Magazine article The New Yorker

Scandals

Magazine article The New Yorker

Scandals

Article excerpt

Few things excite the public as much as a financial scandal. When the scandal involves Goldman Sachs, the richest, most powerful firm on Wall Street, and the central figure is an unknown thirty-one-year-old Frenchman who refers to himself as Fabulous Fab, the result is a barrage of news stories that most people don't fully understand but which create a widespread sense that some unprecedented skullduggery has been revealed and that villainous investment bankers will finally be held to account. Yet so far the facts don't suggest anything that dramatic. On April 16th, the Securities and Exchange Commission filed a lawsuit against Goldman and Fabrice Tourre, a relatively junior employee, charging them with misleading investors during a 2007 deal involving subprime mortgages. Goldman has denied wrongdoing, and the suit, in any case, is a civil one. Unless the Justice Department launches a criminal investigation, neither Tourre nor his bosses will face the possibility of jail time.

Even before the S.E.C. suit, it was widely believed that Goldman had placed bets against subprime-mortgage bonds while simultaneously hawking them to some of its clients. This belief persisted despite Goldman's insistence that it neither foresaw the housing collapse nor positioned itself to benefit from it. In a calculated display of humility, David Viniar, Goldman's chief financial officer, recently told Business Week that the firm wasn't that smart. But we now know that, in early 2007, John Paulson, a New York hedge-fund manager and Goldman client, was determined to sell short the subprime market in anticipation of a crash. To help him do it, he enlisted the services of Tourre, a mortgage trader who was then just twenty-eight. The case turns on whether Goldman had a legal obligation to disclose Paulson's involvement in its subsequent issuance of a complicated derivative security known as a "synthetic collateralized debt obligation," whose value was tied to dozens of subprime-mortgage bonds. If the individual home loans that backed the bonds performed well--if the borrowers continued to make their monthly payments--the C.D.O.'s buyers would enjoy a decent return. But if delinquencies and foreclosures rose, they stood to lose heavily.

In such a setup, the buyers assume that someone will be betting against the bonds, so the quality of the underlying credit is key. Goldman told investors that a specialist mortgage firm called A.C.A. had compiled the portfolio. "One thing that we need to make sure A.C.A. understands is that we want their name on this transaction," Tourre wrote in an e-mail, adding that it "will be important that we can use A.C.A.'s branding to help distribute" the securities. The government alleges that Goldman failed to disclose that not only was Paulson betting against the new securities but that he had helped select the mortgage assets, supplying A.C.A. with a list of individual subprime bonds to include with its own choices. (This sounds a little like a racetrack allowing a gambler to select horses and jockeys to run in a race, without informing the other bettors.) Tourre also allegedly told A.C.A.--falsely, the government contends--that Paulson invested two hundred million dollars in the new securities.

Within nine months, rising delinquencies and foreclosures had caused the investors, who included two big European banks, to incur more than a billion dollars in losses, while Paulson made almost as much in profits. Gordon Brown, the British Prime Minister, described Goldman's behavior as "moral bankruptcy," but that doesn't mean that the firm has no legal defense to offer: Goldman says that it lost ninety million dollars on the deal, and that in 2007 few investors knew who Paulson was, so disclosing his role wouldn't necessarily have spooked them. …

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