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Apr. 19 2010 - 8:05 pm | 329 views | 1 recommendation | 10 comments

Goldman’s Fraud: Ignorance, Meet Arrogance

In sifting through the reams of damning documents and news stories that have surfaced over the past three days, it is perversely comforting to rediscover the icky truth behind financial implosions in general and the subprime debacle in particular: no one- no one- knew what the hell they were doing.

I say “comforting” because every time I try to suss out the salient details of any issue having to do with credit-default swaps, collateralized loans or subprime derivatives, I get so confused and lost I wonder if I am perpetrating my own personal fraud- moron hack journalist. So the news frenzy set ablaze last Friday by the SEC’s civil fraud case against Goldman Sachs has granted us a new opportunity to gawk at the stunning hubris of some Wall Street traders and remember that common sense has not yet been rendered irrelevant by ad networks, quant models, the iPod or Wikipedia.

To get a handle on just how much the involved parties didn’t know, a little background is helpful:

1. What’s the SEC’s suit all about?

In short, the SEC is accusing Goldman Sachs, the lionized Harvard of investment banks, of lying to investors. In finance- as in relationships- not telling the whole truth is tantamount to lying. When Goldman hawked to investors a shiny new product- a synthetic collateralized debt obligation tied to the performance of subprime residential mortgage-backed securities (sounds sexy- surely someone smart put it together) back in early 2007, they didn’t bother to tell investors that the fund’s holdings were chosen with the help of an independent hedge fund (billionaire John Paulson’s Paulson & Co.) who wanted the fund to fail. While Goldman was marketing the fund on the premise that the housing market was sound, bear Paulson was betting housing would flop and, the SEC alleges, made the portfolio pics accordingly. Spoiler alert: he was right. Paulson made $3.5 billion shorting subprime in 2007. [For more background, check out the SEC's formal complaint- it's surprisingly readable].

2. So what was in this fund, exactly?

A big pile of dodgy debt. No kidding. Investment banks nationwide binged on subprime mortgage securities back in the heyday of the housing bubble. High-risk mortgages- the kind banks were normally loathe to give out because of the high likelihood of default- were suddenly hot on Wall Street. Investors developed complex statistical models to determine borrower behavior (defaults, prepayments, etc.) driving bond value. Fancy algorithms- portfolio analytics- developed by the super-genius “quant” traders at banks showed that distributing risk over a broad “basket” of loans could turn subprime loans into safe ones. So by bundling some very risky loans in along with a heap of not-so risky loans, you had an AAA-rated product. A rock-solid way to mint money. The same way that mixing some arsenic into a pie crust recipe will make for an overall perfectly-healthy treat. Make sense? No? You’re right- it doesn’t make sense. These two Brits articulate the nonsensical-ness of it all rather nicely:

Because Paulson had a gloomy view of the future of mortgage securities, he participated in the market largely through Credit Default Swaps, insurance contracts which paid out a premium if a loan defaulted. Paulson essentially, had a lot to gain if housing went bust and (the SEC alleges) his firm influenced the Goldman fund’s portfolio picks to emphasize the dodgiest of the debt.

3. Why is this Goldman’s fault? Seems like Paulson is the bad guy.

Paulson so far hasn’t been implicated in any shenanigans though there’s a case that he should be. Goldman made the critical mistake not to be disclose to prospective investors the involvement of Paulson & Co. and their bearish view. In their response, they say ACA an “independent and experienced portfolio selection agent” and the largest investor in the fund, selected the portfolio. But how independent were they if they were the largest investor? And selected from what- a list given to them by Paulson?

The moral takeaway- and the thing that is really going to tarnish Goldman (and the stock market) in the long run is how arrogant and clueless those involved come across. “Fabulous Fab,” the named orchestrator behind the particular fund, is a straight-to-screen character. His now-famous 2007 email says it all:

“More and more leverage in the system, The whole building is about to collapse anytime now…Only potential survivor, the fabulous Fab[rice Tourre]… standing in the middle of these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstruosities!!! (sic)” he wrote in an email to a friend in January 2007, according to the SEC.

via¬†‘Fabulous Fab’ emails revive broker conflicts – MarketWatch.

Surely politics has more than its share of ignorance and arrogance and the timing of the SEC probe could not be more politically-perfect for the Dems and Obama’s financial-reform agenda. But fraud is fraud and meddling in things you don’t fully understand is always a bad idea, be it home renovation or statistical derivatives models.


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  1. collapse expand

    The U.S. Securities and Exchange Commission used to receive high grades for ferreting out and prosecuting finanical fraud. During the 1970s, I wrote about the agency often as a Washington correspondent for newspapers and magazines.

    The vigilance at the SEC seemed to diminish starting in the 1980s, as legislators, presidents and judges made wisely aggressive regulation increasingly difficult–and often downright unpopular.

    Here’s hoping that the SEC vigilance in the Goldman Sachs case, however belated, is the dawning of a renewed regulatory era. Greedy Wall Streeters, greedy bankers, greedy automobile makers, greedy pharmaceutical executives and corporate executives in most other industries cannot be trusted to regulate themselves in the public interest. Anybody who cares about the public welfare must admit that truth.

    • collapse expand

      With Bill Clinton’s daughter working at a hedge fund, and Barack Obama’s administration infested with GS fraternity brothers, the outlook for democrats to seize upon this out-sized political opportunity is iffy. Money loves power. Politicians are addicted to power. As Niall Ferguson has chronicled: money has risen to the top of the power pecking order. It will take national will and a complete change of thought process for the majority of Americans to see this opportunity through. An Ancient philosopher once said: “A 1000 mile journey begins with the first step.”

      In response to another comment. See in context »
    • collapse expand

      Well you put a fraud in the White House…and this is a set up between the fraud in the white house , the SEC, and GS to dupe the public…..to give more dictatorial powers to The Chosen One….the shit bumm in the white house

      In response to another comment. See in context »
  2. collapse expand

    The SEC case against Goldman is built upon a sand foundation, and the case doesn’t show the main cause of the financial crisis.

    The CDO at issue didn’t contain actual assets. It was a synthetic CDO tied to assets that paid if the value of the underlying assets changed. In other words it was a bet on the performance of the dollar value of the assets.

    ACA officially selected the assets and insured again their change in price. ACA was the housing expert. John Paulson wasn’t a housing guy nor did his hedge fund trade in housing products. He merely made a bet against housing.

    One could buy protection on 10 million dollars of asset protection for about $65,000 dollars that paid on any decrease on the value of the assets. If you owned mortgages, it would be a reasonable move to buy the insurance.

    If you understood the housing market,financial markets in general and the role of the US government in the housing market in general, it wasn’t a difficult decision to understand the housing market was on a sand foundation. But this wasn’t received wisdom on Wall Street or Washington at that time.

    In 2007, some sellers of housing insurance told buyers they were throwing good money away by betting against housing.

    Wall Street has a long history of making products that have flaws. But stupidity isn’t against the law. If it were, there’s another group that could be thrown in jail for crafting programs that don’t work.

    One cannot properly correct a problem is it’s not fully understood. If we don’t structure programs properly, will we be known as the smartest people in America who had not the gift of foresight?

  3. collapse expand

    They didn’t know what they were doing? C’mon! More accurately, they didn’t care what the consequences would be. These players didn’t just set up a lemonade stand on weekends. These were college grads, experienced financial officers and major figures in the arena. Laws and regulations are not for the socially conscious, rules are set up to rein in those who put their own interests above the rest of us. These men took advantage of the deregulation and lax enforcement to make buckets of cash. They knew darn well what they were doing.

    • collapse expand

      I agree, these guys made full use of a pretty lax regulatory environment to try to make as much money as they could. Is that bad? Not necessarily- as traders, its their job. What is bad is that I’m not convinced they fully understand the instruments they were trading or the market they were modeling with the Abacus CDO. A computer told them it was a good way to make a buck so they went at it. Grad degrees and experience in financial markets are no sub for common sense.

      In response to another comment. See in context »
      • collapse expand

        Did they understand that subprime mortages were bundled and given triple A ratings? Did they understand the nature of a cyclical economy? Of course they did! They sold crap to their own investors, then hedged their bets by creating and buying insurance packages against the very instruments they were marketing as golden. They were glorified car salesmen selling a product they knew was crap and then insuring themselves against the inevitable crack up. Don’t buy into another example of the “no one could have known” excuse.

        In response to another comment. See in context »
  4. collapse expand

    Common sense is what motivated the buyers of the CDO. For peanuts, one could insure against price change of a financial investment.

    The CDO product worked. The players were all experienced investors. No losses were unintentional or part of Wall Street business risk. The public wasn’t effected in the SEC claim against Goldman.

    If you seek economic harm caused, you must look elsewhere and you need a scorecard.

  5. collapse expand

    I like your analogy in the beginning, since trust is the foundation of banking, these people are just modern day big city cannibals, and when the pendulum goes to far, regulation is how we bring it back. Let them cry. The video is great, I needed that!

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    About Me

    I am a Brooklyn-based, Boston-born freelance writer beguiled by the lives, moves, thoughts and impact of those heroes of capitalism (or plain lucky bastards) we call billionaires. My fascination with these moneyed Masters of the Universe started while I was a reporter at Forbes Magazine where I spent my days tracking and tallying billion-dollar fortunes from Aspen to Auckland.

    Before Forbes I worked for Outside Magazine in Santa Fe- just long enough to pick up a pair of cowboy boots and an addiction to green chile- and prior to that did a stint shuffling papers for rich Emiratis at a Dubai investment bank before deciding it was much more interesting to stalk them than work for them.

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