Goldman case breathes life back into the blame game
The fallout from the Abacus affair could see Lloyd Blankfein humbled and US banks brought dramatically to heel
As grey clouds gathered overhead, it looked like just another day at 200 West Street in lower Manhattan. With the usual line of black limousines parked outside, bankers, traders and assistants swirled through the glass-lined front of the 43-storey tower block that is home to Goldman Sachs. It was clearly business as usual.
But, at 10.39am local time, the mood on the executive floors – floors 41-43 – changed dramatically from the usual determined spirit to one of firefighting and quick-fire defence – Goldman was under attack.
For it was at that precise moment that the US’s leading financial regulator, the Securities and Exchange Commission (SEC), filed civil charges against Goldman Sachs and one of its bankers, charging them with fraud over allegations it favoured hedge fund Paulson & Co over other investors.
For Goldman, whose chairman Lloyd Blankfein said last year that the bank is “absolutely anal” about trading conflicts, the allegations struck at its core mantra that it does not place bets against its own clients. Within 20 minutes, Goldman’s shares had lost 10pc of their value. By the end of the day, in spite of detailed denials of wrongdoing, some $12.4bn had been wiped from the bank’s market capitalisation. Billions of dollars were also wiped from the world’s stock markets as investors struggled to come to terms with the allegations being made against Wall Street’s most profitable bank.
But as share prices fell and eyebrows were raised, the implications for the future of Goldman and the wider banking community worsened.
The focus of the allegations against Goldman stem not from its executive floors, however, but from a six-man trading desk located in its old headquarters at nearby 85 Broad Street.
It was there that Fabrice Tourre – a junior bond trader then in his late 20s – carried out his work, allegedly telling investors that Paulson was buying into a package of residential mortgage-backed securities when actually it was shorting it. The investors lost more than $1bn, Paulson made $1bn, while Goldman took home a $15m fee – but lost more than $90m in equity.
Speaking exclusively to The Sunday Telegraph, several sources shine a light on life working with Tourre – and how exactly Abacus, the derivatives parcel at the centre of the SEC’s allegations, came to life.
“Look, no one is going to deny that Fabrice is a cocky guy,” admitted one source. “He’s arrogant and smart, he thought a lot of himself and he would make sure everyone knew that. But he’s not some crazy superstar playboy character. He was a short, French maths geek who was very good at his job.”
“The fact is that Fab would tell anyone that listened, including investors, that the mortgage market was going to tank,” said another source. “By 2007 most of the desk knew that, and Fab was the most bearish of everyone.”
At the time of the allegations, in 2007, Tourre’s desk was made up of staff which included analysts and boss Jonathan Egol. “By the time of the Abacus 2007 deal you had three players who were desperate to make money in a market we all knew was on the verge of imploding,” says the first source. “John Paulson’s appetite outstripped what was actually available to bet against, especially by 2007 when people started to wake up about what was going on.
“Everyone was looking for the last dollar that could be made. Fabrice would be talking to Paulson all the time. If Fabrice didn’t talk to Paulson then where was the deal going to come from?” asked the second source.
Another source said: “You have to understand the Goldman culture. The impression that everyone is a cowboy trader is just sloppy. Goldman is much more slick. Don’t get me wrong – there is greed at every level. But come on, wake up. It’s a disciplined outfit designed to make money.”
This case is about more than the exuberance and misplaced emails of a young French banker. It is about the reputation of one of the world’s largest banks, a reputation which is increasingly under pressure following the latest allegations.
Although many commentators felt the erosion of Goldman’s share price on Friday was an overreaction – fuelled in part by the whole stock market’s recent buoyancy – many others argued that it was a necessary mark-down.
Brad Hintz, Bernstein Research’s banking analyst, estimates that, under a worst case scenario, Goldman could end up paying $706.5m in penalties and return of profits were the SEC charges to be successful.
Dick Bove, Rochdale Securities’ respected banking analyst, warns that the total financial cost to Goldman could end up being as much as $2bn, the highest of any assumption to date.
But Bove goes one step further by suggesting that the ultimate price may yet be paid by Lloyd Blankfein, Goldman’s chairman and chief executive, who he predicts is likely to fall on his sword as a result of the allegations.
For brand Goldman – a name that has already undergone some serious damage in the last 18 months – the situation is clearly troubling.
Although Blankfein, who took the helm in the summer of 2006 following the departure of Hank Paulson for the US Treasury, has masterfully guided the bank through the financial crisis while continuing to deliver substantial profits, the backlash against it has been unrelenting. From continual sniping about its alleged influence over American International Group’s $182bn bail-out, to suspicion over its links to various government finance officials and resulting in the infamous “Vampire Squid” analogy in Rolling Stone magazine, Goldman’s image as Wall Street enemy number one has not helped its cause.
The impact on clients to date does not appear to have been substantial, with much of the back-biting coming from Main Street rather than Wall Street. “The SEC investigation into Goldman Sachs... will turn the American public even more strongly toward holding Wall Street accountable for the financial disaster,” argues Heather Booth, director of Americans for Financial Reform, a US pressure group.
“These are big names and big reputations at stake. Anyone who structures a product and sells to a third party and then bets against the underlying asset looks fraudulent,” said a New York-based hedge fund manager with one of the US’s largest hedge funds.
Although the charges are currently only civil ones – which is all the SEC is restricted to do – there is speculation about whether the Department of Justice may yet bring its own case.
In addition, Andrew Cuomo, New York’s Attorney General, has so far remained silent on the situation. But Cuomo’s office, which can also bring criminal complaints, is known to have been looking into mortgage fraud on Wall Street for some time, and could well have been aware of the SEC investigation before the rest of the world was.
And although the alleged crime took place in New York, Richard Blumenthal, Connecticut’s Attorney General, is now on the prowl. “There may well be a factual and legal basis to consider state investigation... and my office has begun a preliminary review,” he said, without elucidating as to which Connecticut laws may have been broken.
Of course, the implications of Goldman’s fraud charges are far more wide-reaching than for just the bank itself. Ken Lench, head of the SEC’s structured and new products unit, used the statement disclosing Goldman’s charges to point out that the regulator’s long-running investigation of banks involved in securitisation of mortgage-backed products continues.
Although Goldman was the first, it is unlikely to be the last. Instead, in choosing this specific case, the SEC is attempting to make an example of the biggest of Wall Street names.
Chizu Nakajima, director of the centre for financial regulation and crime at the Cass Business School, argues that the SEC knows exactly what it is doing.
“With regards to enforcement, people can become very complacent. By targeting the most prestigious house in Goldman, it sends a message that says ‘We’re not afraid to go after the big guns.’?”
Although Nakajima thinks it is noteable that no criminal action has yet been brought, she does believe that this case could spur other regulators into action: ‘It’s not just about having a nice set of rules, but about showing that they are going to be applied.”
From a domestic perspective, Lord Oakeshott, one of the Liberal Democrats’ Treasury spokesmen, wrote to Lord Turner, chairman of the Financial Services Authority, on Friday asking him for reassurances that Goldman had not distributed toxic assets to UK investors.
“If these allegations are true it shows the extent to which greedy bankers would go to pull the wool over the eyes of their customers and the regulator,” said Lord Oakeshott.
In addition, he asked Lord Turner to initiate a British investigation.
“It will be interesting to see if British regulators follow suit and consider further action against other banks for UK activities, which could be likely,” said Raj Chada, partner at London-based solicitors Hodge Jones & Allen. “This is one of the largest potential actions that regulators have started arising from the banking meltdown.”
In addition to wider legal implications for the industry, far more serious regulatory changes are likely to flow from the US.
As recently as Thursday evening, Tim Geithner, the US Treasury Secretary, wrote to Senator Blanche Lincoln – responsible for pushing drastic derivatives reform – and stopped short of calling for derivatives to be spun out of investment banks’ day-to-day operations.
While at the time of writing his argument was probably likely to win the day, this weekend the regulatory landscaped had changed, with what had been seen as an anti-Wall Street pipe dream now becoming a reality.
Lincoln’s reform suggestions, which would see banks being forced to spin off their derivatives businesses and meet higher capital requirements, are gaining traction with support from certain quarters of President Barack Obama’s administration.
“My legislation reins in this risky behaviour by ending the days of backroom deals, providing 100pc to the derivatives market, putting an end to ‘too big to fail’ and preventing future bail-outs,” Lincoln told the New York Times.
If reform of the US financial regulatory framework had been faltering, the charges against Tourre have lit the proverbial blue touch-paper, galvanising support for reform on both sides of the political divide against Wall Street.
Additional reporting by Harry Wilson and Philip Aldrick
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