The big news today is that Goldman Sachs has been charged with fraud. Here is the indictment filed in the Manhattan Federal Court
Goldman Sachs, which has been described as the "great vampire squid wrapped around the face of humanity" has been charged with selling securities to investors that were selected to fail. Goldman Sachs did that without disclosing this to pension funds, foreign firms and private investors. In other words, Goldman Sachs sold what it said was a great investment knowing the bubble would burst. According to the indictment, it used a hedge fund, Paulson & Co, for this particular security, a collateralized debt obligation named ABACUS 2007-AC1. The investors were going long, expecting it would rise in value, but Paulson & Co and Goldman Sachs shorted the security, knowing it would fail, and made $1 billion, according to the SEC.
The important thing to remember is that Goldman Sachs and the hedge fund needed investors to believe the security would rise in value and that they were making a great investment. But unbeknownst to investors, Paulson and Goldman Sachs chose a security they knew would fail.
And Goldman Sachs knew exactly that the bubble was about to burst. The indictment details an email sent by a Goldman Sachs trader Fabrice Tourre: "More and more leverage in the system. The whole building is about to collapse anytime now … Only potential survivor, the fabulous Fab[rice Tourre] … standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implication of those monstruosities [sic]!!!" On February 11, 2007 he sent another email: "the cdo biz is dead we don't have a lot of time left". Fifteen days later, they finalized the offer to investors. Paulson made $1 billion, investors lost $1 billion and Goldman Sachs collected the fee.
In its 2009 annual report, Goldman Sachs said it not bet against its clients. But this indictment makes it clear that Goldman Sachs doesn't care about its clients, it's just out to make a profit. And if the clients lose, that's the price for doing business with Goldman Sachs.
This practice was endemic on Wall Street. Earlier this week, I did a blog entry looking at how a hedge fund Magnetar contributed to the financial meltdown when it designed a bunch of risky securities, guaranteed to fail and then made a fortune by making them even riskier and then doubling bets that they would fail. At the time, I said it was Wall Street's version of Springtime for Hitler, the musical depicted in the Mel Brooks film The Producers that was designed to be so tasteless that it would fail on its first night, and the producers would walk away with all the money lost by investors.
Because many others were doing the same thing as Goldman Sachs, we can expect more indictments. This is just the beginning. JP Morgan's filings this week reveal it has set aside "$2.3 billion in additional litigation reserves, including those for mortgage-related matters". Wall Street bankers are expecting a tsunami.
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