Why Goldman Got the S.E.C. to Back Off

The weaknesses in the S.E.C.'s case against Goldman were always obvious. To win, the government needed to prove that Goldman lied, and that the lie mattered. The truth is that the bigger deceptions were not lies, but distractions. All the marketing materials and legal documents for Abacus 2007-AC1 were distractions from the most important part of the deal, which was accessible from data service providers but never disclosed by Goldman. Nowhere did Goldman divulge the current performance data on the assets insured by the CDO, 90 deeply subordinated tranches of subprime mortgage bonds.

At the end of the day, an investor who bought Abacus 2007-AC1 was buying a static portfolio of risks. It didn't matter who chose the underlying investments in the CDO, or whether John Paulson was destined to receive a windfall. If you were a sophisticated investor who had done his due diligence, you didn't need to be told that the deal was designed to fail. You would have figured it out for yourself. If you actually reviewed the performance of mortgage backed securities held by the CDO and understood how cash flow waterfalls and delinquency triggers worked, then you could see that subordinate tranches being insured for the benefit of Goldman were already worthless when the CDO closed. You could also figure out that the rating agencies had deliberately delayed announcing downgrades of the RMBS within the CDO, in order to keep the markets and the deal flow moving.

But the dirty little secret on Wall Street was that all too often, due diligence was a sham. People went through the motions without a thorough understanding of what they were doing, like school kids who write reports by plagiarizing the encyclopedia. Investors saw triple-A ratings and stopped thinking. Goldman didn't need to lie in order to sell "shitty deals." It only needed to find a greater fool with an impressive resume at a multibillion-dollar institution who didn't ask too many questions. And it was able to keep the scam going because all CDOs remain shrouded in secrecy to this day. The only people who can buy access to CDO performance data on ABSNet are actual investors, who are subject to nondisclosure agreements.

The risk to Goldman is that more of its dirty laundry would be exposed. As we learned from David Viniar's testimony before the Financial Crisis Inquiry Commission, the company remains in lockdown mode. And once again, the S.E.C. shows little appetite for digging deeper, especially since its new COO of the Enforcement Division is a 30-year-old kid from Goldman.