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Week in Review

AIG May Sue Goldman

American International Group is considering taking action against Goldman Sachs and other Wall Street banks over soured mortgage assets. The insurance giant is examining its mortgage debt pools and securities for any indication that the structures were fraudulently created or sold.

While the insurer has been scouring its books for some time, scrutiny has intensified now that the Securities and Exchange Commission put Goldman Sachs in its crosshairs with a civil fraud lawsuit for allegedly withholding information about collateralized debt obligation ABACUS 2007-AC1. The SEC asserts that Goldman didn't tell investors that the Paulson hedge fund, which wanted to bet against the deal, had a hand in selecting mortgage assets that would determine how the CDO performed. The firm denies any wrongdoing.

In a separate matter, two Democratic Congressmen have reportedly urged the SEC to force Goldman to return funds it received from AIG if it turns out that the insurer's default protection was fraudulently sold.

AIG previously insured seven Goldman-arranged ABACUS CDOs that originally totaled $6 billion, and AIG representatives are poring over the deals for any disclosure issues similar to what the SEC raised.

AIG and Goldman agreed last year to unwind most of these contracts, which led AIG to realize a loss of about $2 billion. AIG still insures approximately $1.3 billion in ABACUS deals.

Meanwhile, the SEC's actions against Goldman have sent credit default swap spreads spiraling wider for the entire banking sector, according to Fitch Solutions. Goldman CDS widened 41%, and liquidity also spiked by five regional percentiles due to uncertainty over the firm's credit condition.

Schwab Settles YieldPlus Lawsuit for $200 Million

Charles Schwab has settled the federal class-action lawsuit agsinst its YieldPlus Fund for $200 million, far less than the $800 million plaintiffs had sought. The settlement, announced Tuesday, is subject to a definitive agreement and final approval of the court. Other related regulatory matters, including a Securities and Exchange Commission investigation, and a case in a California court remain open.

Schwab set aside $172 million in the first quarter to pay for the settlement.

The class-action suits were filed between March and May 2008, after a regulatory investigation into the investment policy, disclosures and marketing of the Schwab YieldPlus Fund, an ultra-short bond fund invested in corporate bonds, asset-backed securities and mortgage-backed securities. After the credit crisis, investors in the fund experienced steep declines. Schwab reached the settlement without admitting liability, and said it "allows the company to avoid the distraction and uncertainty of a trial, and the possibility of protracted appeals."

Clinton Admits Error on Deregulating Derivatives in 2000 Commodity Futures Act

Former President Bill Clinton now says he had an inadvertent role in the credit crisis and the SEC's civil fraud case against Goldman Sachs by signing the Commodity Futures Modernization Act in 2000, exempting the $58 trillion credit default swap industry from meaningful regulation.

In fact, it was a huge mistake, Clinton said in an interview with Bloomberg News. But he blames former Treasury Secretary Robert Rubin and his successor Lawrence Summers for advising him on financial deregulation.

"Their argument was that derivatives didn't need transparency because they were 'expensive and sophisticated,' and only a handful of people buy them, and they don't need any extra protection," Clinton said.

"The flaw in that argument was that, first of all, sometimes people with a lot of money make stupid decisions and make [them] without transparency," Clinton continued, noting that while derivatives make up 1% of financial products, the overwhelming amount of money invested in them effectively threatened to destroy the world economy.

CDO in Goldman Case Cut To 'D' by S&P in May 2009

The collateralized debt obligation at the center of the fraud case against Goldman Sachs, known as ABACUS 2007-AC1, was cut to "D" from "CCC-" by Standard and Poor's in May 2009.

That "D" grade may have been the most recent rating action taken on this specific transaction, which had two classes of debt, or tranches. The ABACUS deal had a Class A1 and a Class A2.

Goldman used ABACUS as the name of a shelf for a series of CDOs, all of which were tied to residential mortgage-backed securities. In 2007, Goldman was the sixth-ranked underwriter of CDOs worldwide, according to Thomson Reuters.

S&P's report said the downgrade of the transaction's Class A-1 "follows a number of recent write-downs of underlying entities that caused the class A-1 notes to incur a partial principal loss."

By October 2007, 83% of the residential mortgage-backed debt in the portfolio had been downgraded, and 17% was on negative watch, according to the SEC. By January 2008, 99% of the portfolio had been downgraded.