Goldman CEO Blankfein stated some months ago:  “We participated in things that were clearly wrong and have reason to regret.”   According the SEC’s allegations investors are now learning more specifically what Mr. Blankfein was referring to.

The Securities and Exchange commission SEC alleges that just before the subprime bubble burst in 2007, Goldman worked with a hedge fund manager to market certain subprime mortgage-related securities. Goldman did not tell the purchasers that they were buying an interest in loans hand-picked by the hedge fund, who took a very bearish view of the subprime market. Or that he had chosen them for their high likelihood of default.  The buyers were also not informed that the hedge fund manager’s purpose in structuring the deal was to take a short position against the investments they were making. This trade ultimately netted him roughly $1bn in profits, while the buyers lost their investment. 

Back in the 1990s, as America writhed in the aftermath of the Savings and Loans crisis, many hundreds of bankers were fined or put in jail as a result of their bubble-era misdemeanors.  Fifteen years later, however, as most of the global financial systems reels from another financial collapse, it is noteworthy just how little real retribution has been exacted on those responsible.  After all, the losses created by the subprime saga were worse than the SAL woes. Yet, thus far, few financiers have been brought to book. No wonder that the average voter in the US or Europe feels so angry: to most, the subprime saga seems like a giant “crime” without any punishment or justice.  But could this be about to change? Friday’s bold civil lawsuit by the Securities and Exchange Commission will undoubtedly prompt some to hope so.

Implications: If the allegations are correct, the SEC should throw the book at Goldman and its executives.  Of course, the bank rejects the complaint, but in any case it will leave a sour taste for investors.  It is high time to establish transparency in the finance system.  If the SEC fails to make its accusation stick, its reputation will be completely in tatters.    Source:  Financial Times

BIIA Newsletter April II – 2010 Issue