The story begins with Paulson & Co., a New York-based hedge fund that manages billions of dollars, approaching Goldman about the possibility of Goldman creating a CDO portfolio with which Paulson could short- a investment strategy in which Paulson would profit from if the portfolio underperformed or defaulted.
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The Case Against Goldman:
In the complaint that the SEC filed with the Southern District Court of New York, the Commission accuses the firm of "making materially misleading statements and omissions" in its marketing of synthetic collateralized debt obligations, or CDOs- in this case, an asset that derives its value from the performance of mortgage-backed securities (MBSs).
The background of the story begins with Paulson & Co., a New York-based hedge fund that manages billions of dollars, approaching Goldman about the possibility of Goldman creating a CDO portfolio with which Paulson could short- a investment strategy in which Paulson would profit from if the portfolio underperformed or defaulted. Fabrice Tourre, a vice president on one of Goldman's trading desks, took on the task of constructing this CDO portfolio. In the process, he approached ACA Management, a firm that was in the market of evaluating the credit risk of MBSs. Paulson made suggestions to ACA about which MBSs should be included in the portfolio. Ultimately, the CDO portfolio consisting of 90 MBSs was called ABACUS. ACA took a long position in the portfolio. In addition, Tourre marketed ABACUS to IKB, a commercial bank that has since been bailed out. And, of course, Paulson took the short position. Following the US housing meltdown, Paulson netted and ABACUS investors lost approximately $1 billion while Goldman probably earned somewhere between $15 and $20 million for its role in structuring ABACUS.
The crux of the argument against Goldman is that the firm failed to disclose Paulson's role in the selection process to IKB and other smaller investors. In fact, the marketing term sheet for ABACUS states at the top of the first page in bold print that "the reference portfolio of [residential] MBS had been ‘selected by ACA.'" The marketing flip-book for ABACUS also stated that the portfolio was "selected by ACA management, LLC." This book, furthermore, described ACA's "business strategy, senior management team, investment philosophy, expertise, track record, and selection process." However, this document, too, failed to mention Paulson or his adverse interests. Finally, the offering memorandum for ABACUS recognized ACA as the portfolio selector while failing to identify Paulson. Some argue that, in truth, Paulson did not ultimately select the MBSs that went into the portfolio. However, Paulson did play some role in the selection process- perhaps a significant or minute role, but a role nonetheless. The degree of involvement can certainly be debated, but the fact that Paulson was involved in the process is difficult to deny. Paulson may have only made suggestions to ACA, but even ACA was not aware that Paulson intended to short the portfolio after it was structured.
Moreover, as the SEC argues, Tourre knew that Paulson wanted to short the CDO portfolio. In fact, they misled ACA into believing the Paulson intended to take a long position with ACA. The SEC points out that an email from ACA to Tourre mentions in passing that ACA believed that Paulson was a long investor. However, Tourre never corrected ACA even though such a correction would have most likely made ACA completely rethink whether to go forward with the portfolio structuring or not.
After a grilling by Senator Carl Levin this week and an already skeptical public turning more and more suspicious, Goldman appears to be on the defensive in this case. In fact, it now seems likely that Goldman will settle the case with the SEC rather than enter into a protracted legal fight.
In Defense of Goldman:
The Securities and Exchange Commission (SEC) has accused Goldman Sachs of defrauding its investors by not disclosing information about mortgage investments that were sold during the collapse of the housing market.The SEC accuses Goldman Sachs of failing to reveal that John Paulson, a client of the firm, helped create and bet against the subprime mortgages securities that Goldman sold to its investors.
The two main financial institutions that were involved, namely IKB and ACA Capital Management, received detailed information about the products and most likely knew what they were getting themselves into since they are leading CDO market participants. Furthermore, it is common sense at their level to know that with every long position in a synthetic CDO transaction, or any type of derivative for that matter, there is a corresponding short position. According to SEC documents, ACA worked with Paulson to select bonds to be included in his portfolio and in the end, 90 securities were selected. However, when Goldman presented these securities to its investors, they never mentioned that Paulson took positions. They only said that ACA was involved in selecting the assets. The SEC argues that Goldman should have revealed that a major hedge fund, Paulson & Co., was taking a short position against these mortgage-backed securities. Personally, I thought it was ethical business practice to not reveal the investment position of clients to other clients in any kind of investment deal. In addition, Tourre did recall informing ACA that "Paulson's fund was expected to buy credit protection on some of the senior tranches of the AC-1 transaction," meaning it was going to take a short position in the deal. All the information that investors needed was presented to them, including the fact that ACA was involved in picking the assets and what mortgage bonds backed the CDOs that the financial institutions were investing n.
We also have to recount what the role of Goldman Sachs is as a market intermediary. In this case, they are there for the sole purpose of allowing their clients to take long or short positions with CDOs. Because there needs to be a corresponding position with every short position or every long position, what a firm often does is take the opposite side of the client's position so that the transaction can be completed. This is what Goldman Sachs did and as you can see, they did not profit. Paulson & Co. profited about $1 billion from shorting the portfolio. Goldman was paid around $15 million for structuring the MBSs and pitching them to investors, but lost $90 million on the deal. If Goldman did have greedy intentions, I'm sure they didn't want to structure an investment that would make them lose $75 million. Perhaps Goldman did make $3.7 billion from shorting the collapse of the mortgage market in 2007 but that is just the action of a firm taking a position in the housing market. Citi took the opposite side and lost money from it's 'bet,' forcing the government having to bail them out. If the housing market went the opposite way than where it went today, we might see the government bailing out Goldman instead and this case would not be a case at all. ACA and IKB would have profited, Paulson would have lost a massive amount of money, and the SEC would probably be picking on another investment bank that profited from the situation. All Goldman was doing was taking a position and managing its risk in their books.
This was definitely not a case of the popular 'Wall Street Greed' that has been circulating the media these days since there was really no profit for Goldman to take. In my opinion, this case was just a political play by the U.S government to use Wall Street's unethical behaviors as the reason for the demise of the American economy. As you recall earlier that week, prosecutors were just starting a case of whether Rajat Gupta, a Goldman director, gave insider information to his close friend, Raj Rajartnam, the infamous Galleon hedge-fund manager. However, if the SEC does believe that this was a problem of ethics, then it should concentrate on amending the law.
If the U.S government wants a real case that could actually help our economy move forward, they should focus on the relations between the financial institutions and the credit rating agencies, not solely on the Wall Street firms themselves.
Jesus, Strawberry Daiquiri ...
Baileys Original
"Perhaps Goldman did make $3.7 billion from shorting the collapse of the mortgage market in 2007 but that is just the action of a firm taking a position in the housing market."
Seriously? Essentially, you're saying, "Perhaps Goldman did make a shit ton of money buying insurance on financial transactions they knew were going to fail, but so what, that's how you make money." That's exactly the problem. These people, and up and coming workers on Wall Street, need to know that their purpose is not to make as much money as possible, especially not at the expense of people who trust banks to protect their money or clients who trust firms like Goldman. Their job is to be productive - to be producing things that benefit people other than yourself, just like every other American. A fascinating concept, I know. They do not have the right to play the free market and make money any way possible. Yes, they have a right to make profits, but only by producing effective products, just like every other American (even if what these people produce is hard to say). The way capitalism works is that you make money by doing a good job - you don't make money by gambling with people's money, cheating, lying, and generally making shitty products.
This speaks to the culture of Wall Street and how those who work on Wall Street think. They think they have the right to make money any way possible, even if it's illegal. I'm sorry, but that's not how it works. When a black man in the inner city steals to feed his family, he doesn't get off light because he needed to make money any way possible. His ass goes to jail. So why should those on Wall Street get off? They do not have a right to make money - they have a right to profit from productive business models that benefit people, just like any other capitalist endeavor (if we're speaking ideally).
Yet, people on Wall Street think that they are owed money. Why, because they spent four years or so in college, and now have to answer their Blackberries and iPhones at four in the morning? Those poor babies! They must not know that many Americans work upwards of two jobs just to make ends meet. The people at Duane Reade stand on their feet at five in the morning just to serve Columbia students, but you don't see those workers - people who actually work and provide services - crying over themselves. Wall Street and its defenders need to get over themselves and stop living in lala land.
Moving on to your assertions though ... the idea that Goldman was just innocently trying to make some money is bullshit. These people knew that what they were doing was dangerous for the entire financial system, but they didn't care.
See: http://www.independent.co.uk/news/business/news/what-the-trader-said-in-...
And see: http://gawker.com/5523649/here-are-emails-where-goldman-sachs-was-happy-...
These emails prove that the guys at Goldman were making money, and that they knew that their activities were irresponsible. I quote from Fabrice Tourre, that Goldman executive asshole who looks fresh out of a college frat: "Darling you should take a look at this article ... Very insightful ... More and more leverage in the system, the entire system is about to crumble at any moment ... The only potential survivor, the fabulous Fab (as Mitch would kindly call me, even though there is nothing fabulous abt me ...), standing in the middle of all these complex, highly levered, exotic trades he created without necessarily understanding all the implications of those monstrosities!!! Anyway, not feeling too guilty about this, the real purpose of my job is to make capital markets more efficient and ultimately provide the US consumer with more efficient ways to leverage and finance himself, so there is a humble, noble and ethical reason for my job;) amazing how good I am in convincing myself!!!"
What. A. Dick. He actually gloats about doing dangerous things that he doesn't understand, and is positively gleeful about making money by acting irresponsibly. And then to mock the role he should be playing .... that puts the icing on the cake.
The other emails (one of which is from Goldman CEO Lloyd Blankfein) shows that Goldman executives were making money, and that they knew they were cheating their clients. They admit it to each other. They also knew what they were doing would hurt the entire economy. They didn't care. Perhaps most damning is the fact that they knew what they were doing would hurt their own firms - but didn't care because individual executives would walk away with millions of dollars! These people don't even care about the companies they work for; they only care about are themselves and their bank accounts.
Finally, the idea that the SEC shouldn't be focusing on those who broke the law is ridiculous. That's what the SEC is there to do - regulate the financial industry, and help punish those who break the law. Yes, there probably was political calculation in the timing of the announcement (finally, Obama is being politically ballsy), but that doesn't mean the prosecutions shouldn't move forward. The SEC did its investigation, found that Goldman execs broke the law, and SEC regulators are doing their jobs. It's simple as that. It seems to me that you're saying Goldman shouldn't be taken down because ... well, they're Goldman, and everybody knows you don't mess with money. Sorry, but this is America, and we need to act on our values and laws.
Seriously, how can you defend these people? And what other smokescreens can you throw up since all your arguments have already been taken down, in Goldman's own words, no less? If what you say is true - that this kind of dealing is just normal on Wall Street - then that's a further argument for financial reform. This careless irresponsibility can't continue. Americans can't suffer again just because a few uppity college grads (who have no skills that a liberal arts major can't do after going through a mere three months of training - see: http://voices.washingtonpost.com/ezra-klein/2010/04/why_do_harvard_kids_...) think they're entitled to money.
Hey Bailey's
Admittedly, I've only read your first paragraph so far (I'll get to the rest later, hopefully), but it's already misguided.
Not that I don't agree with your bottom line. Because I do. But the question is not whether Goldman made profits or not. The question is whether Goldman misled/lied/lied by omission to investors.
You should be aware that when I buy shares in Microsoft, for example, if the price of the stock goes up, then I do make money. But on the flip side, traders who might be shorting the stock lose money. That's how the market works. That's how futures contracts work. At the most basic example, if I'm a farmer and I think the price of grain will fall, then I'm going to buy a futures contract, which will guarantee me a fixed price for grain in the future. If the price of grain falls below this price by the time the contract expires, then the farmer essentially makes money. If the price is higher, then the farmer loses money-- because he could have sold the grain at the now higher price. Financial markets-- the stuff that you see with the DOW and NASDAQ and the more complex indices, etc.-- all operate with one party winning and one party losing.
Therefore, to say that it was wrong for Goldman to be making money while other people are losing money is a nonsensical argument for both you and Strawberry Daiquiri. The question is over whether Goldman misled others, one way or the other. That's the only question at hand in this case.
Haha
Baileys Original
I hope you do read the rest of my comment, because you'll see that your assessment of it is flat out wrong.
I don't have a problem with Goldman making profits. That's what Goldman is there for. I have a problem with Goldman making money in underhanded ways that endanger our economy. Like I said, these people were engaged in practices that they knew would hurt not only their clients, but the wider economy. The emails give us an idea of their thinking. My argument is not that it's wrong for Goldman to make money while others are losing money.
My argument is that it's wrong for Goldman to be engaged in irresponsible practices, even if those practices result in profits. They cannot be short selling markets - which is, in my opinion, a dubious practice at best - by gambling with other people's money. Don't you agree that it's wrong to take money bank customers have deposited and use it to essentially gamble with? The same thing goes for the money of clients. That's how it ended up that these executives walked away with millions while other people's savings were decimated. That's not right, and should be banned.
It's not OK to leverage your firm based on dubious financial calculations, especially when your firm is tied up with the larger economy and could bring the entire house down.
The point is that these people knew they were playing a dangerous game and potentially screwing others. They also knew that their practices would come at the expense of the entire nation. That's wrong, and I don't care what practices Wall Street holds to be normal - when it comes to the wellbeing of the collective, the interests of a bunch of whiny Wall Street bankers take a back seat.
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