London and Wall Street dive as the US regulator charges the mega-bank with fraud.
Investors and traders market-watching at about 3pm on Friday saw UK and US equity indices slide on news concerning mega-investment bank Goldman Sachs.
The most profitable investment bank in the world saw its shares plunge an eighth (12.5%) to $160 on news that US regulator the Securities and Exchange Commission (SEC) has charged the firm with civil fraud. This wiped almost $12 billion from the market cap of the firm once dubbed the Vampire Squid for its ability to suck money from markets.
The SEC charged Goldman and one of its vice presidents, Fabrice Tourre, with misleading investors about a financial product linked to subprime mortgages, known as a synthetic collateralised debt obligation (CDO).
The watchdog alleges that the bank mis-stated and omitted key facts about the CDO, and failed to reveal that a major hedge fund had a hand in selecting the underlying portfolio of securities-- even though Paulson & Co. had bet its value would fall by shorting the CDO.
According to the SEC, Goldman received $15 million from Paulson & Co to structure the CDO in April 2007. By early 2008, 99% of the portfolio had been downgraded. Investors lost around $1 billion (£650 million) in the product, known as ABACUS, as the US housing market plunged and the value of residential mortgage-backed securities (RMBS) crashed.
As I write, the Dow Jones Industrial Index has fallen 130 points (over 1%), ending a six-day rally, and the FTSE 100 has just closed down 81 points, down 1.4%. What's more, all 27 shares in one US banking index have fallen.
A setback for Goldman
This bad news could hardly come at a worse time for Goldman, which has spent months trying to restore its public reputation in the aftermath of the financial meltdown. For example, Goldman CEO Lloyd Blankfein claimed that the firm was doing "God's work" in a November 2009 Times interview.
Also, in its latest annual report and accounts, the bank rebutted accusations that it had benefited unduly from the US government bailout of AIG, and hotly denied that it traded against its own clients. Today's fraud charge suggests that this accusation may well have some substance.
Of course, any allegation of fraud is going to panic investors, just as, say, a restatement of accounts causes investors to rush for the exits. I suspect that this news will hit banking stocks hard, coming as it does on the back of FSA fines following a cover-up at Northern Rock.
In addition, this is hardly likely to be the only scandal to emerge from the securitisation boom of 2000 to 2007. Indeed, it's almost certain that problems with other subprime CDOs and RMBS are waiting in the wings.
Earlier on Friday, Royal Bank of Scotland (LSE: RBS) had sneaked ahead of the UK taxpayer's average cost per share of 50p for a short time. This was after a broker note predicting RBS could produce a profit as soon as this year. However, after the Goldman news, investors may decide to hunker down and adopt a 'risk off' attitude to banks for a little while. Watch this space as this story develops...
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