The implications of Goldman's defence
Goldman Sach's response to the SEC's fraud charge shows that probably the best way to see the SEC's action is as an attack on one important aspect of the leading investment bank's business model - which, of course, probably makes the charge more significant than the narrower allegation that it committed a single billion-dollar crime.
The world's number one investment bank concedes that it constructed Abacus 2007-ACI after the mega hedge fund Paulson "indicated its interest in positioning itself for a decline in housing prices" (see yesterday's note, "Goldman may owe British taxpayers $841m"). And it says that Paulson provided "input regarding the composition of the underlying securities" and stood to benefit "from a decline in the value of the underlying securities".
Also, Goldman doesn't attempt to deny that those who invested in Abacus may not have know that Paulson would be betting against them, or taking a short position that would impoverish them to Paulson's considerable benefit.
But Goldman has a defence that deserves to be taken seriously - which is that the firm stuck to the conventions for how such deals should be managed.
Goldman says that those who invested in Abacus, notably IKB and ACA, were experienced professionals who were "among the most sophisticated mortgage investors in the world".
And it says that the normal practice of a market maker - and part of Goldman's role in this deal was as market maker - is not to "disclose the identities of a buyer to a seller and vice versa".
Goldman is also completely adamant that it did not ever represent to ACA that Paulson would be a long investor in Abacus - although ACA, according to the SEC, believed that was the case.
A bit of explanation is required here: ACA Capital Management was a leading manager of CDOs; it gave final approval for the 90 mortgage-backed bonds on which Abacus was constructed, having received input from Paulson and IKB; and it was the largest investor, in the sense that it provided insurance against default for Abacus, with a $951m exposure (which through a complicated chain ended up generating huge $841m losses for Royal Bank of Scotland).
So, more specificially, Goldman says that ACA and IKB, a German bank, were given all the necessary information on the securities underlying Abacus to have allowed them to assess the risk of investing in Abacus; and that they knew that a deal of this sort was always going to have someone on the "short" side, profiting from the claim on the credit insurance if the deal went bad.
Here's what Goldman thinks is the clincher, in that it's the first line in its defence: Goldman itself lost money on Abacus; although it took a fee of $15m on the transaction, it too was an investor in Abacus - alongside IKB and ACA - and ended up losing more than $90m.
So Goldman can't understand why anyone could think that it constructed Abacus as a surefire lossmaker, to the detriment of ACA and IKB, because if that had been its intention it - like Paulson - would surely have bet on Abacus's collapse, rather than putting its own money into the deal.
All I would say about this apparently simple and compelling point is that CDO structures are highly complicated. And it's simply not possible to know, on the basis of the available financial material, what degree of poor performance by Abacus would have generated net losses for Goldman.
It is conceivable that Goldman invested on the basis that some degree of poor performance by Abacus was highly likely - just not the total meltdown that transpired.
Doubtless all this will become clearer as the SEC's case against Goldman is pursued.
But what may be of some concern to Goldman's owners, its shareholders, is that in denying that Abacus was a rogue deal, Goldman has in a way raised the stakes for the firm.
If Goldman were to lose the case, there could be collateral and expensive damage to the way that it constructs and sells other deals, and thus to the inner workings of one of the most formidable moneymaking machines the world has ever seen.
UPDATE 17:35 Following my blog of yesterday ('Goldman may owe British taxpayers $841m'), Royal Bank of Scotland says that its board has not yet made a decision on whether to sue Goldman.
Royal Bank will let the SEC's case against Goldman run for a bit and will then make a decision. The board will have discussions with lawyers in the coming weeks and "think carefully" about suing Goldman, I am told.
As chance would have it, the previous Royal Bank board, under the then chief executive Sir Fred Goodwin, had a row with Goldman in the spring of 2008 when Goldman was an advisor on Royal Bank's £12bn rights issue.