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America must face up to the dangers of derivatives

George Soros | Financial Times | April 22, 2010

The US Security and Exchange Commission’s civil suit against Goldman Sachs will be vigorously contested by the defendant. It is interesting to speculate which side will win; but we will not know the result for months. Irrespective of the eventual outcome, however, the case has far-reaching implications for the financial reform legislation Congress is considering.

Whether or not Goldman is guilty, the transaction in question clearly had no social benefit. It involved a complex synthetic security derived from existing mortgage-backed securities by cloning them into imaginary units that mimicked the originals. This synthetic collateralised debt obligation did not finance the ownership of any additional homes or allocate capital more efficiently; it merely swelled the volume of mortgage-backed securities that lost value when the housing bubble burst. The primary purpose of the transaction was to generate fees and commissions.

This is a clear demonstration of how derivatives and synthetic securities have been used to create imaginary value out of thin air. More triple A CDOs were created than there were underlying triple A assets. This was done on a large scale in spite of the fact that all of the parties involved were sophisticated investors. The process went on for years and culminated in a crash that caused wealth destruction amounting to trillions of dollars. It cannot be allowed to continue. The use of derivatives and other synthetic instruments must be regulated even if all the parties are sophisticated investors. Ordinary securities must be registered with the Securities and Exchange Commission before they can be traded. Synthetic securities ought to be similarly registered, although the task could be assigned to a different authority, such as the Commodity Futures Trading Commission.

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Goldman Sachs fraud charges ‘just the tip of the iceberg’: prof

Raw Story- By Andrew McLemore
Saturday, April 17th, 2010 — 10:06 pm

Charges of fraud brought against banking titan Goldman Sachs by the Securities and Exchange Commission rocked financial markets Friday, but experts say the allegations are merely the first of many to come, Reuters reported.After the SEC went public with the allegations, the Dow Jones dropped 125 points and Goldman Sachs stocks dropped 13 percent — the largest one-day drop in company history.

“This is just the tip of the iceberg,” said James Hackney, a professor at Northeastern University School of Law. “There are a lot of folks out there in different deals who played similar roles, and once it starts building steam, plaintiffs’ lawyers will figure out this is where the money is and there should be a lot of action.”

Reuters Global editor at large Chrystia Freeland said the significance of the charges is “huge.”

Goldman Sachs’ members like to think of themselves as “the smartest, the richest,” but Freeland said they also like to think of themselves as the “most virtuous.”

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Goldman Sachs FRAUD Charges Filed By SEC Over Subprime Mortgage Securities

Huffington Post |  Ryan McCarthy First Posted: 04-16-10 10:51 AM   |   Updated: 04-16-10 11:49 AM

The Securities and Exchange Commission has charged Goldman Sachs with civil fraud over its controversial collateralized debt obligations tied to the subprime mortgage market.

As the New York Times notes in its in-depth story on the subject, the charges are “the first time that regulators have taken action against a Wall Street deal that helped investors capitalize on the collapse of the housing market.” A London-based vice president at Goldman, Fabrice Tourre, was also charged in the complaint.

In essence, the SEC claims Goldman Sachs and one of its top officers misled investors by failing to disclose that hedge fund manager John Pauson, who made billions betting against the housing market, selected the assets that went into a complex security called “Abacaus”.

Paulson, the SEC alleges, “paid Goldman Sachs to structure a transaction in which Paulson & Co. could take short positions against mortgage securities chosen by Paulson & Co. based on a belief that the securities would experience credit events.”

But Goldman Sachs, which was allegedly paid $15 million by Paulson, did not disclose these facts to investors who bought Abacus, according to the complaint.

Here’s the SEC’s full release — scroll down for the complaint:

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