Putting The Latest Goldman Flap in Perspective

Putting The Latest Goldman Flap in Perspective

 by Elliott R. Morss, Ph.D.

Ok. Let’s make sure everyone understands what the latest flap is all about.

1. Goldman Sachs sold a portfolio of mortgage “instruments” for a company that paid Goldman roughly $15 million in 2007 to create.
2. The company that paid Goldman to create these instruments was Paulson & Company owned by John Paulson (no relation to Henry Paulson, the former head of Goldman).
3. Goldman then sold the portfolio of mortgage instruments to investors.
4. At the same time, Paulson & Company got someone to insure the value of the mortgage instruments so that if their value declined, Paulson would make money.  
5. Ultimately, the mortgage instruments lost all value: the buyers lost $1 billion and Paulson made $1 billion off the insurance.

 Fast forward to the present. The SEC is accusing Goldman of fraud. It alleges that Goldman did not inform the buyers of the mortgage instruments of Paulson’s involvement and objectives.

 The SEC alleges that Paulson was involved in selecting the mortgage instruments in the package. Is it fraud not to inform the buyers of Paulson’s involvement?

 Think of it this way: would you make an investment in something if you knew the person who designed it wanted it to fail? Probably not. If you were considering such an investment, would you want to know that the person designing the investment wanted it to lose value? Of course. It sure sounds like fraud/misrepresentation on the part of Goldman – the seller of the mortgage instruments.

 What will happen? The SEC and Goldman will probably agree to pay some sort of fine – probably less than $20 million. And the buyers of the mortgage instruments will probably sue Goldman to get their money back – maybe it will cost Goldman $1 billion. No big deal for Goldman.

 Some of my friends in the investment business think it unfair to single out Goldman for this infraction. They point to commercial banks whose trading caused the banking collapse. Two thoughts on this:

• The SEC has limited resources. I doubt it tried to “get” Paulson. It must follow leads it receives.
• As I have urged in earlier postings, commercial banks should not be in the trading business. FDIC insurance should be restricted to commercial banks that manage their own loans and don’t engage in significant trading – leave trading to the investment banks like Goldman.