As we already know, the Securities and Exchange Commission (SEC) is accusing Goldman Sachs of fraud, for selling mortgage-backed securities to investors that ultimately collapsed. Obviously, we're all looking for the political angle on this, but the question concerning the case itself is ...
Did Goldman Sachs really set their investors up, anticipating the investment would lose money?
From the National Review:
[B]ecause the instrument used here was a synthetic CDO, all parties knew that by definition there was someone holding the short side of a position that had been custom made for this trade. That’s what a synthetic CDO is for. A synthetic CDO has no existence outside the trade and there is always a long and a short party.
So it’s not like Goldman hid the fact that there was a short seller. It hid only the fact that the short seller was the legendary John Paulson, who wasn’t a legend yet because he became a legend only by doing these sorts of trades.
What was Goldman supposed to disclose: that the guy on the short side was smarter — like way, way, way smarter — than Goldman’s clients on the long side?
The above opinion was authored by Andrew Redleaf & Richard Vigilante.
I'm not familiar with these two gentlemen, but from what I understand, Andrew Redleaf is a successful hedge fund manger who called the crash back in 2006, as well as co-authored the recently published Panic: The Betrayal of Capitalism by Wall Street and Washington, with Richard Vigilante.
Smart guys, but unfortunately they don't provide an accurate description of the investment in question. Let me explain ...
Goldman Sachs packaged and sold mortgage-backed securities on the market, which John Paulson shorted (bet that they'd fail). Yes, a lot of investors were shorting these types of investments at the time. After all, short sellers do play an important role in the market. So far, so good.
But here's what's unique about the investments in question:
- Paulson was directly involved in their creation.
- They were specifically packaged for Paulson to sell short (bet against).
Because he was selling short, it was in Paulson's best interest to package the securities with the worst mortgages he could find. But this still doesn't answer the question of fraud.
What we need to know is:
- Did Goldman properly disclose Paulson's role in packaging the securities and the reason they were created?
- Did Goldman mislead investors about Paulson's role, implying his investment was on their side?
- Or perhaps Goldman mislead investors by telling them they were packaged by an independent party with the best mortgages available?
As you can see, it's not as simple as saying "What was Goldman supposed to disclose: that the guy on the short side was smarter — like way, way, way smarter — than Goldman’s clients on the long side?"
Because if Goldman did not disclose Paulson's role in creating the securities with the intent to short, then they are guilty of fraud, and should be prosecuted accordingly.
More details here: Goldman Sachs and the Wall Street Witch Hunt
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Another important thing for you to know about these investments, is that they are the same securities that brought down AIG (who insured these types of securities).
Despite the securities being highly rated, Goldman Sachs insured themselves against possible losses through AIG. In fact, AIG insured some of the very securities the SEC is now charging Goldman Sachs for fraudulently creating and selling.
Of course it makes sense that Goldman would insure these investments against loss, especially if they felt the investments were riskier than rated. The problem however, is that when the market collapsed, AIG (Goldman's insurer) collapsed too. Sounds like a problem, right?
Not when you have friends in high places ... The U.S. Secretary of the Treasury, Hank Paulson, just happened to be the former CEO of Goldman Sachs.
So after AIG went bankrupt, some $20 billion passed through AIG into Goldman Sachs coffers. In other words, they collected the money they made betting against their own securities ... The very securities the SEC now claims were fraud.
