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

First Posted: 06/16/10 06:12 AM ET   Updated: 05/25/11 05:10 PM ET

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:

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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