RebelCapitalist: Financial Information for the Rest of Us

The Cat is Out of the Bag

Apr 19, 2010 | By: Mr_Blue | Tags: financial reform, goldman sachs, cdo, #wallstreetscam

On Friday, the Securities and Exchange Commission (SEC) charged Goldman Sachs with fraud related to the structuring and marketing of a synthetic Collateralized Debt Obligation (CDO) deal. It was about time but now the question is what other financial conglomerates were doing similar things?

Here is SEC’s press release with link to complaint.

SEC has accused Goldman Sachs of defrauding investors by failing to disclose important information regarding the structuring and marketing of a synthetic CDO that depended on the performance of sub-prime residential mortgage backed securities (RMBS). The complexity of the transaction could have made the perpetration of the alleged fraud easier. However, the actions of Goldman’s and the other party who benefited from this transaction are what matters.

Goldman had a huge hedge fund client - Paulson & Co (the other party). Paulson & Co. is run by John Paulson. Paulson had made billions of dollars betting against the residential mortgage market (with help like it got from Goldman it’s no surprise). Paulson wanted to create a deal where it could short sell a security that involved subprime mortgages. Keep in mind this was happening as the mortgage market - subprime bubble was about to pop. It paid money to Goldman to structure such a deal. Goldman created the synthetic CDO but get this - Paulson chose the subprime mortgages that would be included in the pool backing RMBS and of course Paulson picked the worse performing mortgages.

Goldman needed someone/investors (suckers) to take the opposite position of Paulson to pull this transaction off for Paulson. Goldman was able to find some suckers for the transaction - over $1 billion. SEC alleges that Goldman failed to disclose to investors Paulson’s relationship in the deal and that Paulson was planning to short the synthetic CDO. End result - investors lost over $1 billion, Paulson made $1 billion and Goldman gets huge fee from Paulson.

Are you pissed yet? Goldman used its reputation and credibility in financial markets to sucker investors into investing in this garbage. This was not much different than a ponzi scheme. But how widespread was this lucrative practice?

Well, it appears that the SEC is investigating other toxic deals. It’s about time. Now, one of Goldman’s defenses or responses or public spin is that only big investors (big boys) lost money. Well, that explanation probably doesn’t satisfy UK and German officials who had to bail out the several of the investors in this scheme. But this response is bullshit for other reasons.

Financial transactions and markets rely on a certain level of trust and confidence between participants in markets. To the extent that one or several of the biggest players in the market are not trustworthy that can cause markets to freeze up as we saw in money market funds. Our economy depends on properly functioning financial markets and to the extent that financial conglomerates such as Goldman are endangering the functioning of them because of their behavior then they are a threat to our economy and to us.

Good luck.