Did Goldman Sachs Foresee the Mortgage Collapse?

With the Securities and Exchange Commission now accusing Goldman Sachs of fraud by selling investors mortgage-backed securities that eventually collapsed, one might wonder whether Goldman did, in fact, set up Abacus investments anticipating that it would lose money.

This article suggests there were divided opinions within Goldman.  Of course, companies don’t take any actions by themselves.  People in those companies make decisions and take actions.  But it appears that as a corporate entity, Goldman recognized that despite their securities being highly rated, they were risky, so they insured themselves against possible losses.

That must have seemed like a clever strategy at the time.  They had securities they recognized were more risky than their ratings indicated, so by insuring them they could shield themselves from any losses.  The problem was, they insured them with AIG, and when the mortgage market tanked, Goldman’s insurer went under too.

As it turns out, having your insurance company go bankrupt is not as much of a problem as it might first appear, if your firm’s former CEO is Secretary of the Treasury.  Goldman got $13 billion of the bailout money going to AIG, of which $6 billion was for their failed Abacus investments.  Now there are calls to revisit that bailout, and perhaps recover what two U.S. Congressmen are calling ill-gotten gains.

Did Goldman see the impending collapse of the mortgage market?  They did have enough foresight to insure their own investments against the possibility.

Randall G. Holcombe is Research Fellow at the Independent Institute and DeVoe Moore Professor of Economics at Florida State University. His Independent books include Housing America: Building Out of a Crisis (edited with Benjamin Powell); and Writing Off Ideas: Taxation, Foundations, and Philanthropy in America .
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