Wall Street Journal:
WASHINGTON—The Securities & Exchange Commission on Friday charged Goldman Sachs Group Inc. 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.
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.
It is unclear to me how this particular derivative was "devised to fail." Goldman had no control over whether the housing market really would collapse. Credit default swaps and other derivatives always involve one side "betting against" the other. More precisely, companies and investors try either to reduce risk or increase potential rewards by entering into these kinds of contracts. Anyone who invested in this kind of highly speculative financial instrument would have had access to information about the ratings of the underlying mortgage bonds.
The WSJ story puts the emphasis on the heart of the suit:
"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."
The S.E.C. alleges, in other words, that Goldman misrepresented Paulson & Co.'s role. The Times buries this fact in a later paragraph:
Goldman told investors in Abacus marketing materials reviewed by The Times that the bonds would be chosen by an independent manager.Instead, it focuses on the money that Goldman made - "unfairly," - from the housing market collapse:
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. Those deals, which were the subject of an article in The New York Times in December, initially protected Goldman from losses when the mortgage market disintegrated and later yielded profits for the bank.
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.
The official charges by the SEC can be found here.
7 comments:
More interesting to me is that none of the press caught a whiff of this before the announcement. None of the press corps on the financial regulation beat - probably one of the hottests - wrote anything suggesting this was in the works
I agree that's interesting that no one caught wind of this. But speaking of the beat. One key difference between the two newspapers, is the at the NYT, as they point out in today's editorial, as well as in the bit you quote at the end, published an investigation into this very practice in December.
http://www.nytimes.com/2010/04/17/opinion/17sat2.html?ref=opinion
In other words, they see their muckraking as partially responsible, or somehow related, to the SEC filing suit -- which it probably is! So yeah, they have a different perspective. By the way, the two authors of both that investigative piece and the thing you quote are Louise Story and Gretchen Morgenson. The latter writes a muckraking column in the Sunday Business every week were she beats the drum about some potentially unfair practice on Wall Street. In an era where the banks have been allowed to regulate themselves to the detriment of the whole economy, thank goodness there are journalists at major outfits not inhibited about calling something unfair!
Louise Story and I went to high school together and graduated the same year. I do not know her at all, unfortunately. But she is one of the main business beat writers at the Times, and obviously kicking some serious ass to be doing what she's doing at 29. Her pieces have often been investigative, but she isn't reckless.
Real quick, you call the characterization of "unfair" unfair because Goldman and its clients both had access to the same information via the rating agencies. Well, as we all know now, the rating agencies' information wasn't worth a damn thing. And of course information asymmetries are how people make money, in cases fair and square. I think the problem here is the scale of the information asymmetry. Which gets me to my second point, you say that Goldman had no control over whether the housing market really would collapse. Is that really true? This is the most powerful firm on Wall Street, the "gold standard." The scale of one of their bets could definitely push this or that national or international market over the brink.
One reason the Paulson connection may not have been front and center, to play devil's advocate, is that he his not charged.
Expect with financial reform now on the docket in DC a lot more anger directed at Wall Street, from left and right, that won't be nearly as polite as all this.
you say that Goldman had no control over whether the housing market really would collapse. Is that really true? This is the most powerful firm on Wall Street, the "gold standard." The scale of one of their bets could definitely push this or that national or international market over the brink.
I don't know exactly how these investments worked. But I don't think placing a bet for or against the housing market was a determining factor in its collapse. The problem lay with lending standards and the inability of so many people to pay their mortgages. This is not something that any one firm could have engineered.
I am curious, btw, who bought the "Abacus investment that, the S.E.C. now says, was devised to fall apart" (latest NYT article on this).
No, it's not, in my opinion, that one firm could have engineered the system's collapse, but that one very large firm could have had what almost amounts to a vested interest in collapse. And while the lending practices and the creditworthiness of the borrowers were obviously *a huge problem, to say that they were *the problem, seems to me unjustified. But this is the argument the society has been having since October of 2008, right? Whose to blame? The guy who took out the mortgage, or the guy who designed the credit instrument that made it possible and winked at the bond raters and the regulators?
From what I saw in the paper today, big buyers of these bonds were Bank of Scotland (or some bank they bought) and some other European, esp. German, banks.
Yah, apparently IKB Deutsche Industriebank.
but that one very large firm could have had what almost amounts to a vested interest in collapse
Needless to say, you can have an interest in the collapse of an investment without being responsible for it. Goldman surely cannot be blamed for having profited from it.
But this is the argument the society has been having since October of 2008, right? Who's to blame? The guy who took out the mortgage, or the guy who designed the credit instrument that made it possible and winked at the bond raters and the regulators?
I guess this is my problem with this whole affair. A lot of people seem to be conflating these quite different problems. There is all this anger at Goldman for having profited from the collapse of the housing market, as if the foreclosures of ordinary people were caused by synthetic C.D.O. investments. In fact, the companies who bought those Goldman derivatives were highly sophisticated financial institutions, who had been in this business for several years. These were extremely speculative, risky (as well as potentially lucrative) investments.
Politically speaking, they can definitely be blamed for having profited from the collapse. That's what's happening right now, whether one likes those politics or not.
I find it very hard to isolate the various "causes" of the meltdown. What about the federal government that pushed Fannie and Freddie to lend to all those low-income and particularly minority borrowers who historically were in many ways shut out of home ownership, which gives you an enormous leg up in the American economy?
I agree that the buyers of Abacus were big boys who could -- perhaps not should -- have known better. It's hard to feel sorry for those European banks who already got so much American taxpayer money via the TARP, or their own governments!
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