Markets Tumble On Goldman 'Fraud'

Published in Investing on 16 April 2010

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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CunningCliff 16 Apr 2010 , 9:20pm

Here's Goldman Sachs' one-line response to the SEC charges:

"The SEC’s charges are completely unfounded in law and fact and we will vigorously contest them and defend the firm and its reputation."

Short and sweet!


anshah 17 Apr 2010 , 12:34am

I am struggling to understand what was in it for Goldman in this deal- they were paid $15m in fees for this by Paulson- small fry for a bank like GS. In turn Paulson made a $1bn from this deal.

bimber 17 Apr 2010 , 4:38pm

Anshah, I'm not sure the $15m is all they got. There was a story recently on the "This American Life" webcast about a hedge fund called Magnetar who did deals which I think are similar to Paulson's. It's alleged that Magnetar, by asking to buy the high risk portion of a CDO, encouraged investment banks to create the entire CDO. Knowing that the CDO would go bad, they bought insurance on the whole thing, which would be where Paulson made his money (thanks to the US taxpayer bailing out the likes of AIG, so that there were funds to cover the insured assets). GS could have made money by buying debt cheaply, getting a high rating from their friends in the ratings agencies and selling it to unsuspecting pension funds. In the TAL story, some banks kept the CDO on their own books. This is still a profitable trade because the people making the fees have no interest in the future of the bank once they've earned their fee.

Recounted in act one:

teaboy100 19 Apr 2010 , 1:48pm

Why isn't Paulson being investigated here too? The reports seem to indicate that Paulson was instrumental in building/orcastrating the toxic debt vehicles, and hugely profited from the fallout.

Had to laugh at Gordys comments over the weekend -
"I am shocked at this moral bankruptcy. This is probably one of the worst cases that we have seen.
Everything I find out convinces me that we have got to go in deeper and I believe that I am the man to deal with these problems of the banks and to challenge them about the way they behave in the future."
- Pot, kettle etc.

gordonbanks42 19 Apr 2010 , 11:23pm


Which space do I have to watch for Goldman's side of the story? What you have reported so far is distinctly one-sided.

Goldman has said (in the article linked by another poster above) that the long-side counterparties were sophisticated CDO investors and had full disclosure of the mortgages involved because, among other things, they (the long-side counterparties) helped to choose them.

It is plausible that what Goldman says is correct, and that the SEC will turn out to have been grandstanding, or just plain wrong. (The likelihood that Gordon Brown will turn out to have been grandstanding is ???) In that eventuality your article will, with the benefit of hindsight, look rather odd for not making any mention of Goldman's side of the story.

I am shocked at the moral bankruptcy of those who are shocked at the moral bankruptcy of those whose guilt they assume before they have been found guilty and are still, in law, innocent.

As to the facts, we'll see. I doubt whether anyone outside Goldman, the SEC (maybe) and perhaps one or two law firms actually knows at this point.

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