SEC Charges Goldman Sachs: Ahab Goes After Moby Dick

Last Updated Apr 17, 2010 7:28 AM EDT

From hell's heart I stab at thee; for hate's sake I spit my last breath at thee. - Herman Melville "Moby Dick"
It's not Mary Schapiro's last breath, but she sure did stab at the "Vampire Squid" this morning. The SEC charged Goldman Sachs (press release here) and one of its vice presidents with fraud for misstating and omitting key facts in structuring and marketing a collateralized debt obligation (CDO) tied to subprime mortgages.


The complaint alleges that hedgie legend John Paulson's fund played a role in selecting residential mortgage-backed securities that went into a CDO created by Goldman. (CNBC is saying that Paulson's former employee Paolo Pellegrini ratted him out spilled the beans to the SEC, after the agency came hunting for info on Paulson).

Now pay attention--this stuff is complicated.

Goldman created a vehicle called Abacus 2007-AC1, which was filled with a bunch of toxic crap that would be sold to Goldman clients. Why would they do such a thing? The SEC believes that Goldman was acting at the behest of Paulson, whose hedge fund wanted a fat, sloppy mortgage mess to bet AGAINST. How? Paulson would purchase credit default swaps that would pay him if the bonds in the vehicle failed. Neat, huh?

Think of it like this: Goldman Sachs is asked by Paulson to sell a house that he knows is a fire hazard. Goldman markets the house to its clients and at the same time, Paulson purchases an insurance policy on the house in case it burns down. When the house does in fact burn down, Paulson collects a bunch of money (approximately $3.7B in 2007). And did I mention that Goldman ALSO bought some of that insurance too?

This was known as the Magnetar trade--you can read about it in Yves Smith's excellent book "Econned" or here in a great segment that aired on WBEZ's This American Life.

I'm no lawyer, but here's my guess as to what is likely to occur: Goldman will deny any wrongdoing, claiming that everything was disclosed to the accredited investors (pension funds, foreign banks and other institutional investors) who purchased Abacus. And even if the SEC's claim is sort of correct--that it wasn't disclosed that Paulson was cherry-picking the bad stuff--Goldman will settle for some seemingly large, but ultimately not earth-shattering amount and go on its way. Remember that only Moby Dick and Ishmael survived...

Image by Flickr User kdinuraj, CC 2.0
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    Jill Schlesinger, CFP®, is the Editor-at-Large for CBS MoneyWatch. She covers the economy, markets, investing or anything else with a dollar sign. Prior to the launch of MoneyWatch in 2009, Jill was the chief investment officer for an independent investment advisory firm. In her infancy, she was an options trader on the Commodities Exchange of New York.

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