In the lead-up to the 2008 sub-prime mortgage crisis, banks like Goldman Sachs bet against their clients with collateralized debt obligations and were rewarded handsomely. A new Securities and Exchange Commission (SEC) proposal would make this illegal.
In 2007, as the sub-prime mortage crisis was looming, Goldman Sachs and hedge funder manager John Paulson teamed up to bundle 3,000,000 sub-prime mortgage loans together into a collateralized debt obligation called ABACUS 2007-AC1, and then shorted mortgages to unwitting investors. John Paulson made $1 billion (Goldman took a $15 million cut) and investors lost $1 billion.
According to The New York Times, 25 such investment vehicles were created by Goldman Sachs in order to shield the firm from massive losses in mortgages. However, they turned out to be rather great investments instead of losses. (Deutsche Bank and Morgan Stanley also created these CDOs).
At issue in the SEC complaint was whether the firms who selected the mortgages intentionally chose those most likely to fail and shine the shit for their investors. Investors were okay with John Paulson being involved as long as an independent manager (in this case, ACA Management LLC) chose the mortgage bonds; which, of course, did not happen. Paulson himself selected the mortgages along with ACA.
Goldman, for their part, never told ACA or the investors that Paulson was looking to short the securities. On the contrary, ACA believed Paulson was actually interested in owning the risky securities (at least that is the official story).
Goldman Sachs eventually settled for $550 million.
Under a new SEC proposal, this practice—which was at issue in the SEC’s civil case—would be banned, according to Reuters. Specifically, it would ban third parties from assembling asset-backed pools, or CDOs, with banks like Goldman Sachs, and would therefore prevent these parties from profiting off of investor losses.
It would, with the force of the Dodd-Frank Wall Street oversight law, impose a one-year ban restricting such activity.
SEC Commissioner Luis Aguilar said of the proposal, “[It] is an important step forward to prohibit this practice and to protect investors from being persuaded to invest in products designed to fail.
At least there is something sensible coming out of Wall Street aside from the Occupy Wall Street protests.