Some additional links may be of interest for readers following the charges that the Securities and Exchange Commission has filed against Goldman Sachs and "Fabulous" Fabrice Tourre.
Goldman has put out a lengthier press release giving its side of the story, including the claim that while Goldman made a $15 million fee on the deal, it also "lost more than $90 million." The release also emphasizes that those who took the long side of this trade weren't a bunch of naifs: "IKB, a large German Bank and sophisticated CDO market participant and ACA Capital Management, the two investors, were provided extensive information about the underlying mortgage securities. The risk associated with the securities was known to these investors, who were among the most sophisticated mortgage investors in the world. These investors also understood that a synthetic CDO transaction necessarily included both a long and short side."
A professor of finance at the Bauer College of Business, University of Houston, Craig Pirrong, writes of "a certain weakness in the case" and sees parallels to the recent Bear Stearns cases, where individuals were acquitted of securities fraud. "It is cases like these that build the narrative that is used to justify the need for wide-reaching regulation, most of which relates to matters far removed from the specifics of any particular case," he writes.
Relatedly, President Obama's weekly video address, delivered Saturday after the Friday announcement of the SEC case against Goldman, was on "Holding Wall Street Accountable," and promised, "the SEC will ensure that shareholders have more power in corporate elections, so that investors and pension holders have a stronger voice."
A professor at MIT, Simon Johnson, writes that John Paulson "should be banned from securities markets for life," and also suggests that the Feds aren't going to stop at Fabulous Fab: "The obvious targets are Goldman's top executives...Either Goldman's executives were well aware of the 'Fab' and its implications – in which case they face serious potential criminal and civil penalties – or they did not have effective control over transactions that posed significant operational and financial risk to their organization."
The blog Naked Capitalism has a copy of a 66-page presentation used to sell the Abacus 2007-AC1 $2 billion "synthetic CDO." Highlights include a quite robust disclosure on page 9, a structural diagram on page 50, and, on page 66, a list of names of 16 Goldman Sachs contacts, including Fabulous Fabrice. One of the 16, Shlomi Raz, made the New York Observer in November 2006 when he spent $7.35 million to buy a 4,400 square-foot six-bedroom penthouse triplex in Tribeca.
Finally, a reader emails (no link) to suggest that if the Feds really want to put the screws on Goldman to settle this one somehow, they could threaten to revoke Goldman's status as a bank holding company, which was granted in the throes of the crisis.
I've spent what time I had to spare this weekend wresting with where to come down on the whole case. The thing I keep coming back to is that quote in the SEC complaint from an email sent by the Fabulous Fabrice Tourre himself on January 23, 2007: "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 the implications of these monstruosities!!!"
Why include the quote at all? Mr. Tourre isn't charged with collapsing the global financial system. He's charged with civil fraud in violation of securities law. If anything, the quote is exculpatory: "without necessarily understanding all the implications" suggests that Mr. Tourre didn't really know what he was doing. I'm not an expert on the law of civil fraud, but, to in many cases, to commit a crime, you need to have criminal intent. Not understanding the implications is hard, maybe not impossible, but hard, to square with an intent to commit fraud.
Three final points:
Would the SEC have brought this case had the housing market not crashed, had Mr. Paulson lost lots of money and the European banks he bet against made lots of money? Almost certainly not. In other words, had the European banks made $1 billion rather than lost $1 billion, neither they nor the SEC would care about the inadequate or inaccurate disclosure. So what is being punished here, the level of disclosure or the success of the bet?
If this case goes to trial, it will almost certainly drag on until after Congress votes on financial "reform." If the case affects the outcome of the congressional vote, it will so that based on the SEC complaint rather than the outcome of a fair trial with full due process.
In early 2007, John Paulson wasn't yet the genius who made billions shorting subprime in what became known as "The Greatest Trade Ever." He was just some guy shorting subprime, and knowing he was on the other side of the deal may not have been scared people away the way in hindsight, with Mr. Paulson's subsequently inflated reputation (and bank account), it would have.