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Why I Think Goldman Is Guilty

Posted by Larry Doyle on April 19, 2010 9:30 AM |

Information is everything.

Regular readers of Sense on Cents know how often I have raised that point as being perhaps the most important factor on Wall Street. Information, timely access to information, and the reliability of that information all move markets. Who gets the information, how it is processed and shared, and how it is disclosed all play a very important factor in determining winners and losers on Wall Street.

Against this backdrop, why do I think Goldman Sachs will ultimately be found guilty of the fraud charges brought against it on Friday? Based on discussions I have had with Wall Street colleagues, Goldman Sachs utilized a law firm in this specific Abacus transaction which did not mandate full and proper disclosure. As such, I believe the law firm itself will also face potential charges for aiding and abetting a fraud.

What should have been disclosed? The fact that the hedge fund, Paulson and Co., was heavily involved in selecting the reference collateral used in the deal and was simultaneously taking the other side of the trade.  That information is unbelievably powerful and damaging. Why? As an investor, the immediate question that would come to mind is “What does he know that I don’t know?” If investors were in possession of that information, then they could raise the question and determine the true nature of the transaction. What was the true nature? The fact that Paulson and Co. selected mortgage collateral, which from what I have been told, was largely reflective of mortgages originated in the most overheated states and had the greatest risks of default.

Goldman apologists would state that Paulson and Goldman were merely taking the other side of the housing bet from investors. The fact is, though, the bet was not on a diverse pool of collateral (which would have mitigated the risks), but on a concentrated pool of mortgage collateral which accentuated the risks.

Investors should have asked these questions, but in my opinion Goldman had an obligation to disclose the fact that the mortgage collateral was concentrated and selected by Paulson. As such, I believe Goldman will be found guilty of perpetrating a fraud. The fraud, however, rises well beyond the individual structuring the transaction. That structurer, Fabrice Tourre, was supervised by a manger. That manager should be sweating bullets right now. Why? A failure to properly supervise is a very serious charge on Wall Street.

How high will this go within Goldman Sachs? Will it ultimately cost Lloyd Blankfein his job? Do not discount that possibility.

In the court of public opinion, Goldman Sachs has already been found guilty for taking and losing in regard to the greatest risk of all. That risk is one of a questionable reputation.

Goldman Sachs has the reputation they deserve. To a large extent, Wall Street as an industry does as well.


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