There is a fifth dimension beyond that which is known to (the non-Wall Street) man. It is a dimension as vast as space (within a banker’s penthouse) and as timeless as infinity. It is the middle ground between light and shadow, between science (i.e. economics) and superstition (i.e. economics), and it lies between the pit of man’s (investment) fears and the summit of his (financial) knowledge. This is the dimension of (greedy) imagination. It is an area which we call the (legal) Twilight Zone.
Lucky for you, USDemocrazy is ready to dive into the murky world of high finance to try and figure out what’s going on.
Last Friday, April 16, the Securities and Exchange Commission (SEC) filed a civil suit against Goldman Sachs for fraud.
What is the cause of the suit? In a nutshell:
1) A hedge fund, Paulson & Co., helped Goldman Sachs create a financial instrument called a CDO (collateralized debt obligation… big words, we know). These CDOs are basically a bundle of mortgages.
2) Paulson & Co. purchased insurance on these CDOs ( in case these mortgages go sour, i.e. folks can’t pay their bills). Paulson & Co., having built the CDOs, were now betting that they would fail.
3) Goldman Sachs sold the CDO (created in step 1 above) to investors… And here’s the kicker, without telling them that Paulson & Co. (who were betting on the securities failures) had helped design the CDO.
The SEC is arguing that this is fraud as Goldman Sachs failed to acknowledge a conflict of interests.
If this is true then, as Slate’s Daniel comments, their plan went perfectly:
Goldman collected a fat fee for building and peddling the deck. One Goldman client (Paulson) made out like a bandit shorting it. And several other Goldman clients (the unfortunate banks who bought pieces of the CDO) got their faces ripped off.
Just because things worked out doesn’t mean Goldman Sachs committed fraud. Erik Gerding, of The Conglomerate, points out that
even though Paulson’s role in selecting the deck wasn’t disclosed to investors, the deck itself likely was. In other words, investors probably were told of the assets put into the CDO
So will Goldman Sachs be taken to the cleaners by the SEC or will the case work out in their favor?
It is tough to tell. Some questionable actions were taken by Goldman Sachs (many involving upper management) but fraud is a tough thing to figure out as Alan M. Dershowitz, a legal expert for the Daily Beast, points out:
No experienced lawyer could have predicted with accuracy, at the time they were doing it, whether what Goldman is accused of doing would fall on the wrong or right side of the ever-changing “fraud” line—if there even is a line.
Also, despite everyone’s shock and outrage over Goldman Sachs, similar things have happened. NPR’s “This American Life” uncovers a similar trick that was pulled by Magnetar, a hedge fund whose methods are as smart as its name (the wonderful song at the top of this page is about Magnetar’s scheme).
So what should you take away from this?
Crazy things are continuing to happen in the financial world (and will always happen). Due to this you should do three things:
One is to check out what some smart people are saying at the New York Times.
Secondly, start a hearty debate in our comments section about whether Goldman Sachs actions were right or wrong. Finally, find out more information on this ever-evolving financial world we live in.
Remember, we’re all in this together!
Washington is looking for scape goat for the crisis and it appears they have found it. What Goldman did may have been questionable but it was legal. Blame the regulators no the company. Goldman just did what it does best: make money.
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