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paul mcmorrow

Banks dodge accountability for financial collapse

Ruining the economy means never having to say you’re sorry. And it means never having to take ownership of, or even acknowledge, the desolation that has washed over the country over the last five years.

Most of the instigators of the 2008 financial collapse (the ones that survived the crash intact) have long since moved on. They were greatly aided by a government policy that extracted cash, but not admissions of guilt, as the price of walking away from the collapse. As a recent filing in a Manhattan courtroom shows, that policy continues to leave victims of the financial meltdown in the lurch, years after the crisis itself.

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The prominent hedge fund manager John Paulson approached Goldman Sachs in late 2006, when the subprime mortgage market was sputtering toward its inevitable end. Banks were acquiring, and reselling, flawed mortgages at a furious pace. Paulson told Goldman he wanted to bet against some of the worst mortgages the banks were pushing onto the market. The result was a mortgage instrument named Abacus 2007-AC1.

Goldman’s Abacus deal was like a rancid, $2 billion subprime sausage. The bank took risky slices of 90 subprime mortgage bonds, stuffed them together, and sold the new mortgage instrument to investors. Normally, investors in deals like Goldman’s Abacus made money when their mortgages performed. Paulson laid a relatively modest bit of money on the other end of the deal, betting that the mortgages would fail; when they did, he’d make a killing.

Deals like Goldman’s Abacus were the worst stuff the financial crisis produced, since they concentrated the riskiest, lowest-rated bits of dozens of disparate mortgage bonds into a single instrument. That’s what Paulson’s fund was looking for: a loser of a deal to bet against. Paulson’s fund selected shaky mortgages to stuff into Abacus, and then had Goldman sell the instrument to other clients.

The Abacus deal blew up months after it closed, netting Paulson’s firm a quick $1 billion. A Senate subcommittee investigating the financial crisis would later label Paulson’s role in crafting Abacus a massive conflict of interest; an executive at a rival investment bank compared it to a gambler betting against a football team, after asking the team’s coach to bench his quarterback. The Securities and Exchange Commission sued Goldman in 2010 for allowing Paulson’s fund to craft the deal for itself, and extracted a $550 million settlement.

Goldman never admitted any wrongdoing connected to Abacus. That’s normal. Federal regulators’ most vigorous response to the 2008 financial collapse was to buttonhole financial firms into paying a civil fine, without ever making the firms admit that the fines represented punishment for grave misdeeds. Companies paid to make cases go away and never had to admit guilt. This arrangement enabled the SEC to issue press releases trumpeting multi-million-dollar fines against unpopular banks and mortgage companies, while shielding the companies from far greater liabilities that would follow the firms’ admission of securities fraud. So while Goldman conceded it made mistakes in not describing Paulson’s true Abacus role, the bank didn’t have to cop to any wrongdoing. For the ridiculously profitable bank, it’s as if the whole affair never happened.

Although Goldman didn’t get hit with a foul over Abacus, it certainly caused harm. Investors lost billions. A financial insurer called ACA Financial, which backed the safest half of Abacus and lost millions in the deal, sued Goldman over Abacus two years ago. ACA claims Goldman lied, telling the insurer Paulson was betting with the mortgage instrument, not against it. The insurer has been chasing Goldman for $120 million, and for two years, Goldman has been hiding behind the fine print in its SEC settlement.

The government’s Abacus settlement said that while the SEC was happy to take the bank’s money, it wasn’t making it admit to doing anything wrong. That’s been enough to let Goldman dodge wider accountability from the customers, like ACA, that it put on the wrong side of a deal built to fail. Out of frustration, ACA’s lawyers moved last week to draw Paulson’s hedge fund into their suit against Goldman. But that effort is really just a leverage play to try to break Goldman — a firm that has danced away from Abacus thus far, because its federal regulator let it dodge accountability and contrition.

Paul M. McMorrow is an associate editor at CommonWealth Magazine. His column appears regularly in the Globe.
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