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:

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.

  1. gaius marius says

    @felixsalmon clearly isn’t a lawyer either, but his view is that GS is the appropriate target:

  2. Michael Jung says

    4 word only.

    “It’s far from over.”

  3. Edward Harrison says

    Michael and Gaius, I will have some comments about Goldman in the NYTimes Room for Debate later today.

  4. Anonymous says

    ^is a lawyer and agrees that there has to be a legal duty to create legal consequences. That will be an issue in all of this. As financial liability was shifted by the originator selling mortgages to third parties, so legal liability gets blurred too. A lot of this stuff was sold with little if any representation to hang liability on, or perhaps sellers with legal duty relied in good faith on rating agencies. If you could show that the rating agencies received fraudulent representations or deliberately concealed information, you’d have a good smoking gun, but mostly I think it will be a lot of deciding whether foolishness amounted to gross negligence. Were different players just stupid or stupid enough to be held legally liable?

    It makes perfect sense to me that Goldman is the first target for the reasons you gave, but also for one more: Goldman has recovered faster than any other financial player, and it’s already known that Goldman is back to its old tricks with derivatives and other unregulated or semi-regulated instruments. Rather than investing in and helping to grow the economy, it has chosen to keep skimming money off the economy with betting instruments. This is not just a political show for the public, it’s firing a shot across the bow of the big financial players.

    1. Marshall Auerback says

      I hope you are right. It is true that the burden of proof is lower in a
      civil action than a criminal one, but interesting that nobody was marched off
      in handcuffs a la the (much less egregious) Guiliani trials in the 1980s.
      Also contrast the way this case is handled relative to the Galleon
      CRIMINAL case. Why the differences? I think we have to be somewhat suspicious.

      In a message dated 4/16/2010 1:21:32 P.M. Mountain Daylight Time,

  5. Eric O'Neill says

    “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?”

    I would suggest reading the filing. It’s incredibly readable (reads more like a story than a legal document) and answers this question pretty convincingly.

    To give you an idea, put yourself in these shoes. You walk into a casino, and sit down at the Texas hold’em table. You get absolutely smashed. Every hand you get great cards and you think you have a winner, but some else has a better hand.

    Turns out, the guy sitting next to you stacked the deck, and the casino went along with it because they take a small percentage of every pot.

    Who do you get mad at? The guy who stacked the deck? Well, yeah…but really you should be mad at the casino for letting him. He’s just doing what any rational (albeit immoral) economic actor would do.

    1. Edward Harrison says

      That’s another reason they went after Goldman instead of Paulson. Does that give Magnetar a free pass then? Is this even going to be a sustained effort beyond this one case? A lot of this stuff is still unclear.

      1. Eric O'Neill says

        I’m not sure what you mean by “another” reason. That is *the* reason (your update seems to agree with me). Goldman worked with Paulson to create the CDO’s, knowing full well he was betting against them and had selected the most likely RMBS to fail. They then used ACA to give the CDO’s credibility (they thought Paulson had long positions in the securities), and turned around and sold them off to investors.

        The casino was dealing cards they knew were stacked by one of the players. They knew it would backfire on the investors, but they went along with it because they got their fees.

        I’m telling you, read the report. It’s full of gems. Here’s one of my favorites (an email discussion at GS):

        “‘Attached is the revised portfolio that Paulson would like us to commit to – all names are at the Baa2 level. The final portfolio will have between 80 and these 92 names. Are ‘we’ ok to say yes on this portfolio?’ The response was, ‘Looks good to me. Did [Paulson] give a reason why they kicked out all the Wells [Fargo] deals?’ Wells Fargo was generally perceived as one of the higher-quality subprime loan originators.”

        1. Edward Harrison says

          Eric, I think a lot of this is political. So, when I say that’s “another” reason I mean to say that Goldman is being targeted for political reasons.

          I like the casino analogy. Here’s another one for you that Annie Lowrey made. It’s good:

          So you meet with the broker, who shows you a plain apartment in a plain apartment building. You decide to go for it. He says he will hire an independent home inspector to appraise the home, to make sure it is sound and to help you determine your bid. The process moves forward, you buy the house and pay the broker his fee.

          But just months later, you find out that the neighborhood is drug-addled and the apartment filled with leaks. You try to sell the apartment, but can only do so at a 90 percent loss. It turns out that the third-party independent home inspector had been hired by the seller; that the seller had made a bet with a bookie that the price of the house would go down; and that the broker knew it — he let them overvalue your house.

          In this analogy, Goldman is the broker. Paulson is on the short side of the trade, and behind the home appraiser. The analogy is by no means perfect — collateralized debt obligations are more complicated than houses. But it goes to show that the issue here was that Goldman had a responsibility to disclose pertinent information to the buyer, and it did not.

          1. Eric O'Neill says

            Ah, right. I was referring to just the Paulson vs GS distinction.The fact that GS is being singled out certainly smells fishy. However it may be for legal reasons rather than political, and I’d suggest not jumping to conclusions. The SEC may feel they have a particularly strong case against GS, and is testing the waters to see how things go with a jury (just educating a layperson on the jury will be a struggle, not to mention having to prove reasonable guilt. I’ll wager that GS won’t have pushover lawyers). Another possibility is they’re trying to coax out whistleblowers on similar cases they’re working on. They need to show they mean business, and naming a single individual within GS may make people realize they may not be sheltered by their respective business.The fact that it’s politically decent timing for the democrats seems, at the moment, coincidental at best to me. Remember back in ’06 when oil prices were piling on ($3/gallon) and in the few months before the elections they dropped by almost 1/3rd? There were certainly more plausible explanations than Republican interference. Things like this happen, and there are large elections every other year…Let’s not jump to conclusions.

          2. Edward Harrison says


            I’m not jumping to any ‘conclusions.’ It is early days yet and we’ll see based on future actions whether this is political or not. Actions will speak for themselves.

  6. Bob Morris says

    We need to see Goldmanites going to prison. We’ve had far too much of the stiff fine and no criminal prosecution for executives who are clearly criminals.

    How about the Feds invoke RICO?

    Yes, it is in part political. And Goldman just went from being the hunter to becoming the prey. Capital Hill hates to take a fall for anything. Goldman is now the designated evildoer.

    1. Edward Harrison says


      One reason I am sceptical about the politics here is that this is a CIVIL complaint and I don’t know if we’re actually going to see any perp walks. This is not a criminal complaint to my knowledge. Yves Smith has been asking why not? I would like to know the answer to that one too.

  7. GardenSERF says

    You ask: “Why haven’t we seen any prosecutions of major insiders in the mortgage business?”

    For the same reason this is a civil filing instead of a criminal filing.

    1. Marshall Auerback says

      Burden of proof in a civil case is much lower than a criminal case, and might open the door to Justice exploring criminal action if SEC is successful here.

  8. Anonymous says

    i have been very surprised by the reactions of folks i regard highly, including you edward.

    this is kabuki theatre, perfectly timed for the elections.

    nothing more.

    nothing material will come of it; a small fine perhaps, no admission of wrong doing, and it will be back to business as usual at the first of the year.

    i hate to sound like such a cynical pessimist, but that was my immediate initial gut reaction to the news, and those are rarely wrong.

    1. Edward Harrison says

      girlscoutheroin, I’m not sure what you read into my comments but, for now, I tend to agree with you. I think this has a lot to do with the politics. If you read my comments on this thread you will see that. And that’s why this post was titled as it was.

      I’m not ruling out other reasons for the charges, but, I am cynical enough to think the main motivations here are political.

      See my comments in the NYTimes as well:

      I may have more to say later tonight.

      1. Anonymous says

        thanks for responding edward, i hadnt seen your NYT piece.

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