Goldman Sachs' 'Fraud' Explained: How They Pulled Off The Alleged Scheme

Goldman Sachs defrauded investors by failing to disclose a conflict of interest on mortgage investments it sold as the housing market went sour, according to the civil complaint filed by the Securities and Exchange Commission on Friday.

Goldman allegedly failed to disclose to investors that it was betting against subprime mortgage investments it pushed on clients. Essentially, according to the complaint, Goldman pushed a product designed to fail.

How did Goldman do that? We broke down the case step-by-step. Check it out:

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Goldman Creates A CDO

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In 2007 Goldman Sachs created what is known as a "synthetic collateralized debt obligation," or CDO, called "ABACUS 2007-AC1," which we'll call Abacus. It was one of many. Goldman invited its clients to invest in Abacus, explaining in marketing materials that the $2 billion CDO was based on 90 bonds derived from subprime mortgage loans made over the previous 18 months. If people whose mortgages make up the bonds in Abacus keep up with their house payments, then folks who invest in Abacus -- typically banks, insurance companies, and pension fund managers -- will make money. The financial industry jargon for those investors' position is that they are "long." They're optimistic that the underlying borrowers won't default.

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In 2007 Goldman Sachs created what is known as a "synthetic collateralized debt obligation," or CDO, called "ABACUS 2007-AC1," which we'll call Abacus. It was one of many.

Goldman invited its clients to invest in Abacus, explaining in marketing materials that the $2 billion CDO was based on 90 bonds derived from subprime mortgage loans made over the previous 18 months.

If people whose mortgages make up the bonds in Abacus keep up with their house payments, then folks who invest in Abacus -- typically banks, insurance companies, and pension fund managers -- will make money.

The financial industry jargon for those investors' position is that they are "long." They're optimistic that the underlying borrowers won't default.

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Comments

[PhilipTaylor]

02:24 AM on 05/06/2010

HERE IS ONE BIG REASON WHY: GOLDMAN PUSHED A PRODUCT SURE TO FAIL AND THEN BET IT WOULD FAIL!

STEPS:

1. 2007 Go1dman created $2 Billion Package of Mortgage Loans called ABACUS, one of many.

2. Goldman invited clients to BUY Abacus Package of subprime loans made the last 18 months.

3. If people paid those home mortgage payments, then Abacus Long Investors would make money.

4. Go1dman told investors Abacus loans were chosen by ACA Management LLC but that was a G0LDMAN L1E as Hedge Fundster John Paulson hand picked loans with payments that were doubling, tripling, and quadrupling for marginal LOW FICO Home owners – SURE FAIL LOANS!

5. John Paulson picked those lousy underlying assets so he could bet against them by purchasing "credit default swaps" -- insurance policies that pay out if borrowers default – SHORTING Loans and SEC says G0LDMAN also shorted loans like Paulson.

6. Fabrice Tourre, Go1dman exec helped Paulson set up Abacus and Paulson paid G0LDMAN a small fee of $15 Million to make about $1 Billion. Within one year 99% of Abacus loans were downgraded (FAILED). Surprise! Surprise! Paulson+G0LDANM collect $BILLION!

7. New York Times says “synthetic C.D.O.’s helped make the financial crisis worse ..multiplying losses by providing more securities to bet against." “When you buy protection against an event that you have a hand in causing," said a structured finance expert, "you are buying fire insurance on someone else’s house and then committing arson.”

[PhilipTaylor]

02:24 AM on 05/06/2010

8. The Goldman Scandal could be just the beginning. Phil Angelides, of FCIC said the allegations are central to the "very trustworthiness of the marketplace."

9. Janet Tavakoli, a derivatives expert said the G01dman scandal is "related to activity of aiding and abetting fraudulent mortgage lending, creating phony securitizations and mis-selling them. Massive damage came from the massive risk of massively leveraging securities that could only go down in value, because [banks] created those bad securities. It was malicious mischief."

[PhilipTaylor]

01:47 AM on 05/06/2010

BUFFETT HAS PLANS FOR GOLDMAN!

By no means does BUFFETT have any benevolent bones in his body. That is what he should have, but not what he does have.

Buffett wants to keep G0LDMAN in play until Blankfein can be terminated and then take over and PROFIT from his FAKED IMAGE to boost the price of G0LDMAN like he did with Solomon!

[knighthood]

08:20 PM on 05/05/2010

goldman sacs did exactly what enron did. they told thier employees that that the company was going great. buy thier stock. they did.and the same time enron executives were sellig thiers. what chance the employees have. investments have risk but if the cards are stacked against you're a dead pigion. example you go to las vegas you know gambeling is a risk you take. but if they're playing with loaded dice or marked cards you are in the same boat as gambeling against goldman sacs or enron. no chance you're a dead pigion

[Cobra1]

02:32 PM on 04/30/2010

Goldman Sachs is my hero

[Venu Pietrangeli]

05:31 PM on 04/28/2010

In prostitution, clients know their risk. And yet it is a criminal offense. It does not affect the public directly; but it has proven to be disastrous for the community. What Goldman is indulging in is very similar, it claims that the clients know what they are doing. But it is a criminal offense because it destroys communities. Goldman is very arrogant, its all about making money by hook or by crook, as long they can subvert justice. Synthetic CDOs were created so that Goldman can win; others will loose; otherwise Goldman wouldn't create it. This is a ZERO SUM game, you loose, I win. It was created so that somebody looses. Alas, it is the middle income families that got duped and lost. If this isn't a crime, what is? I am surprised that CNBC, Kudlow and company lobby for Goldman, and ruin the airwaves

[SandmanViper]

10:55 PM on 04/27/2010

An investment is a calculated risk that investors are willing to take. Investors in Abacus were sophisticated investors with a large appetite for risk. They chose to invest in Abacus at a time when returns like those provided by this vehicle were hard to come by. They knew the risks fully well and exactly what type of securities Abacus would invest in - that was the only way to get the returns they anticipated. Goldman had just as much information.

When things went south, it's easy to point fingers on Goldman and say they're responsible. Really? Are they responsible for the average Joe who leveraged himself up the wazoo buying fancy cars and flat screen TVs he couldn't afford - all because he saw the real estate rally, didn't quite know how to make use of it given that he had already paid off his mortgage 5 years ago, so he chose to take out a home equity LOC and went splurging? Now when his imaginary real estate value is supposedly down, he blames the bank that gave him the loan, and firms like Goldman that made it easy for banks to expand credit in the economy? Grow up people - we need to take responsibility for our actions. We are in this mess today because we chose to splurge more than we could afford - all based on the assumption that our property value was significantly higher - that means NOTHING unless we're actually in the market to sell.

[Lucy1886]

01:12 PM on 05/06/2010

Choosing a physician and taking a medication is a calculated risk.

So if a physician accidentally (or intentionally) prescribes a medication that permanently damages your life, I assume that you would NEVER file a lawsuit. After all, CHOOSING DOCTORS IS A CALCULATED RISK in this FREE MARKET ECONOMY and if people had good luck with doctors in the past AND WERE TOO LAZY OR GREEDY TO CHECK ON THIS PARTICULAR DOCTOR OR THE MEDICATIONS...well, it is just THEIR OWN FAULT. Let the FREE MARKET take care of it....and if enough of a particular doctor's patients die, I guess that doctor will lose customers.

SEE HOW GREAT THE FREE MARKET IS?

The conservatives who complain about "NANNY BIG GOVERNMENT" and about litigation are THE FIRST ONES TO RUN TO THE GOVERNMENT FOR HELP and are, themselves, involved in starting all kinds of litigation when it suits THEIR pocketbook.

Liars and hypocrites..........so what's new?

[BURNriverBURN]

10:46 PM on 04/27/2010

Sad to say that the average American can't balance their household budget much less understand a mortgage. So we count on professional bankers and lenders to advise us. Still Joe/Jane Mortgage Defaulter (JMD) has made a poor decision and will pay dearly. We should be thankful that the banks took pity on folks they knew could not afford a house. That's what you get for showing some kindness! Anyway banks have made a poor decision as well and lose the profit from the mortgages however get the houses back now worth more than the principal. The investors in the CDO get wiped and the insurance on their investment pays the bank that sold the investor the CDO? How does the insurance not pay back the investors/owners of the the CDO? How can an insurer underwrite a policy for an event that even at cursory look is unavoidable better yet pays out to the creator of the event? How could this even be possible? This type of insurance is absurd how can this be legal? REALLY!

[Responsible Tax Payer]

03:26 PM on 04/27/2010

Is the real issue not that Goldman 'stole' money from the poor (b/c how could they? goldman didn't take money out of the bank accounts of subprime holders and keep them from paying their mortgages--right? or is that what a CDO does? Collect Debt Owed? ) but that Fabulous Fab (what a riot!) did not tell those two big, sophisticated, institutional banks that Paulson was betting against the securities portfolio in Abacus--the one that ACA/IKB selected? Surely with their experience they knew that there are two sides to every trade--even I know that! That's how markets are made. They knew what side they picked so what's the problem? And why is it a big surprise that Goldman started shorting the housing market when it was going south? If they did not, as a shareholder, I would have sued them!! Isn't this why their clients pay them so much $$$$? Gosh this grows more confusing by the minute!

But it seems like the issue revolves around non-disclosure of a piece of info to the Abacus investors. Ok. By why all these inflammatory remarks about Goldman stealing from the poor or these ridiculous "code pink" protesters? I certainly would not take out a mortgage that I could not pay or that would stretch my funds to a max. That's basic math! Or did I get that wrong again?

TedVail--you seem to know whuz up with all this. Help a girl out!

[Responsible Tax Payer]

03:26 PM on 04/27/2010

Feeling a little out of my element here. Not sure I can adequately inflate my commentary with the shocking level of hyperbole characteristic of this strain's brilliant thinkers. Well, here goes!

"goldmine sucks". LOL! What would we have called them if the housing market had gone north instead of south (i.e., all of the individuals who obtained these "sub-prime" mortgages did, in fact, accurately and honestly represent that they had the means to obtain such mortgages)? Goldmine Rocks? Or would we have hoisted accolade upon accolade upon the Gold Miners for believing in the honest, hard-working, lower/middle class taxpayer? For making a "solid bet"?

Would we have suited up with equal vigor, venom spewing with equal alacrity on behalf of Goldman's shareholders had "short bets" (betting against the subprime mortgage owner) gone south? Would we have defamed Goldman as being irresponsible to their shareholders/hedge fund clients for a hedge that went the other way? I wonder. This is so confusing--isn't a hedge fund supposed to hedge its exposure? Or do I have that wrong? If I put my money with a hedge fund manager who places a long bet on say an energy stock to hedge that exposure with say an energy ETF. I thought consensus was that no one can predict the markets (although Goldman seems to come closer than most!). This seems like the right play to me so what is so wrong about it? Please help!

[Darlis Darwis]

03:16 PM on 04/27/2010

This Company should be better Join with Gov't through The Ministry of Housing and deep study about the relevant Laws and Rules.

[jakeedward]

01:44 PM on 04/27/2010

Where you can go along with world trends on bagshoponline.c o m .There are so many

fashion items you need and all the big brand you love.

[Lucy1886]

01:14 PM on 05/06/2010

How did bagshoponline.c o m get approved and so many of my posts don't?

[Jim Fox]

01:58 PM on 04/24/2010

I am not an economist, and only understand a little about gambling.
Can someone explain: G-S was making money betting that the 5-star rated mortgages that would fail, and they ultimately made a lot of $ when the bottom dropped out of the real estate bubble. Whose money did they get? If they bet, and won, who was betting against them? Whose money was ponied up - who lost? I get confused when journalists call financial transactions bets. Are they stocks, derivatives, bonds, Credit Default swaps, synthetic collateralized debt obligations?

[TEDVAILL]

05:37 PM on 04/24/2010

Jim - What Goldmine Sucks did was obtain insurance from AIG and others that if the money they invested in the toxic mortgages they "securitized" by bundling them together into AAA securities and selling them to suckers went down, they would be compensated for their losses. They said to the investors, "See, we like these securities so much we are buying them outselves", without telling the other buyers that they were so negative on these securites that they bought insurance on them not going down . They also knew that Paulson's hedge fund, who helped put together this toxic bundle of mortgages for Goldmine Sucks, was betting against them, i.e., "shorting" them, and making money if their value went down. Check out my 2009 YouTube video "Ted Vaill Carves Up AIG" which deals with some of this mess.

[SandmanViper]

11:04 PM on 04/27/2010

This is such an ill-informed and outrageous comment! NO investment bank or broker-dealer will EVER make a statement to investors to the effect that "we like these securities so much that we ourselves are investing in them, so you should invest too". Stop airing your uneducated and completely out-of-the-loop comments when you don't know jack. This is infuriating! Folks like you know nothing about the market, you feel left out when the market is soaring and everyone is making money, and you feel this is your moment to shine by pointing fingers at others. Goldman did nothing wrong - get your facts straight.

[olivia]

01:33 PM on 04/22/2010

In a nutshell, what they did:

“When you buy protection against an event that you have a hand in causing," said a structured finance expert, "you are buying fire insurance on someone else’s house and then committing arson.”

[Santiago A Cueto]

11:50 PM on 04/20/2010

To appreciate the depths of Goldman’s duplicity, just take a look at its 2009 annual report. In the opening salvo of the report, Goldman is downright indignant and asserts that its only role in the financial markets has been positive.

To deflect attention away from Wall Street matters, Goldman went to great lengths to say that it spent the year acting in the interests of its clients and that these actions were the driving force behind its business.

That fails to address the huge sums of money that Goldman made in proprietary trading that did nothing to benefit clients, but enriched Goldman's shareholders and employees. The investment bank pressed the case that it paid workers only for their performances and nothing more.

On page 39 of the 2009 report, you find Goldman’s broad-brush disclosure in all its vague and generalized glory. Specific references to open investigations, lawsuits, administrative actions? Move along. Nothing to see here.

This was also the subject of an article “Goldman Sachs' Annual Report: It's All Smoke and Mirrors” on the International Business Law Advisor www.IntlBusinessLaw.com

[DebtNavigation]

05:26 AM on 04/19/2010

While the government FINALLY going after Goldman Sachs (and I hope many others) with civil (and hopefully ultimately criminal) fraud charges is a good thing, the American people still have to deal with the effects of all these shenanigans in their own lives. And they have been devastated. But others have shown the way, and it's time to follow their lead.

In Mexico in the mid-'90s Wall Street engineered a currency coup that tripled the debt owed by small businesses and family farms and also allowed for them to be massively ratejacked on top of it. Mexicans consequently formed the "el Barzon" movement and pushed back Wall Street and deposed their ruling party of 60+ years. In this country YouTube phenom Ann Minch has already declared the debtors' revolt and begun going after them http://www.revoltstartsnow.com

If you've been pushed under, you can read every other page of my book for free: http://www.scribd.com/doc/25443175/Debt-Hope-Down-and-Dirty-Survival-Strategies-Evaluation-Version-Complete