Friday, April 16, 2010

Behind The SEC Suit Against Goldman Sachs

 In a column I posted April 14 I suggested the financial reforms now under consideration by Congress were for the most part going too far that would impede the banking institutions from conducting business. My bone of contention was that the laws we already have could be tweaked for improvements but if they had been diligently enforced by regulators leading up to the 2007 housing market collapse followed by the September 2008 financial market meltdown the twin disasters could have been avoided.

My premise couldn't have been better illustrated by the Securities and Exchange Commission, under new management by the Obama administration and the same old rules, filing suit Friday against Goldman Sachs in connection with constructing and peddling a deceptive investment that cost thousands of investors billions of dollars in losses.

Goldman Sachs, the most prestigious financial institution on Wall Street, pleaded its innocence in the strongest of terms and claimed it, too, had lost money on the venture.

Daniel Gross, author and financial writer for Newsweek, explains how Goldman Sachs favors one set of naive investors over a selected clientele in which they are beholden.


Goldman is just a puppet whose strings are pulled by all-powerful clients. But on Wall Street there is a thin line between clients and easy marks. And Goldman has been accused of not always acting in the best interest of its clients. Several of the books about the financial crisis have noted that Goldman scaled back its exposure to subprime debt while continuing to peddle subprime bonds and securities backed by risky mortgages to clients. Henny Sender reported this week in the Financial Times  that a $1.8 billion real estate fund managed by Goldman has lost 98 percent of its value since 2005. Yes, Goldman lost money too, because it invested alongside its clients in the fund. But the firm has also collected tens of millions of dollars in management fees for lighting its clients' funds on fire.
And at Goldman, according to Friday's SEC complaint, some clients are clearly more important than others. The case alleges that at the behest of one client, the hedge fund Paulson & Co., Goldman cobbled together a CDO (a collection of mortgages) that it would then sell in pieces to other customers. Paulson wanted Goldman to create the CDO just so it could bet against it—Paulson thought the mortgages in the CDO would default at a high rate, thus rendering big chunks of it worthless. It's kind of like a developer (Paulson) commissioning a construction firm (Goldman) to build a condominium tower while purchasing insurance that would pay off in case it fell down. But the SEC complaint alleges the scheme went a step further. The SEC says that Goldman worked with Paulson and ACA, a "portfolio selection agent," to ensure that the edifice was composed of defective and subpar materials. The SEC presents evidence that ACA, as Goldman watched, included in the CDO specific assets that Paulson had chosen. Goldman then proceeded to sell condos (slices of CDOs) to other Goldman clients without telling them of the hazardous design. "In sum, GS&Co arranged a transaction at Paulson's request in which Paulson heavily influenced the selection of the portfolio to suit its economic interests, but failed to disclose to investors, as part of the description of the portfolio selection process contained in the marketing materials used to promote the transaction, Paulson's role in the portfolio selection process or its adverse economic interests," reads the SEC suit.
It worked exactly as intended. Goldman collected a fat fee for building and peddling the dreck. One Goldman client (Paulson) made out like a bandit shorting it. And several other Goldman clients (the unfortunate banks who bought pieces of the CDO) got their faces ripped off. Lloyd Blankfein has said that investment banks like Goldman that focus on serving their clients are simply doing "God's work." Well, yeah, if your God is Mammon.

The New York Times provided the gory details in the civil suit. But first, here's a reflection of the new mood undertaken by the SEC.

“Goldman wrongly permitted a client that was betting against the mortgage market to heavily influence which mortgage securities to include in an investment portfolio,” Robert Khuzami, the director of the commission’s enforcement division, said in a written statement.
The lawsuit could be a sign of a revitalized Securities and Exchange Commission, which has been criticized for early missteps in assessing the causes of the financial crisis. The agency appears to be tracing the mortgage pipeline all the way from the companies like Countrywide Financial that originated home loans to the raucous trading floors that dominate Wall Street’s profit machine.
At a conference in New Orleans on Friday, Mr. Khuzami indicated that he was scrutinizing other deals involving mortgage securities. “We’re looking at a wide range of products,” he said at a news conference. “If we see securities with similar profiles, we’ll look at them closely.”

 Fellas, it's about time.

Readers comments are welcome as long as they remain civil. We reserve the right to delete any comments that are vulgar, libelous and totally irrelevant to this posting. -- Jer 

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