WASHINGTONThe world has been yearning to put a name and a face to the financial quackery. We need a flesh-and-blood crook. The bank CEOsgray, old, predictablewere not enough. Bernie Madoff was an abhorrent byproduct, not a core player. Until Fabulous Fab made the perfect fit.
Or so thinks the U.S. Securities and Exchange Commission, which has charged Fabrice Tourre and his firm, Goldman Sachs, with fraud in connection with a 2007 subprime mortgage security scheme.
Tourre was 29 at the time. He was a mathematical whiz with a masters degree in operations research and a Goldman vice president who structured financial products eerily called ABACUS that he marketed with panache. Calling himself Fabulous Fab in e-mails to a friend, he predicted that the whole building is about to collapse anytime now. He boasted he would be the only potential survivor. Could the SEC find a more perfect villain?
And yet . . . the case against Fabulous Fab and Goldman is balderdash. Few insiders think it will stand in the courts. If this is the best way in which the SEC can strengthen President Obamas hand as he seeks to overhaul financial regulation and in which British Prime Minister Gordon Brown, whose government will also pursue the case, can try to win the upcoming election, lets pack and move to Pandora.
The SEC alleges Goldman sold more than $1 billion worth of Collateralized Debt Obligations (CDOs) tied to subprime mortgageswhich had been put together at the behest of hedge fund manager John Paulsonwithout disclosing to investors Paulsons involvement and his bet against the product.
In 2007, Paulson asked Goldman to put together another of its ABACUS products, whereby a type of bond linked to subprime mortgages was created. Those were synthetic bondsi.e., the issuer did not own the underlying mortgage securities but bought and sold insurance against them. Two investors bought the note in question: ACA, an experienced company brought in as a manager to select the securities that served as reference to the CDO, and IKB, a German bank familiar with these products.
The operation involved three things on Goldmans part: selling the bonds to the investors, selling credit insurance to Paulsonthe way in which the hedge fund manager could bet against the productand buying credit insurance from ACA to offset the transaction with Paulson. When the mortgages failed, the investors lost, and Paulson gained more than $1 billion. Goldman lost $75 million because it had sold to Paulson slightly more protection than it had bought from the investors.
What Paulson didgenerate a product so he could bet against a blatant bubblewas an island of common sense amid a sea of insanity. What Goldman didbrokering a deal between informed sellers and buyersis what a broker/dealer does. What Tourre didmarket the productwas his job description. What ACA didselect the subprime mortgages with advice from others and acquire the product believing the bubble was sustainableis what people such as Paulson, who had been preaching in the wilderness against it, and Tourre realized was crazy. What IKB did was continue to bet on mortgages taken by people who had scant creditworthiness.
Who would you rather have working in Wall Streetthe geniuses who fed the bubble or the prescient minds who acted against it?
The investors the SEC thinks were duped were among the most experienced and fully aware of the nature of the mortgages behind the product. Numerous documents given to them by Tourre, including a 65-page flipbook that mentioned that Goldman might bet against the CDOs, attest to this.
Goldman did not reveal Paulsons role. Not revealing to one client what the others do is . . . pretty commendable. Doing the opposite, which is what the SEC filing suggests Goldman should have done, is unethical. Neither ACA nor IKB would have acted differently had they known that Paulson, considered a killjoy contrarian, was betting against the product. The important thing is that they knew someone was betting against it just as they were betting for it. That is how this type of deal works. Goldman might have done other things wrong in the bubble years. But not this one.
And, yes one final thing: How many of us would come out impeccably humble, prudent and serene if our conversations with a friend were printed for all the world to see?
Alvaro Vargas Llosa
Alvaro Vargas Llosa is Senior Fellow of The Center on Global Prosperity at The Independent Institute. He is a native of Peru and received his B.S.C. in international history from the London School of Economics. His weekly column is syndicated worldwide by the Washington Post Writers Group, and his Independent Institute books include Lessons From the Poor: Triumph of the Entrepreneurial Spirit, The Che Guevara Myth and the Future of Liberty, and Liberty for Latin America.
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