SEC sues Goldman Sachs for fraud

[GGT]

Goldman Sachs Sued by SEC for Fraud Tied to CDOs
(Update1)

By Joshua Gallu and Christine Harper


April 16 (Bloomberg) -- Goldman Sachs Group Inc. was sued by U.S. regulators for fraud tied to collateralized debt obligations that contributed to the worst financial crisis since the Great Depression. The firm’s shares tumbled as much as 16 percent and financial stocks slumped.

Goldman Sachs misstated and omitted key facts about a financial product tied to subprime mortgages as the U.S. housing market was starting to falter, the Securities and Exchange Commission said in a statement today. The SEC also sued Fabrice Tourre, a Goldman Sachs vice president.

“The product was new and complex but the deception and conflicts are old and simple,” SEC Enforcement Director Robert Khuzami said in the statement. “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.”

The SEC alleged that Goldman Sachs, led by Chief Executive Officer Lloyd Blankfein, 55, structured and marketed CDOs that hinged on the performance of subprime mortgage-backed securities. The New York-based firm failed to disclose to investors that hedge fund Paulson & Co. was betting against the CDO, known as Abacus, and influenced the selection of securities for the portfolio, the SEC said. Paulson wasn’t accused of wrongdoing.

Financial Stocks Slump

A gauge of banks and brokerages in the Standard & Poor’s 500 Index sank 3.9 percent for the top loss among 24 groups after the SEC announced its action. Bank of America Corp. and JPMorgan Chase & Co. lost at least 3.5 percent as all 27 companies in the S&P 500 Diversified Financial Index declined.

“This gave the politicians everything they need to push for stronger financial reform and it’s going to further shake investor confidence in Wall Street,” said Matthew McCormick, a banking-industry analyst and portfolio manager at Bahl & Gaynor Inc. in Cincinnati, which oversees $2.8 billion.

Shares of Goldman Sachs fell $23.64, or 13 percent, to $160.63 as of 11:37 a.m. in New York Stock Exchange trading. It was the biggest one-day drop since Jan. 20, 2009.

Goldman Sachs spokesman Lucas Van Praag didn’t return a call and an e-mail seeking comment. A call to Richard Klapper, an attorney for Goldman Sachs at Sullivan & Cromwell LLP, wasn’t returned. Tourre, reached by phone in London today, declined to comment. A call to Pamela Chepiga, a lawyer for Tourre at Allen & Overy LLP, wasn’t returned.

Stefan Prelog, a spokesman for New York-based Paulson & Co., said he couldn’t comment. The company oversees $32 billion.

It's a civil suit, but why not name Blankfein as well as Tourre?

Wonder when/if they will file charges against the rating agencies, too?

[CitizenCain]

Fuck that - they should be suing the congressmen who forced Fannie Mae and Freddie Mac to insure all those junk mortgages. None of this would have happened if the government hadn't guaranteed those loans, and then forced riskier and riskier mortgages to be issued to better the chances of our congressmen being re-elected.

Then again, maybe this'll teach Wall Street a valuable lesson. No good comes from taking the government at its word.

[GGT]

Separate issue. This is specifically about the CDOs and CDSs. There wasn't as much of private-public cooperation going on there, like Fannie and Freddie had. It's a finesse of the term Insurance vs buying the loans on secondary market. FHA loans involve mortgage insurers, not private speculators betting on the derivative.

But I wouldn't mind seeing more legal action against ANY of the bad actors, public or private.

[CitizenCain]

But I wouldn't mind seeing more legal action against ANY of the bad actors, public or private.

Hah. Dream on. The federal government gives itself immunity... so you can clean up the private "bad actors" until Armageddon, and you'll still be left with incompetents and fraudsters leveraging the power of the government to fuck everyone over.

Three cheers for progress.

[Dreadnaught]

Fuck that - they should be suing the congressmen who forced Fannie Mae and Freddie Mac to insure all those junk mortgages. None of this would have happened if the government hadn't guaranteed those loans, and then forced riskier and riskier mortgages to be issued to better the chances of our congressmen being re-elected.

Then again, maybe this'll teach Wall Street a valuable lesson. No good comes from taking the government at its word.

Separate issue. This is specifically about the CDOs and CDSs. There wasn't as much of private-public cooperation going on there, like Fannie and Freddie had. It's a finesse of the term Insurance vs buying the loans on secondary market. FHA loans involve mortgage insurers, not private speculators betting on the derivative.

But I wouldn't mind seeing more legal action against ANY of the bad actors, public or private.

I think you're both right. And you're both wrong.

Needless to say, it seems the SEC has finally found a case where someone seems to have crossed the line. They've probably been hunting for over a year, but they finally found one guy with both hands in two pies in a bad way. Big deal, but not huge.

It's true that this would not have been possible without government backing of these loan packages that were sold. BUT I also don't think this is really about any kind of systemic "fault" for the financial crisis. This kind of behavior would be really bad in any circumstance. This is just all they found after probably a massive amount of scrutiny.

Separately, I checked the news this morning at work and saw this...and that Goldman shares down 12%. 12% in one day! I don't think I've seen that kind of movement for these finance companies since 2008. I've had some cash on the side for a bit since I sold something else, so I bought four shares. I now own part of the Vampire Squid. The market loss for Goldman today exceeds the maximum possible fine — it's excessive. I'm betting that, unless Goldman somehow manages to let this destroy their business completely, they'll come out of it fine.

[GGT]

I think you're both right. And you're both wrong.

Needless to say, it seems the SEC has finally found a case where someone seems to have crossed the line. They've probably been hunting for over a year, but they finally found one guy with both hands in two pies in a bad way. Big deal, but not huge.

It's not that they had to "hunt hard", or settled on a scapegoat, but that accounting and paper trails are complex. Just because it took some time doesn't mean it's not the tip of things to come. Exposing Enron took time, too. Look how long it took to uncover Lehman's Repo 105. SEC was understaffed and underfunded for a long time. I think AIG and Deutsche Bank are probably nervous about more forensic accounting yet to come....

It's true that this would not have been possible without government backing of these loan packages that were sold.

You'll have to be more clear what you mean about government "backing" on which loans. Tons of subprime loans were made by CountryWide and others, not all were bought by Fannie and Freddie but by other investment firms like GS. Then placed into tranches to create CDO bonds to sell, insured by CDS insurance. See AIG.

The original mortgage insurance would pay in default to cover the underwriting bank, but not the derivatives. What's the gov'ment agency you think was guaranteeing the CDOs and swaps?

BUT I also don't think this is really about any kind of systemic "fault" for the financial crisis. This kind of behavior would be really bad in any circumstance. This is just all they found after probably a massive amount of scrutiny.

It's all we know so far. I wouldn't be so quick to pronounce they won't find other illegal behavior, from other firms, or other charges won't be coming in the future.

As for the vampire squid and financial reform, I see no reason why GS shouldn't lose its charter as a "bank holding company". That was their sweet deal (hiding under the wing of gov'ment protection and access to TARP and TALF, etc) that should be undone now.

[GGT]

http://opinionator.blogs.nytimes.com...s-stacked-bet/

“Oooh, things are starting to get interesting,” writes Yves Smith at Naked Capitalism. She explains what the bank may have done that crossed the fuzzy, fuzzy line between right and wrong on Wall Street:

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 underwritten 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?)

But she’s not sure how the federal action will play out: “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.”

The S.E.C. says the bank defrauded clients on bundled mortgages. Will it lose its privileged position on Wall Street and in Washington?
For the handful of Americans who haven’t read this, here’s a good bare-bones explanation of what the firm allegedly did from Annie Lowrey of The Washington Independent: “The hedge fund Paulson & Co … handpicked mortgage-backed securities that were doomed to stop performing, being backed with subprime mortgages, and Goldman packaged them into a kind of bond. Paulson bet against the bond, with Goldman acting as the broker; at the same time, Goldman sold the bond to other clients without disclosing that Paulson had engineered the bond to fail. The S.E.C. filing notes that those other clients lost $1 billion. Goldman had no direct stake in the success or failure of the CDO. It made money either way.”

“Finally!!!!” adds Dakinikat at the Confluence. “The details of a S.E.C. lawsuit against Goldman Sachs basically confirms everything we’ve been saying for some time out here in the financial/economic blogosphere. GS basically let some of its hedge fund managers design CDO’s that were bound to fail, sold them as safe, and then placed sidebets knowing full well they would fail. My biggest hope is that this translates into tougher regulation and more transparency in the derivatives market. We’ve been seeing just the opposite as reform moves through committees. If more of this comes, it will be hard for Dodd to pass watered-down regulations while the focus on such antics is sharp.”

“This isn’t just about the fact that Goldman sold its clients some bonds and then later bet against them,” writes Stephen Spruiell at The Corner. “In my view, that wouldn’t be so bad.” So what’s the problem?

Goldman structured and sold a particular bond, a structured product known as a Collateralized Debt Obligation (CDO). … The outside consultant Goldman hired to select which mortgages would go into the CDO, a hedge-fund manager named John Paulson, is now known as one of the most famous housing shorts ever — he made an estimated $3.7 billion betting that these kinds of mortgage-backed bonds would go bad. So it is pretty disturbing that Goldman would bring him in as an “independent manager” to help it construct a CDO and not disclose this fact to the CDO’s buyers.

It would be like holding a basketball game, letting a Vegas sharp secretly select the players on one of the teams, and then presenting it to the public as a fair game. The sharp would have an incentive to select the worst players for his team and then bet against it. According to the SEC, that is exactly what Paulson and Goldman did.

Gamblers care about when the game is rigged or the deck is stacked.

"Sold them as safe"---ratings agencies got some 'splainin' to do, too.

[EyeKhan]

Fuck that - they should be suing the congressmen who forced Fannie Mae and Freddie Mac to insure all those junk mortgages. None of this would have happened if the government hadn't guaranteed those loans, and then forced riskier and riskier mortgages to be issued to better the chances of our congressmen being re-elected.

Then again, maybe this'll teach Wall Street a valuable lesson. No good comes from taking the government at its word.

Still working that blame re-assignment angle, eh? Carter, Democrats in Congress, Liberal Activist Supreme Court, Clinton, Obama. They fucked up everthing, didn't they? If only Reagan were alive.... <dreamy sigh>


On the OP: Biting the master's hand - the Obama Administration's going to learn a tough lesson with this one. I hope in conjures the votes they're hoping for in November.

[GGT]

Didn't we dissect fannie and freddie a couple of years ago, and agree they didn't work? They have conflicting interests: tax dollars and shareholders, public + private.

If all they do is buy loans so lenders can get loans off their balance sheets, to make more loans, to encourage 'homeownership'....it's flawed.

Still, it's a separate issue from SIVs, synthetic CDOs and CDSs.

[CitizenCain]

Still working that blame re-assignment angle, eh? Carter, Democrats in Congress, Liberal Activist Supreme Court, Clinton, Obama. They fucked up everthing, didn't they? If only Reagan were alive.... <dreamy sigh>

Yes, clearly my blaming Congress was a swipe at the Democrats, because God knows, there are no Republicans in Congress.

Still, it's a separate issue from SIVs, synthetic CDOs and CDSs.

Not really. Ultimately, those are all a way for private firms to offload to the toxic, government mandated and guaranteed debt, so it still all comes back to Congress forcing the market to take on toxic debt... and then blaming the market when it goes bad.

[GGT]

Not really. Ultimately, those are all a way for private firms to offload to the toxic, government mandated and guaranteed debt, so it still all comes back to Congress forcing the market to take on toxic debt... and then blaming the market when it goes bad.

Yes, really. Bone up on the history of these synthetic CDOs. They've only been around since the late 90's, when math quants created these "WMD" in derivatives. Add in changes in commodities and futures trading regulations, undoing other protections, and it's clear why Treasury and central bankers kept saying 'the subprime crisis will not be a contagion' right before the meltdown. They didn't follow the underlying bets being made.

If subprime loans had been carried by underwriters, PMI would pay in default. The insurers would have been the losers. If loans had only been sold to fannie and freddie, it would have died there. Sure, they'd be broke and bailed out, but not like what happened with Bear Stearns, Merrill, AIG, Citi and BofA.

You do realize the unit investigating all this is newly created in SEC, Structured and New Products, right? If you want to blame the gummit for something, it'd be the deregulations under previous administrations, and the SEC not doing its job.

[CitizenCain]

Yes, really. Bone up on the history of these synthetic CDOs. They've only been around since the late 90's,

Uhuh. And what were they used for?

[GGT]

Uhuh. And what were they used for?

It wasn't for "government mandated and guaranteed debt", if that's what you're getting at. It included Alt A and commercial loans, too.

[Dreadnaught]

You'll have to be more clear what you mean about government "backing" on which loans. Tons of subprime loans were made by CountryWide and others, not all were bought by Fannie and Freddie but by other investment firms like GS. Then placed into tranches to create CDO bonds to sell, insured by CDS insurance. See AIG.

Still, it's a separate issue from SIVs, synthetic CDOs and CDSs.

Bingo. Here. Achtung. Po.

This is why I criticize you for using buzzwords and not seeing how government policy impacts this space.

The SIVs and CDOs were portfolios of mortgages, a large proportion of which were bought by the government. The government-backed agencies (Fannie, Freddie, Sallie) were basically making the secondary market for loans. And the CDS were inevitable develops as people sought to make more money from the market that the government was inflating.

None of this stuff would have had a fraction of the value if the government didn't pursue a decades long policy of backing Freddie and Fannie to buy enormous amounts of mortgages. Investing in those things seems stupid in retrospect, but these government-backed entities just kept on gobbling them up, thus inflating their value and encouraging people to make more of them. And because said mortgages were so easy to come by and seemed to safe, speculating on lame CDS contracts also seemed safe.

[GGT]

Bingo. Here. Achtung. Po.

This is why I criticize you for using buzzwords and not seeing how government policy impacts this space.

snip

Po?

And this is why I criticize your talking points that come directly from the WSJ. You act as if all this "innovation" in the secondary market has always been around, since you started paying attention a few years ago. You also like to lay all blame on GSEs like fannie and freddie, without looking farther back in history.

It's like you're using the recent end fall-out to explain your dislike for gummit intervention in markets....when there are "better" ways to be critical. You'll have to go back to the 70's and 80's, the Reagan era, and post-S & L failures, tho. I'm sure you can use your google skillz to find all sorts of history about securitization and The Secondary Mortgage Market Enhancement Act.

Was congress and the SEC involved, even the Federal Reserve? Of course. But not in ways you like to think. They were trying to expand the private markets, at a time when a home mortgage interest rate was around 15-18% after a deep recession! The same sort of thing was happening after 2000-2001 with Greenspan claiming subprime was a great tool for a great party, and go-go years to come. And it was the deregulation of lending that got all the others to drink the Kool-Aid, expanding secondary markets---it was NOT just fannie and freddie.

[Dreadnaught]

Hebrew for "here". Also a river in Europe.

The thing is that securitization isn't the problem. Securitized assets are worthless unless there's a major market for them, which happens to mortgage securities when the government is buying 20-35% of them at a time.

Of course deregulation brings potential problems and needs to be carefully assessed and monitored. But instead of assessing things, the government piled-on with ever-lower interest rates and ever-more incentives to issue risky mortgages. I've never said that bankers never did anything wrong — but I object to the idea that they are somehow uniquely "at fault" in the face of the behemoth moves of the US government.

[littlelolligagged]

Hebrew for "here". Also a river in Europe.

I thought you were referring to the red teletubby.

[GGT]

I thought he meant po'.

Dread, guns don't kill people, people kill people. I'm not laying blame on just securitization of debt or "big banks" either, plenty of cause-and-effect from many places, bad actors all around.

You could afford to get a mortgage precisely because of the low interest rates, with ultimately the federal reserve to thank. But they're a behemoth hybrid of private/public, too.

[Dreadnaught]

Low rates and lax rules, because the government was buying up all the mortgages. Yes, I am a product of a subprime crisis (except without a subprime loan).

[Supermarioman]

This case further proves why I won't be making my fortune on Wall Street.
I'll stick to something more reputable, like drug dealing.

[GGT]

More on Goldman Sachs. More like a vampire octopus than squid?

http://www.bloomberg.com/apps/news?p...uzZCL36I&pos=1

No surprise that UK and Germany have 'inquiries' now. What was the conclusion about GS helping Greece hide its debt from the EU?

[Dreadnaught]

More like a participant in a series of transactions and securitizations that are not obviously ludicrous.

The conclusion of the Goldman - Greece thing was that it was politician chest thumping to cover up their own failures. Goldman didn't help Greece hide its debt. They purchased the rights to Greek assets for cash. The Greeks hid their debt from the EU, not Goldman.

[Lewkowski]

From what I understand Goldman doesn't have a fiduciary responsibility to those who purchased their products. That being the case as long as they did not lie or make false promises about what was in them then they I wouldn't consider what they did to be so wrong.

[GGT]

Right, counterparties vs clients.

You can not lie, and not make false promises, but still be fraudulent by hiding important facts.

[Dreadnaught]

From what I understand Goldman doesn't have a fiduciary responsibility to those who purchased their products. That being the case as long as they did not lie or make false promises about what was in them then they I wouldn't consider what they did to be so wrong.

They have a responsibility to disclose. And selling mortgage products that are designed to fail may go beyond the requirement to disclose that there is some investment risk.

After all, how often do you buy a normal equity like a stock believing that the company is deliberately trying to go bankrupt?

[Lewkowski]

They have a responsibility to disclose.

Disclose what? That another client wanted something like this because they were betting mortgages should tank? IF home prices had continued to balloon like crazy there wouldn't have been an issue. If the investor did not understand what they were getting into that is their fault. Only if GS lied should they be on the hook. And honestly I don't know enough about Goldman Sachs to say they did or did not. I fully believe it is possible that they deliberately deceived, and if so then they should be in trouble. No proof of that has been shown yet.

After all, how often do you buy a normal equity like a stock believing that the company is deliberately trying to go bankrupt?

A CDO is not a stock.

[GGT]

Disclose what? That another client wanted something like this because they were betting mortgages should tank? IF home prices had continued to balloon like crazy there wouldn't have been an issue. If the investor did not understand what they were getting into that is their fault. Only if GS lied should they be on the hook. And honestly I don't know enough about Goldman Sachs to say they did or did not. I fully believe it is possible that they deliberately deceived, and if so then they should be in trouble. No proof of that has been shown yet.

You don't need to know a thing about GS, their history and reputation is not what's being tried (tho its rep may suffer if found guilty). These were sophisticated investors, who knew someone would be short/someone would be long, and someone might buy insurance in CDSs. The question is did they disclose Paulson picked the products in the basket, and that he picked them because he was betting they'd default?

The SEC said that Goldman Sachs created and sold Abacus 2007-AC1 without disclosing that hedge fund Paulson & Co. helped pick the underlying securities and also bet the CDO would default. Paulson was proved correct, and his hedge fund eventually turned a $1 billion profit and CDO investors lost a similar amount, according to the SEC.

I think if GS was really being up front, they would have sold the CDOs with the CDSs to cover them, since that was Paulson's intention in making the basket in the first place, and profiting from the insurance.

[CitizenCain]

After all, how often do you buy a normal equity like a stock believing that the company is deliberately trying to go bankrupt?

Sounds an awful lot like short selling...

[Dreadnaught]

Disclose what? That another client wanted something like this because they were betting mortgages should tank? IF home prices had continued to balloon like crazy there wouldn't have been an issue. If the investor did not understand what they were getting into that is their fault. Only if GS lied should they be on the hook. And honestly I don't know enough about Goldman Sachs to say they did or did not. I fully believe it is possible that they deliberately deceived, and if so then they should be in trouble. No proof of that has been shown yet.

This issue is if they have to disclose to investors that the "independent third party" assembling the fund was betting against the fund. Sure, the standard investment prospectus explains that the third party fund-assembler may be betting against the fund. But the issue is whether the fund was deliberately built to fail. That's sort of a perversion of good-faith disclosure.

If you build a house with a shaky foundation and want to sell it, you at least have to tell potential buyers that the house is built on a bad foundation and let them decide if they want to join the ride.

The issue isn't whether or not investors didn't understand what they were getting into. It's that Paulson contracted with Goldman to build a house with a faulty foundation, then bought homeowner's insurance in case the foundation gave way. Which it did. Which was apparently the plan.

Sounds an awful lot like short selling...

Short selling is more of a temporary stock purchase using borrowed stock, to be technical about it.

[Lewkowski]

If you build a house with a shaky foundation and want to sell it, you at least have to tell potential buyers that the house is built on a bad foundation and let them decide if they want to join the ride.

That information would have been in the documents. I mean who buys a complex investment product without understanding it...