Hudson Mezzanine Funding: more trouble for Goldman?

Hudson Mezzanine Funding

According to numerous press reports (suggesting that in Spitzer-like fashion, the government wants to get this story into the public eye in advance of any possible charges), the SEC is investigating Goldman Sachs for its sale of a collaterized debt obligation linked to sub-prime mortgages called Hudson Mezzanine Funding.

This action follows the indict ment of Goldman on civil fraud charges in April based on another mortgage derivative transaction called Abacus.

As I’ve written before, from what has been made public about Abacus so far, the case against Goldman seems weak to me (remember, I’m an investor, not a lawyer, however).  The accusations appear to rest on the SEC belief that in the Abacus transaction Goldman had an obligation to act as a financial advisor to the participants, not simply as a broker.  The facts, on the other hand, seem to me to show that Goldman functioned merely as a go-between for a deal that the two parties negotiated with each other.

From the leaked information appearing in today’s newspapers, Hudson seems to be a more serious complaint, assuming the press reports are correct, in that:

–Goldman selected the securities for the Hudson deal from its own inventory,

–Goldman asserted in marketing materials that its interests were “aligned” with buyers, since it would own equity in the issue, but failed to disclose that it was taking a much larger short bet against it

–in an internal email, a Goldman salesman describes Hudson as “junk” that his better clients were “too savvy to buy.”

I presume the SEC contention will be that Goldman was in a position to know the contents of Hudson well since it owned them, and made positive public statements about the deal while privately holding a negative opinion and intending to short the security once it came out.

why lead with Abacus and not Hudson?

One possibility, raised right away by the Wall Street Journal, is that the SEC fundamentally misunderstood the nature of the Abacus transaction. 

 Another is that the agency was under political pressure to do something while a financial reform bill was being debated in Congress. 

It may also be that the SEC was only tipped to the existence of Hudson after it went public about Abacus.

why Goldman and not Morgan Stanley or Citigroup?

This morning’s Financial Times, in addition to having a report on Hudson on page 1, contains a very interesting article called “A tricky pick,” in which it discusses the collateralized debt obligation market.  Although the banner on page 1 touts the article as being about “Goldman and the Credit Boom,” the real eye-opener of the story is that it portrays organizations like Morgan Stanley, UBS, Bank of America and Citigroup as engaging in what appears to me to be much more highly unethical and destructive behavior than anything that Goldman has been accused of by the SEC.

My guess is that it’s because Goldman is that compared with a commercial bank, Goldman is relatively simple to understand.  Its activities are more focused and the lines of responsibility for any action are clearer.   Given that the sub-prime derivative business is inherently difficult for non-specialists to get their arms around, why make the task even harder by adding the issue of having to explain a complex  organizational structure?

Also, Goldman has little retail presence.  It does no image advertising.  So few people have strong positive associations with Goldman as “my” bank.  It has also  created resentment, rightly or wrongly,  from seeming to have profited from the financial crisis.  In addition, the company has been described as being “tone-deaf” to public opinion.  Perhaps describing what they do as being “God’s work” isn’t typical of its public relations efforts, but even one gaffe like that can do a lot of damage.

I think the one safe conclusion to draw from all this is that (justifiable) public anger at the financial meltdown isn’t going away.  That implies that neither will the efforts of the SEC to prosecute.  Whether the agancy has the right villain is still open to question, though.

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