Kai Ryssdal: This was quite a day in the evolution of the financial crisis we’ve all come to know so well. The Securities and Exchange Commission has filed its first big crisis-related lawsuit. Rather than start small, the SEC is going after the biggest fish it can: Goldman Sachs. The SEC says Goldman and one of its vice presidents let a big hedge fund stack the deck on some investments based on mortgages that were about to go bad.
Marketplace’s Mitchell Hartman has the story.
Mitchell Hartman: The Goldman Sachs VP at the center of the alleged fraud was Fabrice Tourre.
The SEC says he let the hedge fund Paulson & Co. influence the structure of an investment called a “synthetic collateralized debt obligation.” Karen Petrou of Federal Financial Analytics says it’s one of the most complicated investments out there.
Karen Petrou: I think you need to be at a cocktail party to think you understand collateralized debt obligations, or CDOs.
At its heart, though, a synthetic CDO is simply a pool of mortgages. Paulson saw many of these mortgages were subprime, or pretty dicey. And yet the bonds based on them were still being given the gold seal of approval by rating agencies.
Paulson selected the investments it thought were most likely to go bad. It asked Tourre to fill up one of those synthetic CDOs with them. And then Goldman sold those mortgage-backed bonds to its clients.
Cornelius Hurley of Boston University Law School picks up the story.
Cornelius Hurley: Paulson all the time was betting against the success of those investments. All the while, Goldman was not revealing to its investing clients that it was on both sides of that deal.
In other words, Goldman’s employee knew Paulson was betting against the mortgage bonds. But he sold them on to other investors without saying a word. The SEC says that’s fraud.
Goldman might say investment banks always do this kind of thing. They sell investments to clients, and also hedge against them to spread their risk. Petrou won’t buy that argument, though.
Petrou: An embedded conflict of interest that creates risk for investors is a material fact that should have been disclosed.
Hedge fund manager John Paulson is not charged in this suit, although he made billions when the investments he’d bet against went bad.
I’m Mitchell Hartman for Marketplace.
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