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Thursday, June 20, 2024
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Financial terror or buyer's remorse

Goldman Sachs faces charges from Securities Exchange Commission

Bad press can just be deadly in certain situations.
This week must be such a pleasure for Goldman Sachs. The 141-year-old financial services giant has been handed a complaint from the SEC, which has set the nation's headlines on fire.
If Goldman misled investors, then it should be punished. But going after the entire financial industry is just wrong. Millions have been hurt by the latest financial meltdown, but hunting the bankers is a waste of time. In the current system, bankers play an integral role in the United States economy
Let's take a look at the situation.
Goldman Sachs had been working with hedge fund investor John Paulson, allowing him to place a bet on the decline of the subprime mortgage market. Paulson became famous by betting against the housing market, making billions. The SEC believes that Paulson's company helped pick the certain mortgages in the collateralized debt obligation and withheld the fact that Paulson bet against it from investors.
This is the whole case – whether or not Goldman committed fraud by not disclosing Paulson's position to other investors.
A CDO of this kind is not an investment security, but rather an instrument for betting against the housing market. Its value was tied to a series of mortgage bonds.
If the bonds declined, one set of investors, "shorts," would make money; if the bonds strengthened, another set of investors, "longs," would make money.
Paulson's hedge fund suggested 123 mortgages to be included in the CDO. But to create more interest in the CDO, Goldman got an independent third party to select the bonds in the CDO.
ACA Management, which, according to its own website, specializes in the mortgage market, was picked to select the bonds. ACA rejected 68 of the original 123 bonds selected by Paulson.
Paulson made $1 billion in the deal, while other investors lost $1 billion.
But the problem here is that a CDO transaction, by definition, is a bet for and against securities backed by subprime mortgages. The existence of the short bet shouldn't have mattered to investors.
More importantly, at the time, Paulson was just another trader; no long investor would think anything of it. Goldman's standard procedure never reveals buyers' and sellers' identities to one another.
The issue at play here is not whether a fraud was perpetrated, but rather revolves around a moral question. Many Americans remember Wall Street as intermediary of capital, helping to direct society's savings to productive uses.
Today, these firms navigate the markets for themselves and their clients for maximum gain. The business has shifted away from advising clients to creating trading opportunities for its clients.
The irony here is that Goldman took losses on the deal. It did receive a $15 million fee for putting the deal together, but according to Goldman, it lost $90 million by placing a long bet on the CDO.
The SEC is painting the picture that Goldman wanted to defraud itself.
It may very well be the case that the SEC has more evidence than listed in the initial complaint. But the government seems to be experiencing some hindsight bias. Nobody was outraged when all the subprime betting was going on.
After a financial collapse, the government wants to find an explanation for why the markets tanked. But it doesn't seem like the government has found much evil.


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