Goldman's Blankfein, preparing to testify in Washington early this year, finds himself on the hot seat again Jay Westcott/Polaris
Browse the BusinessWeek Archive
The satraps of Capitol Hill don't have much taste for aggressive financial reform. They do have a certain talent, however, for the theater of aggressive reform. And when Goldman Sachs (GS) CEO Lloyd Blankfein settles in at the witness table of the Senate Permanent Subcommittee on Investigations on Tuesday, that's what they'll try to deliver: a moment that crystallizes three years of global disgust with the smart money boys who seem to have played the rest of us for fools.
When the curtain falls, the case that brought Blankfein to the hot seat—the Securities & Exchange Commission's civil lawsuit alleging that Goldman misled investors when it sold them subprime-mortgage-related investments that were designed to blow up—will still be one small, rotten potato in a large and smelly field. The reforms that might prevent this sort of chicanery will still be elusive. And Goldman, which calls the allegations "completely unfounded" and vows to defend itself "vigorously," will still be the most spectacular cash machine that banking has ever seen.
The SEC chose this case because it is comparatively stark. In early 2007, at the request of Paulson & Co., the hedge fund run by billionaire John Paulson, Goldman structured a deal called Abacus 2007-AC1, designed to let Paulson wager that the subprime-mortgage industry would collapse. Goldman lined up two counterparties for a fee of $15 million: ACA, a bond-insurance company, lost about $950 million (with the banks backstopping it), and a German bank called IKB lost $150 million. Goldman's offense, according to the SEC, was telling IKB that the portfolio of mortgage bonds used for the deal was "selected by ACA," when in fact Paulson was deeply involved in the process, cherry-picking the worst bonds it could find. Goldman didn't tell IKB who was on the other side of the trade, or the extent to which Paulson influenced selections. As a result, the SEC claims, Goldman's statement to IKB was false, misleading, and fraudulent.
The Abacus case is of course far more complex and nuanced than the SEC complaint lets on. This is a cast of characters without a single hero. Not even the supposed victims are sympathetic. IKB sold commercial-paper IOUs to investors in mid-2007 that were worthless by year's end. Its former CEO, Stefan Ortseifen, went on trial last month in Germany for allegedly lying about IKB's financial condition before its near-collapse.
The credit-rating merchants, whose incompetence cannot be overstated, make their usual cameo, as well. And while Paulson didn't get sued, because the SEC said he made no misrepresentations, he did make $1 billion on the deal. Having his name associated with this alleged fleecing carries its own unknowable reputational risk.
The SEC, trying to show that it has grown teeth after doing nothing while Bernie Madoff looted and Lehman Brothers fell to dust, doesn't appear pristine either. Its enforcement chief, Robert Khuzami, until last year was a top lawyer at Deutsche Bank (DB), which, like Goldman, structured transactions for hedge funds betting against subprime bonds. While Khuzami has said he would recuse himself from matters involving Deutsche Bank, he's free to probe its competitors. The SEC filed the suit the same day its inspector general released a horrific report on the agency's decade-long failure to catch accused Ponzi artist Allen Stanford. That PR trick relegated what would have been the day's biggest financial story to the inside pages. The IG's report said the enforcement chief in the Fort Worth office quashed his staff's efforts to investigate, then left for private practice—and landed Stanford as a client. The effrontery of that may well supersede anything Goldman and Paulson are alleged to have done.
The only players in this game that can't speak up for themselves are the synthetic collateralized debt obligations.
Post a comment about this story in Reader Discussion…
Track and share business topics across the Web.
RSS Feed: Most Read Stories
RSS Feed: Most E-mailed Stories
RSS Feed: Most Discussed Stories
About Advertising EDGE Programs Reprints Terms of Use Disclaimer Privacy Notice Ethics Code Contact Us Site Map Press Room
©2010 Bloomberg L.P. All Rights Reserved.
Read Full Article »