The dark, dark, dark side of Wall Street brought into the bright, bright, bright sunlight of day for all to see (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.
A 31 year old Goldman Sachs employee (vice-president) Fabrice Tourre is named in the suit for his key role in negociating the deal with reputable capital management firm ACA (from the suit):
(Fabrice) Tourre was principally responsible for ABACUS 2007-AC1. Tourre devised the transaction, prepared the marketing materials and communicated directly with investors. Tourre knew of Paulson’s undisclosed short interest and its role in the collateral selection process. Tourre 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.
Felix Salmon sums it up well:
The scandal here is not that Goldman was short the subprime market at the same time as marketing the Abacus deal. The scandal is that Goldman sold the contents of Abacus as being handpicked by managers at ACA when in fact it was handpicked by Paulson; and that it told ACA that Paulson had a long position in the deal when in fact he was entirely short.
Goldman Sachs has lost more than $10 billion in market capitalization today, in the wake of these revelations. Good. It can go long markets and it can go short markets. But it can’t lie to its clients. That’s well beyond the pale.
Beyond the pale indeed. What a sordid tale. Goldman Sachs may have lost $10 billion in market cap, but they have lost something even more valuable: integrity.
I found this passage in the S.E.C. suit particularly damning:
At the same time, GS&Co (Goldman Sachs) recognized that market conditions were presenting challenges to the successful marketing of CDO (collateralized debt obligation) transactions backed by mortgage-related securities. For example, portions of an email in French and English sent by (Fabrice) Tourre to a friend on January 23, 2007 stated, in English translation where applicable: “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 monstruosities!!!”
You can say that again Fab. What a great man you are.