Goldman Sachs is possibly the biggest boy in town these days, with the town being every power hub in America, which makes the SEC investigation into its ABACUS subprime mortgage deal curious, both that it’s happening and it’s such a small part of the problem raised by GS’s business practices.  Mike at Crime & Frederalism has been well ahead of the curve on Goldman for a long time, and it’s nice to see the SEC catch up to Mike, if only a little bit.

The details of the deal aren’t all that interesting, except to finance geeks and lawyers paid to care, but the defense  run up the flagpole to see if anybody salutes is worth a look.  Via Ashby at WSJ Law Blog :

all participants were highly sophisticated institutions that were knowledgeable about subprime securitization products and had both the resources and the expertise to perform the due diligence, demand any information that was important to them, analyze the portfolio, form their own market views and negotiate forcefully at arm’s length.

The Big Boy defense, that the others involved in the transactions were big boys, knew what they were doing, and if they got burned, well, it’s their own fault.  It’s a defense with some superficial appeal.  After all, GS’s point, that it wasn’t selling “subprime securitization products,” a description that makes one wince, on the street corner like hot dogs, and no doubt the purchaser won’t come back by arguing that it was far too unsophisticated, incompetent and ignorant to know what it was spending other people’s money on.

Moreover, what difference did it make that Paulson & Co. was betting that the speeding Mack truck was heading straight for a huge brick wall?  There’s no guarantee that somebody wasn’t going short, so why shouldn’t it be Paulson?  Every Big Boy knows that someone out there may be against the thing you’re betting in favor of.  Maybe Paulson wins. Maybe you win. Big boys take risks, which is why they get the big rewards.

The problem with this argument is that even Big Boys get burned.  Big boys may not really be so big, so smart, so sophisticated, which is why an argument like the Big Boy defense has appeal.  A not-so-big-boy will never admit to not being a Big Boy.  They don’t want anybody to know that they really aren’t all that smart, that they got burned.  It would be humiliating.  And Goldman Sachs’ argument plays on this desire to conceal that the “victim” won’t admit to being the dope in the room.

The other problem is that it ignores that it’s a scam from the start.  The objective is to make a beautiful pig, whether by a little lipstick, or more.  Paulson bet against the risk because it knew the ABACUS product was a pig.  The gig was all about making the pig sufficiently beautiful that it would pass scrutiny (to the extent any actual scrutiny happens) with others.

Even if buyers were indeed the sophisticated Big Boys that Goldman, and the victims themselves, would profess to be, you still can’t run a scam on the theory that the victims should have known better.  It’s enough that the seller of the securities knew that it was a pig under all that lipstick, whether the make-up job was good enough to slide it past the victim or not.  Even if no one was fooled, running scams is a wrong.  Even on Wall Street.  Even if you’re Goldman Sachs.

But the real flaw of the argument is that the ultimate victim is never the Big Boy.  The Big Boy plays with the money of the little pipsqueaks, put together in a really big pot.  That’s out money, that was aggregated and shipped in a single electronic transfer to Goldman Sachs.  Millions of our little pipsqueak dollars were aggregated to make a check big enough to interest GS. 

We thought the guys we handed our money to were Big Boys as well, which is why we trusted them with it.  They told us they were sophisticated.  We believed them.  They told us they did their due diligence. We believed them.  They told us to trust them with our money, and we did. 

When the Big Boys get burned, so do the pipsqueaks.  The only Big Boy here was Goldman Sachs, and it was a bad boy too.