Goldman? Fraud? Really?

When the I heard the story about the Magnatar trade in which a hedge fund selected risking investments to create a CDO, collateralized debt obligation, backed by subprime mortgages and then hedged against the CDO basically saying that if the CDO fails we will win both ways; I couldn't believe it. Propublica and This American Life broke a story that is at the heart of the Financial Crisis. In the Magnatar story we hear how a hedge fund pushed for the creation of such risky investments and bet against those same risky investments. In the This American Life story they claim that by pushing for these type of investment Magnatar basically helped the market overheat. Unfortunately the banks didn't disclose to the investors that the company that picked thw risky mortgages to bundle into the CDO also was betting against the CDO. Actually the Wall Street Journal broke the story in 2007 but this type of activity on Wall Street apparently does not raise eyebrows. Wall Street types just want to know how they can get in on the action...

This is basically what the SEC to accusing Goldman Sachs of doing. Goldman is accused of failing disclose to investors that a hedge fund helped stock a Goldman CDO and then bet against it.

Washington, D.C., April 16, 2010 — The Securities and Exchange Commission today charged Goldman, Sachs & Co. and one of its vice presidents for defrauding investors by misstating and omitting key facts about a financial product tied to subprime mortgages as the U.S. housing market was beginning to falter.

The SEC alleges that Goldman Sachs structured and marketed a synthetic (CDO) that hinged on the performance of subprime residential mortgage-backed securities (RMBS). Goldman Sachs failed to disclose to investors vital information about the CDO, in particular the role that a major hedge fund played in the portfolio selection process and the fact that the hedge fund had taken a short position against the CDO.

"The product was new and complex but the deception and conflicts are old and simple," said Robert Khuzami, Director of the Division of Enforcement. "Goldman wrongly permitted a client that was betting against the mortgage market to heavily influence which mortgage securities to include in an investment portfolio, while telling other investors that the securities were selected by an independent, objective third party."

Goldman pointed out that what they did is quite similar to what other major investment banks seem to have done [1] with the hedge fund Magnetar. (Goldman denies [2] that its investments were built to fail. Magnetar also denies [3] it was betting against CDOs it helped create.

When I heard the Goldman story I thought it was about Magnatar but SEC filing is about another fraud case entirely but build on the same premise. Wow! Gambling is not just for Vegas anymore and when you have guys like this who needs the mafia?