Goldman Sachs was charged with securities fraud by the S.E.C. on Friday in a case that is likely going to be a central focus of the ongoing debate about financial regulation. Despite the complexity of some of the financial instruments involved the case itself is relatively straightforward. Goldman created mortgage backed security funds designed in part by people who wished to “short” the funds, or bet that they would lose money. Goldman itself made a fortune betting against these funds. From the New York Times:

According to the complaint, Goldman created Abacus 2007-AC1 in February 2007 at the request of John A. Paulson, a prominent hedge fund manager who earned an estimated $3.7 billion in 2007 by correctly wagering that the housing bubble would burst. Mr. Paulson is not named in the suit.

Goldman told investors that the bonds would be chosen by an independent manager. In the case of Abacus 2007-AC1, however, Goldman let Mr. Paulson select mortgage bonds that he believed were most likely to lose value, according to the complaint.

Goldman then sold the package to investors like foreign banks, pension funds and insurance companies, which would profit only if the bonds gained value. The European banks IKB and ABN Amro and other investors lost more than $1 billion in the deal, the commission said.

Maybe Goldman can blame the Community Reinvestment Act when it offers a defense to the SEC. But somehow I do not think that will work. This case, and the conduct of Wall Street during the meltdown, demand additional oversight and regulation. It will be increasingly difficult for Republicans to hold the line on this issue. Senator Scott Brown has indicated that he will join a Republican filibuster of the Senate bill, but left open the door to compromise. I have included video clips of Senator Mitch McConnell having a real hard time explaining why he and the Chairman of the Republican Senatorial Campaign Committee John Coryn were meeting with Wall Street folks to discuss ways to defeat this bill, and a clip of yesterday’s Face the Nation appearance by Senator Scott Brown, which focused heavily on the Financial Reform bill.

Read the New York Times story here.

Read a New York Times story on the political ramifications of the Goldman case here.