Goldman Sachs is an investing bank in New York, actually more like a hedge fund. Goldman Sachs’s clients are not individuals, most of them are biggest asset managers, pension funds, government, and hedge funds in the world. They’d get looped in early about the various trades Goldman Sachs liked, so they could invest alongside the firm and use their muscle to propel the firm’s investing ideas into self-fulfilling prophecies. Goldman Sachs work like an insurrance company, they pay commssion and bonus for salesperson. They also have leaders and managers.
Why i left Goldman Sachs – Greg Smith
Hedge funds are investment funds that can undertake a wide range of strategies, both going long (buying an asset with the view that it will rise in value) and getting short (selling an asset without actually owning it, betting it will go down in value). Because this funds are not highly regulated, they are open to very large investors such as pension funds, university endowments and high-net-worth individuals.
Goldman Sachs trade derivatives and make future contracts.
Derivatives are securities that derive their value from an underlying asset. They can be complex, and they have a long and controversial history of creating havoc. But if understood correctly, derivatives can help investors hedge against (or speculate on) very specific risks. The term derivatives can be used as a catchall to include products such as options, swaps, and futures And you can get derivatives on all asset classes: equity, foreign exchange, commodities, fixed income.
Derivatives are highly leveraged products: you were borrowing money for your bet, so returns or losses were greatly multiplied. If you mistakenly said “Buy” instead of “Sell” or got the quantity wrong, you could rack up huge error.
Future contract a derivatives contract between buyer and seller where price and quantity are agreed upon today, but delivery and payment occur in the future. The term originated with farmers who were trying to hedge their crops against droughts, rains, and uncertainty of demand.
Going back to hundreds of years, farmer who need to protect their crops against droughts, rainstorms, and uncertainty of demand. In order to hedge themselves, the farmers would make deals with their buyers. Instead of taking the risk that their wheat could be worth $100 a bushel when they needed to sell it, or $200, or as little as $20 – they would lock in a price of, say, $120 per bushel for future agreed-upon delivery. They were taking a gamble by setting a price now that might be too low, but hedging against the risk of being unable to sell all their crop in the future. This kind of deals call Future contract.
Future contract started out with wheat, milk, orange juice, pork bellies; Gold, silver, iron ore. Then people started thinking, “Well, we can apply this to anything. Let’s apply it to stocks”. So there then arose stock index futures: you could implement your viewpoint on where the S&P 500 or NASDAQ – would be in future. There are also interest rate futures and foreign-exchange futures.
Half the business of Goldman Sachs is in equity index futures such as he S&P 500 or NASDAQ contracts. The other 50% is in commodity future such as grains, orange juice, and pork bellies, and the rest was currencies and interest rates (Forex): people betting on the future price of government bonds, or the dollar, the yen or the euro.
What causes The 2008 financial crisis?
The 2008 financial crisis actually started from summer 2007, the fall of a new computer trading models call “Black Box”. “Black Box” was come out from Goldman’s flagship fund – Global Alpha.
“Black Box” was designed to seize on anomalies (mispriced securities), produced such impressive results that in 1997, in the midst of the inflating dot-com bubble. From 2002-2005, Black Box kept mining money for the firm.
The fundamental problem with computer models trading securities is that they don’t effectively take the outside world into account. They don’t have human thoughts. There were too many funds using the same model, and they fail to imagine that everyone would want to get out at the same time. As a result of too many
In August summer 2007, the computer models began imploding: Everyone was trying to upload the same securities at the same time, and as prices went lower and lower, the funds began to hemorrhage money. In addition, investors in these funds panicked and demanded to be cashed out.
After the fall of the “Black Box”, lots of solutions had been taken like Bear Stearns and funding trade, but still don’t work.
In 10/2008, in order to save the financial world, the the US government decided to gives the 9 biggest banks (including Goldman) a lot of money, it call “too big to fail”. The purpose is to cover the bank really in trouble, if just one bank take money, people with think that bank was in trouble. But the markets still keep fall down.
During the crisis, Greg Smith find out a concept call Dry Powder, when all funds started to sell, they will built up a wall of money (Dry Powder), this cash supply was going to become so big that it would have to come back into the market in search of return. He came up with the framework for showing how to track when the dry powder was actually getting deployed, and what that said about the direction of the market.
People were scared and looking for hope that the market might recover, so his dry powder thesis fastly been accepted by clients. In the new world we live in, content is the way we will differentiate ourselves.
4 kinds of clients in Wall Street
There are 4 kinds of clients in Wall Street: The Wise Client, the Wicked Client, the Simple Client, and the Client who don’t know how to ask questions.
The Wise Client are large hedge funds and institutions that have access to all the resources their bankers and traders have to offer. this includes research; communication with the management teams of the companies they are looking to invest in; first looks on deal that are coming to market, such as IPOs and capital raises; their own unbiased derivatives pricing models, to determine what opaque products are actually worth; but most important, human capital: real sharp people working for them. Goldman Sachs would never try to push some high-margin financial product on Wise Client, the people who work on this firms are too smart. They also have tools to spots when a trader is trying to play games.
The Wicked Client are funds engage in rumor mongering to drive down the prices of companies they are shorting. They try to game Wall Street banks against one another to get the best price for themselves.
The Simple Client usually pension funds, they generally move very slowly, these are perfect prey for Wall Street.
The Client who don’t know how to ask questions are the investment managers who are meant to look after the pensions of cops, firemen, and teachers, or they might be running the portfolio of a charity, an endowment, or a foundation. These would be the target clients for elephant trades.
Goldman Sachs’s claim
On 2010, the SEC (Securities and Exchange Commission) was charging Goldman with materially mistaking and omitting facts in disclosure documents for synthetic CDO (Collateralized Debt Obligation) product that they’d originated. Goldman agreed to settlement of $550 million in the SEC suit. $300 million go to the government and $250 million to investors. After the settlement, a lot of clients were no longer comfortable taking counter party risk with Goldman. They would be willing to trade only listed, transparent products that went through a clearinghouse. That way the clients’s money and market exposure would be safe, irrespective of what happened to the bank they were trading with. A clearinghouse is a third-party agency or separate entity that acts as a go-between for buyers and sellers in financial markets. The clearing house is responsible for settling the exchange member’s trade accounts, maintaining margin accounts and collecting money.
Goldman’s new system
From the year 2005, Goldman change the payment system by encourage employees make more revenue under their name. People would now do anything they could to pump up the number next to their name. They sell axe to clients. An Axe is a position the firm wants to get rid of or a risky position it wants to shore up. The firm believes, deep down, that one outcome is going to transpire, yet it advises the client to do the opposite, so the firm can then take the other side of the trade and implement its own proprietary bet. It is like selling doughnuts, you have too many doughnuts in stock and need to sell them before they go bad. In order to drive up sales, you could say: “Our doughnuts are now fat-free!” That would technically be a lie, but it wouldn’t get you sent to jail.
Goldman Sachs teamwork had gone, and this is why Greg Smith – author of this book – decided to left Goldman Sachs. He wrote down a piece titled “Why i am leaving Goldman Sachs” for New York Times and figure out the truth before he left.
The dark side of Wall Street
Wall Street is facilitating business for the smartest hedge funds, mutual funds, pension funds, sovereign wealth funds, and corporations in the world, it know who is on every side of a trade. It can effectively see everyone’s card. Therefore, it can bet smarter with its own money. Wall Street hate transparency and will fight as hard as possible to prevent it from coming.
=============
About the author
Greg Smith resigned in the spring of 2012 as the Head of Goldman Sachs’s US Equity Derivatives business in Europe, the Middle East and Africa since 2012. Born and raised in South Africa, Smvith graduated from Stanford University before going to work for the firm full time in 2001. He spent his first 10 years in the New York headquarters before moving to London in 2011. He currently lives in New York.