Goldman Sachs is a bunch of big fat liars.

Let’s make sure we understand why Goldman Sachs was willing to pay $550 million to settle the SEC’s lawsuit against it – “one of the largest penalties ever paid by a Wall Street Firm.” Goldman Sachs committed fraud to get investors to buy into a fund of securities. It isn’t even a difficult fraud to understand.

Goldman agreed with John A. Paulson, a prominent hedge fund manager who earned an estimated $3.7 billion in 2007, that Paulson could choose the particular mortgage-backed securities that Goldman would sell. Paulson chose securities he knew would default. At the same time he bought credit default swaps on those same securities — in essence, insurance policies that would pay him the value of those securities if they defaulted. In short, he chose the securities for the fund because he knew they would fail and their failure would profit him mightily.

Goldman’s problem, of course, is that no one would buy the securities if they knew Paulson had chosen them. As the complaint filed in the case by the SEC (embedded below) states: Goldman “knew that it would be difficult, if not impossible, to” sell the securities in the fund “if they disclosed to investors that” someone who had “shorted” the securities, “such as Paulson, played a significant role in selecting the securities.”

So Goldman went out and got ACA Management LLC, a company with experience in analyzing the credit risks associated with funds like that it was selling, to agree to be “Portfolio Selection Agent” — that is, to represent itself as the entity that had chosen the securities Goldman was selling. Of course, ACA was not the Portfolio Selection Agent, but Goldman knew what it needed. As Goldman’s Fabrice B. Tourre wrote in a memo:

“One thing that we need to make sure ACA understands is that we want their name on this transaction. This is a transaction for which they are acting as portfolio selection agent, this will be important that we can use ACA’s branding to help distribute the bonds.”

Tourre later wrote in another memo:

“We expect to leverage ACA’s credibility and franchise to help distribute this Transaction.”

I’m happy to learn that the settlement does not include any agreement with Tourre personally. One thing I wonder, though: wasn’t Paulson part of a conspiracy to defraud investors? Why has he gotten to go off with his billions untouched by the SEC?

S.E.C.’s Civil Lawsuit Against Goldman Over C.D.O

A better solution to the mortgage crisis, the federal governments bailout policies, and AIG’s failures to meet the obligations it took the risk of not meeting

I have several thoughts about the AIG bailout apart from what I consider the justifiable outrage over multi-million dollar bonuses being paid to the very people who set up the house of cards AIG had constructed.

First, I can’t understand why anyone would be surprised, much less outraged, that AIG paid much of the bailout money it received to other financial institutions.  Those institutions (Goldman Sachs, for example) owned mortgage backed securities and had purchased from AIG the “credit default swaps” that were, in essence, insurance that the owners of the mortgage backed securities would not earn from those securities what they were supposed to. Goldman Sachs had not received what they were owed on the mortgage backed securities because the crash in the housing market meant that homeowners were not making the mortgage payments that made up the pools of money out of which the owners of mortgage backed securities were to be paid.  Thus, when Goldman Sachs was not paid what it was supposed to be paid from the homeowners, Goldman Sachs turned to AIG and asked to be paid pursuant to the insurance policies it had purchased from AIG (that is, the credit default swaps).

AIG had never planned for such a shortfall in mortgage payments.  It had essentially sold the credit default swaps to earn easy money (the “premiums” for the sales) that it did not believe it would ever have to pay out on.  Thus, when in fact it did have to pay out on those credit default swaps, AIG was threatened with bankruptcy because its obligations to the owners of mortgage backed securities far exceeded its assets.

The U.S. could not afford to let that happen.  AIG is the world’s biggest insurer.  It’s failure would set off massive insecurity in every single aspect of life in which people and institutions depended on the availability of its insurance.  Neither could the U.S. afford to let the financial institutions fail.  That would mean a collapse of our banking system, an even greater and more profound impact on the functioning of our credit markets and other aspects of our economy — in short, a Depression on the order of The Depression.

Here’s what I don’t quite understand.  The underlying problem was that too many homeowners were unable to make their mortgage payments.  Why not readjust everyone’s mortgage payments (by, say, automatically cutting mortgage rates to the current low rates).  The owners of the mortgage backed securities would not make as much as they otherwise would have had the original rates been paid, but too many of the original rates weren’t paid to make enough of the mortgage backed securities assets with any material value.  The owners of the mortgage backed securities would make some of the money they had expected.  They would still be able to look to AIG under the credit default swaps for the difference between what they had expected to make under those securities and what they made under the readjusted, low rates, but AIG’s exposure would have been considerably lower — not the entire value of the mortage backed securities but, rather, the difference between what those securities earned under the new adjusted mortgage rates and what they originally were supposed to have been paid.  To the extent that obligation still threatened AIG’s existence, the government could make up the shortfall, but the amount of federal dollars required to do so would have been far less.

One objection, of course, is that we’d be rewarding those homeowners who took the risk of assuming mortgages they couldn’t afford.  The problem with that argument, of course, is that the owners of mortgage backed securities took the risk they wouldn’t get paid either through the securities from the pools of mortgage payments or from AIG, but we’re bailing them out.  And AIG, of course, took the risk in selling its credit default swaps that it would not be able to meet its obligations under them, but we’re bailing them out.  We’re doing so because we have to.

But we have to bail out the homeowners too.  The very existence and health of our cities depends on us doing so.  Why are the homeowners any more to be the victims of “moral hazards” than the financial institutions.

Everyone wins.  Homeowners stay in their homes at today’s mortgage rates.  The lenders don’t get what they contracted for, but they get what, given the circumstances we’re in, is a perfectly reasonable rate of return.  More importantly, the lenders don’t fail as a result of mortgage defaults and the insufficiency of foreclosure as a remedy to make up the loss resulting from the default.  The banks that own the mortgage backed securities are made whole (or almost so), and AIG is made whole (or almost s0).

Could anyone tell me what I’m missing here?  I do not claim to be an expert on these matters, but I am smart enough to follow the money and the trails of contract obligations, and I’m not quite sure where my logic fails.  I’m sure it must, but where?