For Goldman Sachs, it was a relatively small transaction. But for the bank — and the rest of Wall Street — the stakes couldn't be higher.
Accusations that Goldman defrauded customers who bought investments tied to risky subprime mortgages have only just begun to reverberate through the financial world.
The civil lawsuit that the Securities and Exchange Commission filed against Goldman on Friday seemed to confirm many Americans' worst suspicions about Wall Street: that the game is rigged, the odds stacked in the banks' favor. It is the first big case — but probably not the last, legal experts said — to delve into a Wall Street firm's role in the mortgage fiasco.
It is a particularly sensitive time for Wall Street. Washington policymakers are hotly debating a sweeping overhaul of the nation's financial regulations, and the news could embolden those seeking to rein in the banks. President Barack Obama on Saturday stepped up pressure for financial reform by accusing Republicans of "cynical and deceptive" attacks on the measure.
The SEC's action could also hit Wall Street where it really hurts: the wallet. It could prompt dozens of investor claims against Goldman and other Wall Street titans that devised and sold toxic mortgage investments.
On Saturday, several European banks that lost money in the deal said they were reviewing the matter. They could try to recoup the money from Goldman.
And it raises new questions about Goldman, the bank at the center of more concentric circles of economic and political power than any other on Wall Street. Goldman — whose controversial success has leapt from the financial pages to the cover of Rolling Stone — has fiercely defended its actions before, during and after the financial crisis. On Friday, it called the SEC's accusations "unfounded."
Wall Street played a complex and, at times, seemingly conflicted role in the mortgage collapse. Goldman and others worked behind the scenes, bundling home loans into investments for sale to investors the world over. Even now, more than 18 months after Washington rescued the teetering financial system, no one knows for sure how much money was lost on those investments.
The public outcry against the bank bailouts was driven in part by suspicions that a heads-we-win, tails-you-lose ethos pervades the financial industry. To many, that Goldman and others are once again minting money — and paying big bonuses to their employees — is evidence that Wall Street got a sweet deal at taxpayers' expense. The accusations against Goldman may only further those suspicions.
"The SEC suit against Goldman, if proven true, will confirm to people their suspicions about the total selfishness of these financial institutions," said Steve Fraser, a Wall Street historian and author of Wall Street: America's Dream Palace. "There's nothing more damaging than that. This is way beyond recklessness. This is way beyond incompetence. This is cynical, selfish exploiting."
On Friday, Goldman's stock took a beating, falling 13 percent and wiping out more than $10 billion of the company's market value. It was a possible sign that investors fear that the SEC complaint will damage Goldman's reputation and its ability to keep its hands on so many sides of a trade — a practice that is immensely profitable for the firm.
It is unclear whether the SEC can prevail against Goldman. The bank has long maintained that it puts its clients first and, in a letter in its latest annual report, it reiterated that position. Goldman said it never "bet against our clients" in its trades but rather was trying to hedge against other trading positions.
The transaction cited in the SEC complaint cost investors just over $1 billion, relatively small by Wall Street standards.
Still, Wall Street analysts said Goldman and other banks, having navigated the financial crisis, might now face a new kind of risk: angry investors. Most major Wall Street banks also created collateralized debt obligations, which are at the heart of the Goldman case. CDOs, which are essentially bundles of securities backed by mortgages or other debt securities, turned out to be among the most toxic investments ever devised.
The biggest victim among investors, the SEC complaint said, was the Royal Bank of Scotland, which inherited a loss of $841 million after it took over the Dutch bank ABN Amro. According to a person briefed on the matter, the Royal Bank, now controlled by the British government, is studying the documents but is not ready to decide whether to try to recoup money from Goldman.
The German bank IKB Deutsche Industriebank, as well as the German government, which in 2007 put up billions to prevent IKB from collapsing, still seemed to be sorting out who might have legal standing to pursue a possible claim.
Goldman faces a dilemma in its response. Wall Street firms tend to settle cases like this one, but Goldman's statement on Friday indicated it intended to dig in its heels and fight, perhaps in part to discourage suits by investors. That strategy could set it up for a long, messy and public battle.