Sense and Nonsense about the Case against Goldman Sachs and the SEC

Congratulations America! The SEC has grown a nice set of hangers under the enforcer; SEC boss Mary Schapiro. She cast the deciding vote in a split decision to charge Goldman with fraud. Finally we seem to have a good head on the Nations Financial Watch Dog.

Remember; under her three Bush-appointed predecessors, Harvey Pitt, William Donaldson, and Christopher Cox, Wall Street was basically self-regulating and the SEC was hands-off. This helped enable some of the biggest conmen and cases of fraud in American history: Bernie Madoff, Enron and Worldcom. The lack of regulation over the last decade sowed the seeds of the financial crisis we face today.

So the Securities Exchange Commission has filed a case of fraud on the world’s biggest Investment Bank. The case against Goldman is based on a single deal; the Abacus 2007-aci. It basically enabled hedge fund guru John Paulson to make Millions as the value of American homes crashed.

The Abacus 2007-aci was encapsulated in what is known as a synthetic Collateralized Debt Obligation or CDOs. Now CDOs are derived from mortgage bonds, thus they are derivatives designed to be mathematically complex and beyond the grasp of the average person. However, they don’t hold any actual assets but you can invest in them as you would in the real thing, and you can also short them as you would a stock, using insurance contracts called credit default swaps or CDSs.

The investment banks and hedge funds that made the CDOs are accused of loading them with the equivalent of toxic bonds and buying CDSs for themselves knowing that the CDOs would lose value. Goldman informed investors that they were buying a AAA-rated high-yield investment put together by an independent firm called ACA management. Goldman did a great job of selling a worthless well packaged fake investment. Netherlands’ ABN Amro agreed to issue more than $900 million Abacus bonds and Germany’s IKB bank invests $150 million into the deal. These sophisticated banks stand as fools/losers in a game of deception designed and enabled by Paulson and Goldman Sachs.

What Goldman failed to mention was that ACA picked most bonds for the portfolio from a list Paulson had pre-approved. So basically Paulson handpicked the losers he wanted to bet against. Now I’d like to add to our story a character who deserves equal credit for this mess; Goldman’s Fabrice Tourre. He played a key role as he misled ACA into believing that Paulson was going to invest in the deal. Whereas Paulson was buying Credit Default Swaps that would pay off if the portfolio drops. We all know what happened, as the housing bubble burst and prices took a dive, mortgage bonds began to default and investors in the Abacus lost over $1billion. Most of this went to Paulson as he had issued CDSs and bet against the Abacus investment.

Paulson is not the subject of the SEC’s complaint and is not facing any charges. Goldman says it didn’t set up investments to fail and didn’t mislead clients. They call the charges completely unfounded and vow to fight the allegations aggressively. It will be interesting to see how the SEC fights a full-on defense from Goldman on this.

Wall Street’s CDOs engaged the finance sector of the economy in producing nothing but pure economic waste. They didn’t help anyone afford a new house, no new cars were purchases, nobody got an educational loan and there was no actual productivity via such investments. They simply assisted in the transfer of wealth from the American working man in the service industry (i.e. the backbone of the economy) to a smaller group of already richly rich traders who profited as CDOs failed.

Goldman is the first in line to get a beating from the SEC, and this is a great thing as it shows that the SEC is serious about handling its responsibility as a regulator. The SEC has other banks under investigation for similar synthetic CDO financing deals.

Morgan Stanley had the dead president’s deals called Buchanan and Jackson. JP Morgan and Chase profited from the meltdown via their hedge fund Magnetar and even Merrill Lynch a subsidiary of the Bank of America Corporation is under investigation.

This makes me wonder… What Happened? How did we reach here? How did we end up letting a bunch of self-interested greedy investors run our financial markets? Why are we mesmerized by a purely capitalistic ideology? Why are we here in a world of artificial investments? Why are the traders in charge, those who will make a profit even at the cost of running the economy into the ground?

Investments in markets are essentially supposed to boost actual productivity by maintaining long term relationships and nurturing the economy and the companies and people in it. Whereas for the past two decades the dark world of unregulated high frequency trading generated millions of dollars of cheap money and left the traders in charge. A trader’s only goal is to maximize profits at whatever cost, they only have short term goals. So as a trader if you need to bet against the economy to make a profit, you will do it… everyday… knowingly… drive the economy to the ground and hurt your own fellow citizens in the wake of it.

Is it really worth it?

I have lots more to say which I will continue over the week… your thoughts and criticisms are greatly appreciated.