Do you know how to guarantee that you’ll win at least one of two simultaneous chess games? Make your opponents play each other. If you’re white in one game, take black in the other. Take your first opponent’s moves and play those exact moves against your second opponent. Consistently applied, you will win exactly half of your games. You’ll break even.
In the world of bookmaking and investment banking, there is value associated with playing these opponents against each other. The opponents want to find each other. The investment banker, the bookie helps them find each other and collects a fee. It’s called a vig. It’s no surprise that “vig” is a word used in both banking and gambling.
Senator Carl Levin doesn’t understand (or doesn’t care to understand) how a vig works. For
someone on the Senate Banking Committee a U.S. Senator, he should probably step back and do some light reading.
Levin just wrapped up his questioning of Goldman Sachs Chief Executive Lloyd Blankfein, insisting that Blankfein was derelict in his duties. Goldman created large bets for its clients while simultaneously making large bets that the opposite would occur and then seeking out investors for those bets, attempting to make money both ways. This doesn’t surprise me.
When bookies (or investment bankers) find it difficult to find buyers for a particular bet, they can become reluctant to sell the opposing bet. It leaves them (say it with me) exposed to the risk of one side of a wager. Why is it surprising that when you structure a bet for someone that you would attempt to find a way to minimize the risks you take when structuring that bet?
Investors who want to buy a derivative don’t care how you cover your risk. They just care that you’re able to pay when they win their bet. And they want you to be able to pay. A clear way to do that in a complicated marketplace is to try to find buyers for the other side of the wager, thus taking no particular interest in who wins what bet.
This should not surprise anyone.