The SEC (Securities and Exchange Commission) today, April 16, charged Goldman Sachs (GS) with civil fraud. And the whole market has sold off. At 12:30 ET the Dow Jones Industrial Average was down 162 points or 1.45%. The Standard & Poor’s 500 Stock Index was down 1.97%.
What is the SEC charging and why is this such a big deal?
The charges go to the heart of a long-standing conflict of interest at Goldman Sachs in particular but also at Wall Street’s big investment houses in general. And they threaten to put an end to Wall Street’s argument that the financial crisis in the United States was an act of God and nobody’s fault.
And they come just as investor were buying up bank stocks in the belief that the sector’s problems were over. (For more on the state of the banks as revealed in JPMorgan Chase’s recent earnings report see my post https://jubakpicks.com/2010/04/15/jpmorgan-chase-disappoints-on-loan-loss-reserves-bank-sector-earnings-pop-delayed/ )
The SEC has charged that Goldman Sachs created a financial product called Abacus—a derivative based on subprime mortgages called a collateralized debt obligation (CDO)—that it sold to one client as a good investment while knowingly allowing another client, hedge fund giant Paulson & Co, to short the product and to influence what subprime mortgages went into this pool of mortgages. Goldman, the SEC alleges, never informed the buyers of Abacus that Paulson & Co. had helped select the mortgages underlying the Abacus portfolio, and indeed represented that the mortgages had been selected by an independent third party, ACA Management. Goldman further, the SEC charges, represented to ACA that Paulson & Co. had invested long in Abacus and thus its interests were aligned with other investors buying the Abacus product when, in fact, Paulson & Co. was betting that Abacus would go down in price. (You can see the official complaint here http://www.sec.gov/litigation/complaints/2010/comp-pr2010-59.pdf.)
The Abacus deal closed on April 26, 2007, and by October 24, 2007, 83% of the mortgage-backed securities in Abacus portfolio had been downgraded by ratings companies and the other 17% were on negative credit watch. By January 29, 2008, the SEC says, 99% had been downgraded. The SEC’s complaint alleges that investors in Abacus lost more than $1 billion.
The SEC charges note that Paulson & Co. paid Goldman Sachs $15 to structure and market the Abacus CDO. (Paulson & Co. have not been charged in the case.)
This is a big deal for Goldman Sachs because the company’s business model includes a huge dose of conflict of interest between Goldman and its clients. Because Goldman does so many deals for clients in often obscure corners of the financial markets, it frequently becomes the market for all intents and purposes. Clients have long felt—but few have ever said—that Goldman uses its knowledge of these markets to trade for its own profit, frequently against the interest of its fee-paying clients.
Because Goldman is so powerful, few companies have been willing to say this. But the complaint is there and it does occasionally surface. For example, in recent Washington testimony, Kerry Killinger, the former CEO of former mortgage giant Washington Mutual made it clear he didn’t trust Goldman enough to hire the company as an advisor when Washington Mutual’s cratering mortgage portfolio put the company at risk. In one email released as part of the ongoing Congressional investigation of the financial crisis, he wrote of Goldman “They were shorting mortgages big time even while they were giving CfC [Countryside Financial, another aggressive mortgage lender] advice.”
But it’s one thing to have clients grumbling or to have a former CEO complain about your business practices, and quite another to have the SEC file a case that seeks disgorgement of profits and financial penalties from Goldman and that charges specific Goldman executives, in this case Goldman Sachs Vice President Fabrice Tourre, with offenses that carry substanial penalties.
But the worries about this case extend well-beyond Goldman.
So far Wall Street has been very successful in arguing that the financial crisis could not have been anticipated. To hear Wall Street CEOs—and their pals at regulatory bodies such as the Federal Reserve—tell it, you’d think the whole bust that almost took down the global financial system was an act of God. Nobody on Main Street really believes that defense but until today no agency or court with the power to do real harm to Wall Street profits has challenged that view.
In its charges against Goldman Sachs the SEC says, quite plainly, that it just doesn’t buy the act of God defense. There was real fraud at work. Companies and individuals should pay the price.
Wall Street has been hoping that its defense would hold. Even this week’s Congressional hearings at which former Washington Mutual executives detailed the extent of conscious mortgage fraud at that company weren’t too big a problem. Congress could investigate all it wanted but it didn’t have the guts, Wall Street believed, to do anything that would really hurt Wall Street profits. The SEC does.
But most damaging to Wall Street profits as a whole is that the SEC charges come just as Wall Street is trying to fend off meaningful regulatory reform in Washington and to line up its regulatory buddies at the Federal Reserve and the U.S. Treasury to fight against the tough international rules on capital proposed by the Basel Committee on Banking Supervision in what’s called Basel III.
The comment period for Basel III closes today—the same day the SEC filed its charges. Sure makes it tougher for the Fed and Treasury to argue, publicly at least, that banks don’t need strict new rules.
This case will hurt Wall St. profit, but it shouldn’t be end of the world. Don’t forget a lot of people or firms will quickly fill in the gap. Yes, GS maybe a big player on the commodities market, but the commodities’ fate is ultimately determined by the global demand. Don’t forget there are many foreign security firms working on Wall St. too. My 2 cents, investors shouldn’t panic. I am more interested in economy fundamentals than the fate of Wall St. which is afterall a middle man.
Tight SEC over-sight is essential to a healthy market, but the timing of this case is highly suspicious. The banking “queen” had admitted it this morning that the GS case will help passing the financial reform bill. Coupled with the fact that only the “small guys” were charged, it makes people wonder how effective this case will be. The French man at GS and the Italian man at Paulson probably are the weakest in the entire universe of the masters. They two poor guys probably did not bribe (oops, I mean to say “contribute”.) enough personally and get pulled out while all the heavy weights ‘lucked out”! This is why I fear this is going to be a show trial, good for lawyers.
All markets are a scheme. But we still play. The game is the thing. We crave action. Las Vegas knows this.
Judging from the bearish sentiment of this message board I can see the bank stocks have a lot of rooms to run. All this exciting comments here are from the old days and nothing new and basically trying to assert “See I am right to be bearish on banks even though I missed their huge run”. I see a giant EGO !
Nobody even bother to mention how Citi smashed expectation. That is why I love to be along in longing Citi and still recommend C right here and right now because it is “a diamond in a rough”
Where was the SEC when Madoff was stealing? Everything is not what it seems. As a couple of people have suggested much of the timing of this action is political in nature. Sure Goldman’s is a bunch of fat cat but this is more about giving the Blanche Lincoln’s of the congress a bone to take home for re-election bids.
I think Goldman’s does what they all do but don’t say and that is to fill the pockets of their friends. My bigger concern is that much of the housing crisis stemmed for easy credit for people who could not afford the payments. I would like to see a more thorough investigation of FANNIE and FREDDIE and congress’s influence in this debate but that won’t happen.
Politics is the same ole same ole.
Not only is the timing not random, it also suggests that this has, is and will continue to explode.
First, this is only a regulatory event. True, they can recommend criminal action, on the Federal level, but they cannot file it. That is Justices decision.
Second, what the AG in New York – the Federal Attorney and/or the State AG decided to do is another question. Both state AND Federal laws may have been broken.
Third, this probably is a RICO crime as well. That could mean treble damages ordered paid back to all of U.S. that were effected.
Fourth, like a DWI, criminal charges do NOT result in “civil” – well, sometimes they are not all that civil – damages. What you may, permissive, expect is that each and every Class Action Attorney among U.S. is already typing away on their complaints in their Complaints.
As Lawrence showed/told U.S. all…, it is a terrible thing to see wave after wave of Shiites rolling down the hills all around you.
As the Devil will tell you & all of U.S.: Aren’t you even tempted to be a wee, skoshi bit sympathetic?
Opinions, etc.:
Timing of this announcement: completely oriented toward impending legislation.
Scope of this investigation: very limited
Probable true breadth of similar wrongdoing: much wider than the current investigation.
Scope of the implications: extremely broad – so as to significantly harm the derivatives markets worldwide. Is TARP also screwed?
Chances that the SEC can make the allegations stick: It seems that only the first shot has been fired and the somewhat incestuous relationships between SEC and the folks they regulate will come under beneficial scrutiny.
How long this soap opera will remain an excuse for a selloff: Help us Jim!!!
Oh yay, another book for summer reading.
Liar’s Poker, Barbarians at the gate, Titan……I can’t get anything done. The “big swingin dicks”
keep giving the writers more material.
What about the fraud against the American people? You know. Where banks signed mortgage contracts with people they KNEW couldn’t afford them, for the purpose of collecting late fees and seizing their property? You know, where they stole people’s equity? Where the thieves got caught when it all crashed down like the giant Ponzi scheme that it was? And where the federal government took OUR money to pay the thieves so they didn’t lose their ill-gotten gains?
Jim, I sense this could get real ugly before it’s all over. Please, we need your thoughts going forward for equities as well as bonds. A thought, if Goldman is guilty, being a packager, why wouldn’t the originators – Bill, the blue dress, Clinton, his buddy Cuomo, Barney Frank and Dodd be just as guilty – just an editorial thought!
The SEC needs to look closer to home and review the relationship of Hank Paulson and Goldman. Let’s not forget AIG, either. Mr. Paulson was a busy guy- bridge loans to AIG benefitted his former firm in excess of 12billion dollars. Then have a look at good old Fannie and Freddie and the relationship with Paulson and Barney Frank. What a laugh- crooks investigating crooks!
people cannot do their Due deligence themself eveytime they want to invest in something. The general public lack the know how and probably lack the time (mind you regular people have jobs and family to attend to).
that is why bodies like the SEC are created, they hire and train knowledgable professional how should be watching over the market and players to protect the general public.
companies and banks cannot help it (we all have to dance while the music is playing). they can refuse to do bad stuff for a while but if they see others are getting away with it and no one is stopping them, well they start to play themselves (or shareholders through the CEO out).
i think SEC should come hard on them, but i think it would have been better to that earlier. so that others will feel justified not doing that bad work.
Main Street and Wall Street have short attention spans and shorter memories – unless someone discloses prostitution or other sexual misdeeds somewhere.
Until then, populist rage at “fat cat bankers” will mix with rage against “government interference” – blaming both simultaneously for every ill (see the “overpaid bankers, overpaid government employees” threads widely disseminating on the web).
A community that heaps disdain on its firemen might anticipate fires burning out of control.
This is just a show case with a fall guy to appease the public and display the SEC as doing something to boost Obama’s ratings. The court case will drag on for years. When consideration is made for all the publicity surrounding GS and bonuses etc what else could the SEC do to dampen down the uproar.
Unfortunately, business is not poker. If it was, GS just raised the pot and got re-raised. We’re going to see their cards, which I’m guessing are full of jokers. They have a certain obligation to act justly, otherwise it’s fraud. If they knowingly sold a client subpar mortages without disclosing it, they should be punished. The issue at hand is the can of warms this will open as many other investors lost a lot of money and will inquire into how their worthless mortgages were chosen.
Milestone,
Well said. I think there are lots of naive people out there who thinks that company have some sort of moral compass. Likewise, I think people are foolish to think that just because they pay some one for financial advise that they will be taken care of. That is so totally baloney. I wish the general public is a lot more smarter than this. What I see here with GS is an assault on capitalism and I hope the SEC takes all measure to punish these people and I hope they realize that they must go all out on these guys to protect the market and the economy. A lot is at stake here.
cjxland, I agree that we need this dose of reality here. The market has been going up like the recent recession and high unemployment was some distance memory. This is very healthy as I think the market will be in more solid footing when it is sound and their is transparency and integrity on Wall Street. I hope all the greedy SOB that had a hand in this get some jail time and bankrupted.
Who cares? SEC just gives us yet another opportunity to make some extra bucks on this dip.
Why would you trust a company in the first place?
Their main goal is to make money.
They have NO morals linking them to democracy and the democratic process.
They are a company.
They are allowed to do what they want.
You don’t have to do business with them if you don’t want.
Why would you trust a company in the first place to tell you about what you should do with your money.
They have a major conflict of interest no matter the case because they are designed to make money for themselves.
They bet against the market and then tried to get to bust.
In poker do you not bet and then do whatever you can to trick your opponent, including telling them lies?
I do, you can’t be mad at a company.
Its called due dilligence….do it b4 you blindly trust someone or some entity.
People want to trust the companies, the government, they all want power and money.
Don’t be sheep!
Other investment banking firms that have gone belly up are likely judgment-proof at this point, but–as “the Fabulous Fab[rice Tourre]” just learned–individual liability for securities fraud is another matter altogether.
SEC & every trader working for any trading house knows that market is rigged. GS rigged oil prices in 08. Ask any commodity trader about JPM’s trading house’s rigging of commodity (especially Gold & Oil) prices and they will explain you in detail.
GS pays boatload of money to head of states, senators, and any one in power. who in their right mind will act against GS/MS.
SEC knows this well. GS will walk away. The real question is why SEC speak now? I wouldn’t be surprised if GS shorted them-self and asked their SEC for some -ve publicity.
ntack5
Yes, WOW. Now that’s what I call capitulation! [Always the problem with market timing- you’ve made the right call, but maybe are just a bit early? I think Jim has mentioned that… ] Hold that scapel there, bro, that comet isn’t due for awhile yet.
Yeehaw! I knew we would get some better grist for the Friday Fray/Cuss than China fiddling or cheap money [both fine articles Jim, don’t get me wrong]. Maybe the SEC is finally going to stand up on its hind legs- let’s hope this isn’t just a wrist slap and a side-show…
Personally, I would be willing to contribute to the $8 Mill legal fund of the Fed. Crisis Investigation Commish Jim mentioned in the lead to his “Cheap Money” piece earlier, if it would help put a few more of these crooks- or to quote Jim: “lots of somebodies”- behind bars, and quick.
If this knocks the [arguably artificial] props out from under the [argualbly artificial] market rally and the [arguably artificail] recovery, and we finally have to take our medicine, that would also suit me just fine, altho it will hurt us all some more. But maybe we would then find even more of those “lots of someones” to jail, and start to get this mess cleaned up- before things get really bad in this country.
When all that happens, and the S&P is around 500, then there will be buying opps everywhere you look- so keep a little powder dry, as the guy on the other channel says.
Henry the Citi, what is your take on the GS story?
Why did the SEC drop their bomb on Triple Witching Friday? It’s not nice to influence the markets.
Jim, is this a buying opportunity on us banks ie US Bancorp or would you sit on the sidelines?
lolo,,
but seriously i cannot understand why is this causing this huge selloff. i understand banking sector but the today everything looks like going down.
do you think it is a buying oppertunity
ntack5: wow!
Jim,
It has been said that these financial contracts and arrangements are extremely complicated. Will the SEC have the resources to battle GS’s fat cat lawyers and make something stick. If so will they continue to look further into other institutions or be happy with this one trophy. Are we finally looking at a crack down of the entire industry?
Jim, is this the beginning of the end? Earthquakes, volcanoes, fireballs in the sky, Obamunism, Tiger’s & Jame’s affairs, Ricky Matin is gay…where does it end??? I feel like castrating myself and waiting for the next comet!
The same thing probably has occurred at many other investment banks, notibly some that have gone belly up. Wonder if they can still go after them anyway?
But I think this is good for the market… SEC finally doing its job… I’m sure there will be more, but I believe that this should make the market stronger, not be sold off in the long run…
Jim,
Is the SEC release today a mere coincidence or a planned event?
Sure caught the market off guard.