"The essence of the alleged fraud," Stewart reminds readers, is not that Goldman did not disclose Paulson's identity, nor that there was a short seller, but "that Goldman let the short seller choose some of the underlying subprime mortgages, failed to disclose that, and instead promoted the idea that an independent third party chose those securities." He then joins the panoply of observers who have sought a metaphor to illuminate the moral essense of this kind of dealmaking, and comes up with a good one:
If I may venture an emendation: it's as if Goldman allowed "the other bettor" not to choose two horses but to assemble one horse, Frankenstein-style, picking more than half of its genes at the outset from an available pool (admittedly of a specified, dicey quality) and signing off on every gene eventually included -- all with an eye to creating a horse misbegotten enough to be almost certain to break all its limbs should the race terrain grow at all rocky (the race will be across unknown terrain) . The promoter seeks bettors on the other side, emphasizing that an expert genetic designer of horses created this specimen, and thus suggesting that it is sturdiest horse that could be created from the agreed-upon gene pool. (I've compiled various other informed perspectives on the ethics of the deal here.)
With the Kentucky Derby in mind, let's consider a horse-racing analogy. There are just two horses and two bettors. The promoter offers you the opportunity to bet on one horse. Someone else is betting on the other. He doesn't tell you that the other bettor chose the two horses in the race, and picked one horse with no chance of winning. Instead, he says the horses were picked by an independent racing federation. You bet and lose. Would you feel that was fair?
Somewhat complicating the metaphor, as well as the case, is the fact that the portfolio selection manager ACA, which negotiated the portfolio's contents with Paulson and had final say over its contents, was also by far the largest long investor and the biggest loser (with the exception of ABN Amro, which bet not on the portfolio itself but on ACA's continued solvency, and had to cover ACA's losses when ACA went bankrupt). Moreover, the former Paulson employee who put the deal together has apparently testified that he told ACA that Paulson intended to short the portfolio. In addition to Goldman itself, the only other loser -- and perhaps the only one ignorant of Paulson's role -- was IKB Deutsche Industriebank. Goldman, however, tried unsuccessfully to sell its own long stake, and in its marketing to investors who didn't bite (and presumably to IKB) it stressed ACA's role s independent portfolio selection agent. The SEC complaint cites several internal Goldman memos emphasizing this point, e.g.:
One thing that we need to make sure ACA understands is that we want their name on this transaction. This is a transaction for which they are acting as portfolio selection agent, this will be important that we can use ACA's branding to help distribute the bonds.Goldman's proud display of the pedigree of this particular horse, in other words, was really a moon for the misbegotten.
We expect that the role of ACA as Portfolio Selection Agent will broaden the investor base for this and future ABACUS offerings (p. 8).