This is juicy — the New York Times just reported —
Goldman Sachs, which emerged relatively unscathed from the financial crisis, was accused of securities fraud in a civil suit filed Friday by the Securities and Exchange Commission, which claims the bank created and sold a mortgage investment that was secretly devised to fail.
The move marks the first time that regulators have taken action against a Wall Street deal that helped investors capitalize on the collapse of the housing market. Goldman itself profited by betting against the very mortgage investments that it sold to its customers.
Goldman investors lost billions, the article says, but Goldman ended up making money on the “investment instrument.”
The “instrument,” called Abacus 2007-AC1, was packed with mortgage bonds chosen by John A. Paulson, a hedge fund manager widely praised for correctly predicting the bursting of the housing bubble. The SEC says Paulson chose bonds he believed would default. Marketing materials for Abacus claimed the bonds were being chosen by an independent third party, when in fact they were chosen by someone intended to make a lot of money from the deception.
I’m not entirely clear how one might “bet against” a fund, but as I understand it Paulson and Goldman Sachs took a ton of insurance (mostly from AIG) on the fund so that they would clean up when it went bust.
I hope this signals the Obama Administration is getting tougher on the Golden Parachute crowd.
Update: Andrew Leonard at Salon clarifies things a bit:
According to the SEC complaint, in early 2007, at the request of John Paulson, a prominent hedge fund trader, Goldman Sachs created a security — called Abacus 2007 AC-1 — built from underlying mortgage-backed securities that Paulson had cherry-picked as most likely to blow up. While Goldman Sachs then turned around and sold the security to its own clients, Paulson and Goldman bought credit default insurance on the underlying mortgage bonds. Paulson and Goldman cashed in, while Goldman’s clients lost millions. At no time did Goldman divulge Paulson’s involvement to its clients.
Update: Paul Krugman’s column was written before this news came out, obviously, but it sorta kinda relates.
The case shows how pathological the markets had become. The cart was beginning to drive the horse: rather than packaging mortgage-backed securities together and selling them around the world in order to spread risk, such products were being created for the sole reason to permit traders to short them and make money on their almost certain failure. As blogger Yves Smith pointed out in her withering review of Michael Lewis’s new book, The Big Short, such short sellers kept the subprime market going long after it should have died a natural death by creating products that fooled investors into thinking the market was healthier than it really was.
Even as I keyboard, someone at Reason must be frantically writing a “Hit & Run” blog post that blames government regulation.
Update: The libertarians at Reason so far haven’t commented on the Goldman Sachs situation. So far the only pushback I’ve seen from the Right is that Goldman Sachs was Barack Obama’s biggest Wall Street contributor during the 2008 elections. In other words, it’s the old McCarthyite guilt-by-association trick.
Goldman Sachs was a major contributor to both the Obama and McCain campaigns, according to OpenSecrets.com, although it’s true Goldman Sachs gave more money to Obama. But then, so did just about everybody.
McCain’s top five contributors (individual contributions bundled together by industry):
Merrill Lynch $373,595
Citigroup Inc $322,051
Morgan Stanley $273,452
Goldman Sachs $230,095
JPMorgan Chase & Co $228,107
Looky there — they’re all from the financial sector.
Barack Obama’s top five contributors:
University of California $1,591,395
Goldman Sachs $994,795
Harvard University $854,747
Microsoft Corp $833,617
Google Inc $803,436
A little more variety, there.
Update: Reason, the Cato Institute blog and the Lew Rockwell site still haven’t posted anything about the Goldman Sachs issue as of 5:30 pm. I guess they’re still struggling to find a way to blame government regulation.