A man became a billionaire by persuading Goldman Sachs to let him choose which subprime mortgages to bet against. That's the gist of a civil lawsuit filed against Goldman Sachs by the Securities and Exchange Commission.
Allow me to make an analogy.
Let's say you were allowed to take out life insurance polices on complete strangers without their knowledge, making yourself the beneficiary. Then you persuaded a car dealer to aggressively market sports cars to people who had been convicted of drunken driving. Then, from this select pool of risky drivers, you chose who to buy life insurance policies on -- with the knowledge that the car dealer had somehow rigged things so that the insurance company was ignorant of the risks it was taking on.
Goldman Sachs acted like that car dealer, according to the SEC's lawsuit: Instead of selling sports cars to drunks, it sold sure-to-fail collateralized debt obligations to sucker investors.
The SEC says Goldman Sachs let a hedge fund manager pick the worst-available mortgage bonds so they could be securitized into a collateralized debt obligation -- just so the hedge fund manager could buy insurance (called credit default swaps) that eventually paid him billions when the underlying subprime mortgages went bust. The SEC's lawsuit accuses Goldman and an employee of securities fraud. The hedge fund manager, John Paulson, is not named in the lawsuit.
Paulson made $3.7 billion in 2007 by betting against his hand-picked mortgage bonds, according to The New York Times. Goldman Sachs made money, too, by betting against the CDOs it securitized. That's a no-lose proposition, akin to betting against yourself in a tennis match, that people outside of Wall Street and the District of Columbia would classify as dishonest.
Investment banks eagerly jumped into the subprime business during the most frenzied years of the housing bubble. Bear Stearns and Lehman Brothers bought subprime lenders outright; other investment banks, such as Goldman Sachs, had close ties to subprime giants such as New Century. The Wall Street investment banks made huge amounts of money by securitizing subprime loans and also by creating and selling derivatives (the aforementioned CDOs and CDSs) that were based on securitized subprime loans.
I want to stress the importance of the linkages within this chain. Powerful, wealthy investment banks wanted -- needed -- a steady influx of subprime mortgages. They used bribes and lies to make sure the subprime loans would keep coming. They bribed subprime lenders with huge commissions, and they lied to rating agencies that gave investment-grade stamps of approval on junk bonds.
With so much money at stake, Wall Street was going to get its way. I know a lot of good, smart people who ultimately blame the housing bust and financial crisis on homeowners who bought houses they couldn't afford, and who treated their houses as ATMs to finance Jet Skis and fancy vacations. Borrowers made these mistakes out of human weakness. Investment bankers counted on human weakness, exploited it, and collected huge bonuses because of it.
Goldman Sachs and its ilk are populated by a bunch of Milo Minderbinders.