The SEC? The same SEC that stood by as securities traders saddled teachers' pension funds with toxic products they didn't understand? The same SEC that let Bear Stearns, Lehman Brothers, and Merrill Lynch pile on debt like diners at an infinite all-you-can-eat buffet?
Welcome to the newly ferocious SEC, which is also investigating which investment firms used tricks to hide debt from regulators, the way that Lehman Brothers did.
But what's remarkable is that the SEC is taking on Goldman Sachs, an institution that almost alone has emerged from the financial crisis wealthier and stronger than ever. Goldman did so well in part because it bet early on that the housing bubble would implode, and it could collect on that bet with the help of the $80 billion Treasury bailout of insurer AIG. Now we're learning another secret to Goldman's success: It colluded, according to the SEC's allegations, in a scheme to bet against failing mortgage- securities derivatives, known as collateralized debt obligations (CDOs). According to the SEC's lawsuit, a Goldman trader named Fabrice Tourre, who helped control a CDO investment fund called ABACUS 2007-AC1, based on low-rated, high risk slices of mortgage-backed securities, colluded with a hedge fund to set up ABACUS to fail - and then collect on bets that it would do so. At the same time, Tourre was selling the CDOs to investors who had no idea that the fund was programmed to fail.
The SEC charges that the hedge fund, Paulson & Co., helped hand pick which securities would go into the CDO pool, and then bet against the pool using credit default swaps - essentially, an insurance policy that pays off in the event the CDO fails.
Paulson & Co. allegedly made sure that would happen by packing the pool with extremely risky securities. It also paid Goldman $15 million for its work putting the pool together and marketing it to investors (Goldman also reportedly helped arrange Paulson's credit default swap trades). Investors lost $1 billion. Paulson reportedly made $1 billion.
Just to get a sense of Goldman's hubris in the scheme, check out Tourre's emailed comments to a friend in early 2007, just as it became clear to Wall Street insiders that the mortgage market all their bets and borrowing were based on was about to implode.
Now Tourre and his employer stand charged with fraud, and may have to pay back everything they've earned, plus interest. Yes, that's a lot of money."More and more leverage in the system, The whole building is about to collapse anytime now...Only potential survivor, the fabulous Fab[rice Tourre]...standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstruosities!!!"
Goldman's scheme isn't the only one like this. Last week, ProPublica and NPR's This American Life ran a fantastic investigation of Magnetar, a hedge fund that ran a similar scheme with a number of investment banks, including UBS, Merrill Lynch and Citigroup.
Think about what it would have meant to have the SEC taking on cases like these, even just a few, as securities frauds like this proliferated over the last decade. Wall Street would have known that Washington was watching, and that it had better be careful about how it does business. Instead federal regulators effectively sanctioned fraud by the companies they were , and we're all living with the consequences. Let's hope this is the beginning of a new way of doing business.