They Don’t Even Bother Trying To Hide It Now

There comes a time when the rip-off schemes become so in your face that there is no longer any attempt to hide them with tricky 5,000 page contracts and inside deals (such as the CDO^2s that blew up in so many people’s faces — while the banks that created them designed them to do exactly that.)

This latest offering from the squid is such an example:

Goldman Sachs Group Inc. (GS) plans to issue four certificates of deposit linked to stocks as record low interest rates drive investor demand for the potentially higher-yielding CDs.

Why wouldn’t you just buy DIA (Diamonds) and be done with it?  That’s an ETF that closely tracks the DOW and has very low expenses.  If you want the risk of being in the market, then you should get both sides – the upside and the downside.

The problem is here:

The four-year CD tracks the monthly percentage change in the Dow, with gains capped at 1.5 percent to 2 percent and no floor on the declines. That means if the Dow advanced 5 percent, the monthly return would be recorded as no more than 2 percent, while a drop of the same amount would be taken in full.

In other words in the event of a big rally in the market on the month Goldman will keep much if not most of the profit.  In the event of a big crash, you will eat the loss.

Why would anyone buy such a product?  There’s no reason to do so, and if there’s any sort of fiduciary responsibility associated with the seller I’d love to see their argument justifying how this isn’t a raw violation of that responsibility.

Since this is listed as a “CD” I presume it falls under FDIC coverage if Goldman fails.  That too is an interesting premise since these “devices” are put together by combining zeros (a form of bond) with derivatives to create a “synthetic” financial construct that should (in theory) always provide them with more cash flow than the “CD” pays (thus, in theory, it is always a winner for The Squid)

The obvious problem of course comes when the derivative counterparty can’t pay…..

The not-so-obvious problem is that in the derivative market for every winner there is a loser.  So if Goldman is always the winner, who would be dumb enough to take an always-losing bet?  Well, nobody once they figure it out, which means that somewhere there is likely a scheme in here much like the old CDO games — we just haven’t found it yet.

The FDIC is supposed to protect depositors, not firms that set up hinky derivative structures with depositor funds…..

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