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SEC Sues Goldman Sachs For Fraud

SEC Sues Goldman Sachs For Fraud

Just as Senate Majority Leader Harry Reid vows to take up Wall Street reform, and just as the Republican leadership comes out against any form of meaningful regulation of financial firms, Goldman Sachs gets hit with a civil fraud suit by the Securities and Exchange Commission alleging the investment bank created and sold mortgage investments that were secretly designed to fail.  The facts of the case, just like the investment vehicles created, are highly technical.  But a quick translation of the jargon reveals nothing more than good old-fashioned fraud.

The investment vehicle at issue of the suit is called the Abacus 2007-AC1.  The mastermind behind the deal was prominent hedge fund manager John A. Paulson.  Goldman let Paulson hand select mortgage bonds hat he believed carried higher credit ratings than the underlying loans deserved.  Goldman would then place insurance on these bonds, called credit-default swaps, inside the Abacus bundle.  Goldman then sold the Abacus product to investors like foreign banks, pension funds and insurance companies.  At the time Paulson believed the housing market was overheated and destined to crash, and this vehicle allowed Goldman to continue to profit off of bundling and selling mortgages while simultaneously betting those mortgages would fall into default. 

Goldman was just one of many Wall Street firms that created these kinds of complex mortgage securities at the height of the housing boom.  These securities, known as synthetic collateralized debt obligations were essentially insurance policies written on mortgage bonds.  If the mortgage market continued to do well then the investors who bought products like Goldman’s Abacus notes would have made money from the insurance premiums paid by other investors like Paulson who were betting against the housing market.  But since the housing market went bust, just like Paulson and Goldman had predicted, the result was that investors lost billions while Goldman and Paulson made billions.

And the only reason they got away from it is because these kinds derivatives, remain unregulated by Congress.  Basically a derivative is any kind of financial security, such as an option or a future, that gets its value in part from the value and underlying characteristic of an underlying asset.  Typically that underlying asset is a bond, stock, currency, etc…  For those who play the derivatives market they are essentially betting that the value derived from that underlying asset will either increase or decrease by a certain amount within a certain fixed period of time.

Derivatives are not in and of themselves inherently bad or dangerous products.  In fact, many investors see derivatives as an essential tool in the kit of an informed investor.  Of course, that requires that investors be given the full-range of relevant information related to the underlying value of the derivative asset and any other bits of relevant information, such as whether or not the firm selling the derivative is actually betting against its performance. 

And that right there is the heart of the claim against Goldman–that it willfully withheld relevant information from investors while simultaneously betting against them.  It was a no-lose proposition for the investment bank.  They made money on the sale of the original product, so if the housing market continued to rise they faced no risk.  But if it didn’t, and we all know it didn’t, then not only in was insured against any losses, but it had effectively passed those losses onto its’ clients.

As Wall Street reform heats up in the coming weeks and months it will be interesting to hear just how those opposing derivative regulation plan to excuse this kind of behavior.  Of course Goldman denies it’s done anything wrong.  But ask the teachers pension funds, mutual fund holders, and taxpayers who are on the hook for the AIG bailout and you might get a different story.

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photo courtesy of aresauburn via Flickr

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58 comments

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4:09PM PST on Dec 3, 2012

hmmm

12:52PM PDT on Nov 4, 2010

One big difference from the Pension Fund scandals of the 90's: When Volker cleaned up that mess, thousands of people were arrested and went to jail including top junk bond kings like Michael Milken and shady arbitrageurs like Ivan Boesky.

Nobody significant has gone to jail or even been indicted in this recent massive collapse, in which trillions of dollars were siphoned out of middle-class homeowners and out of the market.

Whether you're liberal or conservative, D or R or independent, that is a huge symptom of something profoundly, systemically wrong with our leadership in the last 10 years. Basically our country is a giant financial colony and we the citizens are relegated to 3rd world status, until we have leaders with the courage to stand up to the banks and multinational corporations.

12:23PM PDT on Sep 27, 2010

Just the tip of the iceberg. I'm sure it's the same as the Wall Street scandals of the 80's and repeated in the 90's. Stock holders, pension funds and the public were all ripped off.

When a company goes public or is beings taken over by another in leveraged buyouts for billion(s), millions of dollars are paid to hedge fund operators, arbitragers, investment bankers, and lawyers. In order for a company to remain in business the cost of goods and services has to be inflated. If the inflated price is too much, people won't buy and that company will be out of business: more job losses and pension funds raped.

The bank bailouts sure helped the banks, but they have reaped windfall profits by their excessive fees.
This is a game to the big money men. And you want less regulatation? Frankly they need to be prosecuted under the RICO law and illegal profits should be confiscated.

12:43AM PDT on Apr 21, 2010

thankyou

12:33AM PDT on Apr 21, 2010

Sorry, Linda, petitions just finish in the trash can after having provided amusement for those at whom they are directed. Cynical? Yes, but true.

3:03PM PDT on Apr 20, 2010

thank you

1:48PM PDT on Apr 20, 2010

Bush started this crap!

7:40AM PDT on Apr 20, 2010

We can thank the past administration for deregulating wall street, allowing this to happen. And the really dumb thing is that the Tea Party is blaming Everything on the current administration for it.

6:44AM PDT on Apr 20, 2010

lool

5:22AM PDT on Apr 20, 2010

I saw on CNN where Goldman-Sachs 1st quarter profits were expected to be "huge". It seems they came out of this recession months or years ahead of the rest of us.

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