April 27, 2010 - Goldman Sachs made a huge mistake: it made too much money when too many others lost large amounts. While the economic circumstances were somewhat different, this is very reminiscent of when Drexel Burnham Lambert made the error of profiting from deals no one else could do. And then had the audacity to pay the genius behind the deals, Mike Milken, a great deal of money. Those howls of moral righteousness that brought down Drexel and Milken are echoing in the halls of Goldman Sachs.

So the pool was filled with mud. But remember: someone had to buy the pool in order for this trade to work. It wasn't sold to retail clients or little old ladies on fixed incomes from Social Security. This was sold to institutional buyers. Didn't they carefully read the documentation on these loans? Didn't the buyers make an educated guess as to whether these loans were proper for investing? Didn't the buyers drill down into the pool to look at each loan, to determine how creditworthy each one was, as the "flip book" from Goldman advised? Apparently no is the answer to each question. These professional investors didn't adequately do due diligence on the pool. Unless Goldman hid information and didn't fully disclose everything, these sophisticated, institutional buyers, managed by a professional investor, have no grounds to cry wolf. Or expect sympathy. They were simply on the other side of this trade and felt the mortgage market would continue to prosper.

There are always two sides to every trade: the seller and the buyer. Goldman was the seller of this mortgage pool. This pool was somewhat unique because it was made up of mortgages selected by a third party, Paulson & Co. which in turn used another party ACA, to identify the loans. Paulson created a derivative security to "short" this pool of loans, a derivative that paid off at almost $1 billion. The company made the right bet. The mortgages defaulted within about 6 months. The insurance companies that wrote the counter side to the derivative trade lost a bundle. They, too, had the same access to the pool information that the buyers of the pool did. If they did their homework, by taking the positive or "up" side of this trade, they bet the mortgages would perform. But they didn't.

Here's the nexus of this case: did Goldman Sachs hide any information from the buyers? If it didn't fully disclose all details of the mortgages, then it's guilty, as described by law. If it did disclose the details, then the buyers and insurance companies didn't invest in a professional manner and should be liable for their incompetence.

What really happened here is that Goldman Sachs (and Paulson & Co.) made a ton of money on this trade (though Goldman claims it lost money on the mortgage market in general). Nevertheless, Goldman hauled in fees and trading profits while the rest of the world was still hurting. Bonuses were huge last year.

Many people were out of work. They screamed and pointed and the politicians heard them and looked at Wall Street, where the fingers were pointed, many of them the middle one. Clearly, too much money was being made. Some individuals were making way too much. A scapegoat needed to be found for the current disparity. The spotlight finally landed on Goldman and has held there.

Americans love a success story, but they hate a "too succesful" story. It's OK to make money, just don't make too much, particularly if others are losing money or jobs. When a company gets too successful, they're often taken down a notch or two, even wiped out (Drexel put Giuliani on the map after he did his work). Goldman's moving into its new, high rise headquarters couldn't have been timed worse.

So Goldman is in a fix. Fraud has been charged. Now the government needs to prove it. A trial will bring out the facts of the case, and we can all judge later, when we know them. Until then, the only thing Goldman is guilty of is being very smart and making a lot of money while many others lost. (The same is true of Paulson but it isn't charged with anything.)

That's what investing is all about. If investors don't do their homework, don't work hard enough to determine exactly what it is they're buying, that's no one's fault but their own. However, if material facts are omitted from the investors' information, that's fraud, and the guilty should receive all the punishment the law allows.

- Ted Allrich