Goldman Sachs in trouble
The SEC has charged Goldman Sachs with “defrauding investors by allegedly marketing a financial product tied to subprime mortgages without telling them a big hedge fund was on the other side of the trade.”
My first question was one which appears at the end of the WSJ article:
…Bill Larkin at Cabot Money Management [says]. “The question is, has the SEC discovered what may have been a common practice across the industry? Is this the tip of the iceberg?”
Goldman Sachs stocks have gone sharply down, as might be expected. Goldman Sachs says it is innocent, as might be expected (lt also could be saying, “Some thanks we get!,” considering it was one of the biggest contributors to the Obama campaign in 2008).
Here’s the scoop on what is alleged to have happened at Goldman:
According to the SEC, Goldman structured and marketed a synthetic collateralized-debt obligation, or CDO, that hinged on the performance of subprime residential-mortgage-backed securities.
The CDO was created in early 2007 when the U.S. housing market and related securities were beginning to show signs of distress, the SEC complaint said.
“Undisclosed in the marketing materials and unbeknownst to investors, a large hedge fund, Paulson & Co. Inc., with economic interests directly adverse to investors in the [CDO], played a significant role in the portfolio selection process,” the complaint said.
The complaint said Paulson had an incentive to stuff the CDO with mortgage-backed securities that were likely to get into trouble. SEC enforcement chief Robert Khuzami alleged that Goldman misled investors by telling them that the securities “were selected by an independent, objective third party.”
A specific person with the dramatic-sounding name of Fabrice Tourre (man? woman? literary light? entertainer?) was named as “”principally responsible” for creating the CDO. Here’s some background on the 31-year old Goldman VP and Frenchman Tourre, from the HuffPo. He may not be an entertainer, but he does exhibit a certain flair:
In an email to a friend on January 23, 2007, the London-based trader called himself “The Fabulous Fab” and warned about the coming collapse in the subprime mortgage securities market, according to the SEC complaint. In the message, he also dramatically expresses his own lack of foresight about the consequences of his risky trading activity:
“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 all these complex, highly leveraged exotic trades he created without necessarily understanding all of the implications of those monstrosities!!!”
Monstrosities indeed. Here are two related posts of mine, in which I discussed how carried away the financial world got with complex interactions they poorly understand but used and manipulated in order to make short-term profits (see this and this).
Did Tourre really believe his own hype, that he was immune to the collapse all around him? Or did he merely think he could get away with it and get out in time? I assume we’ll hear more about this, as well as his side of the story.
What do you know there is actually a pulse at the SEC! Rahm must have shouted till he was blue in the face at the bureacrats at SEC to get them to finally put down that donut and start actually cracking down on this kind of fraud. Of course, this comes three years too late…
Just wondering if this “Paulson & Co” hedge fund is the same Paulson as the former Secretary of the Treasury?
I just read the investigation has been going on for two years and the timing of the charges may be politically motivated as a way to pressure Republicans to support the financial regulation overhaul bill.
The comments so far are pretty interesting:
1) Why give credit to Rahm? Does he have anything to do with anything? I would think that finding double dealing that breaks the law would require some investigative work, how or why Rahm yelling at people is relevant I can’t understand.
2) The Paulson in question is not the same person as George W’s treasury secretary. No mention in the articles of any relation. If they were brothers or something, I would bet it would have been mentioned – but maybe.
3) How this would affect financial regulation is beyond me. If the charges are true, then it was already illegal. Adding another layer of laws on top of the layer they broke isn’t going to change anything. Though I guess the public doesn’t understand that.
The main point I’d like to make is that bubbles tend to produce illegal behavior. But the illegal behavior doesn’t really cause the bubble. The bubble was caused by other legal behavior – none of which the current administration is trying to change. The illegal behavior should still be prosecuted, but that doesn’t mean it caused anything.
The causes of this bubble were low interest rates from the Fed and mortgage purchases from Fannie and Freddie. Those two things created an environment where housing prices never went down. Because housing prices never went down, anyone could get a loan at any price, because the house could always be foreclosed and sold at a higher price.
Since anyone can get a loan, loans are risk free, which turns them into financial product to be traded like stocks. Creating the financial products when drives the bubble some more.
Blaming the financial products industry is fun and complex – so it shows how smart you are. But the bubble was driven by $2 trillion in federal money thrown at the housing market in 2000-2006. It was a plan to make the US a great place where everyone owned a house. The road to hell is paved with good intentions.
James
Goldman Sachs … also could be saying, “Some thanks we get!,” considering it was one of the biggest contributors to the Obama campaign in 2008).
Absolutely correct. Next counter-factual spin: Wall Street fatcats in general and Goldman Sachs in particular are Republican allies.
You heard it here first.
Speaking of donuts …
Accounting and Auditing Enforcement Release No. 2433 / May 23, 2006
SEC v. Federal National Mortgage Association, Case No. 06-00959 (RBW) (U.S.D.C., D.D.C)
Fannie Mae to Pay $400 Million Penalty for Accounting Fraud
Interesting to see some commenters giving Goldman a pass. Sadly, it’s an all too common practice on the right (“Capitalism Good, Socialism Bad, Must defend Big Business …”) It is common knowledge on the street that a lot of banks engaged in this kind of fraud. Setting up the Fannie and Freddie straw man hardly cancels out the actions of banks like Goldman Sachs from behaving the way they did. The investors on the other end of this one deal lost over $1 billion. Multiply these kind of shady deals over and over again and you can begin to understand why so many banks are carrying so much crap on their books. And it is the taxpayer at the end of the day who has to step in to clean the mess up (not to mention pay out bonuses to the very villains who enabled this kind of fraud.)
As for Rahm, it looks very much like Team Obama timed this SEC action to co-incide with the debate on derivatives reform to weaken the banks’ position. So the Rahm getting blue in the face scenario is a comical way of depicting how the Administration might have gone about pressuring the SEC to announce the case one week before debate begins on derivatives.
Charles Reardon: Who gave Goldman Sachs a pass in the comments here?
Or is that just the narrative you feel you need to push?
I don’t see any comments giving Goldman “a pass.” What I see are folks who are understandably concerned that the Obama administration is going to use fabricated or unsubstantiated allegations that “a lot of banks engaged in this kind of fraud” as basis for imposing draconian controls over the financial industry. As James notes (and as in 2002), existing laws provide an adequate basis for prosecution. The danger is that in the zeal to achieve risk-free securities markets, Obama, the Democrats and compliant Republicans will give us Sarbanes-Oxley on steroids, and we all know how well that has worked.
See, e.g., http://falkenblog.blogspot.com/: “[I]t should be recognized that this kind of deal is not representative, and that most CDOs were created by people who sincerely, if stupidly, thought they were good deals. Note that Paulson is one of the few hedge funds that really cleaned up in this mess, most hedge funds missed it with everyone else.”
The “Paulson” involved in these transactions, by the way, is John Paulson. His firm earned billions of dollars by shorting CDO’s in 2008. He and his firm now have a substantial position in gold.
Karl Denninger at The Market Ticker has been screaming bloody murder about this for a couple of years now. It’s long past time that indictments were handed down.
However: I think the chances of the Obama administration doing anything positive for America are approximately zero. As Neo pointed out, Goldman Sachs was a major contributor to Obama’s campaign. Rush Limbaugh said today that this ties in with Obama’s proposed overhaul of financial market regulation, which will of course give the government more control over the financial markets.
You can bet that Obama will find a way to blame this on unregulated capitalism, even though we haven’t had unregulated markets since the 1920s, at least.
Neo-Neocon: Poor wording on my part. I said giving GS a pass because the thread is steering away from the actions of GS (or rather I should clarify, the alleged actions of GS) and focusing on derivatives reform. My concern is that too many conservatives in their zeal to take down Obama and the Left are are not willing to spend time on the problem of crony capitalism since they feel it will be to the Democrats benefit and undercuts the meme that Obama is hostile to business. Limbaugh does this all the time telling callers who are angry about the Wall Street bailout to focus instead on Fannie and Freddie and Barney Frank. By all means they played a roll. But that doesn’t excuse what Wall Street did.
I would agree that additional laws are for the most part useless and could be counter productive. The problem is not that regulators lacked the authority to police the financial markets it is that for too long regulators have been captive of the industries they regulate. They spend their time going after the small fish leaving the big fish to get away with murder. This is why a consumer protection agency is such a loopy idea. It will be yet another useless federal agency that gobbles up gobs of money to do what agencies like the Fed, SEC and CFTC should have been doing all along.
Charles Reardon: well, no one here is giving the perps a pass at all. It’s not an “either-or” thing. It’s an “yes-and” thing.
There are plenty of perps to go around. But political people will use this sort of story for their own purposes.
Point taken neo-neocon. Sometimes I have a hard time keeping my populism in check 🙂
Oh, and by the way Chuck, “Capitalism – good, Socialism – bad” still sounds about right to me.
Goldman has a lot of ‘splainin’ to do. It’s sort of of shame. Goldman used to have the reputation as having higher quality people than, say, Bear Stearns or Salomon. Now that we have seen the character of the fabulous Fabrice, not to mention Jon Corzine and Jack Ryan, I am wondering about the damage to Goldman’s reputation in the business community.
Theres another breakdown besides capitalist/socialist and conservative/liberal that better describes what’s out of whack here. That would be the moral and immoral.
I’m betting not a single player in this saga, no matter their professed political bent, attended a tea party demonstration where someone sang God Bless America on the 15th.
For the life of me, I can’t understand why Fannie and Freddie, and those who were running it at the time (I’d like to earn 90mm in 6 or 7 years, myself) as well as Dodd and Frank, are not also brought up on charges – and prosecuted. The dominos are still falling, the foreclosures running rampant again, and we the taxpayers, are out billions more to boot.
Please accept my apology should the above already have been mentioned. I have not read the thread, or the comments. Just the header. I still go off like a bottle rocket at the mere mention of this situation.
A couple of quick thoughts:
First, Goldman was a major contributor to the Obama campaign in 2008 because it has positioned itself to make trillions on Cap and Trade and the new carbon currency it hopes will pass with it. That, btw, promises to be another boon-doogle of unprecedented proportions.
Next, this whole Goldman Sachs thing reminds me of a great truth that a wise money man once told me: no matter how many regulations the federal government passes, its regulators can never keep up with their enforcement. Private sector brains are just too inventive, agile and quick and will find ways to circumvent whatever Congress conjures up. Their business is to stay far ahead of the curve, as with Goldman and global warming legislation.
It is and always remains that investors and stockholders must know what they’re investing in or what others are investing in for them or they will pay a great price. And anyone who goes to these big firms IMO at this point, needs to have their heads examined.
The name glaringly omitted from all the articles on the GS Fraud case is George Soros who was feeding at the same trough as Paulson. I know for a fact that Paulson and Soros used these products and had the portfolios stacked with CDO’s from Ameriquest. Why? because they knew that Democratic presidential hopeful Eliot spitzer was going to go after Ameriquest and the bonds written on their CDO’s were bound to drop drastically. I also believe all parties involved knew this would collapse the mortgage market. Why do I believe this? Ask yourself, how did Herb and Marion Sandler who owned World Savings the inventor of and the biggest writter of Adjustable Rate Mortgages and huge donors to liberal left wing cause’s know to sell their company just before the whole thing went south? I do believe this is just the tip of the iceberg and you will see class action suits on behalf of employees of several mortgage companies that were run in to the ground purposefully to make Soros, Paulson and GS billions, while they lost income, homes and savings.
Great points, webutante and Le Trebuchet. Let me add my $0.02 to rebutting comrade Reardon’s assertions.
For which crap we can thank the CRA, Fannie, Freddie, and the Democrat Party. (Remember the left’s sloganeering about “redlining” and “affordable housing?” Well, they got their way.) What asset do you think underlay collaterized debt obligations constructed with credit default swaps? Mortgages, many subprime. Adios, Bear Stearns, Lehman Brothers, AIG. Thanks, Dems.
Crony capitalism? Cronies of whom, you ask? The Democrats, for God’s sake.
Here are the 2008 campaign contributions from Goldman Sachs, one of the top 10 heavy hitters listed by OpenSecrets.org:
Out of a total of $5,934,089, $4,463,788, or 75% went to Democrats. OpenSecrets.org (a non-partisan site, which merely compiles FEC submissions) blandly says:
So stop pushing the Wall StreetRepublicans meme. It’s simply not true. Dems were (and continue to be) involved in creating this mess right up to their beady little eyeballs.
I am very suprised this deal was approved by the GS legal dept.They would have to sign off on any advisory work, and yet they did, even though the conflicts of interest are stunning.Not only is it a sleazy transaction,but how can they permit a client(Paulson) to have such a conflict? Bear Stearns turned it down;they could smell it’s stench,but not the GS who still like to espouse John Whitehead’s sainted 10 core principles.It’s a revenue generating factory regardless of the damage it does to it’s reputation,but other firms thought they could do what they wanted at one time, too, and they paid a severe price.Salomon Bros were once the Kings and they almost lost it all in 1991.
Will Warren Buffett once more be required to clean house at a major firm with which he’s a large shareholder?
El Beardo: I have never said that Democrats didn’t play a role in this mess. And how are Democrats to blame for the decision of big banks to create and peddle all these CDO’s to investors? Regardless of who encouraged all these risky mortgages is the fact that the banks knew this stuff was garbage but as in the GS example gladly flogged this junk anway making the banking crisis that much worse. And when it all went wrong GS used their Washington connections (Hank Paulson, former GS executive, Bush Treasury Secretary) to bail them out of their bad deals. It was Hank Paulson and George Bush who engineered the biggest government intervention in the economy since LBJ. It was Hank Paulson and George Bush who shovelled billions in corporate welfare to these PRIVATE companies that should have been put through bankruptcy like any other private company that can’t cut it on its own. THAT is crony capitalism. That is the Government picking winners and losers in the marketplace. And THAT is a fact of history.
And how are Democrats to blame for the decision of big banks to create and peddle all these CDO’s to investors?
Easy. Because the Dems forced banks to loan to people who in fact could not qualify for a regular, fixed, 30 year mortgage with 20% down, the banks had lots of toxic crap on their balance sheets. The banks (which I’m not excusing here) peddled the toxic crap to investors to get rid of it.
And while I subscribe to your sentiment of letting the banks go bankrupt, I also appreciate that in the view of those knowledgeable about the financial system that doing that might have destroyed the economy, because banks are in a unique position – for them money is a raw material. Consequently I am agnostic on this issue.
In any case, the issue is a wash between parties, unless anyone thinks for a nanosecond that an Obama administration wouldn’t have intervened in the economy and done exactly the same thing. (Particularly given GS’s hefty campaign contributions).
Speaking of bankruptcy, just out of curiosity, would you have let GM go bankrupt? I would.
I disagree. The banks peddled this crap to make money off of it, (which is fine. I don’t have a problem with banks trying to legally make money. I do have a problem with banks coming to the taxpayer to bail them out after they screw up.) Anyway, using the GS example the banks that bought GS’s crappy abacus derivative all believed they would make a killing from the rise in home prices. They were greedy and foolish, and as alleged, victims of deceit. But nobody was forcing them to buy this stuff and nobody was forcing Goldman to put the deal together. Everyone was looking to make a killing.
In regards to GM it was allowed to go through a quickie bankruptcy, which I supported at the time. In hindsight however this was a mistake. The manner in which the federal government is now bullying Toyota only goes to highlight my earlier point about crony capitalism. GM & Chrysler now have a huge unfair advantage in the market place due to the Government’s ownership of these two companies. I now believe they should have been put down. George Bush could have done that but he threw them a life line in his last days in office. This is further proof that crony capitalism is not a partisan issue.
Of course banks peddled this crap to make money off of it, but why were they trying to get it off their balance sheets in the first place? If they thought they had a valuable asset, they wouldn’t have been flogging it off.
The good news is that we’re in 100% agreement re crony capitalism. I detest it, viewing it as a perversion of both democracy and capitalism, and strongly support efforts to curb it. I’m a little concerned about legislation to do so, however, fearing that it will just establish new opportunities for rent-seeking. I’d rather that the media actually did their jobs and investigated and publicized such abuses, and then the US attorneys prosecuted it under legislation already on the books.
On reflection, I have to admit another reason I worry about any proposed legislation is that I don’t trust this Congress or Administration. At all. If they want to clean up corruption, they would do well to start with ACORN. I don’t mean a symbolic gesture (such as Congress passed earlier) that they can subsequently circumvent, but a real reform measure to deal with an obviously corrupt organization.
Agree with you on trusting the Administration regarding “reform” legislation. Obama isn’t about reform. He is about the pursuit of power, pure and simple.
Most of the comments here are very well thought out. For sure you are all knowledgeable people. I am just a simple man who has been careful and consistent my whole life and might I add honest in all my business matters.All of the people you are discussing are wealthy beyond what is needed to live well. Now the simple folks must suffer for the actions of the greedy few .To make matter worse we cannot believe in any one, there is so much information and misinformation who did what, what did who ,political favors subjective media coverage ,hear say.It is difficult to form an opinion and believe in what you think from day to day.We the simple folk can only fall back on our value system for stability.Sad that the powers that BE ( ALL) have not demonstrated “commitment,accountability and stewardship.” we are buried in a culture of greed.Sad day’s for the USA . Our nation cry’s out for leadership.
It makes me sick that these people got away with scaming so many people. I hope they get convictions, and those convictions lead to changes that make sure this type of thing never happens again.
Stop the presses. As recent WSJ articles make clear, all communications from this administration must be viewed with great skepticism. Andrew Sullivan summarizes: “Unless the SEC has more than what is laid out in its complaint, this isn’t fraud. It’s politics.” ( http://article.nationalreview.com/431910/in-search-of-a-villain/andrew-c-mccarthy?page=2 )
LB100: Andrew Sullivan or Andrew McCarthy?
Yikes! My apologies. Andrew McCarthy. Perhaps it’s their common Irish heritage that caused the confusion.