Which Bank Will the SEC Hit Next?

Last Friday's announcement by the SEC that it is bringing fraud charges against Goldman Sachs and one of its traders rocked Wall Street. As the agency continues to examine comparable transactions to the ABACUS 2007-AC1 CDO at the heart of its complaint against Goldman, banks are no doubt legitimately concerned whether they could be next in the SEC's crosshairs. In order to establish a short list of likely candidates, let's take a look at some of the largest underwriters of similar CDOs in 2007:

Lead Underwriter

2007 Volume, CDOs Comparable to Goldman's ABACUS 2007-AC1 (US$millions)

BofA Merrill Lynch (part of Bank of America (NYSE: BAC  ) )




Citigroup (NYSE: C  )


Royal Bank of Scotland


Barclays Capital (part of Barclays PLC)


Morgan Stanley (NYSE: MS  )


Goldman Sachs (NYSE: GS  )


JPMorgan Chase (NYSE: JPM  )


Source: Credit Suisse.

2007: A very good year for fraud
It's logical to look at 2007 -- the year in which the real estate bubble drew on its last reserves of momentum before beginning to come apart. Indeed, the further we advance into "Ponzi finance" territory (to use Hyman Minsky's expression), the greater the incentives to continue "dancing" by resorting to any means -- including fraud. These raised, skewed incentives are present at all levels of the system -- whether it be speculators who need to refinance their home mortgages or credit rating agency executives and derivatives salesmen who need to keep generating revenue in order to guarantee the annual compensation they have become accustomed to.

Goldman's CDO was putrid
According to a report by Wachovia Capital Markets cited by the Wall Street Journal, Goldman's ABACUS 2007-AC1 CDO was one of the worst performers out of hundreds of comparable transactions. Within a year, 100% of the bonds underlying the CDO had been downgraded -- only two other transactions, structured by Deutsche Bank and UBS, achieved that dubious distinction. (Mind you, the performance of the CDO or the size of losses incurred by investors aren't by themselves grounds for a fraud charge.)

It's not just Uncle Sam the banks need to worry about
Finally, the government isn't the only party Goldman (and other banks) should be concerned about. I expect the SEC's action will embolden CDO investors to bring lawsuits of their own. AIG (NYSE: AIG  ) is already examining whether or not to attempt to recover losses on mortgage-related securities from Goldman. Dutch bank Rabobank is waging a suit against Merrill Lynch for misrepresenting the risks of a CDO named Norma. Expect more -- perhaps many more -- to follow.

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Fool contributor Alex Dumortier has no beneficial interest in any of the stocks mentioned in this article. Try any of our Foolish newsletters today, free for 30 days. Motley Fool has a disclosure policy.

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  • Report this Comment On April 22, 2010, at 10:11 AM, augustoferreira wrote:

    I would really like to know when the real responsible for the failure of these CDOs will be addressed. The real responsible are the people that took loans larger than they could PAY. If all loans had been payed the CDOs would not fail. So the citizens that take good care of their finances will now have to pay higher taxes to pay for the loans that irresponsible real estate speculators took. Nobody has yet blamed the irresponsible consumer!!!! Another problem is that home loans should not only be guaranteed by the home, it should also have personal guarantee from the loan taker. Imagine if in my Margin account the only guarantee is the stock I buy, if the stock price goes down I just surrender the stock to the bank and no loss to me!!!! Thats absurd, you take the loan you pay the loan, no matter what the home price does, and be more careful when buying a house.

    WHY ISNT ANYBODY SAYING THAT!!!! To blame a Bank is so easy, the the bad loan payers are to blame!!!!

  • Report this Comment On April 22, 2010, at 11:32 AM, goballstate wrote:

    Well, the consumer is certainly at fault, but it's not so simple. Even if everyone paid all those pesky loans, we'd still have to deal with a broken bubble. Blaming the consumer doesn't fix housing revaluations and a real loss of money. And if a bank says no money down, low payments for now, and we won't worry about whether you didn't pay your credit card bill last year a few times, exactly how many individuals do you expect to say no? Dollar signs in everyone's eyes. Consumers were lied to in an attempt to increase participation. Simply because the more money the banks lend, the more they can take part in the high risk/reward sketchy investment vehicles. The greed lived in two places, the consumer, and the lender (they both lied). Since neither party cared that it wasn't maintainable, banks are failing, and the individuals who caused this are going to stuck with the tax bill. The consumer will pay in the short term (housing/income/security losses) and the long term (tax increases, government service reductions, debt repayment). So I'm not sure exactly how blame helps here. This housing bubble will cost me, who wasn't involved, for decades. Whether or not someone blames the housing speculators just isn't relevant here.

  • Report this Comment On April 22, 2010, at 1:44 PM, TMFAleph1 wrote:


    Thanks for your comment and I quite agree with the spirit of your remarks. However, the object of the article wasn't to assign blame with respect to the credit/ housing bubble, but simply to assess which banks -- beyond Goldman Sachs -- might have the greatest litigation risk with respect to the complex, mortgage-related securities.

    I think the following passage in my article makes clear that I don't consider banks to be the sole culprits in the fiasco that was this bubble:

    "These raised, skewed incentives are present at all levels of the system -- whether it be speculators who need to refinance their home mortgages or credit rating agency executives and derivatives salesmen who need to keep generating revenue in order to guarantee the annual compensation they have become accustomed to."


    Alex Dumortier

  • Report this Comment On April 22, 2010, at 10:49 PM, jackcrow wrote:

    Any bank that Andy Cuomo can put his political/legal cross hairs on should be drenched in cold sweat.

    Two kinds of greed going head to head that has got to get nasty.

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