SEC's Goldman Charges Send Shocks Through Financial Markets

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http://online.wsj.com/article/BT-CO-201 ... inesEurope

 
   

By Michael J. Casey
   Of DOW JONES NEWSWIRES
 

NEW YORK (Dow Jones)--Stocks fell and Treasurys rose Friday as news that the Securities and Exchange Commission had filed fraud charges against Goldman Sachs Group Inc. (GS) sparked a flight out of financial firms' stocks and risky assets in general.

The SEC said Goldman Sachs failed to disclose to investors vital information about a synthetic collateralized debt obligation, or CDO, based on subprime mortgage-backed securities. In particular, the SEC noted the role played by a major hedge fund that had bet against the CDO. Subprime CDOs were at the heart of the recent financial crisis.

Goldman said the allegations were completely unfounded. Goldman said it will "defend the firm and its reputation."

Still, as Jay Suskind, senior vice president of Duncan-Williams, noted, "the word 'fraud' is the key. When you throw that word fraud in there, all bets are off then."

In response, investors moved into safe haven assets and out of riskier securities, buying Treasurys and the dollar, while selling stocks and commodities.

"The revival of risk aversion has benefited traditional safe-haven assets, like the dollar and the Japanese yen," said Omer Esiner, senior market analyst at Travelex Global Business Payments in Washington.

However, noting that the complaint is focused on a specific incident, Esiner said the broad flight out of risk appeared to be a "knee-jerk reaction."

Goldman stock was recently down 13% on the news. The shares of other financials, especially those with large investment banking activities, were also lower, but to a lesser degree. Morgan Stanley (MS) was off 5.5%, J.P. Morgan Chase & Co. (JPM) was down 3.8%, Citigroup Inc. (C) was 7.5% lower at and Bank of America Corp. (BAC) shed 4.7%.

The selloff dragged the Dow Jones Industrial Average lower; it was recently down 165 points at 10980, while the 10-year Treasury note was up 20/32 to yield 3.768%. Gold futures, which have tended to rise with commodities and other risk assets over the past year, were down 1.4%, according to the most active June contract.

The euro plummeted to $1.3489 from $1.3577 late Thursday, according to EBS via CQG, while the dollar fell to Y92.10 from Y93.04. Higher-yielding currencies, whose performance depends on investors' appetite for risk, lost ground against the dollar. The greenback rose firmly above parity with the Canadian dollar to C$1.0148.

The shockwaves of the Goldman charges rippled through the credit markets, led by financial firms' bonds. The Markit CDX North America Investment-Grade index of 125 credit default swaps weakened 3 basis points to 85.15, while its high-yield counterpart fell 0.75 basis point to 100.55, according to Markit.

Counterparty risk concerns rattled investors and left them wondering whether other firms may see similar charges, said one investment manager. Those worries fed through to the interest rate swaps market, which is a useful proxy for perceptions of the risk involved in trading with the financial firms who use those instruments.

Risk premiums on short-dated swaps widened over the risk-free rate on Treasury debt, with the two-year swap spread at 15.75 basis points over comparable Treasurys, compared with 15 basis points Thursday, while the 10-year spread saw its premium to Treasurys narrowing, going to minus-2.25 basis points from minus-3.25 basis points.

The SEC case deals only with one CDO, and there were no indications that more charges against Goldman or other firms are in store. Still, the civil lawsuit is one of the biggest moves by authorities in response to the financial crisis of 2007-08.

U.S. investigators have said they are pursuing cases connected to the collapse of the subprime mortgage market and the broader problems that engulfed Wall Street in 2008, resulting in the bankruptcy of Lehman Brothers and the government takeover of some leading financial institutions.

Until now, relatively few major figures or companies have been hit with civil or criminal charges. The SEC filed civil fraud charges last June against former Countrywide Financial Corp. Chief Executive Angelo Mozilo.

The hedge fund involved in the Goldman case, Paulson & Co., also contributed to the headline effect. Paulson had earned legendary status on Wall Street during the crisis by making an estimated $20 billion in betting again the housing crisis. Paulson executives were not immediately available for comment Friday.

There were other contributing factors to the market's fearful reaction Friday. For one, there is mounting speculation that heavily indebted Greece will in coming days draw upon a financial aid package from the International Monetary Fund and the euro-zone countries worth up to EUR45 billion in total.

Concerns about the health of Greek banks and the exposure of European institutions to Greek debt had already spurred buying of Treasurys earlier Friday.

There was also a preweekend trading effect in play, as investors don't wish to be exposed to risky positions when there is such uncertainty around.

"People are saying, 'It's the weekend, I'm going to sell first, ask questions later,'" said Andrew Busso, a trader at Cowen.

That stance was likely strengthened given the nature of the Goldman case, which has left investors with more questions than answers.

"The question is, has the SEC discovered what may have been a common practice across the industry? Is this the tip of the iceberg?" said Bill Larkin, a portfolio manage at Cabot Money Management.

 

-By Michael Casey; Dow Jones Newswires; 212-416-2209; mailto:michael.j.casey@dowjones.com">michael.j.casey@dowjones.com

(Bradley Davis, Michael Aneiro, Anusha Shrivastava, Deborah Blumberg and Kristina Peterson in New York and Fawn Johnson in Washington contributed to this article.)