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Big banks bundled toxic debt, sold it to rubes, then bet against it and won big

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Mr. Egol, the new managing director at Goldman Sachs had risen to prominence inside his company by creating a program that was at first intended to protect Goldman from investment losses if the housing market collapsed. However, as the market did in fact start heading for collapse, it became apparent to Goldman what was about to take place, and it greatly expanded this program, enabling the company to pocket huge profits, at considerable cost to others.

As we all know by now, pension funds and insurance companies lost billions of dollars buying toxic, but highly rated, securities which they had good reason to believe were good solid investments.

Goldman was, of course, not the only firm that peddled these toxic securities (known as synthetic collateralized debt obligations, or CDOs), and then made financial bets against them, selling them short (called "selling short" in Wall Street parlance). Others banks that created similarly toxic securities and then bet they would fail include Deutsche Bank and Morgan Stanley, as well as smaller firms like Tricadia Inc., an investment company whose parent firm was overseen by Lewis A.Sachs, who this year, perhaps rather significantly, became a "special counselor" to Treasury Secretary Timothy F. Geithner.

How these disastrously performing toxic securities were devised, and with what ultimate purpose or plan, is now the subject of scrutiny -- by investigators in Congress, at the Securities and Exchange Commission, and at the Financial Industry Regulatory Authority, Wall Street's "self-regulatory" organization. Those involved with these inquiries declined to comment.

While these investigations are in the early phases, authorities are supposedly looking at whether securities laws or rules of fair dealing were violated by firms that created and sold these toxic mortgage-linked debt instruments and then bet against the clients who purchased them. But given the blindness that the SEC exhibited with regard early and plentiful evidence that Bernie Madoff was operating a Ponzi scheme, and given the amount of money Wall Street contributes to the re-election campaigns of various members of Congress, don't hold your breath.

The central question within these inquiries is, allegedly, whether or not the firms creating these toxic securities purposely helped to select especially-risky, mortgage-linked assets that would be most likely to crater, setting their clients up to lose billions of dollars if the housing market imploded. Indeed, some securities packaged by Goldman and Tricadia ended up being so vulnerable that they went bad within a two or three months of being created.

The evidence seems to be strong that Goldman and other firms used the CDOs to place unusually large negative bets (i.e. bets against their duped customers), which obviously put the firms at odds with their own clients' interests.

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Several years after receiving my M.A. in social science (interdisciplinary studies) I was an instructor at S.F. State University for a year, but then went back to designing automated machinery, and then tech writing, in Silicon Valley. I've (more...)

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