Was Goldman’s sleazy behavior really illegal?

Goldman Sachs founder Marcus Goldman

Keep an eye on the Securities and Exchange Commission’s case against Goldman Sachs. It’s hard to imagine a less sympathetic defendant than Goldman. That may be the problem, because evidence is already emerging to suggest regulators are concocting violations in order to punish sleazy but legal behavior.

In today’s New York Times, Binyamin Appelbaum offers a useful analysis of the SEC’s civil suit against Goldman, which stands accused of defrauding investors. The story quotes experts who point out that those investors were fully informed about what they were buying. The only thing investors didn’t know was that a hedge-fund manager named John Paulson helped pick what went into the investment vehicles and then bet they would lose money, to the great benefit, as it turned out, of Goldman’s shareholders. [Note: The previous sentence has been corrected since this item was first posted.]

Elsewhere in the Times, Andrew Ross Sorkin asks, “Why was Goldman, or any regulated bank, allowed to create and sell a product like the synthetic collateralized debt obligation at the center of this case?” The key word in that sentence may be “allowed.”

The Goldman case seems similar to one investigated recently by ProPublica and the NPR program “This American Life” involving Magnetar, a hedge fund that created collateralized debt obligations (CDOs) that it then bet against. Magnetar has been accused of deliberately making those CDOs as risky as possible and then shorting them, running up many tens of millions in profits when they failed. (Magnetar denied the accusation.)

According to the report, Magnetar’s dealings may have single-handedly extended the housing bubble for at least a year, making the subsequent crash much deeper than it otherwise would have been. Yet not only has there been no hint that there was anything illegal going on, but Magnetar itself is still in business.

(And by the way, if you haven’t heard the report, you should download the podcast. It is a rare model of clarity about an exceedingly murky subject. You will come away, as I did, actually knowing something about what CDOs are and why they were so harmful to the economy.)

Although the charges Goldman faces are civil rather than criminal, the story calls to mind my friend and occasional collaborator Harvey Silverglate’s book “Three Felonies a Day,” which details the expansive reach of federal prosecutors who use vague laws (“conspiracy” is a favorite) in order to punish people and corporations they have targeted.

The news media ought to follow Appelbaum’s lead and be on alert against getting spun by tales of wrongdoing at Goldman. The real outrage may prove to be not what’s illegal but what’s legal. Perhaps a better story is whether the massive financial-regulation bill now being considered by Congress would outlaw the sort of behavior that made Goldman and Magnetar clients even richer than they already were — while leaving the economy in ruins.

Photo via Wikimedia Commons.

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6 thoughts on “Was Goldman’s sleazy behavior really illegal?”

  1. “. . . investors were fully informed about what they were buying. The only thing investors didn’t know . . .”

    My head exploded.

  2. Although it’s difficult to follow the likes of Matt Taibbi, you have to admit his piece in Rolling Stone was pretty much on the money about Goldman Sachs and co. Taibbi aside, that was a good piece of journalism.

  3. My go-to source for information on the Wall Street banker scandals has been Simon Johnson’s blog The Baseline Scenario.

    Take a look at Johnson’s analysis of the SEC case. Once of his points:

    One of the things I say now and then that most annoys people is that the financial crisis was not caused by criminal behavior. (Note: The “Prayer for the Relief” at the end of the complaint only asks for civil penalties, but I suppose this does not preclude a criminal action — someone who’s a real lawyer could answer that.) My general line is that I’m sure there was some bad behavior that rose to the level of criminal liability — like lying in disclosure documents — but that it wasn’t necessary for the crisis, and we could have had the crisis without any criminal activity at all. (For example, since most investors weren’t even reading the disclosure documents, Goldman could have said that Paulson was involved in the security selection, and then everything would have been hunky-dory.) For the most part, the ideological takeover and the resulting non-regulatory environment that we discuss in 13 Bankers were enough to do the job.

    And I don’t think this action contradicts my general point. I would love it if the SEC could nail banks for some of the CDOs they created, but I’m still betting that the vast majority will not create legal liability for them.

  6. “The simultaneous selling of securities to customers and shorting them because they believed they were going to default is the most cynical use of credit information that I have ever seen.” –Sylvain R. Raynes, an expert in structured finance at R & R Consulting in New York.

    “Goldman wrongly permitted a client that was betting against the mortgage market to heavily influence which mortgage securities to include in an investment portfolio, while telling other investors that the securities were selected by an independent, objective third party.”

    “When you buy protection against an event that you have a hand in causing, you are buying fire insurance on someone else’s house and then committing arson.” –4/16/09 NYTimes

    Matt Taibbi, among other observers, goes further, stating that Paulson and GS knew the securities selected were likely to fail, facilitated getting them rated as AAA, sold them to investors as solid investment opportunities, then proceeded to bet against them and cashed in big time when they did, in fact, fail. If proven, this is an outrageous and fraudulent practice.

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