This morning, the Securities and Exchange Commission brought charges up against Goldman Sachs for fraud. The SEC alleges that Goldman Sachs defrauded investors by “misstating and omitting key facts.” The SEC suit against Goldman Sachs is an outgrowth of the investigation into the collapse of the U.S. housing market, urged on by unsecured loans at all levels of the financial system.
The SEC suit against Goldman Sachs
The downfall of the housing market and much of the associated U.S. economy is the “fault” of many different entities such as Goldman Sachs. Specifically, the SEC is alleging that Goldman Sachs had a cut-and-dry conflict of interest that they lied about. Specifically, Goldman Sachs allowed a hedge fund that was making bets on mortgages to have a say in the “quality” of those mortgages. Goldman Sachs then told investors that an independent third party had verified the quality of these investments.
Goldman Sachs responds to the SEC filing
At the same time that the Securities and Exchange Commission filed its suit against Goldman Sachs, Goldman Sachs released a response. The response was all of one sentence:
The SEC’s charges are completely unfounded in law and fact, and we will vigorously contest them and defend the firm and its reputation.
The products Goldman Sachs was selling
The basis of the SEC filing against Goldman Sachs is a product called Collatoralized Debt Obligations, or CDO. A Collateralized Debt Obligation is simply a group of mortgages. Once a homeowner gets a mortgage, the bank bundled it up with lots of other mortgages, and sold that bundle. Because the homes acted as collateral, many banks and investment firms saw these CDO products as safe investments. The idea is that payments on the mortgages would continue to come in, and the investment firm would make money. What many banks – like Goldman Sachs – did not tell investors is that these mortgages were not all good. In fact, many of these home loans were practically payday loans – given with no credit check and no certainty that the mortgage would actually be paid.
The specifics of the Goldman Sachs CDO
The debt obligation that the SEC filing against Goldman Sachs is based on is the ABACUS CDO. Goldman Sachs bundled up all these bad mortgages, known as Residential Mortgage Backed Securities, or RMBS. Goldman Sachs then asked ACA Management LLC to analyze how risky the investment might be. What Goldman Sachs did not tell ACA Management or investors was that these mortgages had been selected by a group of people who had taken out a bet that the mortgages would fail. In other words, investors bet that the mortgages would fail, then selected mortgages they knew would fail. When Goldman Sachs sold these mortgages in groups, the company didn’t tell investors that huge bets had been taken out against the mortgages. To put it simply, Goldman Sachs knew that this was a bad investment and didn’t say a thing about it.
Find out more about the Goldman Sachs inside job
A great resource to find out more about how these financial products work and how some companies made billions of dollars off the housing collapse is the This American Life episode Inside Job