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Generational Dynamics Web Log for 17-Apr-2010
17-Apr-10 News -- Goldman Sachs is accused of subprime securities fraud

Web Log - April, 2010

17-Apr-10 News -- Goldman Sachs is accused of subprime securities fraud

Backlash is spreading against Greece bailout aid package

SEC accuses Goldman Sachs of fraud in subprime mortgage-backed securities

I believe that this case is a very big deal.

As I understand it, Goldman Sachs is charged with doing the following:

An investor asked Goldman Sachs to put together a portfolio of subprime residential mortgage backed CDOs that the investor could purchase as an investment.

The investor asked Goldman Sachs to have a neutral third-party select the CDOs that were to go into the portfolio.

Goldman Sachs instead went to a manager (John Paulson) of a hedge fund that was in the business of shorting these CDOs, and who stood to benefit if the portfolio collapsed.

Paulson (according to the allegations) selected the weakest CDOs for the portfolio, because he wanted them to collapse so that he could make money.

Goldman Sachs told the investor that a neutral third party had selected the CDOs for the portfolio; Goldman Sachs did not tell the investor of Paulson's involvement. (This is the specific fraud that was alleged. Paulson was not involved in this step, so Paulson was not charged.)

The particular Goldman Sachs executive who set up the deal was Fabrice Tourre. The SEC charged Tourre individually with fraud, along with Goldman Sachs.

When the CDOs collapsed, the investor lost a billion dollars, and Paulson made a billion dollars.

This deal was consummated in early 2007, just before the time that the global financial crisis began, according to NY Times.

Regular readers of this web site are aware that for several years I've been discussing circumstantial evidence that proves that massive fraud must have been taking place over the creation of these CDOs. (See, for example, "Financial Crisis Inquiry hearings provide 'smoking gun' evidence of widespread criminal fraud.")

A principle argument that I've used is as follows: The experts who created these CDOs may not have known in 2002 that their computer models were faulty, but by 2006, when the real estate bubble was bursting, they must have known, but didn't tell investors. Instead, as the real estate bubble continued to burst in 2006-2007, they created and sold CDOs in even greater volume, in order to collect as much as possible in commissions before everything started collapsing.

That's exactly what happened in this case. The WSJ quotes an e-mail message sent by Fabrice Tourre in 2007 as follows:

"The whole building is about to collapse anytime now...Only potential survivor, the fabulous Fab(rice Tourre)...standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstruosities [[sic]]!!!!"

So the "fabulous Fab" knew that a collapse was coming, but he put together and sold this deal anyway, collecting a fat commission by lying to his client, the investor, who ended up losing a billion dollars.

The significance of this case is that, I believe, it will be the first drip of water in an approaching torrent. I've been saying for years that bankers will be going to jail, because that's what happened in the 1930s. As time goes on, a lot more of these fraudulent deals will be discovered.

Backlash is building in Germany and Greece over European aid

Yields (interest rates) on Greek 10-year bonds rose again on Friday, to 7.43%, according to Bloomberg.

It was already clear on Thursday that Greece and Europe were headed for a major crisis, which is why, as we've been reporting, Greece finally "capitulated" on Thursday and asked the IMF for 'consultations' on getting an aid package. So the even higher interest rates on Friday prove that there is no hope for Greece without outside aid.

It's been true for a while that polls have shown strong public opposition in Germany to aiding Greece. That opposition is spreading into a backlash, as economists, business leaders and politicians express opposition to a German contribution. For example, Bloomberg quotes the president of an exporters' lobby group as saying, "I’m stunned. If I as a small or mid-sized business owner conducted myself as Greece did, I’d be held responsible. [Instead, Greece] is being rewarded with offers of loans at subsidized interest rates."

Some radical Germans are even calling for Germany to quit the euro currency and set up a smaller monetary union. The Daily Mail quotes a Morgan Stanley economist as saying that the Greek rescue proposal sets a "bad example," and makes it more likely that the euro area "degenerates into a zone of fiscal profligacy, currency weakness and higher inflationary pressures."

But there's a backlash forming even in Greece, mainly because of the onerous conditions that an IMF bailout would impose on the country, according to the Guardian. The article quotes a left wing Greek leaders as saying "Yesterday was a humiliating day for Greece and Europe. You don't have the popular mandate to allow the IMF to come in," he said, referencing Thursday's actions by Greek prime minister George Papandreou.

More bond sales are scheduled for next week. The situation in Greece is very bad, getting worse every day, and events are unfolding rapidly.

Additional Links

User of Apple iPad tablet computers traveling to Israel are shocked to learn that their iPads get confiscated when they arrive. The government has banned iPad imports. Haaretz

The volcanic ash could that's grounding planes throughout Europe is not expected to have a major economic impact, since the disruption appears unlikely to last continuously over a long period of time. Reuters

(Comments: For reader comments, questions and discussion, see the 17-Apr-10 News -- Goldman Sachs is accused of subprime securities fraud thread of the Generational Dynamics forum. Comments may be posted anonymously.) (17-Apr-2010) Permanent Link
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Generational Dynamics Web Log for 17-Apr-2010 17-Apr-10 News -- Goldman Sachs is accused of subprime securities fraud

SEC accuses Goldman Sachs of fraud in subprime mortgage-backed securities

Backlash is building in Germany and Greece over European aid

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Generational Dynamics Web Log for 17-Apr-2010
17-Apr-10 News -- Goldman Sachs is accused of subprime securities fraud