Vampire squid alert: Goldman is clearly being singled out

I just posted on Goldman’s fraud charges this morning with my article "SEC Charges Goldman Sachs With Fraud; May The Perp Walks Begin." Below are my (now updated) thoughts on the case having seen more of the information surrounding the case including the complaint which is embedded in the post linked above. I have also provided other reactions from around the net at the bottom of this post.

My initial reaction to these charges is largely positive.  It is clear to me that fraud was a major factor in the financial shenanigans which led up to the spectacular bust we witnessed in 2008. Eighteen months after Lehman’s demise it is high time we saw the investigations into the activities from that time period reach an indictment stage.

Goldman Sachs has long been accused of looking after its own interests and not that of its clients – and certainly not that of its counterparties.  To date, most of this behavior could have been construed as unethical, if legal. Here are a few articles testifying to this:

There are many more articles of this ilk written in the past months about Goldman. Now, the SEC has something on Goldman which it believes is clearly illegal. Goldman is clearly being targeted here because they are the poster boy for bad behaviour – vampire quid smelling money and all of that. You will notice that the complaint reads in bold at the top right: Jury Trial Demanded. That’s not by chance You know why. It’s the populist rage. A jury is more likely to convict.

Nevertheless, there are other aspects of this case I find troubling.

Here’s an aspect I find strange. John Paulson seems to be the offensive party here since his firm made the collateral selections in question.  If it was these actions which were deemed improper, why is Goldman Sachs being charged?  Is it that the charges against Goldman are easier to prove? Why is he not named in the complaint which obtained from the SEC’s website?  I am no lawyer but this makes no sense to me at all.  It seems like a selective prosecution [Update: see the explanation at the bottom of this post as to why this was].

What about this: FBI warns of mortgage fraud ‘epidemic’: Seeks to head off ‘next S&L crisis’? Why haven’t we seen any prosecutions of major insiders in the mortgage business.  The media is replete with stories of predatory lending and fraud. We are even hearing an increasing number of cases of short sale fraud. Yet, we see nothing on this front.

What about Lehman Brothers? Just yesterday I posted the Bloomberg interview with Vanity Fair’s Vicky Ward who wrote a book about Lehman. She was saying aloud "we really do need prosecutors to get people into a courtroom." And given the fact that Lehman is the firm which collapsed in a heap with a massive $150 billion gaping hole it its balance sheet, it seems to me they would be an easier target for fraud.

Why are the first major charges against a TBTF firm not against Lehman or Lehman’s former executives?

I can think of three reasons:

  1. Lehman went bankrupt and may soon be wholly liquidated. There’s not as much to get there.
  2. The Goldman case has been ongoing for some time (see this Gretchen Morgenson story from December). Perhaps, the Feds are just more prepared to file in this case.
  3. Goldman has been targeted in order to maximize the political benefit associated with this first prosecution.

That last bit regarding the politics occurs to me in particular because Yves Q. Smith forwarded me a letter that the Obama people sent out just this morning.  It reads:

Friend —

It has now been well over a year since the near collapse of our entire financial system that cost the nation more than 8 million jobs. To this day, hard-working families struggle to make ends meet.

We’ve made strides — businesses are starting to hire, Americans are finding jobs, and neighbors who had given up looking are returning to the job market with new hope. But the flaws in our financial system that led to this crisis remain unresolved.

Wall Street titans still recklessly speculate with borrowed money. Big banks and credit card companies stack the deck to earn millions while far too many middle-class families, who have done everything right, can barely pay their bills or save for a better future.

We cannot delay action any longer. It is time to hold the big banks accountable to the people they serve, establish the strongest consumer protections in our nation’s history — and ensure that taxpayers will never again be forced to bail out big banks because they are "too big to fail."

That is what Wall Street reform will achieve, why I am so committed to making it happen, and why I’m asking for your help today.

Please stand with me to show your support for Wall Street reform.

We know that without enforceable, commonsense rules to check abuse and protect families, markets are not truly free. Wall Street reform will foster a strong and vibrant financial sector so that businesses can get loans; families can afford mortgages; entrepreneurs can find the capital to start a new company, sell a new product, or offer a new service.

Consumer financial protections are currently spread across seven different government agencies. Wall Street reform will create one single Consumer Financial Protection Agency — tasked with preventing predatory practices and making sure you get the clear information, not fine print, needed to avoid ballooning mortgage payments or credit card rate hikes.

Reform will provide crucial new oversight, give shareholders a say on salaries and bonuses, and create new tools to break up failing financial firms so that taxpayers aren’t forced into another unfair bailout. And reform will keep our economy secure by ensuring that no single firm can bring down the whole financial system.

With so much at stake, it is not surprising that allies of the big banks and Wall Street lenders have already launched a multi-million-dollar ad campaign to fight these changes. Arm-twisting lobbyists are already storming Capitol Hill, seeking to undermine the strong bipartisan foundation of reform with loopholes and exemptions for the most egregious abusers of consumers.

I won’t accept anything short of the full protection that our citizens deserve and our economy needs. It’s a fight worth having, and it is a fight we can win — if we stand up and speak out together.

So I’m asking you to join me, starting today, by adding your name as a strong supporter of Wall Street reform:

http://my.barackobama.com/StandForWallStreetReform

Thank you,
President Barack Obama

Also see Obama calls together congressional leaders in push for new financial regulation in the Washington Post. I was heartened that there were no requests for money in any of the links above. But I still see the reform agenda as connected to this specific prosecutorial announcement;  that’s a bit too political for my taste.

Anyway, that’s my view.  Here are snippets of what others are saying:

Gretchen Morgenson, NY Times

The move marks the first time that regulators have taken action against a Wall Street deal that helped investors capitalize on the collapse of the housing market. Goldman itself profited by betting against the very mortgage investments that it sold to its customers…

For months, S.E.C. officials have been examining mortgage bundles like Abacus that were created across Wall Street. The commission has been interviewing people who structured Goldman mortgage deals about Abacus and other, similar instruments. The S.E.C. advised Goldman that it was likely to face a civil suit in the matter, sending the bank what is known as a Wells notice.

SEC Charges Goldman with Fraud – James Kwak

One of the things I say now and then that most annoys people is that the financial crisis was not caused by criminal behavior. (Note: The “Prayer for the Relief” at the end of the complaint only asks for civil penalties, but I suppose this does not preclude a criminal action — someone who’s a real lawyer could answer that.) My general line is that I’m sure there was some bad behavior that rose to the level of criminal liability — like lying in disclosure documents — but that it wasn’t necessary for the crisis, and we could have had the crisis without any criminal activity at all. (For example, since most investors weren’t even reading the disclosure documents, Goldman could have said that Paulson was involved in the security selection, and then everything would have been hunky-dory.)

And I don’t think this action contradicts my general point. I would love it if the SEC could nail banks for some of the CDOs they created, but I’m still betting that the vast majority will not create legal liability for them.

Goldman (full statement)

The SEC’s charges are completely unfounded in law and fact and we will vigorously contest them and defend the firm and its reputation.

Zero Hedge

AIG stock only fin up today on expectations the firm will now have legal precedent to sue Goldman Sachs.

Business Insider (Here Are The Financial Companies That Got Screwed By Goldman’s Alleged Fraud)

  • ABN Amro (now RBS), ACA Capital, IKB

I’m sure there is much more out there. As I write this Goldman’s stock is down 25 points or nearly 15%. The financials are getting killed across the board. Will there be more prosecutions like this in future? I suspect this is just the beginning.

 

Update: We now know why Goldman was charged and Paulson was not. From the WSJ:

Why was Paulson & Co. spared from charges in the Securities & Exchange Commission’s case against Goldman Sachs Group?

The SEC’s head of enforcement, Robert Khuzami, said there was no evidence that Paulson had made representations to ACA Capital Holdings about the collateral in the collateralized debt obligation, known as Abacus.

“Goldman was responsible for the representation to the investors, and Paulson was not,’’ Khuzami told a group of deal makers gathered in New Orleans at the 22nd annual Corporate Law Institute sponsored by Tulane University Law School.

About 

Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty years of business experience. He is also a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College. Edward also writes a premium financial newsletter. Sign up here for a free trial.