Something had been lacking in the turmoil over the American financial system. Eyes glazed over when the news was all about derivatives, swaps and CDOs, especially when someone explained that the initials stand for “collateralized debt obligations.” The missing element was bad guys. It takes some flesh-and-blood targets to make a scandal interesting and understandable.
Now, just as Congress is taking up long-needed financial regulatory reform, the often somnolent Securities and Exchange Commission has burst forth with fraud charges against not only one of the nation’s biggest banking giants but also a specific individual, with hints of more to come.
The first in what promises to be a rogues’ gallery of financiers accused of manipulating complex investment products to siphon billions of dollars from losers to winners is a 31-year-old Goldman Sachs vice president named Fabrice Tourre. He helped create and sell an investment vehicle called Abacus 207-ACI that was secretly designed to fail, according to the SEC complaint.
If the commission’s investigation follows the usual pattern, it will squeeze Mr. Tourre to get him to inform on the higher-ups, the way the Enron investigation led to the conviction of CEO Kenneth Lay and other top officers. The Enron case also involved the loose government supervision that come into vogue with the drive for deregulation.
Goldman’s leader, Lloyd C. Blankfein, has repeatedly denied any wrongdoing, adding that his firm lost money on the deal. His defense is that other companies have been doing the same thing and that the investment products in question were sold to experienced investors who knew or should have known the risks and background of what they were buying. (That doesn’t explain the loss suffered by the Royal Bank of Scotland on Abacus bonds.)
A key figure in the Abacus deal was a New York hedge fund manager, John A. Paulson (no relation to former Treasury Secretary Henry M. “Hank” Paulson, who earlier headed Goldman Sachs). The complaint says that John Paulson, who has not been charged, helped pick the risky subprime mortgages that figured in the Abacus package, then bet on its failure and made $l billion when it collapsed within a few months. Goldman is charged with failing to tell investors how the deal had been put together.
Pointing the way up the company ladder, the SEC says that a high level committee approved the deal and wrote a memo naming Mr. Paulson and describing his role. This Mortgage Capital Committee comprised senior executives who managed Goldman’s mortgage and credit operations.
The investigation is still in its early stages, and Abacus may be just the opening wedge. Goldman has mounted a spirited defense and has lawyers that may outmatch the SEC’s crew. But regardless of how the case comes out, it is likely to showcase some of the people who got us into the recent financial mess by dealing in trillions of dollars and making many millions for themselves in the process.