The encyclopedia · Trading & Investing · Financial decision · 2007–2010
Goldman Sachs' Abacus CDO — the $550M settlement for a deal designed to fail
Goldman let Paulson pick the mortgage bonds for a CDO, then didn't tell investors Paulson was betting against it. Investors lost $1B. Goldman paid $550M.
Goldman Sachs · Paulson & Co. · 2010-04-16
What happened
Goldman Sachs structured a synthetic collateralized debt obligation called ABACUS 2007-AC1 that closed on April 26, 2007. A synthetic CDO was a bet on a portfolio of mortgage-backed securities — investors bought the CDO and collected premiums, but if the underlying mortgages defaulted, they lost their investment. The deal was designed at the height of the housing bubble, when subprime mortgages were already beginning to fail.
The SEC's investigation revealed that Goldman had allowed John Paulson's hedge fund, Paulson & Co., to select the portfolio of mortgage bonds underlying the CDO. Paulson then shorted the same portfolio through credit default swaps — betting it would fail. Goldman told investors that ACA Management, an independent advisor, had selected the portfolio, but ACA was not told about Paulson's role or his short position. Paulson's fund made $1 billion from the trade. Investors lost over $1 billion.
The SEC filed civil fraud charges against Goldman Sachs and Fabrice Tourre, the vice president who structured the deal, on April 16, 2010. Goldman settled for $550 million in July 2010 — the largest SEC penalty at the time — while acknowledging its marketing materials contained 'incomplete information.' Tourre was found guilty of securities fraud in 2013. The case became a symbol of Wall Street's deception during the financial crisis and the most famous example of a bank selling a product designed to fail.
Why it happened
- Goldman did not disclose the most material fact about the deal — that Paulson, who helped select the portfolio, was betting against it. Investors believed a sophisticated hedge fund was on their side.
- ACA Management was presented as the independent portfolio selector, but ACA was not told about Paulson's short position. The investors relied on ACA's supposed independence, which was a fiction.
- Goldman earned $15 million from Paulson for the deal — a small fee compared to the reputational damage, but the incentive was to say yes without asking hard questions.
- The deal closed in April 2007, when the subprime market was already collapsing. The CDO was designed to fail — Paulson knew this and Goldman should have known it too.
The lesson
When a bank lets a hedge fund pick the assets for a product and does not tell the buyer that the same hedge fund is betting against it, the deal is not a transaction — it is a trap.
Aftermath
The Abacus case was the highest-profile securities fraud case from the 2008 financial crisis. The $550 million settlement was the largest SEC penalty at the time. The case became a symbol of Wall Street's deception. Fabrice Tourre was the only individual charged and convicted. John Paulson was never charged, and his $1 billion profit was not recovered. The case led to increased regulatory scrutiny of synthetic CDOs, though the financial system had already moved on from them. Tourre later said he was made a 'scapegoat' for the crisis.
Sources
- Wikipedia — SEC v. Goldman Sachs
- WealthManagement — Goldman Sachs Agrees to Record $550M Abacus Settlement
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