Goldman Sachs Charged with Fraud

Date posted: 19 April 2010
View this article online here: http://www.sacsis.org.za/site/article/226.19

On Friday, 16 April 2010, the US Securities and Exchange Commission (SEC), charged Goldman Sachs with fraud related to a sub-prime housing mortgage deal.

The SEC's press release states, "Goldman wrongly permitted a client that was betting against the mortgage market to heavily influence which mortgage securities to include in an investment portfolio, while telling other investors that the securities were selected by an independent, objective third party."

Paul Jay of the Real News Network reports that it all started when John Paulson, who ran a big New York hedge fund company, Paulson & Co., went to Goldman Sachs in 2006 and said that he wanted to bet against the housing bubble. He asked Goldman to put together a big package of mortgages as well as identify investors who would bet that the housing bubble wouldn't burst. Recent history tells us that the housing bubble did indeed burst and Paulson made millions of dollars.

Jay speaks with Greg Gordon from McClatchy Newspapers about the SEC's case against Goldman Sachs.

This is a test case by the SEC who are trying to chart a future path for enforcement. They are trying to see if some clear guidelines can be developed about what disclosures are required in some of these very sophisticated investment deals, including those that take place off shore in places like the Cayman Islands, argues Gordon.

In this case, Goldman put together a collateralised debt option (CDO). This CDO comprised very sophisticated investors, such as banks, insurance and other experienced investment companies who generally put together very complicated deals.

According to Jay, part of Goldman's defence in the case being brought against it is that the people who lost money in this deal are large banks and similar big investors, not "grandmothers who don't understand the market."

Gordon elaborates that there's going to be a big debate about this particular issue. Lawyers are going to fight over it because what actually happened is that Paulson was given an inside role in selecting what mortgages were going to be included in the deal. Those he selected were subprime loans, i.e., loans to marginally qualified or unqualified buyers. Paulson had a strong conviction that these mortgages were going to go sour as he selected and bet against them.

Allegedly, the investors that were on the other side, including the company that was managing these deals, were not told that Paulson was going to be betting against these mortgages. So, these other investors put up a billion dollars and Paulson bet the other way without their knowledge.

Goldman's claim is that the other investors had as much or more input as to what got included in the investment package.

But the suit against Goldman argues that the bulk of the mortgages that were used to place these bets, were not actually acquired by the CDO. The investors simply betted on the mortgages, which would ultimately be downgraded to junk.

The SEC argues that these investors had a right to know who was involved in picking the mortgages, in addition to the fact that the company betting against the deal, was also the one who was submitting the mortgages for approval to the manger of the deal -- that was an obligatory disclosure that should have been made by Goldman Sachs, contends the SEC.

One of Goldman's defences is that it itself bet wrongly on the deal (that the bubble wouldn't burst) losing a huge amount of money. But the point left out of Goldman’s statement is how much money (in bonuses) the individuals within the company made, regardless of whether or not the Goldman Sachs Company made any money on the deal.

Such details are unknown says Gordon who recounts the story of a then 28 year old employee of Goldman, who, at the time of the deal, was sending emails to his friends saying, "the building's going to collapse at any time, but I'm going to win on this because I'm the Fab guy (his name being Fabrice Tourre) who put these deals together and god knows what's going to happen with these monstrosities."

According to Gordon, the real significance of this case is that it is the first case in which the SEC has stepped forward after a "long lull" and taken on the biggest giant of Wall Street. In his view, the SEC is sending a message to Wall Street that it is going to be held accountable for creating a financial crisis that has caused a global recession.

Editor's Note: You may also be interested in reading "Banking with Piranhas" and "Goldman Sachs' Bloody Nose." Then there's also comedian Stephen Colbert's hilarious take on the SEC's case against Goldman.

 

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