derivatives rules

It recently came out that a $1.2 billion derivatives portfolio that Goldman Sachs Group Inc. (NYSE: GS) managed for the Libyan government lost 98.5% of its value between 2004 and June 2010.

If a firm like Goldman will sit idly by while a client eats about $1 billion on a single investment, where do you think you and your portfolio land on Wall Street's list of priorities?

The message here is simple: You can't trust Wall Street - not with a $10,000 investment, a $100,000 investment, a $1 million investment, and especially not with $1 billion investment.

Goldman Sachs claims that the Libyans were picking the derivatives trades themselves. But that's exactly what they would say.

After all, if it got around that Goldman's ace traders were capable of losing virtually all of their clients' money, bonuses would fly out of the window along with most of the business. I'm sure the Libyan government would have offered a rebuttal if it weren't being toppled in a civil war.

The Libyans no doubt did much of the investment decision-making themselves, but the real problem is that there was no basis of comparison for the prices of the derivatives products they were being given.

And that's where there's a lesson to be learned. As a retail investor, you have to be able to determine a two-way price quote for whatever investment you buy.

The investment landscape is littered with the wreckage of failed structured investments.

Between 2008 and 2010 already-strapped cities and states had to pay Wall Street $4 billion in termination fees to get out of various interest rate products that had gone wrong.

For example, there's the exciting 2007 "Abacus" deal by Goldman Sachs trader "Fabulous Fab" Tourre, which lost European banks a total of $1 billion.

The investors in Fabulous Fab's Abacus deal had no independent means of assessing the value of the subprime mortgages in the pool. These were large, "sophisticated" banks, but they deluded themselves with the risk/reward tradeoff they were taking on.

Losses are not confined to the notoriously murky derivatives investments, either. I would bet that the special Goldman clients who earlier this year bought privately offered shares of Facebook Inc. at a $60 billion valuation will end up losing big on their investment as well.

As investors, most of us are not rich enough to get Wall Street's attention, but we should stay informed about how these firms are luring their clients into spectacularly bad deals.

That way we'll all know what to avoid.