Academic

I've have a great time today catching up with this story via Erik's post, Steve Bainbridge's links, and Larry's Ribstein's analysis.  It's got everything: conspiracy theories, questionable timing, behind-the-scene machinations...and that's just the U.S. government's behavior!

That's only somewhat tongue-in-cheek; as many have commented, the timing of the SEC action seems awfully convenient for an administration seeking to push financial regulation through the Hill.  Having read the complaint, I'm still not convinced about the strength of the SEC's claims. They amount to "Goldman's favored client, Paulson, asked it to create a CDO it could bet against.  Goldman hired a middleman to lend credibility to the deal, misled that middleman as to Paulson's true role, and failed to disclose to portfolio investors 1) that Paulson had actually done the picking of the stable of assets or 2) that Paulson was betting against them."

Maybe.  But the CDO buyers did know that they were buying subprime RMBS in a real-estate bubble.  Didn't you know it was a bubble?  Of course you did.  We were all out there on the dance floor with Charles Prince, shaking our HELOCs and ogling vacation homes.  So it seems a bit disingenuous to complain about buying subprime securities and being misled as to how bad they were. Most tellingly for me, the SEC's complaint contains this quotation from a Paulson employee: 

It is true that the market is not pricing the subprime RMBS wipeout scenario. my opinion this situation is due to the fact that rating agencies, CDO managers and underwriters have all the incentives to keep the game going, while 'real money' investors have neither the analytical tools nor the institutional framework to take action before the losses that one could 'anticipate based [on] the 'news' available everywhere are actually realized.

Everyone knew that the finale was near.  And, as Larry says,

Everybody knew that Paulson was bearish on the real estate market. The banks arguably wouldn't knowingly go into a deal to make money on the upside knowing a notorious bear was on the other side.

The problem with this argument is that Paulson had been losing his bets. The market simply didn't believe what he knew, which was that the risk in the real estate market wasn't fully priced into the securities. Or else they thought they would be able to get off the merry-go-round before it stopped spinning.