SEC Sues Goldman Sachs, Stunning Observers

It's already been dubbed "the trial of the century"

The S.E.C. has filed a civil suit against Goldman Sachs, roiling the financial community. The suit "claims the bank created and sold a mortgage investment that was secretly devised to fail," reports The New York Times. The "instrument" in question was called Abacus 2007-AC1. It was designed as a way for Goldman "and select clients" to "bet against the housing market." The players were Goldman Sachs, ACA--a third-party firm "with experience in analyzing credit risk," according to the press release--and a large hedge fund led by John Paulson.

Finance commentators are alternately shocked, skeptical, and jubilant.

• 'TRIAL OF THE CENTURY,' shouts the Financial Times' Joseph Coterill from an Alphaville team liveblog of the suit.

• Big and Little: An Explanation  Economics blogger James Kwak identifies some of the challenges of this case, which focuses on Goldman's failure "to disclose the role that John Paulson's hedge fund played in selecting residential mortgage-backed securities that went into a CDO created by Goldman." Kwak reiterates the position he's held all along, that "the financial crisis was not caused by criminal behavior." Though there may have been much behavior that "rose to the level of criminal liability," the crisis would have happened anyway. He also thinks the "vast majority" of banks will be hard to prosecute.
  

• Congrats, Bloggers  Columbia Journalism Review's business writer Ryan Chittum tweets that it's "worth emphasizing the role of bloggers here in Goldman story. Yves Smith, Zero Hedge, and Janet Tavakoli all emphasized Abacus before NYT."

• 'Oooh, Things Are Starting to Get Interesting,' writes Yves Smith, one of the bloggers Ryan Chittum identifies and a former Goldman employee herself. She's particularly fascinated by the fact that "the SEC is suing Goldman and one of its employees, and not the collateral manager, ACA Management."

• 'Explosive Stuff,' says Reuters finance blogger Felix Salmon. "With this suit, the SEC has finally uncovered the real scandal behind the Abacus deals," which he says The New York Times attempted to do back in December, without success:
  

The scandal here is not that Goldman was short[ing] the subprime market at the same time as marketing the Abacus deal. The scandal is that Goldman sold the contents of Abacus as being handpicked by managers at ACA when in fact it was handpicked by Paulson; and that it told ACA that Paulson had a long position in the deal when in fact he was entirely short.

Goldman Sachs has lost more than $10 billion in market capitalization today, in the wake of these revelations. Good. It can go long markets and it can go short markets. But it can't lie to its clients. That's well beyond the pale.