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Pointless deals line Wall Street pockets, Goldman Sachs suit shows

April 17, 2010|Michael Hiltzik

There comes a point in every man-made disaster when the guilty parties are identified and brought to book. That way the victims can at least snatch from the wreckage some confidence that lessons have been learned and mistakes recognized.

If Friday's federal fraud lawsuit against Goldman, Sachs & Co. over its role in the subprime mortgage meltdown signals the start of that process, all we can say is: Finally.

Goldman, like other big Wall Street banks, has taken the position that the crisis was something of a natural disaster. In January, its chairman, Lloyd Blankfein, told Phil Angelides' Financial Crisis Inquiry Commission: Sure, events look predictable now, "in hindsight." But "we never knew at any moment if asset prices would deteriorate further, or . . . snap back."

Goldman's role in the crisis, Blankfein insisted, was that of an "intermediary" helping its clients "manage their risk . . . in distressed or challenged markets."

But the Securities and Exchange Commission’s lawsuit shows that Blankfein's attempt to blame the meltdown on the vicissitudes of the broader economy is a dodge.

At the heart of the case is a deal Goldman concocted that turned $1 billion in losses for some customers into $1 billion in profits for another, in part through deliberately concealing what the transaction was all about. (The losers were a couple of European banks; the winner was a U.S. hedge fund. Goldman made millions of dollars in fees.)

Goldman had to lie to entice buyers into the deal, the SEC alleges, and that tells you how it really saw its role in the modern business of raising capital, something Blankfein has called "doing God's work."

The deal ended up "magnifying losses associated with the downturn in the United States housing market," the SEC says, thereby underscoring what's wrong with the way Wall Street does business. Perhaps more important, the case provides a framework for the coming congressional debate on financial regulation. In fact, it stakes out a rationale for strong, aggressive regulation.

The real issue isn't what Goldman knew or didn't know about the larger economy. The issue is that Wall Street's business model has become corrupted into one dependent on creating transactions that spin financial wheels to virtually no economic end, merely to generate fees and profits.

You see, the synthetic financial instruments and insurance contracts on subprime mortgage securities at the center of the commission's case didn't have anything to do with raising capital for the broad economy, much less helping to expand the nation's housing stock or ownership by financing the building and purchase of homes.

They had to do with what Wall Street likes to promote as "financial engineering," which it claims makes the financial markets healthier and makes it easier for companies to raise capital and create jobs, etc., etc.

But it isn't engineering in the same sense that, say, civil engineers dig a highway tunnel to make life more tolerable for millions of commuters. It more resembles what would happen if those engineers dug their tunnel, filled it in, and dug it again without telling anybody, pretending it just took twice as long to finish as they expected and collecting fees every step of the way. The extra effort wouldn't make the tunnel any longer or more capacious, but it sure would generate lots of cash for the engineering firm -- excuse me, the "intermediary."

The SEC complaint concerns an April 2007 transaction called ABACUS 2007-AC1, cooked up by a Goldman employee named Fabrice Tourre, who is named as a co-defendant by the SEC, and the hedge fund manager John Paulson, who isn't.

Paulson was known at the time for being extremely bearish on mortgages. But the ABACUS deal wasn't a mortgage or a bucket of mortgages. It wasn't a mortgage-backed security or a portfolio of mortgage-backed securities. It wasn't a collateralized debt obligation, which is a security backed by securities backed by mortgages. It was a "synthetic" version of the latter, which is to say an investment that tracked the performance of certain collateralized debt obligations without actually requiring ownership of them.

In fact, it wasn't even an investment in those underlying instruments, but a device for Paulson to sell them short -- to bet their prices would plummet.

In other words it was four degrees of separation, maybe five, from anything that provided money to a human being to buy, improve, or refinance a home. For this terrific advance in investment banking, Paulson paid Goldman Sachs $15 million.

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