Tuesday, April 20, 2010

Celebrity Hanging – Goldman Sachs

The SEC action was almost inevitable – a regulatory agency in full retreat

William D. Cohen…. on Wall St and Main St.

What makes the market’s pounding particularly painful is that early next week, Goldman’s stock likely would have soared after it announced huge earnings for the first quarter; instead, the S.E.C.’s civil complaint has crushed it.

But wait a second. Does the punishment fit the alleged crime?

“Are we suffering from hindsight bias?” wondered Peter Henning, a professor at Wayne State University Law School and a former lawyer at the S.E.C., after reading the commission’s complaint. Has the fact that we are all looking for someone to blame for the financial crisis — and haven’t found anyone yet — influenced the government sanctions? Or did Goldman actually mess up?

Despite the market’s reaction, the questions will be answered only after months of discovery, depositions and documents enter the public realm.

Goldman might also settle — which is the usual course these things take, witness Quadrangle Group’s decision, announced on Thursday, to pay $12 million to settle allegations that it paid kickbacks to win lucrative business from the New York State pension fund — rather than face a trial and months of negative publicity. Goldman says it won’t settle and that “the S.E.C.’s charges are completely unfounded in law and fact.”

(Disclosure: I own a small amount of Goldman stock.)

In this unusual shot across Goldman’s bow, the S.E.C. certainly makes its case in dramatic fashion. Among other things, the commission alleges that, starting in early 2007, Fabrice Tourre, a vice president working in Goldman’s New York headquarters at the time, structured and marketed Abacus 2007-AC1 — a synthetic collateralized debt obligation tied to the performance of a bunch of residential mortgage-backed securities. The problem was that he did this without telling Abacus investors that John Paulson, a prominent hedge fund manager who made billions of dollars by famously betting against the mortgage market, had selected the mortgage-securities that went into Abacus specifically because they were so lousy.

And then, the S.E.C. alleges, Paulson bet against Abacus and made $1 billion, while the investors — among them, ABN Amro and IKB, two big European banks — lost $1 billion when the real-estate market collapsed.

The S.E.C. spiced its complaint with slices of e-mail message that certainly make both Tourre and Goldman look unappealing. On Jan. 23, 2007, Tourre sent an e-mail message to a friend, referring to himself as fabulous Fab: “The whole building is about to collapse anytime now. … Only potential survivor, the fabulous Fab … standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all the implications of those monstruosities!!!” This is painful to read, but is it the whole message? The S.E.C. does not say.

There’s something else the complaint doesn’t do. It doesn’t mention any of Tourre’s bosses, let alone David Viniar, Goldman’s chief financial officer, or Lloyd Blankfein, its chief executive. This suggests to me that Tourre may have been a lone ranger, not an unheard of occurrence on Wall Street.

Goldman did not become the most admired and feared Wall Street firm by cutting corners in legal disclosures for securities sold to sophisticated investors. As has been well documented by now, Goldman started shorting the mortgage market in December 2006 and, in another part of the firm, continued to create and sell securities like Abacus. This might not be good for public relations, but it turned out to be pretty good for business.

Goldman also was not above working with a client like Paulson to structure a security — for a fee — that Paulson could then short. Would those European banks not have bought Abacus if they had known that Paulson had helped select what went inside it? Possibly. But no one forced them to buy Abacus.

And if the housing market had soared for a few more years, and Paulson and Goldman had lost billions instead of making billions, would the S.E.C. have filed a lawsuit against Abacus’s investors?

These might not be the most popular questions to be asking right now, but until we get the answers we can’t assume Goldman’s guilt. For now, all we have is a media frenzy and billions of lost shareholder value.

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