US banks are braced for a massive sell-off of their shares this week, as the fallout of the alleged fraud at industry blue blood Goldman Sachs continues to spook the New York Stock Exchange.
Although the grand old institution of the US banking industry has been embroiled in a number of controversies – bonus rows and claims by the chief executive, Lloyd Blankfein, that Goldman does "God's work", and angering critics by skilfully making money out of the start of the financial crisis in 2007 – few expected that the $45bn-revenue group would ever be accused of a scandal of this magnitude.
No less shocked were Goldman executives, who on Friday discovered that the company, and a London-based executive director, Fabrice Tourre, had been named in an alleged $1bn fraud in and around 2007, involving dodgy mortgages, powerful hedge funds and extraordinarily boastful emails. Nearly 13 per cent was wiped off Goldman's share price, while Bank of America, JPMorgan Chase and Morgan Stanley were also hit.
The blue-chip bank, which traces its history back to 1869, intends to fight the action and vigorously defend its reputation. Executives believe the bank is being victimised as part of a political move by Barack Obama to gain support for his financial reform policies. President Obama's weekly video address was yesterday entitled "Holding Wall Street accountable", and promised shareholders additional powers in a more heavily regulated financial system. Also, Goldman's results for the first quarter of this year, which are expected to be strong, will be announced on Tuesday, leaving Mr Blankfein open to media questions on the affair.
The Securities & Exchange Commission (SEC) has been privately investigating the case for two years, though Goldman had not been contacted by the Wall Street watchdog since September. This led some in the bank to believe that the investigation was running out of steam.
Goldman and Mr Tourre, through a civil claim, have been accused of failing to tell investors of the role that Paulson & Co, the hedge fund founded by the American billionaire John Paulson, had in the creation of a "collateralised debt obligation" (CDO). These fiendishly complicated financial instruments package together a variety of different loans, in this case including mortgages given to people who couldn't afford them.
Paulson would make money if the CDO was devalued, while investors, including ABN Amro, the Dutch bank that is now owned by Royal Bank of Scotland, would gain only if the scheme performed strongly. Goldman is accused of misleading investors to put money in a rotten mortgage product to the benefit of a hedge fund that was betting against the market. Paulson has not been charged.
Recently, Mr Blankfein has been emphasising the strength of Goldman's relationships with its clients. In the introduction to Goldman's 2009 annual report, Mr Blankfein and the company president, Gary Cohn, said: "The firm's focus on staying close to our clients and helping them to navigate uncertainty and achieve their objectives is largely responsible for what proved to be a year of resiliency across our businesses and, by extension, a strong performance for Goldman Sachs."
Royal Bank of Scotland, which lost $841m as the CDO failed, has been working with the SEC for the past year. A small team of former ABN Amro employees has been passing on information to the US authorities. Privately, RBS does not expect the case to be resolved in the courts until next year. A leading City lawyer said that the only way of speeding up the case would be if the SEC decided to "water down" the charge from fraud to negligence, and Goldman then decided to settle. However, Goldman would fight even this lesser charge.
Included in the SEC complaint are extracts of emails Mr Tourre sent to a friend. In one, from 23 January 2007, he wrote: "More and more leverage in the system. The whole building is about to collapse anytime now... Only potential survivor, the fabulous Fab[rice Tourre]... standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstruosities [sic]!!!"
The Independent on Sunday decided to doorstep the clearly colourful Mr Tourre, now based in north London, and visited his abode in a vibrant corner of fashionable Islington. There, next to the world-renowned Sadler's Wells theatre, stands the former Metropolitan Water Board headquarters. Built in 1920, it is an imposing structure of brick and stone which, from the outside, looks almost like a fortress. It wouldn't have looked out of place in Soviet Russia.
Through the great oak wooden front doors, however, which stand at the top of a stone staircase flanked by cast-iron lamps, it is a different story. The doors, each carved with the MWB crest, open on to the kind of art-deco splendour usually reserved for Hollywood films. The ground floor atrium is like a ballroom. Polished marble floors shimmer in the light which floods through the glass and steel roof.
From this building, before privatisation and hose-pipe bans, London's water supply was masterminded. It has long since been sold off, however, and turned into luxury flats. Behind the double oak doors which line the inside walls of the four-storey building, are not offices, but two- and three-bedroomed mezzanine flats – with just as many bathrooms. They cost upwards of £1m.
Mr Tourre was not at home, no doubt hiding away from the investigatory and media glare that is now bearing down on him.
Under investigation: UK regulators kept in the dark by bank
Goldman Sachs failed to inform the Financial Services Authority (FSA) that Fabrice Tourre was under investigation in the US when the bank transferred him from New York to London.
To work in prominent financial services roles, such as managing client investment portfolios, individuals must be approved – on the FSA's public register. Mr Tourre was approved on 24 November 2008, several months after Goldman had first been approached by the Securities and Exchange Commission over his activities.
Goldman believed that the investigation was groundless, and so felt Mr Tourre was "fit and proper", as the register requires, to work in the UK.
Mr Tourre had to pass several key but innocuous tests, such as criminal record and qualifications checks. His resulting registration code, CF30, allows him to discuss transactions with members of the public.
That Mr Tourre was accepted casts further doubt on the suitability of the tests that the FSA uses to vet bankers dealing with hundreds of millions, sometimes billions, of dollars.
The FSA has been strengthening its rules – for example, establishing a committee to review appointments at the UK's biggest banks. But, as a then fairly junior vice-president, Mr Tourre would still have been approved under the current system.
The FSA is set to go to Goldman's UK arm to demand information on Mr Tourre. It could widen its search to see if the bank has been involved in conflicts of interest – in effect, favouring one client over another.
Vince Cable, the Liberal Democrat Treasury spokesman, said the FSA had to prove its mettle with a thorough investigation of the bank's UK dealings, saying: "Now is the time for the FSA to show that it can be tough with guys in big business."