Goldman Sachs SEC Fraud Charges and the 2008 Financial Crisis

Introduction: The SEC Charges Against Goldman Sachs

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" arising 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—that is, the subprime mortgage-backed securities identified by Lewis (2010) as triggering the wave of financial distress that led to central banking intervention through unconventional monetary policy, also known as quantitative easing, and the inflation of asset bubbles still observed 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).

Reputational and Market Impact of the Charges

The impact of the charges on Goldman's reputation and stock price were not negligible. Charges were filed in April 2010, when GS stock was trading at $180. By June 2010, the stock had fallen to $131. It rebounded to $175 by January 2011 before falling back to $88 in November 2011. From that low, the stock bounced between $275 and $150 and at the time of writing traded just under $225—thanks in no small part to central banking intervention and quantitative easing.

The company's reputation was hurt, but not as severely as one might expect. The bank is still recognized as one of the top financial institutions in the industry, and its role in the financial crisis of 2007–2008 was not meaningfully different from the role played by any of the other major banks, as they were all essentially engaging in the same type of derivatives activity and moral hazard (Murray, Manrai & Manrai, 2018). Were investors and clients to stop doing business with Goldman on the basis of these charges, they would effectively have to withdraw from the finance industry altogether, since these practices were widespread among institutions and were not limited to Goldman.

Goldman's Role in the 2007–2008 Financial Crisis

Goldman's role in the crisis was indeed significant, as numerous researchers and journalists have pointed out—from Rolling Stone's Matt Taibbi to Michael Lewis to Bethany McLean. Goldman was actually the largest purchaser of the credit default swaps issued by AIG, as Taibbi and others demonstrated. 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 that the CDOs it was selling were of poor quality and that the credit default swaps served as insurance—a hedge against what was being sold to less-informed investors, whom Goldman employees were reportedly known to call "muppets."

Had AIG been permitted to default, Goldman and the other major banks that had purchased CDSs from AIG would have become holders of the worthless underlying assets. Because the then-Treasury Secretary was a former Goldman CEO, the bank ensured that through TARP, AIG received a bailout—which in turn guaranteed that Goldman would receive the return it had sought. Goldman was thus both a major actor in causing the financial crisis and a major beneficiary of its resolution.