The disputed investment at the heart of the Goldman Sachs fraud allegations -- and the subject of last week's Senate hearings -- may seem a long way removed from the financial concerns of the rest of us.
After all, few of us ever deal with collateralized debt obligations, exclusive hedge funds or complex billion-dollar derivative products. And Goldman, which is contesting government charges, insists the case only touches a very narrow and specific part of its business, dealing with very sophisticated institutional clients.
Nonetheless if you're an ordinary investor with $50,000, rather than a hedge-fund manager with $500 million, it's still worth paying attention to the case of the doomed $1 billion Abacus fund.
Why so? Because it's a timely reminder that, for many big financial institutions on Wall Street, we're simply customers to be sold a product.
The case is also a great example of how not to invest. You could go a long way in this life just by observing the behavior of wealthy and powerful investors in Abacus and then doing the opposite.
Never assume the big money is also the smart money.
What are the lessons?
1 Never put too much faith in a bank.
Goldman denies defrauding customers in Abacus 2007-AC1, the complex financial product in this dispute.
But whatever the legalities, nobody is going to claim it behaved well. The bank worked closely with hedge-fund tycoon John Paulson to construct a sucker's bet on subprime bonds that Mr. Paulson could bet against.
Then it went looking for suckers ... er, customers ... to take the other side of the bet. According to the Securities and Exchange Commission, it didn't tell those customers that Mr. Paulson had helped construct the portfolio. They ended up losing more than $1 billion.
I don't want to over-romanticize the past. Wall Street banks have always been businesses run for a profit. But once upon a time, they were, at least, partnerships. That meant the owners had some vested interest in the long-term reputation of their firms, and hence in treating the clients decently.
Today you should probably view them the way you view someone selling a used car. (Indeed, that may actually be unfair to used-car dealers.)
Goldman calls what it did "market making," and says in this instance it was permitted. Either way, it's clear Fabrice Tourre, the broker who devised the deal, was willing to sell a product about which he privately expressed serious misgivings.
Mr. Tourre denied to the Senate subcommittee that he misled customers and that the Abacus deal was designed to fail.
"We certainly did not bet against our clients," added CEO Lloyd Blankfein, though he conceded "how such a complicated transaction may look to many people."
Typical Wall Street bankers have three priorities: their own bonuses for the year, their bosses' bonuses and their own stockholders. Customers -- you and me -- come a very distant fourth. It's a mistake to forget that.
True, few funds are going to do to you what Abacus 2007-AC1 did to its investors. But they are products that are created to be sold to the public for the benefit of the bank. Don't take too much on trust.
2 Think twice before buying any complicated financial product.
It still baffles me that investors are so willing to buy complex "synthetic" products that the banks have cooked up in the back room. These are usually a poor deal (for the customers, if not for the bankers).
That's because, even when they're not being put together as a sucker's bet, they're often being put together to sock you with high fees.
Someone I know, who used to work on Wall Street about 10 years ago, always gets the simplest mortgage possible. Why? "I used to sit in the room when we designed the complicated mortgages in order to get higher fees," he says.
Today the banks -- from Wall Street to Main Street -- are out hustling new complicated structured financial products to the public. Some are called "reverse convertibles." Others, offering some stock-market "action" with limits on the upside and the downside, come with names like "principal guarantee" or "equity participation" notes.
No, they probably won't be a disaster. Don't assume they're a new "Abacus." But as a rule of thumb, the more complex a product is, the worse the deal. If the problem isn't the hidden traps, it's probably the hidden fees.
3 Be wary of investing in something you don't understand.
In the world of investing, the easiest way to end up looking really stupid is to try to do something really clever.
What were Goldman's customers thinking? OK, so they didn't know that Mr. Paulson had helped construct Abacus 2007-AC1. But it seems pretty clear that they didn't understand much about the product at all. Yet they still invested more than $1 billion into it.
Whatever the SEC achieves, over time it has very little ability to prevent the inevitable divorce between a fool and his money.
When it comes to investing, humility and common sense will go a long way. Investors in Abacus 2007-AC1 would have been far better off investing in some really boring blue-chip dividend stocks with business models like selling hamburgers or shampoo.
4 And when in doubt...
The doomed product was hustled by Goldman's Mr. Tourre. There's one simple question that the customers could have asked him that would have saved them a lot of grief, as well as about a billion dollars:
"How much of your own money are you putting into this?"
When all else fails, it's not the worst question to ask your broker. His reaction may tell you what you need to know.
SOURCE: THE WALL STREET JOURNAL
