Goldman Sachs' Piracy

by John M. Curtis
(310) 204-8700

Copyright April 17, 2010
All Rights Reserved.                                

             Shaking Wall Street to its core, the Securities and Exchange Commission filed civil suit against Goldman Sachs & Co., accusing the 130-year-old upscale investment bank of defrauding investors by creating risky derivatives or collateralized debt obligations [CDOs] for its short-selling client Paulson & Co., no relation to former Treasury Secretary Hank Paulson.  Goldman’s client, John Paulson, Chariman and CEO of Paulson & Co., shorted the market, betting against Goldman’s derivatives, earning his hedge fund $1 billion.  Ranked 45th on Forbes Magazine billionaires list, Paulson has a net worth of around $12 billion.  While there’s nothing wrong with hedge funds selling short or betting against the market there’s something fishy when the deal was orchestrated by a Goldman Sachs’ executive, making oodles of cash short-selling mortgage backed securities

            When the tech-rich Nasdaq crashed in 2000, losing nearly 80% of its value, plummeting from 5,000 to a low of 1,130 by Nov. 2002, hedge funds, like Paulston & Co., shorted tech stocks, crashing the market.  Had Paulson been connected with insiders at the Nasdaq surely the SEC would have cried foul.  Hedge funds bet against derivatives in 2007, eventually tanking the real estate market, causing defaults, bankruptcies and the run-on-the-bank, eventually seizing up credit at Wall Street’s biggest banks, investment houses and institutions.  Hedge fund short-sellers like Paulson contributed to the financial collapse prompting Federal Reserve Board Chairman Ben S. Bernanke, President Barack Obama, Treasury Secretary Tim Geithner and certain key members of Congress to demand radical changes to the country’s banking system, including reinstating the depression-era Glass-Steagall Act.

            Important parts of Glass Steagall were relaxed in 1999 under former President Bill Clinton, when Congress passed the Gramm-Leach-Bliley Act, permitting bank holding companies to engage in risky stock market investing.  When Goldman Sachs encouraged Paulson to short CDOs in 2007, the stock and real estate markets collapsed, causing the cash crisis at major financial institutions.  Calling derivatives “exotic trades,” Goldman executive Fabrice Tourre boasted about creating “without necessarily understanding all of the implications of those monstrosities,” which Paulson shorted in 2007-08.  Paulson paid Goldman Sachs $15 million to devise investments designed to fail, selecting bands of subprime mortgages [loans for unqualified borrowers] and creating collateralized debt obligations.  Several domestic and European banks lost billions on these risky investments.

              SEC’s crackdown on Goldman Sachs is long overdue.  While Goldman denies any wrongdoing cherry-picking rotten investments to bet against for Paulson, it’s clear that an inappropriate relationship existed.  Goldman finds nothing wrong with creating investments to fit the investment strategy of its clients, in Paulson’s case, short-selling.  Paulson made billions betting against CBOs, hammering down bank stocks, collecting insurance payments and then buying them back at bargain prices.  “It was Goldman that made the representations to investors,” said SEC Enforcement Director Robert Khuzami, explaining why Paulson was not charged with fraud, ignoring the insider relationship.  It’s not legal for investment firms to custom make investments at the request of clients to dupe investors.  While Goldman Sachs sold risky derivatives, Paulson shorted the investments and made billions.

            Goldman Sachs was the first to point fingers at former Nasdaq Chairman Bernard Madoff for his $60 billion Ponzi scheme.  Now that Goldman Sachs has been exposed, it’s hard to know what’s worse:  A Madoff-lke Ponzi scheme or a Goldman Sachs fraudulent security built on carefully cherry-picked bad investments, like subprime mortgages?  Allowing Paulson to make billions on short-selling is an affront on every legitimate investor, seeking reasonable returns on real investments.  It surely isn’t legal or ethical to ask a Wall Street investment firm to create an investment designed to fail so you can make billions selling short.  Paulson made $15 billion in 2007 short-selling CBOs.  He made another 3.79 billion in 2008 shorting bank stocks, especially those with high portfolios of derivative mortgage-backed securities.  Both Goldman Sachs and Paulson were equally culpable.

            President Obama, Fed Chairman Bernanke, Treasury Secretary Geithner and responsible members of Congress can’t stop until they properly regulate Wall Street firms, like Paulson & Co., currently abusing the system.  Filing civil charges against Goldman Sachs finally forces some accountability on Wall Street firms currently running amok.  Until provisions of Glass Steagall are reinstated and Wall Street firms are no longer permitted to create investments for the purpose of short-selling, stock and financial markets will continue wild gyrations.  SEC’s action against Goldman Sachs “undermines their brand,” said MIT professor and Goldman Sachs critic Simon Johnson, convinced the filing was long overdue.  “The SEC has changed its style,” said Columbia Law professor John Coffee, hinting at more enforcement but begging Congress to enact tougher trading rules.

John M. Curtis writes politically neutral commentary analyzing spin in national and global news. He's editor of OnlineColumnist.com and author of Dodging The Bullet and Operation Charisma.