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SEC Sues Goldman for Fraud

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Oooh, things are starting to get interesting.

A number of journalists and commentators (yours truly included) have taken issue with the fact that some dealers (most notably Goldman and DeutscheBank) had programs of heavily subprime synthetic collateralized debt obligations which they used to take short positions. Needless to say, the firms have been presumed to have designed these CDOs so that their short would pay off, meaning that they designed the CDOs to fail. The reason this is problematic is that most investors would assume that a dealer selling a product it had underwritte was acting as a middleman, intermediating between the views of short and long investors. Having the firm act to design the deal to serve its own interests doesn’t pass the smell test (one benchmark: Bear Stearns refused to sell synthetic CDOs on behalf of John Paulson, who similarly wanted to use them to establish a short position. How often does trading oriented firm turn down a potentially profitable trade because they don’t like the ethics?)

The SEC is now mounting a civil suit against Goldman against one of its Abacus trades, which was a series of synthetic CDOs used to take short positions in real estate. Interestingly, the deal in question was on behalf of John Paulson. Greg Zuckerman’s book on subprime shorts, The Greatest Trade Ever, indicated that Paulson wanted to take down the all the credit default swaps created through the CDO issuance process (which would typically leave him 95% short the par value of the CDO, since Paulson would put up the equity tranche, usually 4-5%). The SEC may have started with this transaction because the communications between Paulson and the SEC would make it easy to show the intent, that of putting crappy CDS in the CDO.

Strange as it may seem, structured credit-related litigation is a new area of law, with few precedents. Until the credit crisis, unhappy investors seldom sued dealers and other key transaction participants.

From the New York Times:

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 instrument in the S.E.C. case, called Abacus 2007-AC1, was one of 25 deals that Goldman created so the bank and select clients could bet against the housing market…

As the Abacus deals plunged in value, Goldman and certain hedge funds made money on their negative bets, while the Goldman clients who bought the $10.9 billion in investments lost billions of dollars….

Goldman let Mr. [John] Paulson select mortgage bonds that he wanted to bet against [for Abacus 2007-AC1] — the ones he believed were most likely to lose value — and packaged those bonds into Abacus 2007-AC1, according to the S.E.C. complaint. Goldman then sold the Abacus deal to investors like foreign banks, pension funds, insurance companies and other hedge funds.

But the deck was stacked against the Abacus investors, the complaint contends, because the investment was filled with bonds chosen by Mr. Paulson as likely to default. Goldman told investors in Abacus marketing materials reviewed by The Times that the bonds would be chosen by an independent manager.

Mr. Paulson is not being named in the lawsuit.

Update 11:30 AM. The complaint is here. Reading through it quickly, the SEC is seeking to apply traditional securities law standards (the overarching charge is “making materially misleading statements and omissions in connection with a synthetic collateralized debt obligation (“CDO”) GS&Co structured and marketed to investors,” with the key issue being that John Paulson’s role in having a significant influence in the selection of the collateral was not disclosed:

After participating in the selection of the reference portfolio, Paulson effectively shorted the RMBS portfolio it helped select by entering into credit default swaps (“CDS”) with GS&Co to buy protection on specific layers of the ABACUS 2007-AC1 capital structure. Given its financial short interest, Paulson had an economic incentive to choose RMBS that it expected to experience credit events in the near future.

Yves here. This is also interesting because Paulson appears not to have bought the CDS created to serve as collateral for the transaction, but instead shorted (via Goldman) some of the tranches. We’ve been told that shorting CDO tranches (as opposed to shorting BBB supbrime bonds) was pretty uncommon, but “pretty uncommon” may not be quite as rare as we had been told. Later in the complaint, we get further detail:

Paulson discussed with GS&Co the creation of a CDO that would allow Paulson to participate in selecting a portfolio of reference obligations and then effectively short the RMBS portfolio it helped select by entering into CDS with GS&Co to buy protection on specific layers of the synthetic CDO’s capital structure.

Yves here. Paulson could have simply taken down all the CDS in the deal and achieved the same result. But Goldman itself may have taken down the CDS (a New York Times story on the Abacus program suggested as much), or the swaps could have gone to other clients. Presumably, doing it this way was more attractive to Goldman (arranging a short on a CDO tranche has to have been a higher fee event), but I’m a bit perplexed as to how this mechanism would have been to Paulson’s advantage (unless the shorts on the lower-rated CDO tranches, which would fail first, hence assuring Paulson a faster time to profit realization).

It is also interesting that the SEC is suing Goldman and one of its employees, and not the collateral manager, ACA Management:

Fabrice Tourre [a Goldman employee who is a party to the SEC suit] also misled ACA into believing that Paulson invested approximately $200 million in the equity of ABACUS 2007-AC1 (a long position) and, accordingly, that Paulson’s interests in the collateral section process were aligned with ACA’s when in reality Paulson’s interests were sharply conflicting.

Second update 12:00 PM: Reader Hubert points out that the SEC suit was announced minutes before this e-mail was sent out in Obama’s name. Coincidence?

I cannot stand these Obama missives, so I am only including the beginning, which is sufficient to give you the drift of the gist.

Friend –

It has now been well over a year since the near collapse of our entire financial system that cost the nation more than 8 million jobs. To this day, hard-working families struggle to make ends meet.

We’ve made strides — businesses are starting to hire, Americans are finding jobs, and neighbors who had given up looking are returning to the job market with new hope. But the flaws in our financial system that led to this crisis remain unresolved.

Wall Street titans still recklessly speculate with borrowed money. Big banks and credit card companies stack the deck to earn millions while far too many middle-class families, who have done everything right, can barely pay their bills or save for a better future.

We cannot delay action any longer. It is time to hold the big banks accountable to the people they serve, establish the strongest consumer protections in our nation’s history — and ensure that taxpayers will never again be forced to bail out big banks because they are “too big to fail.”

That is what Wall Street reform will achieve, why I am so committed to making it happen, and why I’m asking for your help today.

Please stand with me to show your support for Wall Street reform.

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144 comments

  1. Tiger

    It is about time Goldman is called out. Will be interesting to see how they battle this (millions of $s in high priced attorneys, the politicians in their back pockets, etc).

    1. NK

      I sincerely hope Goldman does not get away with a slap on the wrist. Instead, I wish the investigation pursues deeper..It is hard to imagine the top-brass at Goldman did not know about this. given how crooked Goldman is, I hope go by the way of Arthur Anderson and become extinct due these fradualent practices

    2. sgt_doom

      No offense, dude, but look at the date. It’s almost time for the 2010 elections. This is simple politics. After the elections this all disappears, with perhaps a minimal fine at best, hardly spare change given all the free money GS has been given.

      1. Bob Falfa

        Sarge, I agree – but as others have pointed out it opens the door for the saps clients and their ambulance chasers.

      2. Gary Anderson

        It is not simple politics. It is an attempt to control a financial system that is so out of control it could be worse the next time. It must be controlled, and the Volcker rule needs to be added.

  2. C

    Big deal–so Goldman now pays ten bucks and neither admits nor denies wrongdoing, and gets to keep all the profits from all of its deals. The SEC pretends that it has a bare minimum of competence. And the band plays on.

      1. lud

        At least it’s “something” right? I was losing hopes that there were going to be *any* legal or political consequences for the big Wall Street banks.

        1. ndk

          I’m not convinced “something” is better than nothing, no.

          A little bit of coordinated kabuki theater — as I’m almost certain this is — serves only to protect the status quo. It gives the populace a sense that something has been done, and anger and frustration are vented. Meanwhile, absolutely nothing regarding the underlying disease is changed.

          It alleviates almost all of the pressure for meaningful reform in exchange for a wrist-slap. I don’t think that’s a good trade.

          1. sgt_doom

            Exactly, and it diverts attention away from two major theatres: those faux “derivatives” financial reform, and the faux commission, the Financial Crisis Inquiry Commission, heavily stocked with the usual hedge fund lobbyists from that hedge fund lobbyist group, the American Enterprise Insitute, and those other influence peddlers, the Peterson Institute.

          2. Doug Terpstra

            Yup, I suspect you’re right, Kaubuki theater, but like you, I long to be surprised, see some teeth in flesh and prison terms down the road. But because the Ministry of Justice is just way too busy doing nothing about Guantanamo so as to be conspicuously out to lunch on this, the greatest financial crime in world history, makes the SEC’s action here most likely theater.

            I mean this is the SEC, right? Following its FEMA-like non-response to Bernie’s $65-billion Ponzi scheme until he turned himself in, I wouldn’t expect much more than a fine and later throwing a few pesky whistleblowers in prison (like the poor guy who blew the whistle on UBS tax cheats).

    1. cougar_w

      Politicians have few loyalties other than themselves. The Democrats are looking like they will be asked to fall on their swords in the next election. Killing off GS would be a very small sacrifice if they could avoid that.

      I’d say this could go either way.

  3. john

    One has to assume the end game has already been negotiated. Who do we think was on each side of the table for that one? Visitor and phone logs would be an interesting study.

    Nice timing, though. Puts Republicans on the defensive w/r/t financial regulation. Headlines today, “mongo” settlement sometime around late September, early October…just in time for mid-terms.

    Second wave of stimulus cash about to start rolling in…gotta admit, it’s setting up to be less of a bloodbath for the Dems than is currently being assumed.

  4. Robespierre

    So if the the SEC says it was fraud then why not a criminal investigation in parallel with the civil one?

    1. charles

      If IKB who apparently lost 150 million $ ( happy happy Germany right now ) lodges a complaint or via BAFIN to the
      DOJ for having been “defrauded”, then the DOJ imho could come into the picture, as there are also all of the investment banks involved in the Magnetar trade in the package. Luckily
      California made some space available in its jails, lol !!

  5. BenF

    Yves, what do you think this holds for Magnetar?? Similar situation. No wonder the DailyFinance story was taken down, they are probably about to go after Magnetar.

    1. Yves Smith Post author

      No idea whether Magnetar is in the pipeline. Paulson was stunningly blatant about what he was up to. I am amazed at the admissions he made in the Greg Zuckerman book (published at the end of last October). I thought he was asking to be sued. Pressure increased by NY Times piece on Abacus late last year.

      The SEC may not be onto Magnetar yet, they went to some lengths to be low profile, despite the size of their program. Or they may want to get one under their belt (perfecting arguments) before they go after another CDO player.

      1. Ginger Yellow

        The implication of this suit is pretty clearly that anyone doing the “Magnetar trade” is going to be hit by the SEC. As Yves says, they may wait to see how the courts react to this test case, but the logic applies across the board. If the arrangers knew about the short positions and didn’t disclose it, that’s the basis of a civil fraud suit. The only question is whether the SEC has good evidence that the arrangers knew about the short position.

        1. Kid Dynamite

          but Paulson (and thus, Magnetar) isn’t being prosecuted here, right? The complaint is against GS.

          from the cnn writeup:

          “Khuzami said Paulson wasn’t charged because, unlike Goldman, which sold the securities to investors, it didn’t have a duty to fully disclose conflicts to other investors.

          1. Yves Smith Post author

            If you would bother to read ECONNED, it clearly states that what Magentar did appears to have been legal.

          2. Kid Dynamite

            right Yves. I never doubted that. so when people talk about prosecuting the “Magnetar Trade,” it should be clarified that just as Paulson isn’t prosecuted here, Magnetar isn’t the party that would be targeted if the “Magnetar” Trade was investigated. The issuing banks would be the target.

          3. BenF

            Kid Dynamite – There was nothing illegal about what Magnetar did, and I wasn’t suggesting there was. I was asking Yves what she thought of the implications for the Magnetar story/issue generally because today’s GS story and the Magnetar CDO trading are closely related.

          4. BenF

            “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.”

        2. Thomasina Jefferson

          Not certain. It will be interesting to see how the SEC handles this case.
          It might lead to further, similiar cases – such as the Magnetar one – being brought, but it might also be that this is the investigation to stop exactly that from happening.
          All you would need to do that is a badly handled case, a judge who throws out the charges and then you have res iudicate and precent and cannot successfully this or another case.

      2. sgt_doom

        But if Alan Greenspan is still with Paulson & Co., that makes Paulson an Untouchable, as if he weren’t anyway in his bracket…..

      3. charles

        A view from Europe ( well the other side of the pond ):
        If any other ‘victims’ from the fraud, namely most likely
        the investors to whom were resold the ‘fraudful’CDO’s by
        the European investments bank-either on the buying side, on the selling side, or on the intermediary side- such as ABN-AMRO as described in the SEC’s complaints, take action and
        file a complaint for “fraud” not through SEC, but directly through the DOJ, say IKB for example, is that a remote possibility ? Understandably other European investments banks could be sued also , such as the Deutsche Bank, for çomplicity in / of fraud’, I am thinking from the line
        existing in European law between ‘voluntary’ and ‘complicity ‘

  6. Tim

    I cannot stand these Obama missives, so I am only including the beginning, which is sufficient to give you the drift of the gist.

    Those emails are written for the masses, not Harvard grads.

    I think none of this is a coincidence:
    1. GOP: No, no, no.
    2. Wall Street Lobbying
    3. Wall Street fuck you on our pay.
    Etc, etc, etc.

    My theory is, Obama learned alot about the health care reform getting outta hand and losing the message vs. the lies that took over.

    Now – they went aggressively right for the top.

    Note:
    1. Tax Day.
    2. Expiration day.
    3. GOP signing another stupid non-thinking “no” letter.

    1. Kathi Berke

      Absolutely true. Dems must set agenda with clear narrative: Wall Street sold you gasoline-soaked house, bought insurance against it, then torched it with your money.

      Not ready for the South to rise again.

    2. sgt_doom

      “My theory is, Obama learned alot about the health care reform getting outta hand and losing the message vs. the lies that took over.”

      Geez, how can anyone be so self-deluded? Just look at all those neocon, Wall Street lobbyists, pharmaceutical lobbyists, private equity types, and Monsanto lobbyists Obama has appointed.

      Please, catch a clue, for chrissakes, already!

      Obama didn’t “learn” anything from healthcare reform, it was simply a pre-set deal, with insurance exchanges now paid for by the taxpayers, instead of the health insurance and pharma. industries.

      It was Step #1 in the privatization of taxation.

      I realize all this involves a bit of reading and study, but could you please leave all that magical thinking at home.

      It doesn’t matter what you WISH for, or HOPE for, it matters what the actual reality is.

      Obama’s econ advisors were Robert Rubin (one of the gang) and the chair of UBS America.

      McCain’s econ advisor was Phil Gramm (one of the gang) and the vice-chair of UBS America.

      Beginning to finally notice a pattern here?????

      1. Tim

        My point was simply this if you had cared to folks the logic:
        1. Obama fucked up allowing flat out lies take hold in the media.
        2. Financial reform? I dare the insane wing of the GOP make shit up again. And I’ll tell ya what. We’re starting by charging the most powerful in a case where we have no downside. In that – if this isn’t fraud, if this isn’t illegal then why the he’ll isn’t it?!!!

        My bet is – GS wins most of this case – but the facts from transparency will finally get people for real reform.

        1. sgt_doom

          I sincerely hate to rain on your parade, Tim, but if there was any hope for reform, they wouldn’t have marched Bradley Birkenfeld off to jail (check out UBS’s P.E.P. department).

          Nope, that Financial Crisis Inquiry Commission is staffed with rubes from the American Enterprise Institute (hedge funds lobbyist group, officially or not, that’s what it be) and the occasional Peterson Institute clown.

          No boat rockers aboard that ship…..

    1. MyLessThanPrimeBeef

      I believe calling things and people by the proper name is the minimal step to meaningful interaction among the involved.

      So, for example, perhaps the Supreme Court buidling should be renamed Public Servants Building No. 1, the Capitol be called Public Servants Building No. 2 and the White House Public Servants Building No. 3, etc. and the Chief Justice of the Supreme Court Public Servant No. 1, the Speaker of the House Public Servant No. 2, so on and so forth.

  7. John

    How did GS hedge its exposure after writing the CDS for Paulson? Is there an AIG connection? Were some of the Goldman positions Treasury bailed out when they payed AIG counterparties 100% on the dollar related to this trade?

    1. VenusVictrix

      John –

      I question this too. See my more detailed comment below.

      I’ve been interested in this problem with the AIG story for a long time.

    2. Yves Smith Post author

      There’s a description of how a synthetic/heavily synthetic CDO is put together (as in transaction mechanics) in Appendix II of ECONNED.

      Briefly, the other side of the CDS is the CDO. The dealer typically does not put a deal together until he has the equity tranche lined up and often the AAA tranche “buyer” (which remember can be a monoline, since a guarantee will also serve to lay off the AAA/supersenior tranche risk). So when the CDO closes, the dealer is often long the BBB, A, AA, and sometimes the junior AAA tranches. Those need to be disposed of, pronto, with the usual suspects correlation traders and less sophisticated foreign institutions.

  8. chris trakas

    Looks like they’re gonna try and put this all on Tourre.

    Yeah, like this 31 year old (20 something at the time) could have caused the global derivatives crash all by himself.

    The real criminals will remain unscathed.

    1. Tom

      I agree – I find this especially implausible. He is the only Goldman employee named. While they have his emails, It seems hard to believe he was operating alone.

      1. Mr. E

        This is how you roll someone small. Put them on the spot and they will avoid jail time by telling on their superiors.

        they are doing this in public, rather than private, because they know the trail leads to the top. People are going to talk like crazy to avoid jail time. This goes all the way to the top.

  9. Doc Holiday

    http://www.zerohedge.com/archive/all/article/moodys-puts-143-billion-jumbo-rmbs-downgrade-review?page=4649
    Goldman’s seven Abacus deals [Abacus 2004-1, Abacus 2004-2, Abacus 2005-2, Abacus 2005-3, Abacus 2005-CB1, Abacus 2006-NS1, Abacus 2007-18] were unique among all the CDOs in AIG’s portfolio. For all the other deals, the collateral manager, the entity that oversaw and managed the CDO after closing, was entirely independent from the bank that originally arranged and structured the transaction. For all the Abacus deals, Goldman acted both as both the arranging bank and the collateral manager. This is no small technicality. In other Abacus deals, Abacus 2006-13 and Abacus 2006-17, Goldman used its “sole discretion” to retire lower rated CDO tranches without regard to seniority. This approach, under documentation drafted by Goldman, upends the entire premise of structured finance.
    Most importantly, the government never purchased the Abacus deals when it bought $62.1 billion other CDOs at par, back in November 2008. Why didn’t the parties feel a need to take the Abacus deals off of AIG’s balance sheet? It’s an extremely important question, for which we will not have an adequate answer until we see the actual documentation, specifically: the offering memoranda, the performance reports and swap agreements.

    1. Tim

      I’m in your cave, optimizing your database.

      Slide.

      (We’re updating Project Mayhem. Zero Hedge will be right back).

      Does this mean essentially:
      “Goldman used its “sole discretion” to retire lower rated CDO tranches without regard to seniority.”

      GS simply changed the rules of the game during the game?

      1. Doc Holiday

        GS simply changed the rules of the game during the game?

        The old saying, that “it may be a crooked game, but it’s the only game in town” is very appropriate, and with Paulson in the White House, and the FTC, and the SEC, the Treasury, Homeland Security, small-time Americans had no chance to win in this crooked game of conspiracy. These are financial terrorists and they are running America into the ditch.

        Why do we allow Goldman and the crooks on wall street to run around un-touched by our laws, and then hunt al Qaeda terrorists down? If there is justice in America, we need all crooks to be in jail!

        The SEC says, “It was Goldman that made the representations to investors. Paulson did not.”…

        Paulson helped make the bombs, just like Warren and Bush, and a long string of people in this conspiracy to defraud …. so what will happen? Goldman will be fined $10,000 and then the Dow will spike to 25K and then the business of corruption will go on as usual!

        1. sgt_doom

          Thank you!

          It is really getting silly when people attempt to micro-analyze everything down to the smallest possible action.

          Just step back for a moment and reflect upon the macro picture: credit derivatives are the tool of choice for the ultra-leveraged speculation used to rig and manipulate the markets.

          This is what they do. This is how they continue to get those profits while screwing up the planet.

          End of story. And this is why they won’t allow their securizations, and securitized financial instruments (thousands of types of credit derivatives) to ever be changed or altered or regulated.

          It MUST stay opaque and non-transparent.

          1. Tim

            This was my semi macro question: they not only made garbage, made fees & bet against it- we actually created this garbage so we could choose how we blow it up.

            Is that what this means:
            ““Goldman used its “sole discretion” to retire lower rated CDO tranches without regard to seniority.”?

        2. Evelyn Sinclair

          There’s a great scene in a W.C. Fields movie, where he invites a young man to play poker.

          The young man says, “Gosh, is that a game of chance?”

          Fields mutters, “Not the way I play it, no.”

  10. Blurtman

    Yves,

    I hope you start changing your tune about crimes that have been committed by investment banks.

    And think about it – we have had a recent US Treasury Secretary (the other Paulson) who is a major league felon.

    A cheesy fraudster as Treasury Secretary and war crimninal president and vice-president.

    Sad.

  11. anon

    Why did the SEC choose the VP? VPs are pretty low on the totem pole and I presume ACA is a major Goldman client who would probably be serviced by staff at a higher pay grade No one at that level would have been the closer. No?

    What’s the SECs strategy here? Get an easy hit on the low level guy to protect the bigger guys, or go after the junior guy first in the test case, then target the higher ups in the next round if this case is successful?

    I would think it would be easier to go after Merrill (although the BoA takeover makes them a more complicated target), since they’re a sloppier shop and they did tons of this stuff with more obviously captive collateral managers.

    For the time being I’m going to believe the SEC has grown a pair and wants to proceed effectively. Not holding my breath but I think we’ve finally reached a tipping point in the last few weeks. (Lehmans bankruptcy issues, Magnetar,Greece, Jefferson county, the Maidens disclosures, Greenspan/Rubins farce testimony.)

    1. chris trakas

      maybe pressure on Tourre will get him to spill the beans. that could lead somewhere, yes…

      1. sgt_doom

        Yeah…..riiiiigggghhtt….really worked great for that other phony, Patrick Fitzgerald….

  12. Doc Holiday

    “The simultaneous selling of securities to customers and shorting them because they believed they were going to default is the most cynical use of credit information that I have ever seen,” Sylvain Raynes, an expert in structured finance at R & R Consulting in New York, recently told The New York Times. “When you buy protection against an event that you have a hand in causing, you are buying fire insurance on someone else’s house and then committing arson”
    How Goldman Sachs Made Tens Of Billions Of Dollars From The Economic Collapse Of America In Four Easy Steps

    http://theeconomiccollapseblog.com/archives/how-goldman-sachs-made-tens-of-billions-of-dollars-from-the-economic-collapse-of-america-in-four-easy-steps

    1. sgt_doom

      Excellent simile or analogy (I forget those college English course terms now), but I would further elucidate by saying it is more similar to buying hundreds, or thousands, of insurance policies on an unsuspecting entity, then burning down their house and collecting on those policies, all the while the entity is unaware of why their credit is now forever baaaaad.

    2. Skippy

      I prefer the analogy of: select houses (BBB) were dowsed with petrol, and they burnt down a world (AAA), as a mechanism of camouflage.

      Skippy…how were we to know that it was civilians in the house / wedding party and not terrorists planing their next strike…well there was one or two attending any way…missions accomplished.

    3. Doug Terpstra

      It’s increasingly impossible to argue logically that these are not serious, widespread crimes, and it is self-evident that laws to the contrary are invalid on their face. Given the monstrous aggregate cost to the world of this corrupt casino racket, the penalties to be paid to society must be harsh as a stark deterrent.

  13. steelhead23

    I fully expect MSM to scream that SEC is causing a market crash by unnecessarily going after a well-respected market-maker, primary dealer, etc., etc. That is, the cops will be blamed for the crime. I hear that Cramer already has. Praise Allah for the blogosphere.

  14. Cathryn Mataga

    This is a total guess, but I’ll
    bet 2 whole dollars, Obama heard the “This
    American Life” story. Their comparison
    to “The Producers” in the
    form of musical comedy might have
    penetrated the thick haze of Banker-speak
    being fed into his ears.

    1. sgt_doom

      Dream on, Ms. Cathryn, dream on.

      By any chance, your being so sold on this “President Obama as different from all those other presidential lackeys,” — do you happen to know the background of any of his appointments such as:

      Diana Farrell, Laura Tyson, Larry Summers, Timothy Geithner, Tara O’Toole, Robert Hormats, Richard Holbrooke, Gary Gensler, etc., etc., ad nauseum to the max?

      By any chance, do you happen to know who Henry Kissinger is and was? Did you know Obama appointed him early on?

      Do you know that over 50% of Obama’s top appointments happened to work, at one time or another, for Henry Kissinger?

      Or are you completely happy in your blissful ignorance?

  15. Blurtman

    Recall Obama’s March 2009 appearance on the Jay Leno show where he said that everything that happened, while terrible, was legal.

    What a tool! And fool.

  16. Hugh

    I think it is safe to say that Obama has not gotten religion. The day we see Summers gone and Timmy considering spending more time with his family, maybe, but not before.

    I don’t have a good explanation brought this case at this time. As hard as it is to believe sometimes there actually are a few regulators left trying to do their jobs.

    Meanwhile the stock market is a fully formed, mature bubble. It really could head south at any time. It is all in the psychology. Economics never had anything to do with it. The question is whether this is a crack in the facade à la Bear Stearns or more like the Fannie/Freddie receivership which presaged the soon to follow collapse. As this happened on a Friday, it will give markets time to catch their breath.

  17. Doc Merlin

    It looks like a political move here, to make the white house look tough on wall street, while insulating the actually politically powerful individuals in wall street.

  18. Justicia

    I share concerns that have been expressed about the SEC rolling over for a sweetheart settlement.

    But I’m sure the pension funds and others investors (suckers) on the losing side of the deal are lawyering up. Goldman will have to fork out many hundreds of millions, if not billions, for lawyers and settlement fees. They’d be insane to have these cases go to trial and endure daily drubbings in the media as the juicy bits come to light..

  19. steve from virginia

    Ho hum.

    Nothing has changed, it’s the SEC kittens rather than the FBI/Justice Department Tigers.

    No indictments, no arrests, no collection of files, just Administrative Action leading to a fine and maybe a suspension of trading privileges for a few individuals.

    The culmination of ANY action is years in the future.

    The fine will be appealed and other enforcement challenged in the Courts. Penalties will be overturned on appeal – years from now when the particulars are long forgotten.

    This is simply Obama tossing some illusory red meat to the teabaggers.

    (Goes back to sleep!)

  20. brad

    Hopefully, SDNY piggybacks on the civil lawsuit with a criminal prosecution. As already mentioned SEC lawyers are either in league with the banks or incompetent or both. The same can not be said for the SDNY lawyers.

  21. KnotRP

    The SEC, much like the policemen in The Sting, are
    there to remove the mark from the scene of the con.

    Fine? One dollah.

  22. Frank Ohsen

    I’ll believe it when I see it = A Parade of Yellow Jumpsuits and not just BS slap on the popo fines.

    Until then as far as I’m concerned it’s still Kabuki.

    FO

  23. LeeAnne

    “But the deck was stacked against the Abacus investors, the complaint contends, because the investment was filled with bonds chosen by Mr. Paulson as likely to default.”

    So, when the facts are laid out by the SEC, all the ‘ foreign banks, pension funds, insurance companies and other hedge funds’ investors to whom Goldman sold the Abacus deal will be suing Goldman for fraud?

    Is that correct?

    1. VenusVictrix

      Remember the Fed already bought all those toxic assets, and shuffled them quickly into the Maiden Lane black box.

      1. sgt_doom

        That may be a premature assessment, VenusVictrix.

        They are still churning out those toxic assets at every opportunity, be they Pinnacle Notes from Morgan Stanley, Citi’s Crises Derivatives, future q-forwards and other mortality-linked derivatives from JPMorgan Chase, securitized notes based on life insurance from AIG (wonder how much their book value will ever be worth??), etc., etc., etc.

        And don’t forget all those Carbon Derivatives in the pipeline to make the big bucks for GS, JPM and Morgan Stanley and the oil cartel (and perahps Al Gore’s Generation Asset Management fund).

        It’s still raining toxic assets (and why they refer to those contracts as assets is most peculiar??).

        1. VenusVictrix

          You may be correct – although I only intended to point out that I think the perpetrators have taken care to cover their tracks. But you’re certainly right that we’ve opened the floodgates and no one is in charge (as usual).

        2. VenusVictrix

          And I agree – that “contracts” as “assets” is a crock of *&^B__S*&^!

          Can’t believe the public buys it. But we have to keep educating, and informing, and respecting the intellect in most people that actually have the critical thinking skills necessary to see that they are being led to slaughter.

          On that happy note, good night!

  24. VenusVictrix

    If Abacus was structured like any of Goldman’s other Cayman Island CDOs then AIG-FP was the hedge counterparty for an interest rate and cashflow swap. As stated in the complaint, Goldman Sachs was the CDS counterparty.

    I would still like to know when and how AIG took on the liability for the CDS guarantees which Goldman was initially on the hook for.

    AIG claims they exited the CDS business at the end of 2005. Then they and Goldman claimed that AIG had issued forward commitments that covered GS through the 2006-2007 period. If AIG had a commitment to provide the credit default swap protection on any of these deals, why are they not identified in any of the circulars? Why are they only identified as cashflow, interest, and in some cases, currency swap providers?

    Did AIG really have a forward commitment with Goldman – or is that just the story they’re peddling to cover-up what in essence appears to be an accommodation of Goldman’s delusional gambling?

  25. Cathryn Mataga

    Even if Goldman does pay out massive
    settlements for fraud, because they are
    “Too Big To Fail” the US government will
    just gives them more free money. I think
    that’s how this works. Heh.

  26. Kathi Berke

    Thank God for Yves. She taught me how to count using an Abacus. First place I learned about those CDOs.

    After SEC conference call this am, a hedge fundster said this indictment was a “witch hunt”. Spin, spin, spin.

  27. Neil D

    If Ms. Smith doesn’t like the Obama “missives” why doesn’t she just unsubscribe? I like them just fine.

    1. Doug Terpstra

      I unsubscribed a while back too, finally when it was clear Obama cut secret deals on corp wealthcare, shut out single-payer, and help scuttle the public option.

      This is really irksome: “We cannot delay action any longer. It is time to hold the big banks [saavy buisnessmen] accountable to the people they serve, establish the strongest consumer protections in our nation’s history — and ensure that taxpayers will never again be forced to bail out big banks because they are “too big to fail.”

      That is what Wall Street reform will achieve, why I am so committed to making it happen, and…”

      “[...and that's why I support Senator Doddering's bill to lock up the 'new and improved' CPA right in the Fox den's kitchen, under the head chef's supervision. That way we can be sure that the same people who presided over and enabled the last crisis will protect the people from the next one."]

  28. Jojo

    Don’t get too excited. Probably right at this moment, discussions are underway about burying this distracting issue.

    GS – How much do you want to fine us?

    SEC – We’re thinking $5 million.

    GS – Do you want a check or cash?

  29. gigi

    I think this goes about as far as Geithner and/or Bernanke resigning over fraud at Lehman, i.e. nowhere. Goldman will be given a slap on the wrist and that is about it.

    There is a corollary to “Madness is doing the same thing over and over again and expecting a different result”. It is “Madness is expecting different behavior from the same people”.

    My apologies for being so harsh. But we need to wake up and realize that without a meaningful change at the top, the bankers remain in charge. ObamaBush are two fronts for the same group. I don’t see how this changes for the foreseeable future.

    1. Ignim Brites

      “ObamaBush are two fronts for the same group.”. Yes it is the American mainstream, cultural and academic. Just remember when the going got hot, Enron was abandoned and Ken Lay was left to his own devices. Same fate awaits GS.

  30. fiscalliberal

    Yves – do you have any confidence in the SEC being capable of prosecuting this case.

    Did they not loose against the Bear Hedge funds?

  31. Chad

    Now, I’m quite the cynic when it comes to politics. So, fair warning.

    This information isn’t new. Now, I understand it takes time to mount a suit based on the evidence. Still…….with the President now focusing on his new financial regulation bill…….the timing of this charge was no doubt timed to coincide with the President’s latests legislative campaign.

    What will be telling will be this will go to trial long after the legislative battle will have been fought.

    If the legislation passes……….which looks very promising………I suspect Goldman will get off with a slap on the wrist. If the legislation doesn’t pass……Goldman may well have a very, very significant problem on their hand……….And, for the rest of wall st. they would certainly be inline for similar suits should this legislation fail.

    Look for the banks to line up overwhelmingly in favor of the new legislation.

    1. lambert strether

      Yes, the banks will be for the financial “reform,” just as the insurance companies were for health care “reform” (despite the sturm and drang, the baseline text of the Senate Bill was drafted by Liz Fowler, a Wellpoint VP on secondment to Max Baucus).

      Chris Bowers is, as ever, the political blogger to read to get the party line. Do you see the option of breaking up the TBTF banks? Neither do I. Bowers has scrubbed it from the discourse; that is his function.

  32. chicago mike

    Yves,

    Don’t forget to investigate Lee Sachs, who worked at Tricadia before joining Tim Geithner’s treasury department.

    As the NYT reported,
    http://www.nytimes.com/2009/12/24/business/24trading.html

    “Some securities packaged by Goldman and Tricadia ended up being so vulnerable that they soured within months of being created.”

    “Among the most aggressive C.D.O. creators was Tricadia, a management company that was a unit of Mariner Investment Group. Until he became a senior adviser to the Treasury secretary early this year, Lewis Sachs was Mariner’s vice chairman. Mr. Sachs oversaw about 20 portfolios there, including Tricadia, and its documents also show that Mr. Sachs sat atop the firm’s C.D.O. management committee.

    “From 2003 to 2007, Tricadia issued 14 mortgage-linked C.D.O.’s, which it called TABS. Even when the market was starting to implode, Tricadia continued to create TABS deals in early 2007 to sell to investors. The deal documents referring to conflicts of interest stated that affiliates and clients of Tricadia might place bets against the types of securities in the TABS deal.”

    (keep the heat turned up.)

    1. Neil D

      Oh and let’s throw everyone in jail who took out a mortgage or refinanced between 2002 and 2008 too. They are guilty of looting our country too. Home equity extracters should definitely go to jail for theft and fraud. They misrepresented the value of their properties. Before you know it, you’ll find most Americans are guilty of some financial crime in the last 10 years.

      1. KnotRP

        > Oh and let’s throw everyone in jail who took out a mortgage or > refinanced between 2002 and 2008 too. They are guilty of
        > looting our country too. Home equity extracters should
        > definitely go to jail for theft and fraud. They misrepresented
        > the value of their properties. Before you know it, you’ll find
        > most Americans are guilty of some financial crime in the
        > last 10 years.

        Uh, yeah, because the banker’s appraiser sure couldn’t have caught the mispricing and denied the loan…oh…wait….the bankers appraisal shopped amongst appraisers to find higher appraisals.

        Not enough?

        Oh, because the bankers couldn’t have verified incomes using, like, real documentation. They ABSOLUTELY just
        had to take the spec^H^H^H^Hbuyer’s word for it.

        Hello? Still there? Need more?

        1. Neil D

          I can’t keep up. Are these people victims of predatory lending or mortgage deadbeats using the equity to buy boats, SUV’s, take vacations, and otherwise live it up?

        2. sgt_doom

          Sorry, knottyrp, but they didn’t write securitization upon securitization upon securitizations so they could do speculation upon speculation upon speculation.

          That is, ultra-leveraged speculations which allowed for those debt-financed billionaires to walk away with all their loot.

          In other words, get real, dude!

          But please never get a bank charter!!!!

          1. Neil D

            Sure, but who loaded up on debt? Individuals ran up their credit cards, used tax deductible HELOC to pay them off, then ran them up again. Sure GS et al loaded the gun, but we pulled the trigger. That’s really all I’m saying.

          2. Doug Terpstra

            Neil’s is right, but profligate homeowners, who banks were begging to take on debt, are almost inconsequential in the big picture and differences in degree, from petty Main Street crime to Wall Street robbery, are differences in kind—on the Richter Scale. It’s ungodly leverage ratios and dirty-bomb CDS derivatives that blew up the world and looted the treasury, no?. This was premeditated.

  33. Tim

    For all you cynics:
    1. What better place to turn around the SEC than GS?
    2. What better charge than simply fraud?
    3. What better product than the garbage CDOs.
    4. What better way to illustrate what an “financial innovation” it is.
    5. What better timing could there be?

    It is clearly up to US to ensure this goes case goes far.
    It is clearly up to US to ensure there are plenty of cases behind it.

    Otherwise – why did Yves, as example, bother digging into this?

  34. Cathryn Mataga

    Really, they’ll find a few mid-level
    bankers to throw to the lions, and though
    this will be fun to watch it is an issue
    apart from whether there’s going to be
    any actual reform.

    As far as derivatives, has this all started
    all over again? Are banks still making
    massive bets that the new bubble keeps
    growing, only for the US taxpayer to take
    the hit, yet again, when the next crash
    comes? This is some kind of crazy economy.

  35. a

    I guess I think the SEC going after Goldman is more serious than most.
    Whoever predicted a few months ago that Blankfein, Goldman’s CEO, would be out within a year is a genius. That’s the safe bet now. That’s the least that will happen.

    And this could really get ugly for Goldman. What brought down Solomon Brothers, then the most profitable IB, was a scandal involving Treasury Bond auctions. It just never recovered from the hit to its reputation, and, believe it or not, reputation is paramount for IBs.

    And, by the way, what is it, anyway, with Warren Buffet and IBs? He was one of Solomon’s biggest shareholders before its collapse, and now he’s in pretty much the same position to Goldman. If I were Morgan Stanley, I would run, not walk, if he were ever in the room.

  36. scharfy

    For those who think this doesn’t have enormous far-reaching implications for Goldman – THEY ARE INSANE.

    This is enormous.

    Pensions, private money, public money, IPO’s – who’s gonna want to touch these guys with a ten foot pole?

    Foreign anti-American banks don’t need any more excuses.

    This is not about the paltry fine they will incur.

    This is about perception, and having a SEC fraud charge associated to your name.

    This will route some % of existing business to the other criminals on wall street – to be sure. Maybe not a game changer on the whole of Wall Street.

    But this hurts Goldman badly. They are salesman for the most part, and people can go elsewhere if they feel things are not on the up and up.

  37. LongAndShort

    I read the complaint and while GS comes off like complete dbags, neither ABN nor ACA entirely innoncent.

    No one forced ACA to accept the names submitted by GS/Paulson. That ACA would select positions based on Paulson’s investment position speaks volumes about ACA. Anyone who trusted ACA needs to live and learn.

    ABN is one of the largest banks in the world. Their geniuses came up with CPDO. At the time, their LaSalle subsidiary was heavily involved in the RMBS market so they had enormous expertise in the field. Again, no one put a gun to their head. They ahd access to the same information that Paulson and GS had.

    1. rootless_e

      I’m totally unsympathetic to the banks who bought this crap. They had to understand that someone was buying the other side of the bet. Who did they think was making their premium payments and why did they think those payments were being made?

    1. scharfy

      Hate to beat a dead horse, but the trial is immaterial. They were involved in shady dealings with a major client.

      This is about goodwill.

      And don’t think the other investment houses won’t play this to the hilt against Goldman to get more business.

      I think the case is, in the legal sense, somewhat weak.

      But they have a rape charge against them. The trial will bring out more facts and “shady” business that will make Goldman appear unscrupulous. It won’t be good for them.

      People will go elsewhere. They are Drexel-Burnham Lambert and have seen the peak of their organization.

      1. anon

        There is no elsewhwere to go. They’ve all done the same trade. That’s the issue here. Goldman just gets to go first.

      2. BenF

        Another thing to consider is whether Goldman itself was shorting any tranches it sold to clients(or any MBS, for that matter). They made money on the housing collapse, remember.

      3. Doug Terpstra

        You don’t think they’ll pay the usual cost-of-business fines and reach a non-disclosure settlement with the SEC and other claimants to quash the teapot tempest? That would let Obama beat his chest about “fat cat bankers” and then let everyone get back to killings-as-usual.

  38. Al

    1. The timing is political- focus on financial industry next week.
    2. Unsubscribed.
    3. Flip the roach
    4. There’s never one roach.
    5. There is a low grade criminal conspiracy, Knot. A societal rip off. The Banality of Evil, Hannah Arrendt.

  39. alex black

    On the “Obama missives” – THANK YOU! I made the mistake of contributing to him early on, twice, and now my two main email accounts are constantly deluged with “Obama missives” – and I ended up voting against the Liar!! I have emailed them repeatedly asking them to take me off their f***ing spam list, that didn’t work – emailed them telling them I hope Obama has a fatal heart attack and please stop sending me his blatant lies, that didn’t work. My inbox is still clogged with incoming missives as to how I can “help” him.

    Does anyone know how to get them to STOP??? Thanks…

    1. NotTimothyGeithner

      I made a promise to vote Republican until a number of people in the administration resigned in disgrace. Getting off the state Party lists was a lot harder.

      In the case of the DNC, I was snarky. I responded how glad I was the champion of the regressive repeal of the estate tax had resigned. I then made note of how Tim Kaine (repealed the estate tax in Virginia) was still there, and I asked why would they be sending me a request for money when the guy in charge champions Republican policy.

      They’ve called since then, but not with the frequency other people get. Maybe some enterprising young person took me off the list?

      1. rootless_e

        “I made a promise to vote Republican until a number of people in the administration resigned in disgrace. ”

        Do you also want the government to keep its hands off of medicare?

    2. Jerry Denim

      The day I saw Larry Summers on TV yapping about how you can’t just abrogate contracts in America, right after I just finished reading the Jake DeSantis letter I went into my mailbox and hit the reply button on a few of the nasuating Obama campaign emails and fired off a fairly intense F-you letter to David Plouffe and Mitch Somebody. The gist of it was F-you for having the nerve to ask me to be a part of what you’re doing and shame on you for fooling everyone into believing they were voting for change. I also demanded my money back and said never, never, ever send me anything again and I couldn’t wait until the next election so I could work to get them all thrown out of office.

      I haven’t recieved any more emails from team Obama but I am still waiting for my refund.

  40. sunny129

    “Indeed the evidence paints Goldman’s role in an excruciating light. To entice in end investors, the bank persuaded an independent credit adviser, ACA Management, to lend its name to the transaction. ACA did so on an understanding it obtained from Goldman that Mr Paulson was to take a long position in the securities. This was not the case. Had ACA not been invol­ved in the trade, investors might not have purchased the securities. What is worse, ACA, now a subsidiary of Royal Bank of Scotland, then insured most of the issued securities. That ACA took an $841m loss when the deal went bad can hardly make for good relations between Goldman and the UK government, which owns most of RBS”

    http://www.ft.com/cms/s/0/4d8a3056-4981-11df-9060-00144feab49a.html.

    There are still ramifications from European Banks/Govt affected by this! Remember UK’s elections are just a couple of weeks away!

    1. rootless_e

      ACA is the party most at fault in this transaction. They put their stamp of approval on it, presumably in exchange for fees that they were paid for supposedly vetting the assets. They have no valid complaint against Goldman.

  41. Brett

    Looks like Fabrice Tourre is going to take the fall, and on CNBC, they’re saying he’s fairly junior.

    Control fraud in action. To SEC investigators: Can a pattern be established?

  42. bird

    Yves – you’re diluting your message with political vitriol. The SEC is finally doing something about what you’ve been complaining about forever. Focus on the big picture – fraud.

  43. Jacob

    We will need to see if there is any follow through from AIG or any of the other insurance houses. If they do not immediatly file suit against both Goldman and Paulson (John), then we know that this is another ‘window dressing white wash’.
    Rogue trader…poor clever bastard. Talk about being groomed for the guillotene. Probably got his bonus in Goldman stock anyway!
    I know there is a lot of jaded cynisism here, but if there is no follow through and no accountability, this market place is just about done. There is nolonger any reason to invest money anywhere.

  44. MJP

    Does anyone have a ballpark figure for the amount of SYNTHETIC CDO’s that were sold into the market, in total? It appears most of the potential fraud allegations will be linked to the synthetics, which I figured all along would be the heart of the fraud, but I can’t find raw numbers on synthetics.

    thanks if anyone is educated on this.

  45. harry

    If Goldman committed a fraud in the sale to the longs, didn’t they also by definition defraud the insurer or cds sellers on the same security? If so, would not AIG (Treasury, the Fed, the American taxpayer) have a right to go after Goldman for the tens of billions that AIG paid it?

  46. curmudgeonly troll

    I’m a little unclear on how ACA could be that stupid and not know it was Paulson.

    It was a ‘synthetic’ CDO. In other words, the collateral was a derivative portfolio that matched the cash flows of the notional underlying – someone was selling that derivative.

    So clearly someone was going short, and you would think they would ask GS, what’s the story behind this deal?

    If GS says, ‘well, client confidentiality yadayadayada, we do deals like this as part of our ordinary business of selling credit protection to people on the bonds they hold and then laying off the risk’, wouldn’t ACA would put 2 and 2 together and say, ‘but it’s not Paulson, right?’.

    GS must have either sold a false story, and depending on how blatantly false, ACA must have been more or less stupid, or simply have chosen to pretend to believe it.

    Am I missing something, or is the fact that it was a synthetic a dead giveaway that it was created to satisfy demand for shorting the underlying?

    1. Yves Smith Post author

      The bit I think you are missing here is that synthetic/heavily synthetic CDOs had been marketed as being equivalent to cash CDOs. And remember, cash CDOs came from tranches of mortgage securities, with loans as the underlying assets. Thus the investors in cash CDOs had believed that the loans were being made by people who did not have an incentive to make bad loans (something we now know is false).

      Even so, demand from traditional “cash” buyers fell off in 2005. But new investors came in with the creation of synthetic and heavily synthetic products. namely correlation traders. Monolines like ACA were also under pressure to keep in the market (synthetic products had become such an important part of their business that pulling back from the market would have led to big falls in reported earnings, which in turn would have produced pushback from investors and ratings agencies. So short-termism trumped sound credit decisions).

      Anyway, an ACA would NOT expect that a single player would be behind the short side of a CDO, and in particular, be in a position to steer it to take on drecky exposures. Remember, the collateral manager was supposed to pick GOOD assets. The dealer would arrange for an auction of the CDS that the collateral manager had identified to assure the prices were fair. And also remember, the protection buyers would not be only shorts, but also parties hedging their business exposure (sometimes to free up capital, which an originator or pipeline player might want to do).

      1. curmudgeonly troll

        Thanks Yves … wild world where people conjured up $1b deals, not to funnel capital to actual mortgages, not even to make a bet on the short side, but just to tune credit exposures or do a correlation trade.

  47. Eric L. Prentis

    All Kabuki theater, designed to placate the gullible masses; Goldman Sachs will get a light slap on the wrist and told to be better boys in the future; Washington politicians will not damage their political version of a sugar daddy, especially since Goldman Sachs pays the politicians’ huge campaign contributions with yours and my money. This is an example of US crony capitalism at its worst; we live in a banana republic not worthy of the name.

  48. florin negru

    This story is just going to fade away because that’s what they want . All we can do is stay away from investing in these companies that defraud the public and mortgage our future with help from Washington .It is a joke played on us. financed by us via Goldman’s friends in Washington and
    AIG. And they talk about client comes first mantra ” which one ,is it the one that has the most connections ” Wake up the game is rigged.

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