A new Schwab advertising campaign states, “Ask not what you should do for your broker.” What a great way to successfully communicate Schwab ‘s value promise given what’s happened with the “too big to fail” banks – Schwab will always act to benefit its clients. The company has built it’s business model around this value promise.
Not so Goldman Sachs. The SEC charged the investment bank with fraud for selling an asset to banks whose return depended upon a group of home mortgages being repaid by the home loan borrowers. The alleged fraud arises because Goldman Sachs did not tell the banks that the specific sub-prime mortgages in the group were recommended by another Goldman Sachs customer who planned to bet against these same mortgages ever being repaid by the home loan borrowers. (The fact that Goldman Sachs is selling bets and banks are buying them is a topic in itself, but hey, this is how we set up our regulatory frameworks thanks to Greenspan.)
Would you host a poker game for your friends knowing the dealer was bringing stacked cards and not at least inform your friends of the dealer’s intention? It’s not hard therefore to wonder, “Who is Goldman Sachs’ target customer?”
“Who is your target market?” – the group you will design your company around to benefit – is one of five core business model questions. Goldman Sach’s behavior suggests it is changing its business model. Is this a wise thing?
In the good old days
Goldman Sachs traditionally served both investors and businesses seeking capital outside traditional depository banks (the banks with our checking accounts). This intermediary role was good for both sides of the exchange and good for the economy, as investment banks traditionally channeled capital to the best uses for society, according to economic theory. As an economist, I think the theory pretty much got it right. The US became the wealthiest nation in the world in large measure because free markets and democracy moved capital to the right places. Until recently, that is.
“Too big to fail” bank interests stopped being aligned with Main Street’s best interests
On Wall Street today, President Obama spoke to financial industry leaders. According to an early release of the speech, he said, “A free market was never meant to be a free license to take whatever you can get, however you can get it.” I disagree with Obama. Free license to maximize one’s well-being is what a free market does. In other words, capitalism is devoid of a moral code. The moral behavior of a business therefore depends upon who is leading the business. With most leaders, behavior benefits the business, its customers and society. But not with all leaders. That is why we need a strong (note that I did not say big) government – to establish laws and incentives to best align business interests with society’s best interests.
Which brings us to the SEC filing a case against Goldman Sachs. Our courts will decide if the SEC is reading the law correctly.
An issue irrespective of guilt or innocence
Goldman Sachs may not have broken the law. After all, as the firm claims, they were selling the bet to highly informed professional investors. Was it Goldman Sach’s role to point out the risks? Well, it used to be.
So who is Goldman Sachs’ strategic customer – the one leaders design their firm to serve? If it’s the investor, Goldman Sachs’ omission of facts from its prospectus broke the firm’s commitment to its investors. If Goldman Sachs’ strategic customer is the man influencing the selection of the mortgages (a hedge fund manager) then Goldman Sachs should hang a huge sign outside their new building for investors to read stating, “Buyer Beware.” I think Goldman Sachs’ strategic customer was itself – profit for the sheer purpose of profit, at anyone’s expense.
Lawyers must argue a case for their client, whatever the lawyer’s belief about guilt and innocence. This principle and professional commitment creates our nation’s a stellar legal system. Goldman Sachs will say the same thing – their role is merely to make markets. OK, I get that, especially for derivative contracts that help airlines manage fuel costs and new issues of stock that enable a high potential company to grow. But the market maker must be fair, not someone who’s knowingly allowed the game to be stacked in one person’s favor not because of economic trends but because facts are omitted by the market maker.
Were I a Goldman Sachs partner, I would vote to plead guilty to fraud. Yes, it would be expensive for the firm to do so. But it would communicate that Goldman Sachs:
- Understands its true value to society
- Works according to its publicly-stated principles
- Will get back to this important work as soon as it gets rid of the leaders who forgot why the firm really exists.
Another way to look at the situation
For insight on business model strategy, read my recently released book, Beyond Price.
Brad Shorr says
Kay, Your solution to Goldman Sachs’ problem is bold and possibly brilliant. It certainly runs contrary to the usual dance of denial and stonewalling. (Think baseball, steroids.) Our current societal stampede toward big government and high taxes is a direct result of the business sector’s failure to hold the confidence of the public. What worries me is, when we realize that big government and high taxes are disastrous … where will we turn?
.-= Brad Shorr´s last blog ..5 Great, Free Keyword Research Tools =-.
Bill Welter says
Great point of view. Thanks for taking this out of the legal world and putting it in the real world.
Kay Plantes says
Thanks Bill and Brad,
I am a capitalist at heart and I share a deep concern about the backlash against business due to the greedy behavior of the few and the weak regulatory structure Bush created. I am a firm believer in strong but small government, an oxymoron in today’s black-white politically polarized world, but nevertheless exactly what our economy needs right now.
Government is now the culprit precluding an effective allocation of capital to the best uses. It’s over-investment in housing and inefficiencies are diverting needed capital from an innovation agenda, which our country very much needs.
Have a good weekend, Kay
.-= Kay Plantes´s last blog ..Who Is Goldman Sachs’ Customer? =-.
Fred H Schlegel says
Your comparison to the poker game and gambling is quite appropriate. Truth is, we’re willing to sit at the table because everybody understands and accepts the odds. Even though they are always stacked in favor of the house. This particular example appears to be another example of a ‘trusted’ institution purposefully changing the odds without providing warning to their partners. It is easy to assume that if they had provided such warning a number of folks at the table would have walked away or changed what they were willing to bet.
Companies that promote themselves as casinos are heavily regulated to avoid that sort of behavior. Goldman traded away a good portion of the trust folks had in it by acting this way and it will be interesting if any strategy will get that back. What we don’t know is how many other deals exactly like this are on the books waiting to be exposed.
.-= Fred H Schlegel´s last blog ..The 2400 Year Old Problem =-.
Kay Plantes says
Hi Fred. Great comparison to how the gambling joints are regulated. Goldman Sachs’ top executives apparently sold lots of stock in advance of the SEC announcement. Will be interesting if they are accused of inside trading. Some lawyers are saying the Goldman case is the top of the iceberg. I’d like to see some people held accountable for what happened. But the way, I’d add Barney Frank to this list as his push for affordable housing was one of the catalysts. Why is our government this may years after the mortgage market was created still such a large player in mortgages? It’s led to an inappropriate and harmful allocation of capital towards housing. I must be influenced by living in Europe part time where home-ownership is not the big deal that it is here.
.-= Kay Plantes´s last blog ..Who Is Goldman Sachs’ Customer? =-.
Walter Simson says
This is the clearest, least didactic piece on Goldman yet. Not that such bad behavior on the bank’s part is not worth a little bombast, but I believe that your clear-headedness on this topic is a good indicator of future straight shooting.
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Dallas SEM says
Thanks for this AWESOME article! I will definitely have to implement this in my blog!