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Transactions: May 3, 2010

07/03/2010 05:12 am ET | Updated May 25, 2011

Here's the good news: With the Securities and Exchange Commission leveling civil charges against Goldman, Sachs & Co., the crisis enters Phase 4. We now have giddyupped past collapse and destruction; staggered from handwringing, teeth-gnashing and soul-searching punditry and book production; tossed up, in that bilious way democracies have, a culprit; and we enter, to trumpeting headlines, the litigation phase. According to the manual, this means we must withstand (or wallow in) a purgatory of charges and countercharges, a spreading oil slick of complicity and tattletaling, and the appearance of mobs of lawyers huddled on marble steps. Arcane debates will erupt. Obscure souls with names like Fabrice will emerge, then submerge. At some point, usually when we can't squeeze another drop from this overripe fruit, we will arrive at catharsis and closure. This may take time: We must traverse all phases to achieve public acceptance, satiation, well-being, boredom. We will wrap ourselves in schadenfreude. We will consign losers to oblivion. We will comfort ourselves with progress and apologies. Then, fortunately, memory loss will set in and we can begin anew.

The bad news: A semipermanent cloud of volcanic ash has settled over Goldman's shiny new tower, falling softly, softly falling. There's no escape, even if Goldman triumphs in court. Damage -- a little, a lot? -- will be inflicted; ponder Microsoft as monopolist or defunct Drexel Burnham Lambert. Others will undoubtedly be dragged into this, but Goldman has been anointed symbolic culprit, after months of auditions, beating out Lehman Brothers, Bank of America, poor old AIG. Bernie Madoff was a scandal that spoke to the utter breakdown of SEC oversight, but it was, beyond big numbers, just a scam that never threatened global finance. Goldman now has to defend practices that have been deemed, by public outcry, sinister, dangerous, systemically wrong. Its usual defense: We deal only with financially sophisticated players. Caveat emptor, bub. That defense, prior to 2008, kept Goldman from woes that dogged, say, Merrill Lynch & Co., which was ritually beaten for various retail sins (Orange County, Henry Blodget). Goldman not only built its business on the financially sophisticated, it drove the logic of that approach to hell and back. Goldman lives (quite nicely) on smarts and information flow; and in that rarefied air, rules were looser, more flexible; if not opaque, a sort of twilight. Dealing with other "sophisticated" players (an adjective not necessarily synonymous with smart) in this state of nature meant, as Hobbes explained, that everyone is alone, self-interested, existentially uncertain. Regulators winked and nodded, viewing it as a free market exemplum, or perhaps they were just nodding off.

Alas, this isn't the entire financial world; it's more like a special table for high-stakes players. Goldman, however, is big enough and interconnected enough that what it does -- even purest speculation -- has giant repercussions. Goldman was wildly successful, only to stumble into a classic trap. The popular perception of regulation is that there are clear-cut rules, like traffic laws; break one, face the consequences. This is naive. There are many rules -- volumes of technical, legalistic rules -- riddled with ambiguity, like the definition of materiality. Given this ambiguity, regulators allowed sophisticated players to play rough out of the public eye; indeed, the shifting, fluid roles of principal and intermediary were built into the very structures of banks like Goldman. In good times, those rules, including the moral nostrum that we don't screw customers, loses its bite. Then crisis strikes, the populi rise in horror and demand moral reckoning, and regulators must prove they're not as dopey as they seem.

This, without positing guilt or innocence, is what happened to Goldman. The firm sold the Abacus CDOs with John Paulson's input and didn't disclose because it was a speculative bet among sophisticates. The bubble was ripening. To anticipate problems, Goldman would have had to foresee mortgage collapse, which it did, a breakdown of global capitalism, panic, near depression, which it didn't. Someone would have had to anticipate Matt Taibbi, the mounting infamy, the backlash against speculation, shorting and complexity; the fact that no one did hints at hubris and a deficient sense of history. As Fabrice's CDO won approvals up and down Goldman's old HQ, no one appeared to say we can't hammer a dumb bunny from Düsseldorf. To do that would not only run against Goldman's evolution from advisory to trading powerhouse, from partnership to public company, but against the mindset that fueled it. It's a pity, in a way. Goldman built a beautiful machine for infiltrating all parts of Hobbesian finance. Now it goes to war in a Dickensian legal jungle. Goldmanites are smart and they'll have the best lawyers in the land, but there's no manual for this situation. Welcome to limbo.

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Robert Teitelman is the editor in chief of The Deal.