The SEC May Turn Out to be Goldman's Smallest Problem

In a recent Daily Beast article, Charlie Gasparino describes Goldman Sachs as “already the most hated investment bank among investment bankers.” Perhaps that’s so. Throughout its long and storied history Goldman has been the most elite and prestigious firm in a very competitive pool of investment banks. It’s not surprising that its success could have ruffled more than a few feathers.

However, what has always benefited the bank most was its sterling reputation for excellence. Not only has GS been capable of consistently churning out money hand over fist for itself, but it’s also offered the allure of doing the same for clients. Even if the firm regularly operated on the very borderline between what is legal or moral, it produced results. Even today it’s reporting a 90 percent increase in profits.

Sure, the SEC has publicly slapped it down for securities fraud, but that’s only the beginning. Now it puts an even bigger problem on its radar… the details behind the allegation. Goldman Sachs is being shown to have intentionally bet against its own clients, perversely hawking financial products that the firm itself was confident would tank. This is the kind of legacy that can surely soil even Goldman’s pristine white-shoe firm.

From The Daily Beast:

“Goldman CEO Lloyd Blankfein recently took pains in the firm’s widely read annual shareholder letter to state explicitly that Goldman plays fair—or in his words, ‘did not bet against its clients’ particularly in 2007, when it was possibly the only big firm that made money by shorting the bonds tied to the housing market (i.e. betting it would decline), even as it sold the same type of mortgage bonds to investors, who eventually lost billions as the housing collapse turned into the broader collapse of the entire financial system…

“… John Paulson […] was one of a handful of hedge-fund managers who bet that the mortgage-bond market would decline beginning in late 2006, and he made billions from that bet. Here is where the SEC charges get interesting: Goldman allowed Paulson to help create the bond that Goldman later sold to its other clients, large institutional investors. Paulson made money on the investment—which allowed him to bet that housing prices would go down through a short position.

“But the other investors took the opposite bet—that housing prices would remain vibrant, which eventually became a money loser. Now there’s no law against Paulson making money on the deal or the others losing money, but the SEC basically alleges that the game was rigged from the start without the investors having the faintest idea; Goldman created the bond with the help of Paulson, who put some of the most risky mortgages in the portfolio—mortgages that were most likely to default and tank the investment.”

Goldman sold its very own clients a financial product designed by Paulson who then turned around, bet against it, and made a fortune. We suppose you could say that GS didn’t work against all of its clients in this instance… but it sure picked a favorite. Right now it looks like the SEC may want to fine Goldman Sachs around $1 billion. Yet, that could turn out to be a small slap on the wrist compared to the irreparable damage that’s being done to the firm’s already tarnished reputation.

You can visit The Daily Beast to read more about Goldman’s dirty pool.


Rocky Vega,
The Daily Reckoning

The Daily Reckoning