Wednesday, April 28, 2010

Goldman Takes Its Customers to the Zoo

Back in 1981, I had been a market-maker on the Chicago Board Options Exchange for less than a year when one day a broker walked into the pit where I was trading and announced that he had a cusotmer who wished  to purchase several hundred contracts in two different strikes of puts and calls and sell several hundred contracts in two other series.  I don't remember exactly what the trade was but I did recall that it made no sense to me.  Nevertheless, the other market makers in the pit and I quoted a price for the transaction and the broker executed the trade.   About an hour later, the broker returned and said that some one in his firm had made a mistake on which options to buy and which to sell and he explained what he actually wanted to do.  Unfortunately, the market had moved against him in the meantime and it cost him several thousand dollars to correct his mistake which was pure profit for the traders in the pit.

After the broker left, I turned to one of the older traders and said. "You know I wondered why he was doing that" (meaning the original trade).  The trader looked at me and said "Not me Vinny.  I'm just a fucking taxi driver.  The guy wants to go to the zoo, I take him to the zoo.  I don't take him to the airport."

According to Goldman Sachs, it was simply meeting its clients' desire for exposure to the housing market chairman.  As a market maker, it was simply giving its clients the opportunity to make the trades they wanted to make.  They were not obliged to tell their clients how foolish they were being or that Goldman was betting against them.

The problem with Goldman's defense is that it was not simply acting as a market maker.  It was also acting as a salesman and broker.  As a market maker on the CBOE, I was not allowed to give advice to customers.  I was not allowed to earn commission by persuading clients to buy and sell options.  My profit came solely from taking the other side of customers' trades.  I played no role whatsoever in helping the customer decide whether or not to trade options in the first place.  That was the broker's job.

Goldman didn't just take its clients to the zoo.  It dropped them off inside the lion's cage.  Then it bought life insurance policies on them.

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