Sunday, April 18, 2010

Goldman Sachs And Fraudulent Crap Basket Sales

There's a nice post at interfluidity explaining what Goldman did that's getting the SEC after them. I'll attempt the three-sentence colloquial summary.

An investor named John Paulson wanted to bet that the housing market was going down. He couldn't find a sufficiently craptacular bunch of bad housing stuff to bet against, so he had Goldman design a crap-basket for him. The potential crime is that instead of telling buyers that the unifying principle of the basket was "crap-basket for John Paulson to bet against" Goldman passed it off as "safe, well-designed long-term investment for you."

Or, to put it in Steve Randy Waldman's more traditional terms:
The fact that there was a “seller” in this case, and his role in “sponsoring” the deal, are precisely what ought to have been disclosed. Investors would have been surprised by the information, and shocked to learn that this speculative short had helped determine the composition of the structure’s assets. That information would not only have been material, it would have been fatal to the deal, because the CDO’s investors did not view themselves as speculators.
I'm not sure which aspects of this story caused Goldman to fall 13% on extremely heavy volume yesterday. Eventual penalties? Lawsuits? Future political ramifications for bank regulation? Loss of future business after people get it into their heads that Goldman will sell you a crap-basket in the guise of a safe long-term investment? There's the chart at right, with volume at the bottom. Lots of other financial stocks fell too, but none this much. Anyway, it's probably better that I illustrate the post with this than with an actual basket of feces.

Assuming the SEC has the facts right, I'm looking forward to seeing how this case proceeds. It'll give a nice backdrop to bank reform as well.
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