"Never give a sucker an even break"
Here is a quick summary from the Times:
Investor Devised a Bet Against Risky Loans
Three and half years ago, a New York hedge fund manager with a bearish view on the housing market was pounding the pavement on Wall Street. Eager to up his bets against subprime mortgages, the investor, John A. Paulson, canvassed firm after firm, looking for new ways to profit from home loans that he was sure would go sour. Only a few investment banks agreed to help him. One was Deutsche Bank. The other was the mighty Goldman Sachs. Paulson struck gold. His pre- science made him billions and transformed him into something of a rock star both on Wall Street and in Washington.
But now his brassy bets have thrust Paulson, 54, into an un- comfortable spotlight. On Friday, the S.E.C. filed a civil fraud suit against Goldman for neglecting to tell its customers that mort- gage investments they were buy ing consisted of pools of dubious loans that had been selected by Paulson because they were highly likely to fail. By betting against the pool of questionable mortgage bonds, Paulson made $1 billion when they collapsed just a few months later, the S.E.C. said. Investors who bought what regulators are essentially calling a pig in a poke lost the same amount. Although Paulson, 54, is not a defendant in the S.E.C. suit, the commission found that he was deeply involved in the creation of the investment, known as Abacus 2007-AC1.
After analyzing mortgages made on homes in Arizona, California, Florida and Nevada, Paulson went to Goldman to talk about how he could bet against those loans. He focused his analysis on adjustable rate loans taken out by borrowers with relatively low credit scores and turned up more than 100 loan pools that he considered vulnerable, the S.E.C. said.
Paulson then asked Goldman to put together a portfolio of these loan pools, or others like them that he could wager against. He paid $15 million to Goldman for creating and marketing the Abacus deal, according to the complaint.
One of a small cohort of money managers who saw the mortgage market in late 2006 as a bubble waiting to burst, Paulson capitalized on the opacity of mortgage related securities that Wall Street cobbled together and sold to clients. These instruments held thousands of mortgage loans that few investors analyzed.
GRETCHEN MORGENSON and LOUISE STORY - who, BTW broke this story months before the SEC even had the smallest clue as to what was going on.
And a quick editorial from the Times:
Months ago, The Times exposed Goldman Sachs’s practice of creating and selling mortgage-backed investments and then placing financial bets that those investments would fail. It wasn’t clear whether the practice was fraud. The Securities and Exchange Commission has now decided that it was.
Keep a close eye on this case. If it is handled correctly, it should finally answer the question of whether malfeasance was partly responsible for the financial meltdown.
Goldman insists that what it was doing was prudent risk management. In its annual report, it argued that “although Goldman Sachs held various positions in residential mortgage-related products in 2007, our short positions were not a "bet against our clients.’” The bank also insists that the investors who bought the structured vehicles were professionals who knew what they were doing. The S.E.C. is now charging just the opposite.
It accuses Goldman of intentionally designing a financial product that would have a high chance of falling in value, at the request of a client, and lying about it to the customers who bought it. It says that Goldman allowed John Paulson, a hedge fund manager, to pick bonds he wanted to bet against, and then packaged those bonds into a new investment. Goldman then sold this investment to its clients, telling them the bonds were chosen by an independent manager, and omitted that Paul- son was on the other side of the trade, shorting it. Five months after Goldman sold the investments, 83 percent of the bonds contained in the packaged securities were downgraded by rating agencies.
Goldman vigorously denies any wrongdoing, calling the S.E.C.’s charges “completely unfounded in law and fact.” It will undoubtedly assemble a daunting legal team. But if the S.E.C. makes its case, it will be a watershed moment, changing the dominant narrative of the financial crisis.
Up to now, the bankers have argued that the financial crisis was like what insurers call an “act of God,” a cataclysm over which they had no control. This has allowed them to shrug off responsibility, even as taxpayers bailed them out. It has allowed them to sleep soundly after collecting their huge bonuses. Goldman is not the only bank to have sold mortgage-backed securities and then bet against them. We sus- pect that after Friday, others on Wall Street may have a harder time sleeping.
Watch This Case
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