SEC v. Goldman Sachs

Topics: Subprime mortgage crisis, Mortgage, Subprime lending Pages: 9 (3359 words) Published: April 14, 2014

When financial fraud has occurred to the American people by the alleged “Too Big to Fail” banks on Wall Street, is it more productive to the economy and society to criminally charge the executives of these financial institutions or negotiate a civil penalty that compensates victims and reforms the deceptive trade practices of our nation’s largest banks? Further, if settlement is the best solution, why settle for the less money than the financial harm caused by the big banks? The following will discuss the negotiations behind the Securities and Exchange Commission’s (hereinafter referred to as “SEC”) settlement with Goldman Sachs & Co. (hereinafter referred to as “GS&C”) and Fabrice Tourre, one of the largest securities-fraud settlements to date. FACTS

The aforementioned settlement all began with the rapid growth of subprime mortgages. This type of mortgage is typically lent to people with poor credit at a higher rate than normal residential mortgages in order to account for the increased risk of the loan.1 Subprime lending became legal during the 1980s after three Acts were implemented.2 More specifically, the Depository Institutions Deregulation and Monetary Control Act, in 1980, which preempted state interest rate caps; the Alternative Mortgage Transaction Parity Act, in 1982, which allowed variable interest rates and balloon payments; and the Tax Reform Act of 1986, which “prohibited the deduction of interest on consumer loans, yet allowed interest deductions on mortgages for a primary residence as well as one additional home.”3

Due to the foregoing Acts and changes in the housing market, high interest rates and less prime mortgage volume, the subprime market grew from $65 million in 1995 to $332 billion in 2003.4 The rapid growth led to more people enjoying the fruits of home ownership, but left the housing market on the brink of collapse.5 Executives of the big banks on Wall Street anticipated this problem and formulated a solution to protect their interests from the worst economic crisis since the Great Depression.6 The focus of the S.E.C. case was an investment vehicle called ABACUS 2007-AC1.7 In 2007, GS&C marketed a collateralized debt obligation called ABACUS 2007-AC1 which was coordinated by Fabrice Tourre, a vice president of GS&C.8 The success of this collateralized debt obligation marketed to investors was directly correlated to the success of subprime mortgages.9 ABACUS 2007-AC1 was one of 25 investment vehicles that Goldman created so the bank and some of its clients could bet against the housing market.10 Those deals initially protected Goldman from losses when the mortgage market disintegrated and later yielded profits for the bank.11 However, GS&C failed to disclose the involvement of a third party hedge fund group, Paulson & Co. Inc., in the selection of the mortgages for the portfolio to investors in the marketing of ABACUS 2007-AC1.12 Furthermore, GS&C failed to disclose Paulson & Co.’s adverse interest in the success of ABACUS 2007-AC1.13 According to the complaint, Goldman created ABACUS 2007-AC1 at the request of John A. Paulson, a prominent hedge fund manager who earned an estimated $3.7 billion in 2007 by correctly wagering that the housing bubble would burst.14 In essence, Paulson & Co. selected subprime mortgages that were likely to be foreclosed, but protected itself by entering into credit default swaps with GS&C.15 Paulson & Co.’s short interest incentivized the selection of mortgages likely to fail.16 As a result, the investors lost money when the subprime mortgages inevitably failed, but executives, such as Fabrice Tourre, who had found the proper loopholes made substantial money off the backs of others.17 Mr. Paulson is not named in the suit. In time, it would come to fruition that this practice was not isolated.18 Bank of America, AIG, JP Morgan Chase, and Lehman Brothers are just a few of the other financial...
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