By J. DeVoy
The Securities and Exchange Commission has filed a civil suit against Goldman Sachs and one of its employees, Fabrice Tourre, for securities fraud. The complaint revolves around Goldman’s alleged misrepresentations about the quality of loans underlying a collateralized debt obligation (CDO). Paragraph five summarizes the consequences neatly:
The deal closed on April 26, 2007. Paulson paid GS&Co approximately $15 million for structuring and marketing ABACUS 2007-AC1. By October 24, 2007, 83% of the RMBS in the ABACUS 2007-AC1 portfolio had been downgraded and 17% were on negative watch. By January 29, 2008, 99% of the portfolio had been downgraded. As a result, investors in the ABACUS 2007-AC1 CDO lost over $1 billion. Paulson’s opposite CDS positions yielded a profit of approximately $1 billion for Paulson.
Despite this, though, Moody’s and Standard & Poors rated the class A-1 and A-2 notes for this deal near the top of the reliability spectrum. This is described in paragraph 58.
ABACUS 2007-AC1 closed on or about April 26, 2007. IKB bought $50 million worth of Class A-1 notes at face value. The Class A-1 Notes paid a variable interest rate equal to LIBOR plus 85 basis points and were rated Aaa by Moody’s Investors Services, Inc. (“Moody’s”) and AAA by Standard & Poor’s Ratings & Services (“S&P”). IKB bought $100 million worth of Class A-2 Notes at face value. The Class A-2 Notes paid a variable interest rate equal to LIBOR plus 110 basis points and were rated Aaa by Moody’s and AAA by S&P.
Shortly thereafter, the notes became worthless.
Going back to the transaction that instigated this suit, Goldman created and marketed the CDO for $15 million. A substantial sum of money to be sure, but something that could have easily been foregone by the banking titan. In the halcyon days of the housing bubble, Goldman’s bonuses to top producers were factors of that sum.
It’s unlikely that Goldman Sachs would have walked into litigation where the SEC seeks disgorgement of profits, fines and an injunction over a relatively measly $15 million. The sale of shares in the CDO could have resulted in greater upside for Goldman, but this is just one of dozens, if not hundreds, of similar deals being made on Wall Street at the time.
A number of reasons for this action come to mind. First, collateral estoppel. If the SEC can get favorable rulings or a fat settlement out of Goldman, it can use them as leverage in future suits against the bank and other financial entities. The specter of a potential lawsuit will chasten other banks and potentially even bring them to the table to avoid future litigation, especially as this mornings news has already sunk Goldman’s stock price (ticker symbol GS) 10%. For executives and employees with much of their compensation tied up in stock options, as was the case at Bear Stearns, the fallout from this event poses a significant risk. There is the rage of populism, which spilled over at yesterday’s nationwide Tea Parties. Though these people cannot quite articulate what Wall Street and, specifically, Goldman Sachs do, they’re mad as hell to see the financial sector enriched as the traditional economy crumbles. Though the SEC has more independence than other agencies, the Commission’s actions are ultimately imputed back to the President, and it’s good press to go after The Great Satan of high finance.
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The Legal Satyricon 
> A number of reasons for this action come to mind. First, collateral estoppel. If the SEC can get favorable rulings or a fat settlement out of Goldman, it can use them as leverage in future suits against the bank and other financial entities.
That is not collateral estoppel. It is precedent.
It will be precedent too, but the resolution of specific fact issues can be used as collateral estoppel if counterparties to these CDO deals bring suit, or multiple suits arise out of this transaction. Either scenario seems possible.
http://en.wikipedia.org/wiki/Collateral_estoppel#Issue
So, why are you unhappy about the lawsuit?
Because it’s analogous to when Superman died, when Clinton was impeached, or when Dean lost the Iowa primary. (I spent my youth as a Clinton fan and campaigned a fair bit for Dean as a college freshman in 2003, before my political views metamorphosed into what they are now.) Goldman Sachs inspired me to be on both sides of deals and see every potential avenue to victory – a perspective that has not yet failed me. So, when the SEC sues it because others made a losing bet, it hurts me and crushes what little remains of my youthful idealism and hero worship. It’s disillusioning to see someone or something you thought was perfect suffer an injury and bleed just like everyone else.
You were kinda an odd kid, weren’t you?
Oh, the e-mails my mother could send you…
[…] “A number of reasons for this action come to mind. First, collateral estoppel. If the SEC can get favorable rulings or a fat settlement out of Goldman, it can use them as leverage in future suits against the bank and other financial entities. The specter of a potential lawsuit will chasten other banks and potentially even bring them to the table to avoid future litigation, especially as this mornings news has already sunk Goldman’s stock price (ticker symbol GS) 10%. For executives and employees with much of their compensation tied up in stock options, as was the case at Bear Stearns, the fallout from this event poses a significant risk. There is the rage of populism, which spilled over at yesterday’s nationwide Tea Parties. Though these people cannot quite articulate what Wall Street and, specifically, Goldman Sachs do, they’re mad as hell to see the financial sector enriched as the traditional economy crumbles. Though the SEC has more independence than other agencies, the Commission’s actions are ultimately imputed back to the President, and it’s good press to go after The Great Satan of high finance.” –J. DeVoy, The Legal Satyricon […]
Top-rated securities are packaged and sold, which become worthless in 6 months. The originator of this transaction earns $985 million.
So who knew that actual value of the underlying securities? Were Paulson, S&P, GS, Moody’s and all of the brokers and investors who valued, purchased, analyzed or rated these securities completely ignorant as to their value?
If not, it is horrifying to consider this is legal and apparently (from recent history) a common practice.
On the other hand, if no one can be found to have known the true value of the securities in question, then the global financial community has bigger troubles that beggar the worst nightmare.
The reason is in front of everyone’s nose. Congress will be passing some kind of financial reform very soon and, interestingly, this particular news broke on the same day that the Republicans sent a sternly-worded letter to the Dems about seeking bi-partisanship…NORMALLY, such a letter would threaten a filibuster but not this time…elections are too close.
My own response to the news of this suit was “About fucking time!” What I saw, all along, was a situation that called for banks to issue mortgages willy nilly because the demand for these securitized instruments kept growing…for the bookies (Goldman Sacks being one), it was like printing money. Sell the debt to one schmuck and then sell the bet against it being any good to another. What is wrong with this picture??
High finance and mortages should be a much more solemn and trusted process and not something akin to high roller night on some floating casino deck.
Sell the debt to one schmuck and then sell the bet against it being any good to another. What is wrong with this picture??
It’s just arbitrage; Goldman simply is better at it than its Bulge Bracket peers. It’s not like it was making these deals with widows and orphans. Goldman Sachs’s counterparties were hedge funds, other banks and large insurers who knew the risks, or could have paid enough for attorneys or employees who were familiar enough with the instruments to alert them to the risks. Any non-idiot on Wall Street knows that if you’re going long on something, as CDO’s represented a long position on credit and the assumption that borrowers would repay the MBS’s comprising it over years and decades, someone’s going short on it, as represented in the credit default swaps — bets that the securities would implode as borrowers went belly-up and no longer paid.
While it’s shocking to the average individual, this is business as usual on Wall Street. The margins and profits are fat enough that we shouldn’t neuter the system; further regulation will punish creativity in the short term and eventually force financiers to create new instruments that escape existing regulations, starting the cycle anew.
They were selling these things to institutions that were responsible for peoples’ 401ks and municipal funding.
It was utter and complete greed gone wild and they sold like crazy until their golden boys (privately) forecast the whole house of cards falling. Then Goldman got out and let it come tumbling down…on retirees and cities and the rest of us, widow or no, orphan or no.
Very creative…in a very evil sort of way. Punish them? HELL YES. Regulate the hell out of them. Double hell yes. They will think twice about getting so fucking creative again.
Companies holding mutual funds and large portfolios of 401k’s are still sophisticated investors. As are municipalities, or at least they should be, despite the idiots that stock local governments. Again, another shining example of why democracy is a deeply flawed system.
The issue is that ANY IDIOT could have seen the house of cards falling; real wages were not keeping up with rising housing prices. While the far sweep of the housing bubble ensured everyone was participating – Posner thoroughly discusses this in A Failure of Capitalism – individual investors could have protected themselves by going short on housing and realizing that the repayments that supported MBS’s and CDO’s could not be made once either 1) housing prices stopped rising as precipitously as they had, or 2) the Fed increased interest rates. Both happened. Given how ignorant political candidates often are and how difficult it is for smart people to make it into the system, I have minimal sympathy for them or their constituents – you reap what you sew. Similarly, as a person not yet 25 years old, who has seen an immense stratification of wealth in my lifetime and the decimation of the traditional middle class in the last 20 years, I have NO sympathy for the elderly who caused this mess. They cut costs and construed it as value, and now my generation will not only have to support them through social security, a new healthcare entitlement and repaying the massive debt our government has incurred to prop up the global financial system — which, for better or worse, is heavily reliant on Wall Street and America. They deserve every single bad thing that will happen to them, and it’s absurd that they can pass blame onto the standard bearer of finance by virtue of their own ignorance. Some free advice: If you’re going to spend money on something you don’t understand, it’s worth paying a neutral party to explain it to you.
And now we slide into the false dichotomy of good/bad, right/evil. GS’s actions were simply in its self-interest, and other people didn’t bother to see both sides of the deal. Any punishment for that is mere spite. This is high finance, not a bake sale.
Okay, so back to my original question… why are you unhappy about the lawsuit?
If your problem is that you think such lawsuits will stifle creativity, isn’t your real beef with the law, and not the SEC’s enforcement of it? If you think that the SEC is being selective or… discriminatory?… in its prosecutions, then that’s another kind of problem.
If your problem is that you think GS is innocent of the charges… then, perhaps say so as you would explain it to a five year old (as, that’s about my reading level for financial terms). :)
I’m not sure I agree that more regulation will punish “creativity,” unless by “creativity” you mean GS and other banks finding new and creative ways to inflate economic bubbles, extract huge quantities of cash for their executives, and get out with barely a scratch when the bubble collapses.
@jesschristensen
I’m immediately unhappy with the lawsuit because it destroys shareholder value – a one-day 10% slump is significant. Moreover, it attempts to impose liability for behavior that isn’t violative of securities laws. If Goldman Sachs engaged in this conduct once on a dinky transaction worth $15m in fees, it stands to reason that they did it several times and that peer institutions engaged in the same activity. The law may be good, but it’s being stretched to its breaking point in this case.
Here’s the thrust of my argument:
-The argument that Goldman is in the wrong for selling something “destined to fail” and should therefore be liable is spurious. In 2004-06, anyone who suggested housing prices would slow their rise, let alone decrease, was laughed out of polite company. However flawed, it was the conventional wisdom of the time, and it permeated the financial markets.
Furthermore, all transactions are based on bets. When you buy a stock, you do so because you think it will go higher, and the person selling it does so because they think it will go lower. Similarly, people who bought credit default swaps against CDO’s bet that the borrowers would default before the entity reached maturity; CDO holders believed the loans backing the entity would not go into default. The notion of “betting” is at the core of all these financial transactions, and it makes no sense that it would somehow be inappropriate as applied to this one.
-The CDO’s buyers had a duty to engage in due diligence in the transaction. If they had researched the loans and how they came to ACA’s attention, they would have discovered that they were proposed by Paulson. Nevertheless, all of the information about these loans that could possibly be available was within the realm of their discovery. The buyers failed, for whatever reason, to do so. That’s on them. This isn’t someone with 8th grade reading comprehension being pressured into an interest-only mortgage: The buyers of these instruments were Ivy-types (or should have been) with substantial finance experience. If they didn’t know what they were doing, it’s a lapse of their judgment for failing to seek outside counsel to explain it to them. The complaint itself seems to indicate that GS took all necessary prophylactic measures in structuring this deal, but the bank can’t force its buyers to act rationally.
-It’s irrelevant whether or not Jordan selected any loans underlying the CDO. For all the buyers knew, ACA could have picked those loans independently. As noted above, buyers had a duty to examine the instruments being sold to them according to standard practice and custom in finance. Whether someone outside of the CDO agent picked the underlying loans, and who that was, are irrelevant. A misrepresentation would be if Goldman had said someone other than Paulson picked them out, or that only ACA had a role in that. GS merely omitted that superfluous data.
-And, finally, there’s the allegations of SEC showboating before the White House proposes new financial regulations. The same impotent SEC that investigated Bernie Madoff eight times without finding a violation suddenly has crushing evidence against Goldman Sachs? I’m skeptical. Yet another reason I think this lawsuit was rushed to the court without thinking about the possibility of the SEC losing.
I am presently in litigation with Fremont Reorganizing, Goldman Sachs dba Litton Loan Servicing, et al., (2 different cases) for about 2 years now. The main issue with the complaint is a fraudulent loan originated by Fremont in June 2006. This in turn produced an array of other
issues: unsigned deed of trust, over billing issues, lost payments, excessive balloon payment, back dated assignments, illegal non-judicial foreclosure documentation, missing documentation, illegally reporting to my credit, falsifying declarations, 6 week TRO’s, court procedures not followed, judges wait until the courtroom is cleared to rule against a TRO (both times); retired (78 year old) judge ruled against a seated judges TRO where the retired judge took 30 minutes to read a 300 page brief. The whole time they have been ignoring my request and failing to give me the required documentation so that I can rescind the loan. Goldman Sachs dba Litton Loan Servicing has been aggressively trying to foreclose on my property. I believe to cash out for insurance reasons. (It’s over a million dollar loan) I have invested over $400,000 into this property for the past 5 years and if I had known about this mortgage meltdown game played by Wall Street I would have never proceeded with this Real Estate transaction. The Media and the Government has not once addressed or helped the borrower, namely me, who also has been damaged by these defaulted CDO’s.
A Time line of what’s going on with Goldman Sachs to show how they are scheming to pursue foreclosures for the insurance by acquiring distressed, shelled fraudulent companies which will eventually or haven’t already gone BK…
Oct 26, 2005 Litton Loan Servicing Class Action – mishandling loans, servicing over 400,000 borrowers – case settled Feb 17, 2009 for $537 (limited due to class status)
Feb 27, 2007 FDIC Cease and Desist – Fremont Reorganizing for illegal loan practices, et al., (largest predatory lenders who heavily solicited brokers for their schemes)
Oct 16, 2007 Massachusetts Lawsuit vs Fremont and Goldman Sachs – Predatory Lending Practices – settled May 11, 2009 for $60 mil
Dec 11, 2007 – Goldman Sachs Acquires Litton Loan Servicing
June 2, 2008 Litton (Goldman Sachs) Acquires Fremont Reorganizing Servicing Rights
June 19, 2008 Fremont Reorganizing files BK
Apr 16, 2010 – SEC vs Goldman Sachs – Securities Fraud
Here is the link to my blog http://bushnellcomplaint.blogspot.com/ if you want to download court documents pertaining to my case.
Note: My wife is pursuing individuals who are interested in joining her in a class action lawsuit with regards to violation of her community property rights in a wrongful foreclosure. If you are in a community property state and a spouse is not on title you may have grounds for legal action.