Abacus Cadabra, You're Busted, Says S.E.C. to Goldman Over Abacus Vehicle

Sophisticated Investors

The government, via the S.E.C., is finally going after Wall Street's Goldman, Sachs, and an interesting attempt at misguided justice it will be. While the Republicans continue to fight against passing any legislation that is not exactly what they want, thus holding up needed financial reform, the powers have also decided that Goldman will be one of the fall guys for our financial sins. The specific crime? The argument is that Goldman, with the help of an outside client, devised faulty investment products--designed for failure--and that the buyers were not forewarned that the outside client had a hand in creating them, and planned to bet against their success.

People have pointed out the timing of the suit, and the possibility that getting the masses fired up over Goldman aids in the process of getting financial reform legislation passed with enough support from a broad sector of Congress. Whether they succeed remains to be seen, given Goldman's desire to fight.

Only a few investment banks agreed to help him. One was Deutsche Bank. The other was the mighty Goldman Sachs.

Mr. Paulson struck gold. His prescience made him billions and transformed him from a relative nobody into something of a celebrity on Wall Street and in Washington.

But now his brassy bets have thrust Mr. Paulson into an uncomfortable spotlight. On Friday, the Securities and Exchange Commission filed a civil fraud lawsuit against Goldman for neglecting to tell its customers that mortgage investments they were buying consisted of pools of dubious loans that Mr. Paulson had selected because they were highly likely to fail.

By betting against the pool of questionable mortgage bonds, Mr. Paulson made $1 billion when they collapsed just a few months later, the S.E.C. said. Investors, who bought what regulators are essentially calling a pig in a poke, lost the same amount.

Mr. Paulson, 54, was not named as a defendant in the S.E.C. suit, but his role in devising the instrument that caused $1 billion in losses for Goldman’s customers is detailed in the complaint. Robert Khuzami, the director of enforcement at the S.E.C., explained that, unlike Goldman, the manager of the hedge fund, Paulson & Company, had not made misrepresentations to investors buying the security, known as a collateralized debt obligation.

(N.Y.Times)


The problem with all of this is that 1) the government is filing the case against Goldman and saying that outside client A influenced the content of the product being sold, acting as some sort of portfolio selection agent, while at the same time also saying 2) we are not going to go after client A because they were not involved trying to sell said product to other customers.

"Client A" in the form of a hedge fund run by John R. Paulson, made a fortune betting against mortgage backed securities that Goldman sold to sophisticated investors, and the kicker is that Paulson has denied any involvement in the creation of the product. The government, according to the Times, says otherwise.

It would seem that you would have to prove Paulson's involvement in structuring the product, while also proving Goldman was not just hedging its own book, if you want to win the case in court. We suspect that the government is hoping for some large, well publicized settlement opportunity, because this is a lost cause.

Goldman is not about to go down on the record for this, and shouldn't. All parties involved were supposed to be qualified informed buyers. The only good part of this is that it puts the lie to conspiracy theorist's nonsense about Goldman controlling the government. (Not that the civil fraud suit will sway the conspiracists, who will view anything short of the firm's collapse as evidence of their controlling hand).

It's actually hard to read through the first few pages of the Abacus document and not be quite aware of the disclaimers and warnings about investing in the product. At what point do we make people responsible for their own stupid choices?