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Goldman responds point-by-point to SEC charges

Goldman Sachs Group, Inc.

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Now that we're past the shock-and-awe phase of the SEC's bombshell fraud charge against Wall Street megabank Goldman Sachs that landed in the middle of Friday's trading, we can bring some more analysis to situation and take a look at what Goldman is saying today about its actions.

In a somewhat overheated moment, British Prime Minister Gordon Brown (Labor, or liberal, Party) accused Goldman of "moral bankruptcy." So that's the sort of outrage this charge is bringing in some quarters.

First, a quick recap: At the urging of hedge fund manager Paulson & Co., Goldman designed an investment vehicle called a synthetic collateralized debt obligation, or CDO. Paulson believed the housing boom was about to go bust and wanted to bet against bundles of bad subprime mortgages he believed were going into default. Goldman allowed Paulson to pick the bad mortgage packages that went into the CDO. Then, Goldman got more investors, including European insurance companies.

The SEC charges that Goldman committed fraud by not telling the other investors that the guy who wanted to bet against the crap mortgages picked the crap mortgages to go into the CDO.

No one disputes that this CDO was designed to fail. Paulson believed subprime mortgages were going to crash and he, being a good capitalist, wanted to make money on that fact. Goldman wanted to satisfy a big client and make a big management fee -- in this case, $15 million.

Whether this thing was meant to fail or not is not the point.

The point is: How much was Goldman obligated to tell other investors in the CDO and did it fulfill that requirement?

Goldman is defending itself by essentially saying everyone involved in this case was a big boy and knew how to play by big-boy rules. No naifs were fleeced in this transaction, Goldman is saying. Both sides bet; Paulson won, the other side lost.

However, others say that the European investors believed in good faith that they were insuring a financial instrument, rather than allowing themselves to get sucked into a high-stakes poker game. And ProPublica reports that several other banks created the same kind of investment vehicles that Goldman did. The Wall Street Journal is reporting that the SEC is looking at similar deals structured by other big banks.

Goldman responded today with a lengthy defense of its actions, which I have bulleted below, quoting from the release:

  • Goldman Sachs lost money on the transaction: Goldman Sachs, itself, lost more than $90 million. Our fee was $15 million. We were subject to losses and we did not structure a portfolio that was designed to lose money.

  • Extensive disclosure was provided: IKB, a large German bank and sophisticated CDO market participant and ACA Capital Management, the two investors, were provided extensive information about the underlying mortgage securities. The risk associated with the securities was known to these investors, who were among the most sophisticated mortgage investors in the world. These investors also understood that a synthetic CDO transaction necessarily included both a long and short side.

  • ACA, the largest investor, selected the portfolio: The portfolio of mortgage backed securities in this investment was selected by an independent and experienced portfolio selection agent after a series of discussions, including with Paulson & Co., which were entirely typical of these types of transactions. ACA had the largest exposure to the transaction, investing $951 million. It had an obligation and every incentive to select appropriate securities.

    Here is a good Q&A on the whole magilla from the Wall Street Journal.

    Even if all the parties involved in this high-stakes, highly sophisticated deal were big boys, that's only part of the story and that part -- in and of itself -- means little to average Americans. A bigger question to ask is: How much did these big Wall Street deals extend the housing bubble longer than it should have lasted and made it more painful when it eventually popped? In other words, did they know there would be average American victims because of their actions and did their deals make the situation worse than it would have been?

    Those, by the way, are not necessarily questions that could lead to a legal charge, but they are worth asking. It may very well end up that Goldman did nothing wrong -- legally -- and the firm ends up paying some sort of settlement in which it neither affirms nor denies wrongdoing. If history is any guide, Fabrice Tourre, the 31-year-old Goldman exec who set up this CDO transaction, is probably toast. Goldman may characterize him as a rogue operative and offer him up as the sacrifice the SEC demands.

    The job of Wall Street is to create capital and make our capitalist system run at its highest rate of efficiency and return for as many parties as possible. There will be winners and losers and that's the price we accept for having this system.

    At the same time, however, not every American knows or understands or is able to play by big-boy rules. And they often get caught in the backwash of the schemes run by the Wall Street elite.

    Follow me on Twitter at @theticker.

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    By Frank Ahrens  |  April 19, 2010; 12:22 PM ET
    Categories:  The Ticker , Wall Street  | Tags: Business, Collateralized debt obligation, Goldman Sachs, Hedge fund, Mortgage-backed security, SEC, Subprime lending, Wall Street  
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    Next: Lehman Brothers, the evil Repo 105s and the danger of off-balance-sheet deals

    Comments

    Please accept the lack of comments as an endorsement of this: The damage is done.

    Posted by: NewThoughts | April 19, 2010 1:02 PM | Report abuse

    If Goldman had told these "sophisticated investors" about the garbage in the CDO's they would have just laughed at them. It seems, in retrospect, that the people on the buyer side of these deals were idiots. The fact is people like Paulson, who got it right, were being laughed at. This is much ado about nothing. The real culprits in this mess are the rating agencies, Moody's and S&P. The level of negligence on their part is mind boggling, and it is a mystery to me how they are still in business.

    Posted by: marknelso | April 19, 2010 1:27 PM | Report abuse

    Is the SEC allegation against GS just the tip of the iceberg ? Do the " Big Time Poker Players" in Wall Street even care about the socio economic consequences of their actions on the rest of society when they bet against each other ?. Should we expect them to care ?. Throughout history, the regulatory authorities have always played a game of "catch up" similar to the "confessional and penance" and then allowing the penitent to go back and commit sins which are more sophisticated/innovative".
    "Main Street" has to suffer the consequences in the aftermath until Wall Street restores some semblance of economic stability.
    I wish it were "Go back and, hopefully, sin no more !". But it is more likely to be " Keep on running faster and for heaven's sake, innovate and don't get caught".

    Posted by: hermanz28 | April 19, 2010 1:58 PM | Report abuse

    Goldman is just the tip of the iceberg and their will be plenty of hollering similar to Gordon Brown's when more details emerge regarding other american banks and their casino like practices of shilling these products to european and other investors.

    Posted by: snake_taylor | April 19, 2010 1:58 PM | Report abuse

    It may well be that Goldman's behavior was at least on the borderline of being acceptable given the premises that were being used at the time. But, the trial is more likely to be about whether those premises are really an acceptable way to do business. Making loans is supposed to be about lending money to borrowers with a good expectation that they will repay the money not on giving money to borrowers and betting that they will not be able to pay it back. Clearly, our financial system got badly off track and these complicated hedged bets were a significant part of the problem. The fact that Goldman participated significantly and made money off this kind of operation without losing much when the market collapsed certainly opens them to suspcion. But the bigger problem is to get the big financial institutions to face the reality that these kinds of practices are not going to be acceptable in the future.

    Posted by: dnjake | April 19, 2010 2:20 PM | Report abuse

    It is to the advantage of the Mega rich to keep the American people ignorant. And they spend millions to keep them ignorant,angry, and paranoid about "big governemtn".
    The fact remains that:
    Government did not swindle us out of our life savings - Wall street banks did.
    Governemtn did not outsource 15 million jobs overseas, private industry did.
    Government did not gouge us on energy prices, Enron did.
    Government did not buy up our mortgages and leave us homeless, The banking industry did.
    Government is not the ones brainwashing the masses into thinking that "big government" is the cause of all our problems, the propaganda machine of the Mega rich are, i.e. Rush Limbaugh,Beck,Hannity,bortz, Faux News are.
    Wake up teapartiers, you're being bamboozled.

    Posted by: backsmith2 | April 19, 2010 2:28 PM | Report abuse

    Goldman sure knows how to keep stepping in it. This smells of moral turpitude on Goldman's part. They appear to be a bunch of financial crooks with a lot more to answer for:

    Did Goldman present this CDO as a legitimate investment? How much did Goldman hide?

    Were both sides really betting? Did Goldman fail in their fiduciary duty to their customers ... did they tell the customers these bonds are likely to fail. What customer would buy a CDO that was going to fail? Goldman fails the sanity test.

    Paulson apparently made $ 1 billion from this deal. Goldman/ Paulson doesn't say how? Was Paulson able buy a credit default swap from, say AIG, on these CDOs so that the U.S. tax payer is now paying for the default. Were they able to short the CDO? Did Goldman buy any credit default swaps and also benefit from the U.S. taxpayer?

    The Paulson Hedge fund,no doubt, used leverage i.e. borrowed money from Goldman that Goldman probably got from the FED window at near 0 % interest rates. If so why should the U.S. taxpayer subsidize such crookery. So how many other fees did Goldman make on this deal?


    Posted by: fedupindc | April 19, 2010 2:54 PM | Report abuse

    I think your comments that this scandal will be limited to Mr. Tourre are naive at best. Have you read the New York Time's recent reporting on this subject (e.g. "Top Goldman Leaders Said to Have Overseen Mortgage Unit," 4/18)? There is no way the SEC is going to want to settle simply for Mr. Tourre when his higher-ups had their hands all over this deal...

    Posted by: jerkhoff | April 19, 2010 5:16 PM | Report abuse

    Old guys say it appears things got a little excited and uncomfortable, that's all. It snapped. It looks to be snapping back. It's not popular. Maybe the charges will be dropped. I'm way beyond the credit line, I'm on the danger line.

    Posted by: tossnokia | April 19, 2010 5:47 PM | Report abuse

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