall. So I find somebody who thinks that they’re a good deal(say it’s you) and make a contract with you. The contract says that I will sell you a widget on April 30 for the price of $14. The key is, I don’t actually own any widgets right now. On April 30, I’m going to buy a widget and sell it to you. If the price of widgets falls to $10 by April 30, I make a $4 profit. If the price of widgets rises(or even stays constant) I lose money, and you got a good deal on a widget. No, that’s an option. A short sale of securities requires you to actually physically locate what you’re trying to short as there is no counter-party (unlike an option contract). ---
**Author:** ![friedo](https://avatars.discourse-cdn.com/v4/letter/f/8edcca/32.png) [@friedo](https://boards.straightdope.com/u/friedo)\ **Post date:** [April 16, 2010, 4:55pm UTC](https://boards.straightdope.com/t/so-goldman-sachs-is-getting-done-for-fraud-explanation-please/536360/6 "2010-04-16T16:55:17Z")
> [@Rysto](#): > > The essence of short selling is quite simple. Suppose that currently, widgets are selling for $15. I think that they’re overpriced and the price is due to fall. So I find somebody who thinks that they’re a good deal(say it’s you) and make a contract with you. The contract says that I will sell you a widget on April 30 for the price of $14. The key is, I don’t actually own any widgets right now. On April 30, I’m going to buy a widget and sell it to you. If the price of widgets falls to $10 by April 30, I make a $4 profit. If the price of widgets rises(or even stays constant) I lose money, and you got a good deal on a widget. That’s really a derivative, not a straight short-sale. What you describe could be a put option with a strike price of $14. ---
**Author:** ![IAmNotSpartacus](https://avatars.discourse-cdn.com/v4/letter/i/cc9497/32.png) [@IAmNotSpartacus](https://boards.straightdope.com/u/IAmNotSpartacus)\ **Post date:** [April 16, 2010, 4:55pm UTC](https://boards.straightdope.com/t/so-goldman-sachs-is-getting-done-for-fraud-explanation-please/536360/7 "2010-04-16T16:55:51Z")
> [@Rumor\_Watkins](#): > > A short sale of securities requires you to actually physically locate what you’re trying to short as there is no counter-party (unlike an option contract). Unless you’re a big bank, in which case you didn’t actually need to locate any securities available for borrowing, known as naked short selling. ---
**Author:** ![hogarth](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/hogarth/32/1773_2.png) [@hogarth](https://boards.straightdope.com/u/hogarth)\ **Post date:** [April 16, 2010, 5:14pm UTC](https://boards.straightdope.com/t/so-goldman-sachs-is-getting-done-for-fraud-explanation-please/536360/8 "2010-04-16T17:14:54Z")
> [@IAmNotSpartacus](#): > > Unless you’re a big bank, in which case you didn’t actually need to locate any securities available for borrowing, known as naked short selling. Likewise, it’s easy for Goldman to write a derivative that’s based on a security even if they don’t own the security. For instance, they could enter into a contract where Goldman receives a fixed cash payment, and in exchange they pay out the return on a (junky) MBS or CDO tranche; then when the MBS or tranche becomes worthless, they profit (no more payments to make). ---
**Author:** ![BrotherCadfael](https://avatars.discourse-cdn.com/v4/letter/b/977dab/32.png) [@BrotherCadfael](https://boards.straightdope.com/u/BrotherCadfael)\ **Post date:** [April 16, 2010, 5:23pm UTC](https://boards.straightdope.com/t/so-goldman-sachs-is-getting-done-for-fraud-explanation-please/536360/9 "2010-04-16T17:23:09Z")
> [@Sitnam](#): > > I just don’t get how you bet on something to fail and make money. It’s just like insurance. It IS insurance. When I buy a life insurance policy, I’m betting the insurance company that I am going to die tomorrow. They are betting I won’t. If I win, they pay me (actually my heirs) money. If they win, I pay them money, in the form of premiums. GS was insuring their loans. Whether or not they did so legally or wisely is beyond my competence, but there is nothing per se odd about their doing so. ---
**Author:** ![CaveMike](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/cavemike/32/16379_2.png) [@CaveMike](https://boards.straightdope.com/u/CaveMike)\ **Post date:** [April 16, 2010, 6:04pm UTC](https://boards.straightdope.com/t/so-goldman-sachs-is-getting-done-for-fraud-explanation-please/536360/10 "2010-04-16T18:04:44Z")
> [@BrotherCadfael](#): > > It’s just like insurance. > … > GS was insuring their loans. Whether or not they did so legally or wisely is beyond my competence, but there is nothing per se odd about their doing so. But is that what it really was? From this [news story](http://news.yahoo.com/s/ap/20100416/ap_on_bi_ge/us_sec_goldman_sachs_charged;_ylt=Am2eMRnFFqR8D75QzGx4L1ms0NUE;_ylu=X3oDMTFocDdrc2ExBHBvcwMyNQRzZWMDYWNjb3JkaW9uX3RvcF9zdG9yaWVzBHNsawNzZWNhY2N1c2VzZ28-): > [@](#): > > Goldman failed to disclose that one of its clients helped create — and then bet against — subprime mortgage securities that Goldman sold to other investors. Your life insurance analogy is not an exact match because the product ‘life insurance on myself’ is fixed. It would be a better analogy if GS sold life insurance on people in your town. The question would be did GS cho0se particularly healthy or unhealthy people? And did they misrepresent to their customers the health of the people for whom they were offering life insurance? And if an unusual percentage of people that they offered insurance for suddenly died, it would warrant a closer look to see if GS acted illegally. It is reasonable for a company to insure itself against extreme failure. But if a company positions itself to make a significant profit if the products that it sold fail, then it is reasonable to take a closer look. It suggests the possibility that they knowingly sold a bad product in order for their ‘insurance plan’ to succeed. ---
**Author:** ![ultrafilter](https://avatars.discourse-cdn.com/v4/letter/u/3d9bf3/32.png) [@ultrafilter](https://boards.straightdope.com/u/ultrafilter)\ **Post date:** [April 16, 2010, 7:31pm UTC](https://boards.straightdope.com/t/so-goldman-sachs-is-getting-done-for-fraud-explanation-please/536360/11 "2010-04-16T19:31:16Z")
> [@BrotherCadfael](#): > > When I buy a life insurance policy, I’m betting the insurance company that I am going to die tomorrow. They are betting I won’t. If I win, they pay me (actually my heirs) money. If they win, I pay them money, in the form of premiums. Not true. The distinction between insurance and gambling is that in gambling, you have the option of cutting your losses by not playing the game. You’re going to die whether you have life insurance or not; the difference is whether you’re willing to trade some money now for more money when that happens. ---
**Author:** ![Throatwarbler\_Mangrove](https://avatars.discourse-cdn.com/v4/letter/t/8c91f0/32.png) [@Throatwarbler\_Mangrove](https://boards.straightdope.com/u/Throatwarbler_Mangrove)\ **Post date:** [April 16, 2010, 7:40pm UTC](https://boards.straightdope.com/t/so-goldman-sachs-is-getting-done-for-fraud-explanation-please/536360/12 "2010-04-16T19:40:34Z")
> [@ultrafilter](#): > > Not true. The distinction between insurance and gambling is that in gambling, you have the option of cutting your losses by not playing the game. You’re going to die whether you have life insurance or not; the difference is whether you’re willing to trade some money now for more money when that happens. Insurance agents must love you. ---
**Author:** ![China\_Guy](https://avatars.discourse-cdn.com/v4/letter/c/779978/32.png) [@China\_Guy](https://boards.straightdope.com/u/China_Guy)\ **Post date:** [April 18, 2010, 12:15am UTC](https://boards.straightdope.com/t/so-goldman-sachs-is-getting-done-for-fraud-explanation-please/536360/13 "2010-04-18T00:15:33Z")
Keep in mind that derivatives are a zero sum game. One person makes $1 and the other party loses a $1. It’s that simple. In Goldman’s case, there were investors that thought property values would keep going up and bought a contract that reflected that. At the same time, the Paulson group thought properties were going to go down, and bought the other side of that same contract. Goldman was the middle man matching the bulls and the bears. One wins and one loses. In this case, Paulson’s group is the one that selected the products that the derivatives contract would be based on. That is a clear conflict of interest, if not outright fraud as the buyers did not know this. ---
**Author:** ![Saint\_Cad](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/saint_cad/32/18907_2.png) [@Saint\_Cad](https://boards.straightdope.com/u/Saint_Cad)\ **Post date:** [April 18, 2010, 12:27am UTC](https://boards.straightdope.com/t/so-goldman-sachs-is-getting-done-for-fraud-explanation-please/536360/14 "2010-04-18T00:27:59Z")
Question: Suppose I short a stock that is later worthless because of bankruptcy like Global Crossing a few years back. The stock is unavailable because it now doesn’t exist and the certificates are literally worth 0 cents. Is the transaction over (and I made a ton of $) or do I still need to buy the stock back at a nominal cost like $0.01? ---
**Author:** ![DanBlather](https://avatars.discourse-cdn.com/v4/letter/d/f4b2a3/32.png) [@DanBlather](https://boards.straightdope.com/u/DanBlather)\ **Post date:** [April 18, 2010, 2:02am UTC](https://boards.straightdope.com/t/so-goldman-sachs-is-getting-done-for-fraud-explanation-please/536360/15 "2010-04-18T02:02:01Z")
How about this for an analogy. A firm puts together a fund that buys tickets for horse races, but just bets on the horse with the highest odds because they notice that over time it has a positive return; i.e., even though you lose some races you win enough other ones to make up for it. But, the person who sets the odds works for the firm selling the fund. They lie to you and say that the horses they are betting on have better odds than they actually should. Then, knowing that the odds for the long-shots are actually better than they should be given what they told you, they buy tickets for the long-shots with some of the money they took from you to manage the fund. So they are using their money to bet on different results than they advised you to do. ---
**Author:** ![Palooka](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/palooka/32/2902_2.png) [@Palooka](https://boards.straightdope.com/u/Palooka)\ **Post date:** [April 18, 2010, 2:24am UTC](https://boards.straightdope.com/t/so-goldman-sachs-is-getting-done-for-fraud-explanation-please/536360/16 "2010-04-18T02:24:37Z")
> [@Saint\_Cad](#): > > Question: > Suppose I short a stock that is later worthless because of bankruptcy like Global Crossing a few years back. The stock is unavailable because it now doesn’t exist and the certificates are literally worth 0 cents. Is the transaction over (and I made a ton of $) or do I still need to buy the stock back at a nominal cost like $0.01? You don’t need to cover (or you cover at $0) if the company goes bankrupt. This is assuming that the common shareholders aren’t entitled to any of the firm’s assets, which they never are. If the shareholders did get something, you’d owe it to the person whose shares you borrowed, much like if a dividend payment occurred while you held the shares. (This last part is a guess.) ---
**Author:** ![astro](https://avatars.discourse-cdn.com/v4/letter/a/9dc877/32.png) [@astro](https://boards.straightdope.com/u/astro)\ **Post date:** [April 18, 2010, 7:37pm UTC](https://boards.straightdope.com/t/so-goldman-sachs-is-getting-done-for-fraud-explanation-please/536360/17 "2010-04-18T19:37:51Z")
> [@Sitnam](#): > > I get that Goldman Sachs hired the hedge fund manager John Paulson to pick shit investments that were sure to fail, I get that Goldman Sachs then bundled those together and sold them to investors citing an independent 3rd party organizer. I get that Goldman Sachs then secretly made bets against those very packages (Abacus 2007-AC1 and the like) assured that they would fail. > > I just don’t get how you bet on something to fail and make money. > > For Wiki: > I just don’t get it. Goldman made money on the transaction commissions and the 15 million dollar fee it charged Paulson to set up the investment vehicle. Here’s some background [Profiting From the Crash](http://online.wsj.com/article/SB10001424052748703574604574499740849179448.html?mod=WSJ_hpp_LEFTTopStories#printMode) > [@](#): > > In his 2009 book, Wall Street Journal reporter Greg Zuckerman was the first to lay out how Mr. Paulson approached banks, including Goldman and Bear Sterns among others, with the proposal that they create securities of sub-prime mortgages that he could bet against. It is those trades that are at the heart of the Securities and Exchange Commission’s case against Goldman > [@](#): > > It was the fall of 2007, financial markets were collapsing, and Wall Street firms were losing massive amounts of money, as if they were trying to give back a decade’s worth of profits in a few brutal months. An investor named John Paulson somehow was scoring huge profits. His winnings were so enormous they seemed unreal, even cartoonish. His firm, Paulson & Co., would make $15 billion in 2007. > > Mr. Paulson’s personal cut would amount to nearly $4 billion, or more than $10 million a day. That was more than the 2007 earnings of J. K. Rowling, Oprah Winfrey and Tiger Woods put together. At one point in late 2007, a broker called to remind Mr. Paulson of a personal account worth $5 million, an account now so insignificant it had slipped his mind. > > Mr. Paulson, known as J.P., bet that the housing market would collapse and risky mortgages would tumble in value. The moves put the fund manager from Queens, N.Y., alongside Warren Buffett, George Soros, and Bernard Baruch in Wall Street’s pantheon of traders. And as one rival fund manager later would say, with equal parts envy and respect, “Paulson’s not even a housing or mortgage guy… Until this trade, he was run-of-the-mill, nothing special.” ---
**Author:** ![China\_Guy](https://avatars.discourse-cdn.com/v4/letter/c/779978/32.png) [@China\_Guy](https://boards.straightdope.com/u/China_Guy)\ **Post date:** [April 18, 2010, 11:30pm UTC](https://boards.straightdope.com/t/so-goldman-sachs-is-getting-done-for-fraud-explanation-please/536360/18 "2010-04-18T23:30:31Z")
Let me try a different explanation. In this case it’s not ‘selling short,’ which is probably what is confusing. Think of it like this - you want to bet a lot of money for team A to win the Super Bowl. So you make a contract with Goldman that if team A wins, you’ll get $98. Goldman turns around and finds someone that wants to bet on team B. So Goldman has a legal enforceable contract with you Goldman has a legal enforceable contract with the other guy. You both bet $100. If you win, you will get $98, the other guy pays $100 (Goldman gets $2 for setting everything up). Neither of you ‘own’ anything except for the one way contract with Goldman. Is this clear? The concept is this basic. Paulson went to Goldman and said ‘set up the bet with suckers that want team A because I have inside information that the entire backfield and head coach will be arrested the night before the Super Bowl and won’t be able to play. And lets pay a supreme court justice to give his ‘free and unbiased opinion’ that it’s an evenly matched set of teams, nothing will interfere with a fair game and the best team winning.’ ---
**Author:** ![astro](https://avatars.discourse-cdn.com/v4/letter/a/9dc877/32.png) [@astro](https://boards.straightdope.com/u/astro)\ **Post date:** [April 19, 2010, 12:00am UTC](https://boards.straightdope.com/t/so-goldman-sachs-is-getting-done-for-fraud-explanation-please/536360/19 "2010-04-19T00:00:46Z")
> [@China\_Guy](#): > > Let me try a different explanation. In this case it’s not ‘selling short,’ which is probably what is confusing. > > Think of it like this - > > you want to bet a lot of money for team A to win the Super Bowl. So you make a contract with Goldman that if team A wins, you’ll get $98. Goldman turns around and finds someone that wants to bet on team B. So Goldman has a legal enforceable contract with you > Goldman has a legal enforceable contract with the other guy. You both bet $100. If you win, you will get $98, the other guy pays $100 (Goldman gets $2 for setting everything up). > > Neither of you ‘own’ anything except for the one way contract with Goldman. > > Is this clear? The concept is this basic. > > Paulson went to Goldman and said ‘set up the bet with suckers that want team A because I have inside information that the entire backfield and head coach will be arrested the night before the Super Bowl and won’t be able to play. And lets pay a supreme court justice to give his ‘free and unbiased opinion’ that it’s an evenly matched set of teams, nothing will interfere with a fair game and the best team winning.’ Yeah… but … in this case it’s important to designate that “inside info” in a ball game and real “inside info” in picking stocks are very different things. And it’s extremely illegal to bet using “inside info” in making stock plays. Better to just say he thinks the team he’s betting against is going to run out of gas. ---
**Author:** ![adhay](https://avatars.discourse-cdn.com/v4/letter/a/ecd19e/32.png) [@adhay](https://boards.straightdope.com/u/adhay)\ **Post date:** [April 20, 2010, 7:14pm UTC](https://boards.straightdope.com/t/so-goldman-sachs-is-getting-done-for-fraud-explanation-please/536360/20 "2010-04-20T19:14:34Z")
> **[The Daily Show with Trevor Noah | Comedy Central](https://www.cc.com/shows/the-daily-show-with-trevor-noah)** > > The Daily Show is an Emmy- and Peabody Award-winning program that looks at the day’s top headlines through a sharp, reality-based lens. Want to reform Wall Street? Start by declaring GS a criminal enterprise guilty of economic terrorism. [Next page](https://boards.straightdope.com/t/so-goldman-sachs-is-getting-done-for-fraud-explanation-please/536360.md?page=2)