Goldman and Paulson: Booty Call

The name Goldman gave to its now-famous synthetic CDO deal - Abacus 2007-AC1 - sounds like a cute, cuddly robot from a Pixar movie. Turns out, though, it was more like The Terminator.

The way Goldman put the deal together was overly cute, too. Whether or not the SEC complaint sticks, what the firm did here feels ethically wrong, with a capital WR.

Goldman’s April 18 press release previews its upcoming defenses. First and foremost, they remind us, this CDO wasn't sold to mindless innocents. They say that IKB, the German bank that lost big bucks on the deal, was "then believed to be one of the most highly-sophisticated CDO investors in the world." (Fun fact: Goldman has added the "then believed to be" language since its April 16 press release.)

Sure, you can argue, as a lawyer friend did in an e-mail today, that big institutional investors have "the right to be stupid." These guys employ their own number geeks and they ought to do their homework carefully and thoroughly, which happens to be the same thing I lamely suggested to my son last night. (I wonder if IKB vetted the Abacus deal while watching the NBA playoffs, IM'ing 57 friends at once and plowing through a giant bag of Pirate's Booty.)

But the sophisticated investor defense seems disingenuous in this case. The SEC complaint says that Goldman involved an outside analyst, ACA Management, precisely because it knew IKB wouldn't be comfortable without some nerdy folks around "to analyze and select the reference portfolio." Goldman's marketing document boasted that “no rated notes in any of ACA’s CDOs have ever been downgraded," and also that ACA and the investors had an "alignment of economic interest." (Which was true, since they were all taking the dark side of John Paulson's bet.) Strangely, nowhere in the 28 pages touting ACA's wonderfulness did Goldman say, “oh, and BTW, this CDO is packed with crud that Paulson pushed to include because he thinks it's ripe for shorting."

The invisibility cloak that Goldman stole from Harry Potter and threw over Mr. Paulson, and the heap of pirate’s booty Paulson walked away with, are almost beside the point. The real problem is that Goldman pretended it was designing a deal for folks who wished to go long the underlying collateral, when in truth it was doing the opposite.

I'm giving Bond Girl the last word on the SEC's complaint:

"Why the hell would anyone want to be a client of Goldman Sachs after reading this?"