The U.S. Justice Department’s lawsuit against Goldman Sachs Group Inc. (NYSE: GS
) attacks the bank’s selling of a CDO called Abacus, in which Goldman sold to investors who were going long on the housing market while keeping the short position for itself. Whether or not that’s illegal is the issue, but the deal has been roundly criticized for being unethical.
As part of the investigation, another Goldman CDO, called Hudson Mezzanine, is now being looked into, according to the Financial Times. There is no certainty yet that the investigation will lead to more legal action against Goldman, but such action is surely not out of the question.
Goldman created and sold Hudson Mezzanine, a fund that contained residential mortgage-backed securities, in 2006, a year before the Abacus fund was created. Documents submitted to the Justice Department show that the bank shorted the fund and then collected the insurance as investors lost their money. The issue with the collapse of Hudson is whether or not Goldman disclosed the bank’s short position fully to investors.
According to the Financial Times, a Goldman marketing document stated that the bank’s interests were “aligned” with the fund’s investors “because it would buy equity in the CDO.” The bank also noted in disclaimers that it would by insurance, but did not indicate how much.
Goldman’s CEO told a Senate committee that the bank’s clients knew that Goldman was a market maker in these kinds of investments and that “they know our activities, and they understand what market-making is.”
The U.S. Senate’s inquiry into Goldman’s practices also turned up an e-mail in which a Goldman employee wrote that a potential investor in Hudson Mezzanine was “too smart to buy this kind of junk.”
Goldman’s clients may in fact know what market makers do, and they may have forgotten that in their eagerness to get in on the gold rush in mortgage-backed securities. That doesn’t really change the fact that the bank understated its short position (it was the only investor on the short side) and made a nice profit by doing so. At the least that is ethically questionable.
