SEC Charges Goldman Sachs With Fraud
sec.gov
sec.gov
According to the SEC's complaint, filed in U.S. District Court for the Southern District of New York, the marketing materials for the CDO known as ABACUS 2007-AC1 (ABACUS) all represented that the RMBS portfolio underlying the CDO was selected by ACA Management LLC (ACA), a third party with expertise in analyzing credit risk in RMBS. The SEC alleges that undisclosed in the marketing materials and unbeknownst to investors, the Paulson & Co. hedge fund, which was poised to benefit if the RMBS defaulted, played a significant role in selecting which RMBS should make up the portfolio.
The SEC's complaint alleges that after participating in the portfolio selection, Paulson & Co. effectively shorted the RMBS portfolio it helped select by entering into credit default swaps (CDS) with Goldman Sachs to buy protection on specific layers of the ABACUS capital structure. Given that financial short interest, Paulson & Co. had an economic incentive to select RMBS that it expected to experience credit events in the near future. Goldman Sachs did not disclose Paulson & Co.'s short position or its role in the collateral selection process in the term sheet, flip book, offering memorandum, or other marketing materials provided to investors.
So no, it didn't directly expand the bubble. But this kind of activity indirectly did so. (Though this particular deal came late enough that the bubble was about to collapse anyways.)
So no, it is not a direct connection. But it is indirect encouragement.
http://www.propublica.org/documents/item/magnetars-responses...
http://www.thisamericanlife.org/radio-archives/episode/405/i...
That doesn't change the fact that there are much larger things amiss.
1. Regulators who are ill-suited and ill-willing to enforce existing standards, not to mention any kind of additional authority that gets bestowed on them soon. There are numerous cases of whistles rightly being blown where regulators didn't do anything. Selective enforcement is worse than no enforcement at all.
2. Too much governmental interference in markets and backstopping of market actors to let markets function properly - but blame it all on the markets afterwards and cover up all kinds of fraud at Fannie/Freddie. This encourages fraud in markets which the government kindly looks down upon (it's housing, after all)
3. No consistent policy regarding bail-outs. If you bail-out market actors, you have to split up 'too big to fail'-institutions; otherwise it's just a game of waiting for the next tax-payer-sponsored bail-out.
- Court cases tend to make public previously secret information. Witness the recent publicity of banks under-reporting their debt levels. That pretty much came out of the Lehman bankruptcy proceedings. Lehman's accounting tricks came out in court, and people started wondering if other banks were still doing it.
- It keeps the issue in the spotlight so that politicians feel pressure to do something about it. Perhaps this will help strengthen the Senate's reform bill.
- The SEC is finally doing its job again! It's a small step, yes, but it's a start. Go Schapiro!
The SEC has largely failed in it's mission to prevent things like this happening in the first place - going back and arguing over whether it was technically fraud or not with the benefit of 20/20 hindsight isn't going to prevent stuff like this from happening again.
People get sold bad investments all the time - the onus is on you as the buyer to make good decisions and do your research. If you feel it's fraud, the courts are available to you as a private party. The SEC doesn't add any benefit to this equation that I can see. It does perhaps add one negative to the equation by encouraging people to take these investments "on faith" because they believe (incorrectly) that the SEC is effective at watching out for them.
1. The repeal of the Glass-Steagal act. This allowed banks to undertake the business of commercial banks, investment banks, and insurance agencies. That means that, banks were able to build these complex derivatives, use money from people's savings accounts to partake in risky investments, and then insure them with high standards. All from under one roof.
2. The investment firms went public. This was a fundamental change in the 80's where Goldman, Morgan Stanley, and many others where they became officially owned by the public. That ment that the risk of all their losses was owned by the shareholders as well as profits. Risky investing became the norm, because if you lost a ton of money for Goldman, you may have gotten chewed out or lost your job. But if you made a ton of money for Goldman, you had a very large bonus waiting for you.
Now this mindset has just grown out of hand. It's greed that is driving our financial center, Wall Street.
That Gramm guy is Phil Gramm, who later went on to say that the recession was all in our head's and that we're a nation of whiners. http://www.huffingtonpost.com/2008/07/10/mccain-adviser-amer...
He also happened to be McCain's chief economic advisor and a co-chair of McCain's national campaign during the 2008 Presidential campaign. http://money.cnn.com/2008/02/18/news/newsmakers/tully_gramm....
Too bad we elected a socialist to the White House. Think how much better we'd be off with McCain and Palin right now! Goldman Sachs would be just fine! The economy would be great! Phil Gramm would be vindicated!
Or we'd be living in the economic equivalent of the Weimar Republic right now. Yeah, that's probably more likely.
It's more like an arsonist taking out insurance policies on other people's buildings, THEN burning them down.
Except we don't allow crazy antics like that with insurance. And the insurance companies have to keep money reserved to pay out claims. And it has to go on their balance books.
So what we have here is "a building just burned! Oh crap, who has insurance on that? Who sold it? Who's going to go broke? Who shouldn't we lend money to? Nobody knows!"
Like any memory crash, when the value at the location is wiped out, any pointer to it is useless.
Shorting the value of the pointer makes sense when you know ahead of time that the value at the location will soon be clobbered.
The suit is civil, not criminal which likely means no one is going to jail. They'll get find 1% of what they made on the deal and call it the cost of doing business.
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!!!
Fabulous Fab indeed!
CARY LEAHEY, SENIOR MANAGING DIRECTOR, DECISION ECONOMICS, NEW YORK:
"The SEC has come out swinging, going after the biggest, most recognized name on Wall Street with regard to alleged abuses in the credit derivatives market. This will be a difficult case to prove, particularly to the laymen on the jury, as even supposed experts on Wall Street with years of experience in this area are still scratching their heads trying to figure out who did what to whom and when."
2) Sell those packages as investments to other clients, with clear statements that they were chosen by independent parties.
Doesn't sound too difficult to prove to me.
http://www.businessweek.com/news/2010-04-16/merrill-lynch-us...
Bottom line, this has been staged to defang them in front of next weeks house hearings on banking reform. It's theater. That's not to say it might not be true, but if you really think the administration wants to clean things up, ask why this is a civil action.
- about $2 million in direct fines
- return of the $15-20 million GS made in brokerage fees
- return of any bonuses made by 'Fab' Tourre
- 'equitable relief...appropriate or necessary for the benefit of investors'
This last is extremely open-ended and the nature of such relief is up to the court. It can take many possible forms and I have no idea what the norm is in such cases, only that it is technically complex.
It does strike me, however, that the complaint specifically mentions two investors; IKB, a german bank, lost $150m; and ACA (who may or may not be considered 'investors' in this context) fell into the arms of Royal Bank of Scotland, who ended up paying ~$860 million to GS, most of which went to Paulson & co. This figure is mentioned explicitly in the complaint.
Now, RBS got into trouble themselves (partly as a result of this), and at this point are ~80% owned by the British government. Fabrice Tourre, the Goldman VP at the center of the complaint, currently an executive director of Goldman Sachs International, based in London.
This coincidence might or might not have a bearing on the outcome. Knowing the British tabloid press, I'm willing to bet that at least one of tomorrow's front pages will feature a picture of Mr Tourre with a caption along the lines of 'have you seen this man?'
The following blog post goes in to more depth on this idea, with Massey Energy's recent mine explosion as an example.
http://www.fundmymutualfund.com/2010/04/massey-energy-mee-st...
2. Short those products
3. Profit X 2 !
3a. If fail, have taxpayer pay for it
It's that they represented the products as awesome, when they knew they were structured specifically to be doomed.
GS structured this whole deal from the beginning because Paulson wanted to short specific RMBS portfolios; ACA was just engaged in order to have a "brand-name" signing off on it.
ACA thought that Paulson & Co. were going to buy the equity (riskiest) tranche, and that they, ACA, were only taking on the risk of the mezzanine tranches. GS knew that not only did Paulson not intend to buy in, they intended to bet against the CDO.
If I sold you one diamond, and you were a shrewd buyer, you'd probably take it somewhere, perhaps to two people, to get it examined and ensure its authenticity. But if I offered to sell you a big ol' bag full of thousands of assorted gemstones, and claimed that everything in the bag was either pure diamond, ruby, emerald or opal, 25% each, you probably wouldn't have the time or money to go through each one and analyze its authenticity. Even if you did, my offer may have expired by the time you do. So instead, I say that the gems were all hand-picked and inspected by the American Gem Trade Association, and that they all checked out to be 100% authentic. If you trust me and the AGTA, you might buy the bag at this point. However, when you get home & find out that they're all rhinestones, I guarantee that you will consider my false assertion that they were picked by the AGTA to be both material and criminal.
Magnatar aggressively bought the crappiest traunches of CDOs so that banks would be convinced to create more CDOs. The banks could then sell them, saying "even the crappiest traunches are selling like hotcakes - you can confidently buy these less-risky traunches."
But actually, even the least-risky traunches were VERY risky, and Magnatar was pushing to have riskier stuff included in the higher-level traunches, setting them up to fail. Meanwhile, Magnatar's inevitable losses on the crappy traunches were nothing compared to the bets (CDOs) they were taking against the CDO as a whole.
They might invest $10 million in the crappy traunches and effectively put an $100 million insurance policy on the CDO as a whole.
A good analogy would be if you bought houses next to a dam you thought would burst, thereby convincing developers to build more such houses, and you then took out large insurance policies on all the houses in the neighborhood. Except that you're not allowed to take out insurance on houses you don't own, which is sane, but you ARE allowed to buy credit default swaps on CDOs you don't own, which is a recipe for disaster.
So to the CDO investors in THOSE deals, at least, what the brokers told them was "these investments are rated as super-safe and everybody is buying them - the magic of bundling takes away the risk of the underlying mortgages."
When the reality was, the brokers KNEW that the CDOs were created with the help of someone who wanted them to fail, and the ratings agencies were being paid by the people who wanted the investments rated well. (Another insane situation - it would be like if the food safety inspectors were paid by McDonalds when they came out to check things. How can they be objective?)
Yes, there were investors who saw the crisis coming. But the banks did completely omit the fact that the investments were created, in part, by people who WANTED them to fail. If they had been up front about that, nobody would have bought them. So they lied, and had ratings agencies to back their lies.
Not exactly a situation where the investor has a reasonable chance to make informed decisions.
Oh, you lost? Too bad. Yeah, we forgot to tell you that the other guy knew your horse was poisoned. Yeah. He poisoned it himself. We saw him do it - we helped him, really. Oh well.
Security guards? Oh, they work for the other guy. He pays 'em. Tough luck for ya, though, kid, real tough luck.
You win some, you lose some, eh?"
http://blogs.reuters.com/felix-salmon/2010/04/16/goldmans-ab...
There's a very thin line between what's legal and what's illegal, and the reason banks have compliance departments is to check over things which are borderline. In a lot of cases not only can the bank be fined but the individuals involved can also face jail time. But with borderline issues typically if they're done in good faith (full honestly, going through compliance departments) the regulatory bodies don't get too involved because they don't want to scare people away from the large number of legitimate activities which are beneficial to the system but are borderline.
However in the case where someone lied outright (presumably without the knowledge of their compliance department) that's a much clearer cut-case for prosecution. It's deception for the purpose of making money, and saying "I didn't know it was illegal" doesn't wash, because it obviously is.
> Goldman may have even thought Paulson & Co were the fools
Wrong. The entire point of this case is that GS knew two facts: Paulson & Co. helped construct the fund, and they also held a short position. GS is smart enough to know that someone who shorts their own product is not a fool, they're a con man. Or as Goldman probably saw it, a shrewd businessman.
Goldman: “One thing that we need to make sure ACA understands is that we want their name on this transaction. This is a transaction for which they are acting as portfolio selection agent, this will be important that we can use ACA’s branding to help distribute the bonds.”
ACA: “I certainly hope I didn’t come across too antagonistic on the call with Fabrice [Tourre] last week but the structure looks difficult from a debt investor perspective. I can understand Paulson’s equity perspective but for us to put our name on something, we have to be sure it enhances our reputation.”
So you're saying
1.) GS never needed bailed out
2.) GS was a bank before and after the crisis.
Goldman Sachs takes $12B Bailout, Hands out $14B Bonuses http://www.dailymail.co.uk/news/worldnews/article-1081624/Go...
http://www.huffingtonpost.com/janet-tavakoli/goldman-sachs-s...
Goldman was the healthiest (best capitalized relative to the systemic risk of the crisis) of US iBanks, and thus if there had been no bailout, it's strategy would have been to wait for things to get worse and then acquire various less healthy banks at a huge discount.
To prevent it from attempting this strategy, the government instead bailed out most of its competitors, but Goldman conceded to the deal as long as it was officially "forced" to participate. This was done only for PR reasons so that it could retain the perception of being the healthiest bank while not having to resort to a fire-sale buying binge fueled by an influx of capital that might very well have been from foreign governments -- do you think China wouldn't have sent over $20B in exchange for a huge stake in one of two remaining US iBanks?
The AIG risk was a big factor, but AIG too would have probably taken capital from abroad.
The US Government bailout was partially to retain stability and partially to avoid having the firms that survived become too powerful and foreign funded.
http://www.businesswire.com/portal/site/home/permalink/?ndmV...
http://www.capital-chronicle.com/2008/09/nyt-report-on-goldm...
That's the most disturbing part of all this: profits are kept private, but losses are socialized.
It's the equivalent of "heads, I win; tails, you lose".
You know what's REALLY too big to fail? Capitalism. And rewarding market failure is the surest way to take it down.
The media has made them into a scapegoat out of them in particular, and for some reason, everyone is following along.
And it should have been allowed to fail in my opinion. There would have been a lot of pain and other failures, but those are the risks of playing these games.
If you protect people from all of the ultimate costs of doing things that are rewarding in the short term most of the time, but incredibly risky overall, they will keep doing them!
And we will all pay a huge price for these parasites eventually if we don't wake up and stop subsidizing them.
I'm for criminal charges for those that committed fraud, investigations, more regulation, and so forth, but this "We should have let them crash and burn, damn the consequences" idea was not likely the best course of action, though it seems to be a pretty common attitude for some reason.
When you pick a vendor, a bank or insurance company, there's a chance that entity will fail. You're the one who has to judge that. It's not the government's job to protect you from failing to do that, especially when others took the time to assess the vendor and decided to use a more stable, smarter company.
And its certainly not the job of government to take the consequences from those that misjudged their bank or insurance company and assign those consequences to others that had nothing to do with the decision.
I am not "damning the consequences". The consequences are unavoidable. Its just a question of who should pay for them. Do we leave the consequences with those making the decisions that led to them? Or do we dump them off on everybody else?
This is not a zero-sum game within the US. Some courses of action have much larger consequences overall than others, and the one you are advocating seems likely to have had a relatively high overall cost to the system of the economy compared to the one the govt. chose, at least in the short term.
The government has been trying to keep the ship sailing as smoothly as possible, as is their general responsibility, despite the unsavory nature of bailing out some of those responsible. I believe that was viewed as a necessary evil.
When banks profit, society gets its share of those profits. Taxes, spending by the organization, spending by employees, their taxes. The government bailed out Detroit, why's this any different?
Taxes are not paid in exchange for bailouts... at least if they are tell that to all the other companies that have failed over the years and not had the government swoop in to help.
They are getting a subsidy to mindlessly arbitrage the yield curve and profit by making riskier loans than they would normally be capable of making. Fractional Reserve lending is NOT necessary for a financial intermediary to function. Look at hedge funds or VC firms. They are investing the amount of money they have received from investors and are not allowed to invest 10X they amount they have without raising that extra amount from somewhere.
Banks are not doing anything intelligent that adds significant value, the majority of their profits come from mindlessly arbitraging the yield curve due to a federal subsidy.
If i-banks like GS want to pay large salaries and bonuses to their employees, that is fine by me, as long as they also accept the negative consequences of the risks they take.
I'm also not a fan of the automobile bailouts; to paraphrase Plato, two bailouts do not make a right.
How does that make sense? Coercing the rest of us to take on debt so they can continue an enterprise that doesn't make economic sense?
You're absolutely right when you say there's no difference between subsidizing banks and auto companies. Both actions were wrong.
Here are some differences: - The bank bailouts are turning out to be at least a 100 times as expensive as the Detroit bailout. Detroit is not even worth mentioning in the same breadth as the banks.
- In the detroit bailout, most people that were responsible for the failure did not benefit. CEOs were sacked, all equity holders lost their money, debt holders lost most of their money too. In the bank case most people responsible kept their jobs and many of them are now back to getting multi million dollar bonuses (supported by government loans). Some banks wiped out their equity holders, some banks had only temporary drops in stock price. But pretty much all of the bank debt was guaranteed by the government.
But if the loans did not exist, many of these people would not be getting these bonuses either because their employers would not exist either, or because their employers would not have sufficient capital to generate the profits from which the bonuses come.
So yes, they would have gotten those bonuses regardless, and no, you can't say they would have failed without it.
Also, the bailout of AIG was really a bailout of Goldman. In other words, AIG got bailed out so that they could pay Goldman their enormous losses on securities that they bought from Goldman.
Know of any good reading on the consumer bank point?
OK, yeah, I know, they're only civil charges. But a boy can dream.
If Goldman made some kind of material misstatement about the quality of the products, that's a different matter. But so far, there's no indication of that. They helped execute a deal between two consenting, informed parties; suing them is like suing a condom manufacturer because they facilitated the one-night stand that turned into an unpleasant relationship.
Note: CDO's are not sold to retail investors.
If you want a place to put blame the most apt place would be Fitch, Moody's and Standard and Poors. The ratings agencies were far more complicit in perpetuating false understanding than GS was.
Suppose I sell you a word processing program. Inside the program, I include a snippet of code that will cause the program to stop working in thirty days, without telling you anything about it. By your logic, you would not be within your rights to demand a refund, since it is "your own damn fault" that you didn't understand the ten megabytes of assembly code that I sold you.
This is material information that was not available to investors in the CDO. Hence the complaint.
Edit Got the players wrong. Fixed.
So be patient and then when the thread has cooled down a bit you can reply directly.
If you really must reply there is always the 'link' link to the comment, the page that leads to does have the reply box. But beware of fanning the flames.
You have to separate issues here. Paulson & Co. were counterparties on a credit default swap with Goldman Sachs. That is fine. Goldman Sachs failed to disclose information to investors about Paulson & Co's role, and lied about their position. That is what the SEC is upset about.
You are right that the credit default swap was a zero sum bet between equally informed counterparties. It so happens that one side analyzed the deal better. (Actually that is questionable. The bankers on the Goldman Sachs side knew that they would get large personal bonuses no matter what happened to Goldman Sachs. So they may have analyzed it correctly and done what was in their best interest. But let's not get into perverse incentives.)
The issue that the SEC has with the scenario is that not only did Goldman Sachs fail to disclose Paulson & Co's involvement (instead saying that ACA had selected all of the bonds), they told investors that Paulson & Co had $200 million in equity in the deal, without disclosing the credit default swap position that meant Paulson & Co were actually significantly net short. This was a lie, and that is why Goldman Sachs is in trouble here.
Edit I had the parties wrong. Fixed.
They should have been buying based off the assets in the investment not based off of the counterparty.
Because the party who was short on the product was the same party who created the product, and Goldman did not inform investors of this fact. It's not a matter of just buying and selling. The RMBS's underlying the CDO were packaged by a party who had significant interest in seeing the package blow up.
An Oversimplified Analogy:
Imagine that I come to you and say, "I have a document that represents 100 mortgages and I'd like to broker a sale. If you buy this document, as long as less than ten of these mortgages go into default, you make money. If more than ten of them go into default, your counterparty in the sale (not me) will make money."
"Okay," you say, "that sounds interesting. So where did all these mortgages come from?"
"Oh, we got an independent company to pick a bunch of mortgages that they consider fairly safe and that they believe are a good representation of the overall U.S. mortgage market."
"Great!" you say, and you buy a billion dollars worth. More than ten mortgages end up defaulting and you lose a shit ton of money. Imagine your dismay when you learn that the mortgages were not packaged by some third party as I claimed, but hand-picked by the very counterparty you were betting against. OBVIOUSLY if they were going to benefit from more than ten mortgages defaulting, they would have filled the entire document full of mortgages they expected to fail! This is fraud in its most basic form!
The fact that the people structuring the deal were short on the deal is evidence suggesting a far, far more involved analysis before getting involved. That's a red flag that should cause significantly more due diligence. The entire purpose of the SEC is to make sure that such material information is not lied about.
But if you're betting against Hank, who manages the Griffons, that's something you want to be made aware of. Even if he can't directly influence the game, knowing that your opponent picked the players for the team he's betting against, he's got a lot of information that you can't easily come by, and it'd be a bad move to bet against him. It's a bit of a bait and switch to say that you're betting against another neutral party when you're in fact betting against someone involved in the game.
You're acting like the motives are criminal, here. But if two people take opposite sides of the same trade, they will both have the sinister motive of picking the other side's pocket. That's why there's a big, detailed disclosure agreement. You can read it right here: http://tinyurl.com/y7rnyh3 .
The lock/burglar analogy is flawed, because stealing destroys wealth. Inefficient asset allocations destroy wealth, and asset allocations can only be efficient when people with the same data and different interpretations are able to trade.
That, and recorded conf calls show that GS analysts as trying to convince rating agencies to inflate the ratings of the underlying assets in the CDO.
What happened to winking, nods and understanding looks on golf courses?
That's part of Goldman's job. They want the transaction to happen; if they can get a good rating, they should. The entity that's responsible for making the rating agencies rate things well is... the rating agency.
The first is naivete. The second is Federal securities law.
Not only that, but the sponsor wasn't short on just their portion of the trade. They were short on the entire CDO. They've got a bet that pays off if you crap out. Without that bet, you don't even get the prospectus - you don't even know about the security in the first place.
I recommend reading the ProPublica article.
Deals exist when there is demand on both sides. There can only be demand for both sides of the deal when there's disagreement about how the deal will perform. Goldman is being sued because one of their customers was right, and one of their customers was wrong. If the mortgage bubble had not collapsed, would credit default swap sellers and CDO buyers be penalized for profiting from the shorts' demise?