Goldman's Libya Derivatives Were Fine

Selling derivatives is basically a miserable life. If you're selling a car, you show the customer the car, and you're like, look at this car. It's blue, it has some horsepower, it can make both left and right turns, the seats are soft, it has twelve cupholders. The customer gets in the car, drives it around the block, turns on the windshield wipers. He has an intelligible experience of the car that he can relate to other cars he's encountered. If he likes the car, he gives you some money, and you give him the car. He values the car more than he values the money. You value the money more than you value the car. Everyone wins.

If you're selling a non-expert customer a derivative, you show him a termsheet, and you're like, look at this derivative. It's a cash-settled forward on $600 million of Citigroup stock, it has an embedded put to floor your downside at zero, there's an upside cap at 140 percent on 90 percent of the trade, it has a nine-month lookback. The customer ... nods. "When do I get the shares," he asks. There is an awkward silence. He has no intelligible experience of anything that you are talking about. His goals are simple: He wants to give you a small amount of money to get back a larger amount of money, without much risk. Your goal is ... more or less to persuade him that he's getting that? Preferably without actually lying? While also making a lot of money for yourself? But you are limited by the constraints of economic reality: Upside comes with downside, leverage comes with risk, profit to you is cost to him. Eventually he gives you money, and you give him a derivative that is probably worth less than the money.1476462975015 Maybe he values it more than he values the money, but in expectation, that will change. He'll probably call you to complain when it does. Nobody exactly wins, though you have made a profit, which is not nothing.