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So it begins:
WASHINGTON - The government has accused Goldman Sachs & Co. of defrauding investors by failing to disclose conflicts of interest in mortgage investments it sold as the housing market was faltering.
The Securities and Exchange Commission announced Friday civil fraud charges against the Wall Street powerhouse and one of its vice presidents. The agency alleges Goldman failed to disclose that one of its clients helped create -- and then bet against -- subprime mortgage securities that Goldman sold to investors.
Investors in the mortgage securities are alleged to have lost more than $1 billion, the SEC noted.
http://www.msnbc.msn.com/id/36597290...s-us_business/
My view:
There isn't a civil monetary penalty big enough to possibly inhibit a repeat of this mess. Criminal liability is the key. That said, I am still not sure what GS has done constitues fraud. It was certainly morally dubious but that is no crime and I think the DOJ is going after those least responsible for this mess and doing so soley for political gain.
So you're saying we shouldn't prosecute fraud cases unless the defendants are deemed sufficiently responsible for causing a financial meltdown?
No.
I'm saying that the SEC and DOJ have limited resources and they're using them to go after the wrong people first.
I'm also very curious about what their theory is here. Creating a risky investment is not fraud. Having a client who creates a risky investment is not fraud. Knowing that your client is betting against his own fund is not inherently fraud. It all depends on what information GS actually knew and what it disclosed to or told investors.
There is typically extensive conflict of interest disclosure in the offering memo for any securities deal including disclosure of the underwriter's ongoing relationship with the offering's sponsor and any particularly noteworthy aspects of that relationship (e.g. CLO deals often disclose facts like whether the underwriter also originated a large number of the loans in the pool or is selling loans to the pool or providing pre-closing warehousing funding or holds the fund sponsor's credit line, etc.).
If GS at the time of the offering knew the sponsor was betting against the securities then the question can be raised whether that is a material fact that should have been disclosed. However, I find it hard to believe that any law firm would've delivered a 10b-5 letter on the deal (either to the fund issuer or to the underwriter) if that was the case.
But, who are the right people to go after?The people who lied on their mortgage applications and the mortgage brokers who helped them. That's fraud. Structuring and selling a shitty investment with full disclosure is not.
The issue here is did Goldman Sachs fully disclose to investors what was going on?
There's a lot of debate going on right now on various legal and finance boards about whether Paulson's involvement in the selection of the portfolio would be material to investors or not, with the counterargument being that the names in the portfolio were fully disclosed to investors so even if there was adverse selection at play the investors were fully informed on the names they were exposed to and could perform their own evaluation.
This whole thing involves synthetic CDOs. Here is how those work:
The CDO owns credit default swaps on the "short" side. That is, the CDO is insuring the counterparty (on this deal, the counterparty was GS) against "credit events" in the reference portfolio (i.e. defaults on the referenced mortgage bonds). The CDO issues its own debt to investors (in this deal, it was ACA's insurance company affiliate, 2 European banks, and a very small position to GS). Some of this debt is unfunded (super senior tranche) because the naure of a CDS is that you don't need the full notional value in cash backing it, while some is funded and placed into a segregated account to serve as collateral for the CDO's obligations under the credit default swaps (i.e. the "long" side on the swap wants to see collateral for the CDO's payment obligations if the referenced bond defaults). The CDO pays out interest on its own bonds with the proceeds of the fees it receives under the swaps.
Thus, when the mortgage bonds defaulted, the CDO paid out on the credit default swaps to GS. The inevstors in the CDO lost, because the CDO takes a loss when it has to pay out to GS on the CDO.
Paulson was not a party to the CDO itself. He was a party to a completely separate credit default swap with GS that (allegedly) referenced essentially the same portfolio of mortgage bonds. Thus, at the same time the CDO was paying out to GS, GS was paying out to Paulson. GS was effectively just a step between the investors in the CDO and Paulson. GS' only exposure on the deal was a minor position it had in the CDO's own bonds, on which it took an uninsured loss.
For easy reference I will lay this out as simple as possible. Here are the allegations against GS:
1. Paulson wanted to short a number of MBS bonds and needed a counterparty.
2. Paulson enters into a swap with Goldman referencing those MBS bonds (with Goldman on the protection seller side and Paulson on the buyer side).
3. Goldman structures a CSO referencing that same portfolio (with Goldman on the protection buyer side and the CSO on the seller side).
4. Third party investors buy into the CSO thinking independent ACA had selected the reference portfolio rather than Paulson.
5. Housing market tanks and the reference obligations default. The CSO pays Goldman under its swaps, and Goldman then pays Paulson under his swaps.
6. Goldman makes structuring fees but loses a bit on its prop investment in the CSO (and I think on some minor mismatches between the two swaps).
This has nothing to do with AIG or the bailout. The risk and loss were born by the CSO investors.
*Full disclosure I worked in securties for several years after law school.
Discuss...
WASHINGTON - The government has accused Goldman Sachs & Co. of defrauding investors by failing to disclose conflicts of interest in mortgage investments it sold as the housing market was faltering.
The Securities and Exchange Commission announced Friday civil fraud charges against the Wall Street powerhouse and one of its vice presidents. The agency alleges Goldman failed to disclose that one of its clients helped create -- and then bet against -- subprime mortgage securities that Goldman sold to investors.
Investors in the mortgage securities are alleged to have lost more than $1 billion, the SEC noted.
http://www.msnbc.msn.com/id/36597290...s-us_business/
My view:
There isn't a civil monetary penalty big enough to possibly inhibit a repeat of this mess. Criminal liability is the key. That said, I am still not sure what GS has done constitues fraud. It was certainly morally dubious but that is no crime and I think the DOJ is going after those least responsible for this mess and doing so soley for political gain.
So you're saying we shouldn't prosecute fraud cases unless the defendants are deemed sufficiently responsible for causing a financial meltdown?
No.
I'm saying that the SEC and DOJ have limited resources and they're using them to go after the wrong people first.
I'm also very curious about what their theory is here. Creating a risky investment is not fraud. Having a client who creates a risky investment is not fraud. Knowing that your client is betting against his own fund is not inherently fraud. It all depends on what information GS actually knew and what it disclosed to or told investors.
There is typically extensive conflict of interest disclosure in the offering memo for any securities deal including disclosure of the underwriter's ongoing relationship with the offering's sponsor and any particularly noteworthy aspects of that relationship (e.g. CLO deals often disclose facts like whether the underwriter also originated a large number of the loans in the pool or is selling loans to the pool or providing pre-closing warehousing funding or holds the fund sponsor's credit line, etc.).
If GS at the time of the offering knew the sponsor was betting against the securities then the question can be raised whether that is a material fact that should have been disclosed. However, I find it hard to believe that any law firm would've delivered a 10b-5 letter on the deal (either to the fund issuer or to the underwriter) if that was the case.
But, who are the right people to go after?The people who lied on their mortgage applications and the mortgage brokers who helped them. That's fraud. Structuring and selling a shitty investment with full disclosure is not.
The issue here is did Goldman Sachs fully disclose to investors what was going on?
There's a lot of debate going on right now on various legal and finance boards about whether Paulson's involvement in the selection of the portfolio would be material to investors or not, with the counterargument being that the names in the portfolio were fully disclosed to investors so even if there was adverse selection at play the investors were fully informed on the names they were exposed to and could perform their own evaluation.
This whole thing involves synthetic CDOs. Here is how those work:
The CDO owns credit default swaps on the "short" side. That is, the CDO is insuring the counterparty (on this deal, the counterparty was GS) against "credit events" in the reference portfolio (i.e. defaults on the referenced mortgage bonds). The CDO issues its own debt to investors (in this deal, it was ACA's insurance company affiliate, 2 European banks, and a very small position to GS). Some of this debt is unfunded (super senior tranche) because the naure of a CDS is that you don't need the full notional value in cash backing it, while some is funded and placed into a segregated account to serve as collateral for the CDO's obligations under the credit default swaps (i.e. the "long" side on the swap wants to see collateral for the CDO's payment obligations if the referenced bond defaults). The CDO pays out interest on its own bonds with the proceeds of the fees it receives under the swaps.
Thus, when the mortgage bonds defaulted, the CDO paid out on the credit default swaps to GS. The inevstors in the CDO lost, because the CDO takes a loss when it has to pay out to GS on the CDO.
Paulson was not a party to the CDO itself. He was a party to a completely separate credit default swap with GS that (allegedly) referenced essentially the same portfolio of mortgage bonds. Thus, at the same time the CDO was paying out to GS, GS was paying out to Paulson. GS was effectively just a step between the investors in the CDO and Paulson. GS' only exposure on the deal was a minor position it had in the CDO's own bonds, on which it took an uninsured loss.
For easy reference I will lay this out as simple as possible. Here are the allegations against GS:
1. Paulson wanted to short a number of MBS bonds and needed a counterparty.
2. Paulson enters into a swap with Goldman referencing those MBS bonds (with Goldman on the protection seller side and Paulson on the buyer side).
3. Goldman structures a CSO referencing that same portfolio (with Goldman on the protection buyer side and the CSO on the seller side).
4. Third party investors buy into the CSO thinking independent ACA had selected the reference portfolio rather than Paulson.
5. Housing market tanks and the reference obligations default. The CSO pays Goldman under its swaps, and Goldman then pays Paulson under his swaps.
6. Goldman makes structuring fees but loses a bit on its prop investment in the CSO (and I think on some minor mismatches between the two swaps).
This has nothing to do with AIG or the bailout. The risk and loss were born by the CSO investors.
*Full disclosure I worked in securties for several years after law school.
Discuss...
