She doesn’t show up by name in the charges of civil fraud that the SEC has brought against Goldman. But Reuters reported yesterday that emails written by Gail Kreitman, a Goldman Sachs bond saleswoman until June 2009, are cited by the SEC to show that Goldman misled ACA Capital Management, the company hired to oversee the construction of the Abacus portfolio, and the customers that bought the deal.
In Kreitman’s emails to ACA executive Laura Schwartz she doesn’t correct Schwartz when she refers to hedge fund Paulson & Co. as an equity investor in Abacus. In fact, Goldman knew that Paulson wasn’t an investor and that the fund was actively betting that Abacus would fall in price. Paulson, the SEC says, was involved in the selection of the mortgage-backed securities that went into the Abacus 2007-ADC-1 synthetic collateralized debt obligation and used that involvement to structure Abacus to fail. Goldman’s alleged failure to disclose Paulson’s involvement is a key element in the SEC’s charge of fraud against Goldman. (Paulson & Co. was not named in the complaint. Goldman has said that the SEC charges have no basis in fact.)
Kreitman’s emails clearly make Goldman Sachs nervous. In a legal filing submitted to the SEC last September, Reuters reported, Goldman’s lawyers pulled out every argument they could think of for why Kreitman’s emails didn’t mean what they seem to mean because
Kreitman was merely an intermediary in charge of the relationship with ACA Capital.
Kreitman, who as Reuters reports graduated from Wharton School of Business in 1991 and had worked at Lehman Brothers and Merrill Lynch before coming to Goldman in 2006, didn’t really understand the significance of Schwatz’s belief that Paulson & Co. was an equity investor.
In other words, the boys at Goldman are arguing in their defense, it was just two girls talking and nobody should really expect that they understand this really complicated stuff anyway.
Reuters was not able to contact Kreitman for a comment.
Thanks Ed.
andante and jearly,
There’s a simple reason why more regulation is bad for small businesses, yet good for big businesses: Think about how much time and resources are necessary to comply with paperwork. As the paperwork grows more and more complex, you go from one staffer handing the task occasionally, to a full-time staff dedicated to government compliance demands. As the regulations get more complex, the more staff are required to deal with them.
Now, if you have a small business, let’s say with 50 -100 employees, how easy will it be for your business to comply with the same regulations as a Goldman Sachs?
The worst part about it is the government regulators aren’t really doing their jobs overseeing this paperwork (see Energy Star program, or SEC regulators with porn), which means true crooks like Bernie Madoff get overlooked.
Are we not making a mountain out of mole-hill. OK, it is easy to convince (almost) anyone that GS did a “bad” thing – though I bet that they will wiggle out of any lawsuit – they definitely employ and can employ more and smarter lawyers than SEC can. However, I believe this is a distraction to keep the derivatives trading under the table. Far more important is a clearinghouse for these instruments. We are just loosing sight of few very important facts that should be addressed, pronto:
a) CDS should not allowed to be bought unless one owns the underlying security. (you all know the logic: cant buy insurance on neighbors house and then hope (or try) to burn it down)
b) Rating agencies should be “fired” and their revenue models changed.
And, I just realized that when I sold my shares in XYZ, I forgot to tell the other guy that I was expecting it to tank. Oops, I guess I was emulating GS!!
Ed,
Glad to see you are back in swing.
If you wouldn’t mind indulging me, can you explain with some examples of business regulation benefitting big business while also “strangling” small businesses.
I also agree with andante, I am enjoying Kelvinator insights as well as Ed’s.
EdMcGon and Kelvinator,
Thanks for the commentary. Your posts are very interesting.
“Once upon a time” Wall Street institutions functioned as trusted arbiters of capital providing services and education for their customers to invest their capital and conduct financial business. Now their main business is proprietary trading for themselves and creating trading opportunities for clients. See:
http://www.newsweek.com/id/236725
Ed, I don’t think that regulations that increase transparency and help prevent fraud will have a negative impact on small business. It would probably benefit all business, since it would create more trust in the marketplace and decrease legal costs.
The behavior of Wall Street companies such as GS undermines trust in the workings of the financial system. Perhaps it has something to do with the epidemic of narcissism that has struck the country. That’s all about basic trust.
Ed,
I guess I don’t understand your comment. I was saying that Fabrice was entirely aligned with Goldman’s corporate interest as they saw it: he and they both believed in early 2007 that the mortgage market was ready to crash, but both did not do their fiduciary duty to inform their clients of their real view of the situation and act in their best interests certainly in general, or according to SEC, in the detailed particulars of the CDO in question; they had a powerful incentive to not reveal their real knowledge and views to clients willing to go long the mortgage market because they were making money from short sells like Paulson, who sponsored (paid them the fee for) the deal, and from their own trading. There’s no air between Fabrice and Goldman, except Fab left a paper trail, and they may cut him loose to swing on his own for that at some point.
kelvinator,
If Fabrice openly worked against Goldman’s own corporate interests, and caused Goldman to lose money, I’d be amazed that he’d still be employed anywhere on Wall Street.
Ed- I understand the fabulous “Fab” Fabrice – Goldman’s VP who is now charged by SEC – literally believed that the whole housing sector and mortgage business was about to crash, as per his emails submitted by SEC, and the Goldman management was directing their trading desk to clear out of long positions and move to net short, so I don’t think your statement on Goldman thinking Paulson was an idiot is correct, as I understand it.
Also, on a separate issue, investing almost always not a black or white moral choice, but I find that I have to ask myself: If there is little or no real law enforcing the public interest, (and it seems there’s not), would I back a band of pirates with operating capital so they can rape, pillage and send me a little booty every quarter or boost the value of my share of their operation, as long as they don’t operate in my neighborhood? I don’t consider myself holier than thou, but I’m just saying there should be a line, and everyone has to decide for themselves where to draw it. I guess I draw it with folks like Goldman, etc. Betting that the worst of human traits will win and greed works is why I personally think that the current idealization of unregulated free market, limited liability, detached shareholder corporations is likely heading us straight toward an unbelievable trainwreck in global resource and financial crises that’s going to be very difficult to avoid. The profit motive and perpetual choice of money uber alles has overwhelmed intelligent public communication, discussion, planning and policy on issues like debt and energy that are likely to upend each of our comfy worlds much sooner than we think.
cwt334,
My point is that “common wisdom” would have overridden the obvious conflict of interest for investors. I suspect even Goldman thought Paulson was an idiot.
Saurin,
I still own AOD, and plan to continue holding it for the near future. Right now, I don’t even have a target sell price on it. If they raise their dividend, I might buy more.
Running a bank is gambling with “SOMEONE ELSE’S MONEY” whereas going to Vegas is gambling with the CEO’s own money (which of course they don’t want to do).
Wahat is wrong with a law that makes commercial bank stick to banking and send the gamblers to Las Vegas?
I guess that I’m a little to simple to understand why COE’s can’t just stick to running a bank and do their gambling in their spare time.
Of course you are not going to invest in this hypethetical moon scenario if the same company has a rocket pointed at the moon ready to blow it up. Are you saying that what they did should be legal?
Any advice on AOD. Jim? Ed? Good to hear back from you Ed.
cwt334,
Would you invest in something which would give you a hypothetical return of 30% if the moon does not blow up by next year? Would you make the same investment if you knew someone whom Wall Street thought was nuts, was making a counter investment to yours?
My point is, you’d still make the investment regardless, because it fits your own world view.
Regarding your comment about the choice between big business or big government, I would say big business IS big government. When you hear about government adding more business regulations, who do you think benefits? Big business, because they have the resources to comply with more regulations. Small businesses get the shaft in a heavy regulatory environment. In effect, more regulations give larger businesses a moat against competition.
Think about the insanity of this: Now that we have too many “too big to fail” financial institutions, what are we going to do? Give them a bigger moat against any outside competition.
And thanks for the compliment! 🙂
Ed-
Would anyone in there right mind buy a security that you knew the people putting it together was betting against it? The real fraud is that this might be legal, and people are defending this action.
Is it politally motivated? Maybe. Evererthing in human interaction is politally motivated. This idea that we need to pick a side big bussiness or big government is a false choice. I don’t trust either. Ed thanks for all your comments. Keep them coming
what frustrates me the most (besides the moral and ethical bankruptcy on wall st) is that we taxpayers paid to bail out these firms that created this crisis by selling our pension funds worthless AAA-rated CDOs. Everything tanks, we spend trillions to go into debt to bail them out and the public pension funds are sunk and will require more of our tax dollars to make solvent. I will NEVER invest with a large bank/investment house again. Just as I avoid tobacco stocks (despite their high DY) I will not activily support these parasites. They fooled me once. Not again.
Ed-
Interesting – and of course you may be right. It may be wistful thinking on my part to imagine that real regulatory traction could hope to contain the big boys on Wall Street – but there’s a lot of on-going anger out there, and the high probability of a growing number of civil and criminal Wall St. prosecutions vs. the smart and powerfully connected Goldman may end up creating a real drama – and may keep traders on both the long and short side of Goldman nervous for some time to come…best, Kel
Kelvinator,
You may find this surprising, but I agree with you 100%. But I also recognize the political reality that our government is playing an economic game of musical chairs, with people like Goldman calling the tune.
Opportunity comes in many forms, and some of them are political. Goldman has become a master of that.
EdMcgon,
Whether your position in Goldman will be a successful investment or not is a separate question I don’t have a strong opinion on. Since I believe, along with you, that banks and Goldman in particular have huge control to limit what I consider to be appropriate regulation on behalf of the public, there’s no doubt they will be still standing and may well have been strongly oversold here. You may indeed have established a good trade, though not meaning harm to you at all, I’d rather see them be cut down to a size that can be sustained by ethical business.
I also agree with your idea that Paulson’s gloom and doom views were not fully mainstream at that time – however, in my view, that in many ways goes to the underlying thrust of the SEC complaint. Investment banks across Wall Street did not properly act as fiduciaries – accurate analysts and communicators on behalf of their institutional and individual clients. I don’t believe they properly disclosed their self-interests and the risks both on this particular deal and, for a long time before that, in the entire area of mortgage related investments exactly because all the big banks had a very powerful financial incentive to “keep the con going” for as long as they possibly could because of the huge fees involved. The net effect is that we are left with an entire industry and corrupt government regulatory structure that all say “Who knew? We were caught flat footed.” This is pure nonsense – fraud from people with feathers sticking out of their chops. The financial services industry sold its clients down the river at a structural level because they put their own trading and fees before their clients interests – investors are right to believe the fix is in.
I’m a financial advisor, and along with many other independent analysts without a vested interest in promoting real estate leveraging, saw the real estate bubble and potential collapse building long before it blew and I advised my clients accordingly. Personally, I sold my house in November, 2006 and took my 400% increase in equity (most of my life savings) out in cash to avoid the crash – that was 6 months before Goldman neglected to inform the long suckers, err…”clients”, that Paulson helped construct the CDO and that Goldman was building a huge short real estate position itself. I find it a little hard to believe that I, an independent advisor, could see this forming and the finest minds at Goldman at the heart of the business couldn’t see the same thing, but somehow decided it wouldn’t be profitable to actually do their fiduciary duty and tell their clients loudly about the huge risk in this and a hundred other deals.
I’d like to see these people regulated back to a level that minimizes future fraud and actually corresponds to their classification and function as a commercial bank – the classification that saved them from bankruptcy 1 1/2 years ago. I don’t have much respect for these people or this company.
Kelvinator,
Believe me, I don’t think what Goldman did was ethical, even if it may have been “legal” (and that part is questionable).
Having said that, I should make one important disclaimer: I just bought some shares of Goldman. You may well ask why. It’s simple: They have the political mojo going.
When the financial reform bill passes, and the SEC case is thrown out, Goldman will still be standing, and making even more money out the wazoo.
One other thing should be pointed out about the case. Back when Paulson was giving his gloom and doom theories on the mortgage industry, and putting his money where his mouth was, Wall Street thought he was nuts. Even had Goldman disclosed the facts as we know them today, investors would have ignored them.
Goldman is essentially a hedge fund heavily dependent on its propriety trading to make profits. Its other activities, ie activities required for commerce to function in the business world, or as Michael lewis puts it, socially beneficial activities, are far less profitable. Gold refuses to break down the numbers. Now Goldman may have agreed to support reform but only in a DILUTED form. I would love to have these parasites gamble with their owm money without the poor taxpayres or shareholders backstoping them. BTW the poor taxpayers who support these multimillionaires/billionaires pay higher percent income taxes then most of these vampires. it is high time Americans found out the truth about these hidden activities.
EdMcGon – As I understand it, the case against Goldman is based on the fact that they didn’t disclose to all the investors, including the European banks beyond ACA, that Paulson was short and significantly contributed to constructing the CDO he wanted to fail. The notion that Goldman, or any investment bank, can be on all sides of this or any non-transparent, unregulated deal and be an honest broker is completely laughable based on recent facts and historical experience. Financial services honchos removed regulations starting in the Reagan admin and continuing thru Clinton & Bush, then set up a systematic fraud machine of leveraging, pulling money out for themselves and then bankrupting companies in the same model used historically by the mob. This is documented in the book Inside Job about the S&L crisis. On the recent crisis, the same pattern is described by Bill Black, former Federal Home Loan Bank regulator and white collar crime specialist. He tells how Lehman and the other investment banks began to promulgate fraud by promoting liar and other sub-prime loans via subsidiaries and allied firms and then generating business and bonuses completely irresponsibly, and often completely illegally under current law. I worked at Morgan Stanley when their mortgage unit provided big bonuses to brokers to close any type of mortgage they could. What they called “managing risk” was actually setting up a guaranteed windfall for executives while leaving other individuals and companies holding the bag. See:
http://globaleconomicanalysis.blogspot.com/2010/04/geithner-and-ny-fed-accused-of.html
Oops…here is the link to the article.
http://ftalphaville.ft.com/blog/2010/04/20/206801/the-experience-of-laura-schwartz/
FT has the whole chronology of events here (article listing in this news piece). This one explains more in detail what Jim is talking about.
Sounds to me more like a case of E&O as opposed to willful fraud. Can’t figure out how/why Goldman could be proved guilty on this one.
Cut me a break Jim! Are you saying those emails are somehow conclusive evidence in what was a multi-billion dollar deal?
I can guaranty there were multiple high level people from each of the entities involved negotiating the details on this.
If you want to argue the case here, then explain this: http://www.cnbc.com/id/36685026
Let’s be honest: This case is all about politics. I’d be surprised if the SEC even plans to win it. The point is to smear Goldman, and by extension Wall Street, so they can pass a financial reform bill.
The great irony is that Goldman SUPPORTS the bill. And for you conspiracy theorists out there, the 2 meetings between Goldman’s CEO and Obama (and two other meetings with Larry Summers) leave plenty about which to be suspicious. Not to mention nearly $1 million in campaign donations from Goldman execs to Obama.
Goldman threw themselves on a hand grenade to help politically sell a bill they wanted passed. In reality, Goldman knew the grenade was a dud, and so did the SEC, and so did Obama.
Don’t believe me? Consider this: Goldman will be enjoying the fruits of “financial reform” long before this case is settled.
If this defense succeeds, I guess the next step is to fire all the women working in business and finance, because our little minds really aren’t up to it.
Thanks for the post, Jim.