Buy side vs. sell side.
From tonight's 60 Minutes, an interview with former Goldman VP Greg Smith who became famous last year for resigning from the firm in a scathing editorial in the New York Times.
This has been happening for decades. Investment banks create products to be sold to clients. I've worked both sides. There's no excuse for buy side stupidity. This is how the industry works. Buyer beware. Nor is it in any way limited to exotic derivatives product. It happens with virtually every IPO that comes to market.
Go talk to Morgan Stanley. Facebook ipo @ $38, anyone?
Greg Smith On Why He Exposed The Goldman Muppet Show
Smith says he grew even more disillusioned after the Senate hearings, when he and a Goldman Sachs partner met in Asia with a major client, the head of one of the biggest funds in the world.
Greg Smith: And he looks me and a partner in the eye and says, "Let me be honest with you guys. We don't trust you at all. But don't worry. There's nothing to worry about. We're gonna keep doing business with you because you're the biggest bank. You're the smartest. And actually we have to do business with you." Now my jaw almost dropped because hearing from one of your biggest clients that they don't trust you when your whole mantra and reputation is built on trust, to me, it was the worst possible thing you can hear. And then I leave the meeting and the partner from Goldman Sachs who I was with is jubilant. "This is great news. The client is gonna keep doing business with us because they have to."
Smith says that in Goldman's offices the promotions and big money went to people who sold complex products with unseen risks and hidden fees.
Greg Smith: So what Wall Street will do is, they will approach one of these philanthropies, or endowments, or teachers' retirement pensions funds, in Alabama, or Virginia, or Oregon, and they'll say to them, "We have this great product that is gonna serve your needs." And it looks very alluring to these investors. But what they don't realize is that up front, they're immediately paying the bank two million dollars or three million dollars because of their lack of sophistication.
Anderson Cooper: So they don't say to the client: the price you're paying for us to execute this trade is a million dollars?"
Greg Smith: That's a huge part of the problem. Not at all.
Anderson Cooper: How can it be that the client doesn't understand what the bank is making?
Greg Smith: These are very complicated derivative securities which takes a Ph.D. in physics or in engineering to understand. And there are pension funds and mutual funds that represent people's 401(k)s and retirement savings that are trading the most complex instruments out there without fully understanding them.
Anderson Cooper: So, did the people you work with want unsophisticated clients?
Greg Smith: Getting an unsophisticated client was the golden prize. The quickest way to make money on Wall Street is to take the most sophisticated product and try to sell it to the least sophisticated client.
In 2011, Smith moved to Goldman's London office, the very month the company announced a wide-ranging effort to improve its business practices. Smith saw little change. He say's his coworkers in London repeatedly referred to their clients as "Muppets" and not in the kindhearted way their Sesame Street creators intended.
Greg Smith: In Europe, a Muppet is a term for someone you can manipulate, someone who is an idiot.
Anderson Cooper: So people at Goldman Sachs, who you worked with, used to call their clients idiots, essentially?
Greg Smith: All the time. Not to their face, but behind their back.
Anderson Cooper: You heard people you work with talk about overcharging clients, bragging about it?
Greg Smith: Within week one, I met a junior guy who was 24 or 25 years old and the first thing he told me was he'd just traded a sophisticated derivative with a Muppet client who paid the firm an extra million dollars because the client was so trusting that he didn't check the price with other banks. Now you could think to yourself, "Is this some rogue guy who's just talking callously about clients?" But his boss, who's a managing director, was sitting right next to him nodding and chuckling along. And--
Anderson Cooper: The boss was laughing about it?
Greg Smith: Absolutely. They were both laughing about it.
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