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Goldman's Dark Hour--Skeel

I remember the moment when I realized that Goldman had gone from being the darling of Wall Street—the firm everyone pointed to as the best run, with the best internal risk controls—to something very different. Last summer, in response to a little piece I wrote for a New York Times Dealbook blog discussion, a commentator referred to Goldman as the embodiment of evil, or something to that effect. I couldn’t imagine what he was talking about. Within a few weeks, I began to understand, as rumors surfaced about Goldman profiting from its customers’ subprime losses and being a multibillion dollar beneficiary of the government’s AIG bailout.

After many months of rumors, the SEC has charged Goldman with violating the securities laws by misleading the investors in synthetic collateralized debt obligations (CDO’s). With a CDO, investors invest in an entity that holds bonds issued by a variety of companies.  A synthetic CDO doesn’t actually hold the bonds, but achieves the same effect by holding financial instruments (usually, credit default swaps) that are linked to the same kind of bonds.  As I understand it, based on a quick reading of the SEC complaint, the SEC alleges that Goldman didn’t tell investors that John Paulson, a hedge fund manager who helped to determine the contents of the synthetic CDO, had placed large bets that the underlying subprime bonds would decline in value.  Paulson was picking bonds that he viewed as likely to default.
I personally have somewhat conflicting reactions to the scandal.  First, if the allegations are true, Goldman deserves to be punished for hiding key information about the packaging of the synthetic CDOs.  Although the losers in these transactions seem to have been large institutions, that’s no excuse for withholding key information about how the investment portfolio was selected.  But second, I suspect that part of the reason for charging Goldman is a distaste both for synthetic CDOs and for the fact that Goldman benefitted from the subprime crisis. I’ve never understood the rationale for synthetic CDO’s and have doubts about their benefits. But as long as they’re legal, I don’t think banks should be punished for having profited from them.


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Comments ( 3 )

Professor Skeel,

I read through most of the complaint, I cannot figure out what the fraud is. Yes, they may have lied about who selected the assets of the CDO, but they did not lie about what those assets were (that would be different). Who selects the assets does not affect whether the CDO is a good investment. If Paulson had nothing to do with the selection (leaving aside whether the CDO would have been made), does that make the CDO any better of an investment. While it might have been helpful to know who is on the other side of a trade, in a market, many times, you do not know who is on the other side.

That said, the case law might consider who selected to material. I just have not looked at the cases in a long time.


Professor Skeel,

I'm not sure I understand why you express "conflicting reactions to the scandal".

Isn't your first point -- the "hiding key information" -- the crux of the inquiry on Goldman's conduct? If the facts don't prove violation of the 34 Act, 33 Act and 10b-5 anti-fraud provisions, Goldman has been wrongly tarred with an unfounded civil claim. But if they did in fact mislead under those provisions they simply deserve opprobrium (along with liability).

What does prosecutorial (albeit civil) motivation have to do with the merits?

Joel Webber

Well, Greg Smith, formerly of Goldman Sachs has confirmed that the leadership there has turned to evil. They no longer have high ethical standards of service but now see clients as tools to their own wealth.

See his article in the NYT "Why I am Leaving Goldman Sachs."