Sell Junk, Short The Same Junk, Laugh Your Way To The Bank: Ethical? (MS, GS, DB)

Investment banks like Morgan Stanley (NYSE: MS), Deutsche Bank (NYSE: DB) and the old and venerable Goldman Sachs (NYSE: GS) apparently made a fortune during the recession by shorting the housing market.

According to the New York Times, Congressional and SEC investigators are examining if these firms knowingly created disastrously performing securities, sold them to investors and then proceeded to short the same securities. Essentially collateralized debt obligations were sold to investors. Goldman, Morgan Stanley, Deutsche and other firms sold these securities and then proceeded to short the same securities, in effect hedging against a loss in the value of the securities.

Industry watchers claim that firms like Goldman had perverse incentives in this structure and more alarmingly, they exploited them. There may have been an element of mis-selling involved. The above-mentioned banks may have had information that indicated that these securities were not worth the value for which they had been sold – the reason why they short sold the securities themselves, instead of letting other investors in.

In fact, some of these deals had been structured in a way that actually helped short sellers gain disproportionately if the housing market went bust thus raising moral concerns about the conduct of an industry that has not done much to endear itself to the rest of the economy.