Goldman Sachs and the Integrity Crisis

The SEC charging Goldman for fraud demonstrates the ethics gap at the heart of the economic meltdown.

The fact that the U.S. Securities and Exchange Commission is charging Goldman Sachs with fraud over its marketing of worthless subprime mortgage securities reveals that the world has not only gone through a financial crisis, it is also going through an integrity crisis.

The SEC case centres on how GS put together and sold a complex debt package called ABACUS, even though it knew that the hedge fund that had helped put the package together was betting against it by buying credit protection. That is because the hedge fund realized how rotten the toxic assets in it were. The hedge fund investor, Paulson & Co, a well-known short seller, made an estimated $1 billion off of this transaction while other investors in the U.S. and abroad suffered huge losses. According to the SEC, Goldman did not transmit "vital information" about ABACUS, including the fact that the renowned short seller had chosen the securities in the portfolio.

Even before the lawsuit was announced, GS Chief Executive Lloyd Blankfein admitted to a U.S. Congressional Commission that the bank packaged and sold complex debt while also betting against it because their clients had “an appetite” for it and that GS was not a “fiduciary.” Whether or not the bank’s clients had an appetite for ethics and integrity did not seem to be relevant.

Fabrice Tourre, the GS Vice-President who was responsible for creating the garbage product known as ABACUS, was also charged with fraud. Amid other damaging evidence, the SEC has an email from Tourre to a friend saying: "The whole building is about to collapse anytime now ... Only potential survivor, the fabulous Fab ... standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstrosities!!!"

GS has said it will strongly defend itself, claiming that the charges are completely unfounded in law and fact. The company also claims it lost money on the deal and has provided extensive disclosure.

Maybe there are other investors who like to invest in failing assets. Maybe GS will be successful in law and fact, or maybe it will settle for a few million dollars with the SEC. Whatever the outcome, the damage to the reputation of not only GS, but the entire global financial system will be immense.

Other well-known financial experts such as Janet Tavakoli, president of Tavakoli Structured Finance, Inc., have indicated that the practice of putting together complex toxic packages like ABACUS may be more common than is realized. Some of them look like nothing more than giant ponzi schemes. It is just such practices that led to the downfall of Lehman Brothers and Bear Stearns, precipitating the worst financial crisis since the Great Depression.

Of course, this lack of ethics and integrity extends to the mortgage brokers who facilitated these subprime mortgages and the individual house purchasers who were so easily seduced into buying property they could not afford and sometimes participated in the dubious mortgage practices themselves.

Beyond the possibility of an onslaught of private and government actions against similar practices at GS and other financial titans, there is real danger in having a global financial system that operates without consideration for ethics and integrity.

The Obama administration is attempting sweeping financial sector reform and the backlash against Wall Street may help get those reforms passed in Congress, despite promises from Republicans to kill it. But reforms alone will not insulate Wall Street or, for that matter, the entire global financial system from similar crises in the future.

As I have often stated to both the pubic and private sector, the greatest safeguards we have against such crises lies in the core ethics and integrity of the people who work in the system.