Goldman Sachs accused- an ugly, sordid tale.

The SEC have filed a suit against Goldman Sachs which paints a picture of the banks’ operation, so morally repugnant it is almost cartoonish.

Here’s what the SEC alleges they did. You tell me if it shows the Goldman Sachs bankers to be as morally degenerate as I think they are.

The Goldman bankers were and are in the business of creating securities and then advising (for a large fee) their clients, which securities match their clients particular needs. High risk for those looking for large returns and willing to accept risks, and low risk, low return for those, such as pension funds, who must minimise any chance of losses.

The securities in question were to be based on bundles of residential mortgages. Goldman had to use their expert judgement to select the best bundles of mortgages then slice and dice them into senior (No risk low return) mezzanine (middle risk middle return) and junior (higher risk, higher return) tranches to create the now infamous ‘securities’ that we have all been told are so complex, mere little people like us couldn’t understand them. To simplify, each month a mortgage is paid, that money goes first to pay the senior tranches, what’s left pays the Mezzanine and what is left after that, pays the junior. So, although the rate on Junior is higher, if the underlying mortgages start to default and the flow of money dries up, it is the Junior who will feel the drought first. The senior should still be paid even if quite a number of the underlying mortgages default. The risk and cost of any particular mortgage not paying is spread throughout the security. Making everyone more ‘secure’ and allowing buyers to choose the balance between, risk of loss versus rate of return, that suits them.

And that is the basis of the ‘oh so hard to understand’ securities. Of course only the ‘smartest men in the room’ the bankers could wrap their minds around their fabulous actual complexities. And yet around those complexities lies a simple story of ugly corruption and greed.

Goldman advised clients that the mortgages on which the securities were to be based would be AAA rated. They told their clients, they could be sure of this because Goldman would have an ‘independent’ firm, ACA Management, chose the mortgages for them. And this is true. The reason they got ACA involved was because some of Goldman’s clients had started in 2006 to say they were troubled, even unhappy about buying some of the mortgage backed securities unless there was some independent third party involved in choosing them.

You see the sort of clients who bought these mortgage backed securities were often pension funds who are paid to be conservative. They need AAA security when investing people’s pension money. As you would expect and hope.

So ACA was signed up.

But there was someone else involved in the deal, Hedge fund Paulson and Co. Now ACA knew Paulson were involved in researching and suggesting to Goldman and ACA, a list of packages of mortgages which Paulson suggested should be included in the securities. Of the 123 groups Paulson suggested 55 were eventually included in the securities.

Goldman led ACA to believe that Paulson’s interest in the deal was that Paulson hedge fund was going to invest in the junior, most risky tranche of the securities. What neither ACA nor Goldman’s clients knew was that this list was not of absolutely sound AAA rated mortgages at all but were specifically mortgages which, regardless of how they were being advertised, regardless of how the ratings agencies had labelled them – as AAA etc, had been chosen by because Paulson because they thought those particular mortgages were, in their expert opinion, likely to DEFAULT. Only, this expert opinion was never revealed to either ACA or Goldman’s clients, to whom the securities were to be sold. Paulson and Goldman knew; no one else did. The SEC alleges.

FIne. The securities are created. Goldman bankers advise their trusting clients and get paid for this advice. Goldman bankers sell the securities to their trusting clients and get paid – again.

Then comes the nastiest part. Paulson does not invest in the securities. Instead Paulson buys Credit Default Swaps (which pay out if the securities default) on the precise securities Goldman just sold to its clients. Goldman did the same! They too went out and bought CDS on those securities.

The CDS are a kind of insurance you can buy even on something you don’t own. In this case the securities Goldman sold to its clients as being AAA rated sure-fire-things. The CDS acts as a kind of bet placed against the securities. You bet they will fail and if you are right the insurer has to pay you. Goldman’s bankers sold the securities to their clients as sure-fire-things and then bet they were going to fail

Goldman bankers had created securities it sold to pensions funds investing ordinary people’s retirement cash. They assured their clients the securities were AAA rated, and then went and bought CDS which would pay out if those self same securities defaulted. Both Paulson and Goldman had chosen the mortgages specifically for their poor quality, lied to the ‘sucker’ they sold them to, pocketed the cash the sucker paid for the securities, and then set themselves up via the CDS purchase to profit again from the default of the securities.

And it gets better. Goldman bought the CDS ‘insurance’ from AIG. When the sub-prime ‘event’ happened and the mortgages and the securites based on them collapsed, AIG had to pay out. Sadly, they too had played their own game of fraud and had never ever had the cash to back up the insurance they had sold.

You might think Goldman had come unstuck at this point. You’d be wrong.

Do you remember how all the experts and bankers told us AIG was ‘too systemically important to allow it to fail’? Well here is what they meant by that phrase ‘too systemically important to fail’.

If AIG had gone under Goldman’s bankers would indeed have lost money. Their CDS contracts would have been worth nothing. BUT, because this was a truly terrible outcome for the bankers to contemplate, they cried to their, sorry ‘our’ politicians for salvation – not for them you understand , but ‘for the good of the financial system and for all the good people and their pension funds who depend on it’ – And so AIG were given 183 Billion dollars of tax payers money.

What exactly happened to that money? Well guess what? Some of that $183B bail-out was promptly used to ‘honour’ AIG’s CDS contracts with Goldman. Contracts are sacred remember. Must honour those contracts or imagine the break down in trust and the financial chaos that would result? Remember all that?

So Goldman got paid three times. The Pensioners got screwed twice – once to lose their pension investment and once by being forced to bail out the very bankers who had already robbed them.

The last piece of the story is this. ACA decided to offer insurance themselves, something they ordinarily didn’t do. They offered it only on the super senior (that’s the ‘absolutely-never-fail-ever, guaranteed-AAA-and-then-some’ tranche). Presumably they thought with Goldman advising it had to be safe. ACA after a while struck a deal with the Dutch bank ABN AMRO to sell them this insurance. Goldman advised on this deal – and got paid for the advice.

RBS in their own fit of greed and avarice, then bought ABM at the top opf the market . When this CDS ‘insurance’ too, had to pay out, RBS agreed to pay $840,909,000 to guess who? Yes, you got it – Goldman Sachs and their lovely, lovely bankers. Who made such profits that they all personally got bonuses which they waved in our faces.