SEC Enforcement of Goldman Sachs and AIG

Goldman Sachs & Co. and Fabrice Tourre were charged by the SEC in 2010 with “Fraud In Connection With the Structuring and Marketing of a Synthetic CDO” from the 2007 subprime mortgage scandal at the heart of the financial crisis of 2007-2008 (SEC, 2010). The specific charge was that the bank and Tourre made material misstatements and omissions in connection with a synthetic collateralized debt obligation that the bank had structured, marketed and sold to investors. The synthetic CDOs were linked to the performance of the subprime housing mortgage market—i.e., the subprime mortgage-backed securities identified by Lewis (2010) as triggering the wave of financial distress that led to central banking intervention (unconventional monetary policy—also known as quantitative easing) and the inflation of asset bubbles currently seen today (Huston & Spencer, 2018). Goldman Sachs settled with the SEC and agreed to pay $550 million on the condition that the bank not be required to admit any wrongdoing. Tourre refused to settle and the case went to trial. He was found guilty by a federal jury and did not appeal. Tourre was ordered to pay $825,000 in penalties (Baer, 2014).
The impact of the charges on Goldman’s reputation and stock price were not negligible. Charges were filed in April 2010. GS stock was trading at $180. By June of 2010, the stock had fallen to $131. It rebounded to $175 by January of 2011 before falling back to $88 in November of 2011. From that low, the stock has bounced between $275 and $150 and currently trades just shy of $225 (thanks in no small part to central banking intervention and quantitative easing). The company’s reputation was hurt but not so extensively as one might think: the bank is still recognized as one of the top financial leaders in the industry and its role in the financial crisis of 2007-2008 was not much different from the role of any of the other big banks, as they were all essentially engaging in the same type of derivatives play and moral hazard (Murray, Manrai & Manrai, 2018). Were investors and clientele to stop doing business with Goldman on the basis of these charges, they would have to stop doing business in the finance industry in general because these practices were widespread among the institutions and not limited to Goldman.
Goldman’s role in the crisis was indeed major, as numerous researchers and journalists have pointed out, from Rolling Stone’s Matt Taibbi to Michael Lewis to Bethany McLean. Goldman was actually the biggest purchaser of the credit default swaps put out by AIG, as Taibbi and others showed. McDonald and Paulson (2015) noted that “Goldman Sachs had 44 transactions with AIG, with a total notional value of $17.09 billion” (p. 98). Goldman, in other words, knew the CDOs it was selling were worthless and the CDSs were insurance—their hedge against what they were selling to uninformed investors—or muppets, as Goldman employees were known to call their clients. Had AIG been permitted to default, Goldman and the other major banks that had been buying CDSs from AIG would have become bag holders of the worthless underlying assets. Because the at-the-time-Treasury Secretary was a former Goldman CEO, the bank made sure that through TARP AIG received a bailout—which in turn ensured that Goldman would reap the return it sought. Goldman was thus a major role player in the financial crisis and also a major winner.
Considering that Goldman made nearly $5 billion from its short position in AIG but was only “fined”—i.e., settled with the SEC—for half a billion dollars, it would appear that severity of the settlement was not appropriate to the role that Goldman played in facilitating the economic crisis of 2007-2008 while simultaneously hedging should AIG fall (Weisenthal, 2009).
Specifically, Goldman had been charged with misleading investors about the value of the mortgage-backed securities it was selling to them, particularly when signs of distress in the housing market began to show. It was these mortgage-backed securities that the Federal Reserve would go on to spend trillions of dollars on (along with Treasuries) in order to stimulate the market. In short, Goldman was charged with continuing to sell a shoddy product to investors even after it had become abundantly clear to the bank that the product’s underlying was likely to default. Goldman was hedged accordingly but had not be advising its investors to do the same. Instead, it had kept selling and taking commissions on its CDOs. The Fed eventually had to step in and become the buyer of last resort, and as a result today’s asset bubbles are where they are. Goldman not only helped to engineer the economic crisis, it also capitalized on it and has since gone on to benefit from the re-inflation of its own stock price thanks to the Fed’s quantitative easing.
When analyzed in this context, it could certainly be argued that Goldman’s settlement is out of proportion with the amount of pain the bank helped to cause the global economy. The settlement with the SEC was but a drop in the bucket of the bank’s overall annual revenue and can hardly be considered proportionate to the damage Goldman helped bring about. However, for Goldman to be held accountable in a much more severe manner would have meant, essentially, an undoing of the current financial system since Goldman alums sit in powerful positions throughout that system all over the world (Draghi at the ECB, Mnuchin in the U.S. Treasury, Carney at the BOE and so on). Goldman is one of the most powerful banks in the world and thus can truly be considered “too big to fail” for the fact that it is never really going to be held accountable so long as its alums continue to preside in positions of power.
References
Baer, J. (2014). Former Goldman Trader Tourre Won't Appeal Fraud Verdict. Retrieved from https://www.wsj.com/articles/former-goldman-trader-tourre-wont-seek-appeal-of-securities-fraud-verdict-1401221556
Huston, J. H., & Spencer, R. W. (2018). Quantitative easing and asset bubbles. Applied Economics Letters, 25(6), 369-374.
Lewis, M. (2010). The Big Short. NY: W. W. Norton.
McDonald, R., & Paulson, A. (2015). AIG in Hindsight. Journal of Economic Perspectives, 29(2), 81-106.
Murray, N., Manrai, A. K., & Manrai, L. A. (2018). The role of incentives/punishments, moral hazard, and conflicts of interests in the 2008 financial crisis. The bi-annual academic publication of Universidad ESAN, 22(43).
SEC. (2010). Litigation Release No. 21489 / April 16, 2010. Retrieved from https://www.sec.gov/litigation/litreleases/2010/lr21489.htm
Weisenthal, J. (2009). Goldman Sachs made billions shorting AIG. Retrieved from https://www.businessinsider.com/goldman-sachs-made-billions-shorting-aig-2009-3