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The Securities and Exchange Commission securities fraud complaint against Goldman Sachs (NYSE:GS) and Fabrice Tourre makes for some fascinating reading. In essence, it says that Mr. Tourre, a Goldman employee who is now 31, back in 2007 helped John Paulson's hedge fund set up a "synthetic collateralized debt obligation" so that Mr. Paulson's hedge fund could short it -- and then went out and sold the long side of the security to other investors without adequately disclosing that the whole security had been designed with Mr. Paulson's cooperation for Mr. Paulson to short.

Says the complaint:

GS & Co and Tourre knew that it would be difficult, if not impossible, to place the liabilities of a synthetic CDO if they disclosed to investors that a short investor, such as Paulson, played a significant role in the collateral selection process.

It also quotes an email Mr. Tourre sent on January 23, 2007:

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 the implications of these monstruosities!!!

The SEC complaint says Paulson & Co. made $1 billion on the deal, Goldman Sachs made a fee of at least $15 million, and the losers of the $1 billion were a German bank called IKB and another European bank, ABN-Amro, which was eventually bought by Royal Bank of Scotland.

Mr. Paulson and Paulson & Co. aren't charged with doing anything wrong.

It all makes for lively reading, though, from a public policy perspective, I'm not sure how I see how as an American taxpayer it's my job to pay regulators to protect sophisticated European bankers from 29-year-old Goldman Sachs bankers selling them investments on which they could lose $1 billion. If I were IKB or ABN-Amro/ RBS, next time the Fabulous Fab came around selling something, I'd be a lot more skeptical, and it'd be a $1 billion lesson learned.

Meanwhile, it is another big public relations black eye for Goldman Sachs, From the firm's business principles: "Our assets are our people, capital and reputation. If any of these is ever diminished, the last is the most difficult to restore." The $15 million fee the firm earned from Mr. Paulson on this deal, if that is what it was, wasn't worth the reputational damage caused by the Fabulous Fab.

Update 1: A FutureOfCapitalism.com reader writes in response to today's annnouncement of SEC charges against Goldman Sachs to suggest that Goldman is a useful scapegoat for the financial crisis. It's easier for the Obama administration to blame Goldman in part because it's harder to blame the Federal Reserve (Mr. Obama retained Chairman Bernanke and promoted NY Fed president Timothy Geithner to Treasury secretary), or to go after a firm, like Bank of America (NYSE:BAC) or Citi (NYSE:C), that has a lot of voters as customers, or one like Deutsche Bank (NYSE:DB) that is closely linked to a foreign government. The other thing the SEC charge could do is help weaken Goldman's position as it tries to lobby for its interests in the financial "reform" legislation. The SEC charge could also soften Goldman up enough that it could open a door for Treasury, or AIG (NYSE:AIG), or the Fed, to try to claw back from Goldman through some kind of retroactive haircut some of the more than $10 billion it took as an AIG counterparty.

I wrote back that I think Warren Buffett's $5 billion investment in Goldman will help insulate the firm from a worst-case Washington scenario. Goldman wants the kindly, grandfatherly-appearing Mr. Buffett, with his good Obama connections, not the Fabulous Fab, to be the public face of the firm.

In any case, recall that the SEC is at least officially somewhat independent of the White House.

Update 2: The reader phones in to emphasize the possibility that the SEC charges may open up Goldman to a flurry of lawsuits (and discovery) from anyone who ever bought a CDO, or encourage more mid-level people at the firm to drop a dime to the SEC and tell what they know.

Source: Goldman Sachs, John Paulson, And 'The Fabulous Fab'