The Fall Of Goldman Sachs?

The last 72 hours have left Goldman Sachs with a shattered
reputation among the people who matter to them, their customers and the
politicians they have courted. The SEC's civil fraud suit over one of their synthetic CDO deals is bad enough, but it's just getting worse and worse for them.

First of all, the SEC is not alone in investigating the giant
financial firm. Gordon Brown, fighting for his political life in
Britain, savaged Goldman's "moral bankruptcy" in an interview and called for an immediate investigation with the UK Financial Services Authority. Germany's Angela Merkel joined him,
saying that her nation would evaluate "legal steps." The major clients
in the derivative deal, the ones who bought long while Goldman never
disclosed their hedge fund partner Paulson and Co. was buying short,
included the Royal Bank of Scotland and the German bank IKB.

Obviously, politicians here in America are pushing each other out of
the way to find a microphone where they can denounce Goldman Sachs. You
couldn't find a speech at the California Democratic Party convention
which didn't mention them by name. The DNC bought the Google ad for "Goldman Sachs SEC," and Democrats are clearly wanting to use the case as a springboard for financial reform.

And beyond the politics there are the facts of the case. Securities
fraud is pretty clear on the point that disclosure to investors must be
put in writing. "Nobody reads those statements" is no excuse. The
Abacus (name of the deal) pitchbook
just never mentions Paulson's role in devising the mortgage-backed
securities that made up the deal. And while Goldman wants to claim that
this was merely one deal and they were not trying to mislead their
investors, today's NY Times just obliterates that argument:

Mr. Tourre was the only person named in
the S.E.C. suit. But according to interviews with eight former Goldman
employees, senior bank executives played a pivotal role in overseeing
the mortgage unit just as the housing market began to go south. These
people spoke on the condition that they not be named so as not to
jeopardize business relationships or to anger executives at Goldman,
viewed as the most powerful bank on Wall Street.

According to these people, executives up to and including Lloyd C.
Blankfein, the chairman and chief executive, took an active role in
overseeing the mortgage unit as the tremors in the housing market began
to reverberate through the nation's economy. It was Goldman's top
leadership, these people say, that finally ended the dispute on the
mortgage desk by siding with those who, like Mr. Tourre and Mr. Egol,
believed home prices would decline [...]

With Mr. Paulson's help, Goldman created an Abacus investment that,
the S.E.C. now says, was devised to fall apart. By betting against that
Abacus investment, Mr. Paulson reaped $1 billion in profit, according
to the S.E.C. Mr. Paulson was not named in the S.E.C. complaint.

Goldman's top ranks changed its stance on housing in December 2006.
In a meeting in a windowless conference room on the executive floor,
Mr. Viniar, the chief financial officer, and Mr. Cohn, the president,
gathered about 10 executives for a briefing. Mr. Sparks, the head of
the mortgage unit, walked them through the numbers. The group was
unanimous: Goldman had to reduce its exposure to the increasingly
troubled mortgage market.

All the literature provided to investors said basically the
opposite, that the securities put in the CDO (which is "synthetic"
because the holders of the CDO don't own the product in question) were
designed for long-term advances. With Goldman's top executives
apparently aware of what they were doing in the housing market, they
face serious criminal and civil penalties, says Simon Johnson (he also thinks John Paulson should call a lawyer).

And Goldman's in serious, class-action lawsuit kind of trouble if this is true:

Talk about Goldman not disclosing material information. I'm not
talking about Abacus here, I'm talking about the fact that Goldman knew
as far back as last September that the SEC was on the warpath with
respect to Abacus, and gave no hint to shareholders that there might be
legal trouble afoot.

The WSJ has got its hands on -- but, unforgivably, has not posted
online -- a letter that Goldman Sachs sent to the SEC in September,
claiming that the Paulson's involvement in Abacus was not material ... In
fact, the SEC probe dates back all the way to August 2008.

Anyone who did business with Goldman between August 2008 and last week has reason to sue.

And what's more, this one deal is most certainly the beginning and not the end. The newly vigorous SEC
is actively investigating other mortgage deals. Indeed, what they're
pinning on Goldman in the Abacus deals could just as easily be
subscribed to the banks running the Magnetar deal, where that hedge fund created CDOs on mortgage backed securities they believed would fail.

Brad DeLong has a pretty helpful POV
of the case as well. My gut feel is that this has the potential to take
down the firm, and they're going to have to call in every chit they
have around the world to avoid that.