Goldman Sachs fraud case puts whole industry on trial

The SEC's case against Goldman Sachs could put the entire financial system in the dock.

Last Updated: 31 Aug 2010

Crikey, what a weekend it’s been on Wall Street. The news that the US Securities and Exchange Commission was prosecuting ‘Vampire Squid’ i-bank Goldman Sachs and one of its star bankers, Fabrice Tourre, broke on Friday and it’s been action stations ever since.

It’s not only the nature of the alleged fraud that has got ganders up across the globe – although if proven that is pretty damning. It’s in the wider ramifications that the real dynamite of this story lies. Whatever the outcome of the case – and Goldman’s has vigorously refuted the allegations and is set to battle the SEC all the way – it is being seen by many as a dreadful confirmation of the long-held suspicion that the financial crisis wasn’t quite the accident that the powers-that-be would like us to believe. It may in fact have been more like a global game of financial musical chairs – one played for insanely high stakes where the bankers not only controlled the music but also decide who gets left standing when it finally stops.

No wonder the legal battle looks set to be long and hard-fought, nothing less than the moral (if that’s the right word) authority of the financial system itself is at stake. If Goldman’s loses it could usher in a new era of much more tightly-regulated and lower risk, lower reward banking. If it wins, it’s the SEC which will have to retire and nurse its wounds.

But enough of the big picture, the devil as always is in the detail, and trying to work that out is almost enough to make you feel sorry for the people who have to do this kind of thing for a living. What the SEC alleges is that Goldman Sachs created a $1bn derivative product, a CDO based on sub-prime mortgages (yes, them again) which it sold to one set of customers whilst another customer, a hedge fund run by billionaire financier John Paulson, was short-selling the same product - betting against it, in other words.

Not only that, but the SEC claims that Paulson and his fund managers were actively helping to choose which particularly ripe-smelling loans were to be included in this, ahem, unmissable investment opportunity. Oh, and Goldman’s man at the heart of it all, Fabrice Tourre, knew that the entire house of cards was teetering, as well – or as he put it in a leaked email  ‘More and more leverage in the system, the whole building is about to collapse anytime now… Only potential survivor, the fabulous Fab [Tourre].’ Not much evidence of a duty of care to one’s customers there.

And there’s a UK angle, as RBS ended up $800m in the hole to Goldman’s because it insured the dodgy CDO – or rather it acquired the obligation to insure it when it bought ABN Amro. Still with us? When the product failed, RBS had to pay out.

So there is a chance that RBS – which now essentially means us, the British taxpayer – could get some or all of that back. Don’t go spending it just yet though, it could take years to sort out.

Anyway, that’s about as much banking as anyone should have to take on a sunny Monday morning. The point is that all those people – the vast majority of them blameless and hardworking – who thought it was getting safe to admit to being a banker at dinner parties once more are going to have to think again. They ain’t seen nothing yet…


In today's bulletin:

Goldman Sachs fraud case puts whole industry on trial
Airlines under a cloud, as eruptions continue
City fat cats take home a third of UK's wage bill
Public sector cost cutting calls for surgeons not butchers
Boss-napping back on the menu in France

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