Goldman Sachs: Long on Profit, Short on Its Good Name

April 24 Update: Goldman’s ‘Big Short’: E-mails Show Firm Bet on Housing MeltdownGoldman Sachs
Goldman Sachs & Co. was still reeling today from the civil fraud case brought against the firm and a vice president when it reported a stellar first-quarter performance, nearly doubling its profit from a year ago to $3.29 billion.
But its good name, a faint pre-crisis memory, has a tough road ahead. Details and back-stories and ramifications continue to surface around one complex deal at the heart of the Securities and Exchange Commission case against one of the most successful financial firms in the world.
The deal featured an investment product tied to subprime mortgages originated in the states now plagued by foreclosure filings.
Those filings set new highs in the first quarter.
That connection to the Goldman case has not gone overlooked by Democrats pushing financial reform legislation in the Senate.
Goldman’s impressive quarter resulted in earnings of $5.59 a share, which blew past analysts’ expectation of $4. The firm also set aside $5.5 billion for compensation and benefits in the period – a throwback to its past image struggles from executive bonuses perceived as excessive.
None of today’s impressive numbers helped restore a reputation that has yet to re-emerge from its much-debated role in the months leading up to a housing bubble that fully gave way by the fall of 2008.
And unless Goldman settles with the SEC, details and the time itself may work against the 141-year-old institution. Britain’s Financial Services Authority (FSA) said it is investigating Goldman Sachs International in connection to the SEC allegations.
“In light of recent events involving the firm, we appreciate the support of our clients and shareholders, and the dedication and commitment of our people,” said Lloyd Blankfein, Goldman chairman and CEO in a statement today. 
The SEC alleges that Goldman and Fabrice Tourre, a vice president who has taken a leave from Goldman, orchestrated a synthetic “collateralized debt obligation” (CDO) tied to the performance of subprime-backed mortgage securities that was fraudulently marketed to investors.  
The charge stems from a failure of factual disclosures, particularly that hedge fund Paulson & Co. had structured the financial product along with Tourre, with the intent of taking short positions against the mortgage securities, the SEC alleges. Paulson & Co., which is not named as a defendant, was convinced that the “securities would experience credit events,” as the SEC puts it.
Goldman Sachs denies any wrongdoing and said it lost money on the transaction.
“We are disappointed that the SEC would bring this action related to a single transaction in the face of an extensive record which establishes that the accusations are unfounded in law and fact,” Goldman said in a statement.
Goldman also states that ACA Management, the largest investor with expertise on credit risk tied to mortgage securities, selected the portfolio. Goldman said it never “represented to ACA that Paulson was going to be a long investor,” as the SEC alleges.
A bearish stance against the subprime market was not new to Paulson. The firm had created two funds by buying credit default swaps (CDS) on various debt securities, the SEC said.
The CDS has become the chief non-human villain of the financial crisis, the now infamous derivative that has prompted calls for curbs and exchange-monitoring on its trading by lawmakers debating financial reform.
CDSs paid huge returns to those savvy enough to take its short position on subprime securities. Some institutions that stood on the wrong side of CDS transactions would end up taking U.S. government bailouts.
At the center of the subprime-backed securities structured by Goldman and Paulson was a high percentage of “adjustable rate mortgages, relatively low borrower FICO scores, and a high concentration of mortgages in states like Arizona, California, Florida and Nevada that had recently experienced high rates of home price appreciation,” reads the SEC complaint.
“But let’s be clear, we don’t need to know the outcome of this case to know that the opaque nature of unregulated asset backed securities fueled the financial crisis,” said Senate Banking Chairman Christopher Dodd in a statement after Friday’s SEC announcement. “And even as our country is still recovering from those mistakes, Wall Street financial firms continue to game the system.”

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