In the Abacus Lawsuit, Will Goldman Ultimately Prevail?

Photographer: Alessia Pierdomenico/Bloomberg

Goldman's clients may not have an easy time proving they were sheep led to slaughter.

If you imagined that we were somehow getting to the end of the long fallout of the mortgage bond bust, think again. One of today’s biggest investment-banking stories might seem like a blast from the far-off past.

ACA Financial Guaranty Corp. added the hedge fund John Paulson & Co. to the lawsuit it filed earlier against Goldman Sachs. ACA is seeking to recoup its losses in a mortgage derivatives deal called Abacus, dating from the waning days of the mortgage bond boom.

The news that ACA is just now getting around to suing Paulson (whose spokesperson calls the case ‘baseless’) could well make your eyes go wide. The Securities and Exchange Commission’s complaint in the Abacus case was one of the seminal moments of the long mortgage debacle. The SEC charged Goldman with foisting on investors a package of mortgage bond derivatives almost guaranteed to blow up, leaving them on the hook for payments to Paulson’s fund when the bonds lost value.

The SEC charges came in April of 2010. Three months later, Goldman Sachs settled with the SEC, paying a record $550 million fine. Most folks probably figured that after the quick settlement, investors in the deal would soon get money back. Not at all. As the latest news underlines, ACA’s case is nowhere near a resolution in court. Neither, for that matter, is the SEC’s suit against Fabrice Tourre, the Goldman banker at the heart of the case.

With Goldman Sachs no longer quite as publicly vilified as it was in 2010, don’t assume that ACA’s case is anything like a slam dunk. Goldman settled with the SEC at the height of the mortgage bond blowback. Since then, regulators have found it much harder to make a case that will stand up in court; the SEC dropped one probe in August.

It may turn out to be the same for ACA. The ACA case is much less clear-cut than many of the early reports made it appear. ACA’s own interests in the deal were complex. The chart above, via the blog Naked Capitalism, gives you some sense of just how convoluted Abacus and similar deals were.

ACA says it relied on Goldman to design a fair deal, and was shocked to find that the deal was filled with bonds chosen by Paulson, who profited if they blew up. ACA, which was involved in structuring the deal, invested in what it believed to be a safe slice of the deal, while letting a riskier slice go to a German bank, IKB Deutsche Industriebank AG.

Meanwhile, IKB (yes, they’re suing Goldman, too, in a separate case) believed the bonds in the deal were chosen by ACA … who, as it happens, would have could have profited handsomely had enough mortgages defaulted to wipe out IKB’s share but not their own. ACA also offloaded most of its own risk to ABN Amro (a bank later bought by Royal Bank of Scotland Group Plc).

Everybody here, in other words, seems to have thought they could eat someone else’s lunch. During the mortgage boom, investors like ACA imagined they were wolves running with the big carnivores. Now they need to persuade courts that they were actually sheep led off to slaughter. That may not be as easy as it once appeared.

*Correction: This post incorrectly referred to ABN Amro as “AMN Amro.”

A version of this post appeared earlier in the Market Now newsletter. Click here to register at and subscribe to The Market Now daily email.

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