“Hey wise guy! Wanna buy any synthetic collateralised debt obligations?”
Over the last few years, I have written a great deal about Goldman Sachs and its Svengali-like hold over successive U.S Governments. Some of what I’ve written remains on this site. Hopefully, President Obama’s current initiative, in tandem with the SEC is the dawn of a new relationship between Government and the banking industry.
It seems that the “minders” Goldman Sachs used to have at U.S. Government level have disappeared. Obama has, quite rightly finally set his dogs on them.
A few days ago the company was accused of fraud. What at first appeared to be slight financial naughtiness turns out to have been very bad indeed. Goldman Sachs is accused of eliciting investments from clients into financial ” instruments” which had been designed (by them) to fail. The very same family of products which precipitated last year’s banking crisis.
Not only that but they knew that yet another client of theirs , a hedge fund manager was “betting” on those products to fail and thus make a profit. The hedge fund manager had even helped Goldman Sachs to design that particular product.
John Paulson (no relation to Henry Paulson, former Treasury Secretary Henry Paulson and former Goldman CEO) is the owner of Paulson & Co, the hedge fund which was betting on the American Housing market to collapse. “
During the American sub-prime lending orgy, “exotic” mortgage-backed products had been designed with only one purpose – to generate a profit not-only for hedge-funds such as Paulson & Co but also for investment houses like Goldman Sachs.
The so-called “exotic trades” were no more than pooled mortgages worth billions. These mortgages had been granted to the so-called American Ninjas (No Income, No Job or Assets). It was generally accepted that because these people had absolutely no chance of keeping up with any mortgage repayments, any product based on their mortgages would “tank” – and so it proved.
These mortgages were then “securitised”, that is to say, they were lumped together into what can only be described as a quasi-fund. Then, both private and corporate investors were encouraged to invest.
For instance, imagine 1000 Ninjas with 1000 mortgages worth £100,000 each. Lump them all together and you have a fund totalling £100,000,000. This should produce an income (mortgage repayments ) totalling say £5,000,000 per annum (at 5%). On the face of it, that’s quite a good investment – but only if you omit to mention that within a few months none of the mortgagors will have made any payments.
So, whoever “securitised” these useless mortgages was able to pull-in yet more money which, believe it or not was subsequently lent to other “Ninjas” and the cycle repeated.
Many investors found these potentially worthless investments very attractive – especially our banks. The rest, as they say is history. The only mildly interesting thing is that the banks didn’t understand what they were investing in and neither did the Financial Services Authority here in the UK or the US Securities and Exchange Commission.
The Golman Sachs employee (I hesitate to use the word “banker”) at the centre of this potential scandal is Fabrice Tourre. He boasted that he had created the products “without necessarily understanding all of the implications of those monstrosities.”
He obviously did a good selling job because he managed to lose Goldman Sachs clients who invested in these mortgage-based products over £645 million. At the time, Mr Tourre was himself earning £1.5 million per year.
He has been accused of lying to investors – among the most gullible being our own Royal Bank of Scotland.
Meanwhile, the hedge fund owner John Paulson, with whom the investments were placed, made himself a cool £2 billion.
Not so long ago, someone said that if you put lipstick on a pig, it is still a pig. Mr Tourre and Goldman Sachs put so much lipstick on this pig that it looked like a glamorous dead-cert.
Mr Tourre is no doubt hoping that the Icelandic volcano continues to spew toxic fumes for ever – the last thing that he wants is to fly back to the USA to face the music. The Securities and Exchange Commission is just about to make a formal request to the British Authorities for Tourre to return to the USA to help the authorities with their inquiries and possibly face charges in conjunction with his employers.
Goldman Sachs shares are currently taking a pounding – especially as the SEC has said that it is investigating other financial shenanigans both by Goldman Sachs and other “banks”.
Unsurprisingly, Goldman Sachs has denied all charges and has said that SEC’s charges are unfounded “in law and fact” and that it intends to contest them.
However, as Goldman Sachs knows a great deal about the US Government’s past financial machinations, there will probably be a “deal” of some sort. But, as the SEC is also looking to recoup money lost by investors, it is hoped that Obama is strong enough to resist any easy compromises.
If money is, in effect stolen, then the mere act of returning it to its rightful owners does not usually put things right, although it can be interpreted as an admission of guilt.
It all depends on whether Goldman Sachs want to fight the action and whether it has the appetite for a lengthy trial.
Currently, it seems that Goldman Sachs does not have a leg to stand on, especially as it was paid £10 million by John Paulson to put together the mortgage-related product which was bound to fail.
Paulson took money from investors but at the same time “hedged” his bets by laying-off the risk through taking out a form of “insurance” which paid him vast amounts of cash when the investments failed ( and which he knew would fail in the first place).
These “pooled” mortgages which Goldman’s were selling were given the very impressive name of “synthetic collateralised debt obligations” – which is no more than sales talk for “a load of potentially bad mortgages which have been lumped together for the gullible and feeble-minded to invest in”. For example, the entire banking industry.
The pill was further sweetened by Goldman Sachs through their claim that an independent third party called ACA Management Ltd had selected the pools of sub-prime mortgages. In fact a lot of the input into these potentially bad investments came from John Paulson himself.
This is what SEC Enforcement Director Robert Khuzami said: “Goldman wrongly permitted a client that was betting against the mortgage market to heavily influence which mortgage securities to include in an investment portfolio, while telling other investors that the securities were selected by an independent, objective third party”
Tourre cobbled together the alleged fraud in 2007, just when the U.S mortgage market was beginning to unravel. As a reward, he was promoted to Executive Director of Goldman Sachs in London.
John Paulson is not being pursued by the SEC because in spite of the fact that he may have been complicit in the alleged fraud , he did not make any representations to investing clients. That was done by Goldman’s.
Goldman’s has been an advisor to investment banking clients for many years and is also well-known for filling high-level U.S Government posts with its directors and senior executives. Those days appear to be at an end because , as Simon Johnson, professor at MIT recently said ” I don’t think that anybody really values being connected to Goldman at this point.”
Because the SEC has indicated that it is on a financial witch-hunt, financial shares have fallen heavily in the last few days with Goldman Sachs itself losing about £10 billion in market capitalisation.
It seems that the SEC is retuning to its original role; the one in which it has so manifestly failed and that is protection of the investor. Hopefully, other financial regulators such as the UK’s Financial Services Authority will also have the courage to bare their teeth and not continue to be bullied by the banking industry, its white-collar bandits and their excesses.