Goldman’s Actions Were a Disgrace

04/19/2010 1:12 pm EST

Focus: MARKETS

Terry Savage

Author, The Savage Truth on Money

If Goldman Sachs Group (NYSE: GS) is found guilty of the charges brought by the Securities and Exchange Commission (SEC) last week, these greedy pigs deserve every fine and loss of stock value that the legal system and the markets mete out to them.

But America does not deserve this fate, nor do the innocent employees of the company who will be hurt as this once iconic, always egotistical firm is pilloried.

Although Goldman disputes the government’s allegations and says it will vigorously defend the suit, the battle will publicly bare the ways in which Wall Street—and Goldman, which has been regarded as Wall Street’s “best and brightest”—helped destroy the American dream of home ownership. 

Of course, that destruction started with greedy home buyers, greedy mortgage brokers, and greedy ratings agencies. But now the laser of blame is focused directly on the process that ultimately financed that mortgaged house of cards—and on the firm allegedly at the center of the circle of greed. (The Wall Street Journal reports that the SEC is investigating whether mortgage deals set up by other Wall Street firms “may have crossed the line into misleading investors.”)

Goldman is accused by the SEC of breaking securities laws by withholding critical information about the pools of mortgage-backed securities, pooled into funds that it sold to clients. Goldman was supposed to be acting in the interests of its clients—the banks and institutions that would buy shares in the fund.

Instead, it is alleged that one “star” Goldman vice-president, the 31-year old Fabrice “Fabulous Fab” Tourre, was working closely with prominent hedge fund Paulson & Co. to pick the worst, riskiest mortgage securities to put into the fund.

Why would it do that? Well, Paulson & Co had made a huge bet (using those over-the-counter derivatives traded between banks) that the mortgages, and thus the fund, would fail!  As the mortgages within the fund securities defaulted, the value of the fund shares would collapse. But those who bet on the “short side,” like Paulson, would make a fortune.

And that is exactly what the SEC alleged happened!  Within a year of the creation of this fund in 2007, 99% of the mortgage securities within it had failed, costing the institutional fund investors $1 billion. But the hedge fund made at least that much by betting against the fund investors in its own hand-picked portfolio, the SEC charged.

It’s as if the dealer in a card game had purposely handed most of the players the low cards, while himself dealing all the aces and picture cards from the bottom of the deck to his best friend sitting next to him. The other players were bound to get fleeced.

And it appears that investors weren't the only ones fooled by these funds; Moody’s and Standard & Poor’s rated the securities Aaa, Paulson claims.

Just a few weeks ago, I wrote about efforts in Washington to get stockbrokers to abide by the higher standards of investment advisors—the “fiduciary rule” that requires registered advisors to put their clients’ interest ahead of their own, and to fully disclose any conflicts of interest.

That proposal was sidetracked to a “study group,” because everyone in Washington knows that you can’t make money—or pass laws—if you have to fully disclose all conflicts of interest. But now you see why the big firms in the brokerage and insurance community opposed this legislation. 

Goldman’s alleged conflict of interest and lack of disclosure that it was dealing from the bottom of the deck may or may not result in a win for the SEC when the case ultimately comes to court. 

But the suit has added fuel to the fire that demands increasing regulation over Wall Street’s activities. Never mind that government regulators had the laws, and the power, yet still completely failed to uncover abuses ranging from the Bernie Madoff Ponzi scheme to Wall Street’s manipulations of the mortgage market. 

The real loss, however, is to the future of America, which needs the free enterprise system and vibrant financial markets to provide growth and opportunity, as well as pay down our existing debts. Every over-regulated economy in history has failed—from the USSR to Cuba—to provide for its citizens, despite the “good” intentions of government planners.

The name Goldman Sachs will live on in infamy. And there’s an ultimate irony: Gold, the precious metal, cannot be tarnished. But Goldman has forever tarnished its name—and the free enterprise system.

What do you think? Please join the conversation and have your say.

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