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In Goldman Sachs case, an unsatisfying verdict

From an editorial Friday by Bloomberg View:

Fabrice Tourre, aka “Fabulous Fab,” was a mere cog in the Wall Street machine that, in 2008, crippled the global financial system and sent the world economy into a deep slump. The former Goldman Sachs vice president’s trial, though, goes to the heart of the lessons we must learn from that experience.

A jury found Tourre liable for misleading investors in a 2007 mortgage deal. Known as Abacus 2007-AC1, the deal allowed investors to make side bets on the performance of bonds backed by home loans made to shaky borrowers. At issue was whether Tourre knowingly concealed the role of hedge fund Paulson & Co. Inc., which was betting that the borrowers would default. By disguising Paulson’s short bet, Goldman – through Tourre as its salesman – was able to convince others, including Germany’s IKB Deutsche Industriebank, to take the opposite side of Paulson’s bet.

In parsing the verdict, it is important to recognize that there is nothing wrong with selling investments you think are bad, which is what happens whenever you sell a stock you think will decline. Similarly, there is nothing wrong with buying securities you think will rise in value, or with helping sellers find buyers. That is part of what drives financial markets – and part of how Goldman Sachs and all Wall Street securities firms legally and rightfully make money. The investors who made bullish bets on Abacus must have known that someone was betting against them.

Now a jury has decided that Tourre’s actions amount to civil securities fraud. As a result, Tourre could end up paying hundreds of thousands of dollars and be barred from the securities business.

Our first reaction to the verdict is a sense of missed opportunities. As the SEC prosecutor put it, Tourre was living in a “Goldman Sachs land of make believe” in which deceiving investors wasn’t fraudulent. It is unfortunate that the SEC wasn’t able to use U.S. securities law to mount a case against the more senior executives who allowed that behavior, rather than focusing on a junior-level fall guy.

The second takeaway is that the trial of Fabrice Tourre should have been a curiosity in the world of Wall Street, not a watershed event in the prosecution of a global financial crisis. If regulators had been able to see the risks that deals like Abacus posed to the whole financial system, if banks’ shareholders had provided enough capital to absorb the losses, investors like Paulson and IKB could have made their bets without affecting the lives and livelihoods of millions of people who weren’t involved – and who still have no idea what the term “ABS CDO” means.

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