In Search of a Villain
In SEC v. Goldman Sachs, the government makes Wall Street the fall guy.


Andrew C. McCarthy

Each of these initiatives had the effect of pressuring banks into making risky mortgage loans. The government thumb on the scale induced credit raters to abdicate their responsibilities, while private-public chimeras Fannie Mae and Freddie Mac poured fuel on the fire, backing ever more risky loans with an implied guarantee that taxpayers would pony up when, inevitably, the debtors couldn’t.

Paulson assayed the playing field and drew two conclusions: first, that the system was headed for collapse, and, second, that the government was remorselessly committed to the system. So, he paid market-maker Goldman Sachs $15 million to peddle an investment vehicle he fashioned from the riskiest mortgages: not because he thought it would thrive, but because he wanted to bet against it. As Goldman sold these CDOs to investors, Paulson countered by putting his money into credit-default swaps, so he’d be covered when the crash he thought inevitable finally hit. He was right and the CDO investors were wrong, so he made a killing and they lost their shirts. But Paulson didn’t lie to make his killing. He correctly calculated that the system was unsustainable and shorted it. The other guys bet the other way and lost.

So if Paulson is just a smart guy who didn’t do anything wrong in manufacturing the CDOs, why is Goldman in the soup for selling them? In SEC logic, it’s because the seller knew the manufacturer had a dirty mind but didn’t let the buyers in on that detail.
That is absurd. The supposedly duped investors were no babes in the woods. They were highly sophisticated players. Indeed, the specific investment vehicle at issue is not merely a CDO but something even more esoteric: a synthetic CDO. As the Wall Street Journal’s editors explain, this sort of CDO is not actually composed of the risky mortgages themselves, or even of securities derived from the mortgages. Instead, the synthetic CDO (known as “ABACUS 2007-AC1”) was a financial instrument contrived specifically to enable investors to gamble on whether the value of the underlying assets (the risky mortgages) would rise or fall. We’re not talking about a schoolyard pick-up game here — this is the big leagues. The players are pros, and when they play, it is understood that there will be winners and losers.

In this instance, the investors assumed that a government-run gravy train never ends and that there is no day of reckoning. In contrast, Paulson assumed that at some point the piper must always be paid. Paulson, of course, was right.

Unless the SEC has more than what is laid out in its complaint, this isn’t fraud. It’s politics. If you want to talk material omissions, to charge Goldman but not charge Paulson is pretty darn material. If what Goldman was selling was fraudulent, it can only be because what Paulson manufactured for sale was fraudulent. The two were in cahoots. If what Paulson did was perfectly lawful, Goldman can’t be legally culpable for helping him do it.