The subprime mortgage debacle that has left thousands of people in the United States homeless has been bad enough. Now the American people have to listen to SEC fraud allegations about how a white-shoe investment banker by the name of Fabrice Tourre, then working at Goldman Sachs in New York, apparently defrauded the bank’s clients.
According to the SEC, it seems that Tourre participated in packaging and shorting the sub-prime Residential Mortgage Backed Securities or RMBSs that comprised an ill-fated Collateralized Debt Obligation that the bank then touted as excellent investments to its unwary clients.
Fabulous Fab and John Paulson
Back in 2006, when the Fab boy-wonder was only 29 years old and in charge of the Structured Product Correlation Desk at the Goldman New York headquarters, he was approached by a savvy hedge fund manager by the name of John Paulson.
It seems that Mr. Paulson had studied the sub-prime mortgage market and was sure the market was ready to collapse. As a result, he was looking for a way to take advantage of the situation. The problem was finding enough people who thought the reverse and were willing to buy the risky RMBSs.
Paulson approached Goldman at that point and produced a list of a number of RMBSs which were more than likely to fail. He also paid Goldman $15 million to structure the deal and find investors willing to buy the ill-fated packaged security consisting of these RMBSs.
The Role of ACA Capital Holdings
Just one problem existed with the deal. How was Goldman going to find investors who were willing to bet on a list of securities which originated from a party which expected them to default? A third party was needed to make the alleged fraud work.
The third party turned out to be ACA Capital Holdings. According to the SEC, ACA was apparently falsely informed by “Fab” that Paulson and Co. was sinking $200 million into the Collateralized Debt Obligation or CDO. Although Paulson and Co. had been instrumental in selecting the ill-fated securities for the CDO, they had not actually invested in it.
ACA Capital Holdings made some suggestions and failed to sense any impropriety, despite having Paulson and Co. turn down mortgages from Wells Fargo which were of a higher quality than the ones selected by Paulson and therefore less likely to fail.
With ACA on board, Goldman proceeded to market the CDO under the name of the ABACUS 2007-AC1 with a slick prospectus touting the CDO portfolio as having been selected by third-party ACA Capital Holdings.
The prospectus featured 28 pages on ACA and seven pages on ACA’s officers, but not a word was mentioned about Paulson and Co. or the fact that they were the ones that had really selected the RMBSs in the package which was designed to default.
In an internal memo, Goldman Sachs urged their salesmen to “leverage ACA’s credibility” in order to sell the investment to clients, thereby apparently tricking them into thinking the mortgages would remain above-water.
Bottom Line Results
According to the SEC, Fabulous Fab was directly responsible for coming up with the fraud along with John Paulson, and for structuring and marketing the ABACUS 2007-AC1 and misleading ACA Capital into believing Paulson and Co. had established a long position in the CDO which was doomed to fail.
Paulson and Co., far from investing in the defective CDO for which they selected securities they knew were going to fail, instead purchased Credit Default Swaps from AIG, which were basically insurance against the CDO that would pay out handsomely in the event of the CDO’s pre-planned default.
Eventually, AIG did end up paying out, to the tune of $1 billion which went as profit to the Paulson hedge fund. In part, this transaction precipitated the fall of AIG which the U.S. government subsequently bailed out with taxpayer funds.
The bottom line was that investors in the CDO lost $1 billion and AIG also lost big, while Paulson and Co. made $1billion and Goldman Sachs received a large fee for structuring the deal.
Goldman also contends that it lost $90 million on the deal. Frankly, this does not make much sense since they also claimed that they were only acting as a middleman for the transaction.
Just the Tip of the Proverbial Iceberg?
Given that another related fraud case has now been filed against Bank of America-owned Merrill Lynch, the SEC’s fraud charges against Goldman could be just the tip of the iceberg regarding exposing corruption on Wall Street.
Although with the clout that Goldman has with the Obama administration, it would not be too surprising if this initial case may not get very far in order to protect whatever other potentially corrupt dealings may involve Goldman and highly placed U.S. politicos.