A useful description of what Goldman Sachs did

This discussion by Fareed Zakaria is extremely similar to what I was arguing last week, though his point is undoubtedly more clearly written.

Imagine that you want to make a bet against a sports team, say the New York Yankees. The Yankees have had a strong run, but, poring over the data, you have come to the conclusion that they're going to start losing. So you go to a bookmaker (in a district where bookmaking is legal, of course) to place a bet. The bookmaker now looks for someone to take the other side of this bet. Once the other party is found, the deal is made. That, in essence, is the transaction that took place in 2007 regarding the future direction of the American residential-housing market, in which Goldman Sachs acted as the bookie, and which the Securities and Exchange Commission now charges was "fraud." . . .

The first is that John Paulson—the fund manager who wanted to bet against the housing market—was allowed to select the securities he wanted to bet against. This is disputed—but even if it's true, so what? Here's what a routine hedge transaction looks like on Wall Street. Somebody decides to place a bet against some set of stocks or securities. That person approaches a Wall Street firm and says, in effect, "Can you find me someone who wants to take the other side of this bet?" And the firm goes out and finds someone who has the opposite view on those securities. This is how large companies offset the risks to their balance sheet from fluctuating currency, energy, or commodity costs. They often choose the instrument they want to bet against. . . .

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