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Paulson a major behind-the-scenes player in Goldman Sachs case

By A. James Memmott

April 18, 2010 at 8:37am

The Security and Exchange Commission’s civil suit filed Friday against Goldman Sachs and one of its traders lays out an astonishing narrative.

Essentially, the SEC argues that Goldman helped a favored client, the hedge fund Paulson & Co., make a cool $1 billion in 2007 by letting it make a sure bet against a financial product designed to fail.

The suit contends that in placing its bet, Paulson & Co. had a decided advantage: It had helped pick the doomed assets that made up the product, a so-called synthetic collateralized debt obligation or CDO.

In other words, it was as if Paulson & Co. siphoned most of the gas out of a racecar and then bet the vehicle wouldn’t finish the race.

Meanwhile, Goldman continued to get other people and firms to wager that the car would make it to the end, even though it knew it wouldn’t. Those investors lost $1 billion.

Neither Paulson & Co., nor John A. Paulson, the firm’s billionaire founder, is charged in the complaint.

A spokesman for the firm has denied that it was involved in the “origination, distribution or structuring” of the CDO cited in the complaint.

“We were straightforward in our dislike of these securities, but the vast majority of people in the market thought we were dead wrong,” the statement continued.

In a statement, Goldman Sachs said the charges were “unfounded” and that it would “vigorously contest them.” Fabrice Tourre, the Goldman vice president named in the complaint, has not commented.

The SEC complaint quotes from several e-mails sent by Tourre in 2007 that indicate he had little faith in the CDOs he was marketing.

In one e-mail, he describes himself as “standing in the middle of all these complex, highly leveraged, exotic trades … without necessarily understanding all the implications of those monstruosities (sic).”

The complaint also shows Paulson representatives picking the residential-backed mortgage bonds that made up the CDO.

According to the SEC, the firm favored bonds made up of adjustable-rate mortgages that had been given to borrowers with bad credit scores.

Furthermore, it preferred mortgages given in Arizona, California, Florida and Nevada, states with high numbers of bad mortgages.

The complaint also contends that Goldman engaged ACA Management to serve as the portfolio selection agent for the CDO, thus masking the role of Paulson & Co. in choosing the bonds in the CDO.

According to the complaint, ACA officials did not know that Paulson & Co. was going to invest against the CDO.

Goldman’s final memorandum describing the CDO “contained no mention of Paulson, its economic interests in the transaction, or its role in selecting the reference portfolio,” the lawsuit contends.

Robert Khuzami, the SEC’s enforcement chief, is quoted in The Wall Street Journal as saying that Paulson & Co. wasn’t named in the suit because “Goldman made the representations (about the CDO). Paulson did not.”

Paulson & Co. has managed to do well by going against conventional market wisdom. John Paulson made $3.7 billion in 2007, $2 billion in 2008. He made $2.3 billion last year to become the fourth highest earning U.S. hedge fund manager.

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