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It's Not Just Goldman—It's the Clients

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If the SEC is correct, Goldman Sachs conspiracy theorists missed the mark in one major thing: Goldman wasn't the one creating these securities to short them and then peddling them to funds like Paulson. The point of origin was far deeper. It was the clients who were issuing orders to Goldman Sachs to create these toxic securities—designing them with every failing mortgage. Goldman Sachs structured Paulson's Abacus deal in April 2007, the SEC says. (Goldman's official statement on the matter is: "The SEC’s charges are completely unfounded in law and fact and we will vigorously contest them and defend the firm and its reputation.")

On June 14 of 2007, the Bear Stearns subprime hedge funds collapsed. On June 30, Michael Burry of Scion Capital—who was also betting against subprime—couldn't reach his brokers at Goldman Sachs. He sensed their panic. They told him that while the subprime market collapsed, "the market for insuring them hadn't budged," according to Michael Lewis's book The Big Short. What was going on at the time, Lewis explains, is that Goldman's own hedge funds took giant subprime losses and the firm had "rapidly turned from betting on the subprime mortgage market to betting against it."  In short, before June 2007—when Goldman was helping to create Abacus—Goldman still had bet the subprime market would survive and lost a lot of money in the mistaken apprehension.

Another point the conspiracy theorists, from Matt Taibbi on, missed and kept missing despite all the evidence: Goldman wasn't the only one who did these kinds of deals. Deutsche Bank and Goldman both agreed to work with Paulson, who ended up making $5 billion worth of bets, according to Zuckerman's book.

For that matter, neither was Paulson the only hedge fund to do this: "A few other hedge funds also worked with banks to create CDOs of their own that these funds could short - so Paulson wasn't doing anything new," Zuckerman wrote.

That's why the SEC's allegations are a real watershed in our understanding of the financial crisis. Instead of the crisis being a story about dastardly banks (although it may be that, too), it is really a story of how far banks will go to prostitute themselves for big clients. They will do for big clients what they won't do for the little guy: Burry details the various evasions of his banks to Lewis, all of which were taking place while Goldman slavishly served its own balance sheet and reputation on a platter to John Paulson. And, after all, Goldman Sachs suffered the subprime losses in its Global Alpha hedge fund and eventually had to forgive those Abacus contracts with AIG. But John Paulson got to keep all his money.

What is also amazing about the SEC's case is that it comes from ... the SEC. The beleaguered SEC, which has been criticized in Congress and the financial press for sleeping on the job. But here the agency appears to have filled in a big piece of the crisis puzzle—not just any piece, but the missing link that allows us a window into who may have been really in charge. SEC chair Mary Schapiro scored a big victory, particularly after much public criticism that her SEC would be too soft and too slow. As stunning as it is to hear this news about Goldman, in these times of rampant regulatory capture it is just as surprising to find an example of a regulator actually ... regulating.

Heidi N. Moore, a financial journalist in New York City, is a former reporter for The Wall Street Journal. Her work has also appeared in New York, Institutional Investor and the Financial Times. She tweets here.


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