Your Guide to the Goldman Sachs Lawsuit

During the downturn, Goldman was hardly the only firm that allowed investors to employ these naked credit default swaps. In fact, naked shorts are viewed by many as one of the prime reasons why the housing collapse was so painful. "The naked CDS … wreaked havoc on the market," says Greenberger.

That's because when these shorts are part of synthetic deals, investors are not constrained by physical supplies. Kopff uses the example of home insurance. In that industry, people can only buy as many insurance policies as there are actual houses.

"Once everyone's insured, you've hit the maximum. There's no more insurance that can be written," he says. "While that number can be exceedingly high, it is finite. When you allow naked positions, you allow what doesn't exist in the hazard insurance industry … Now you have someone saying, 'Listen, you've got a house over there, and I'm going to bet that lightning hits it.' And then somebody else comes in and says, 'Well, I'm going to bet that lightning doesn't hit it.' And you can have as many bets as you want."

This, in turn, compounded the losses that investors experienced when the housing market went under. "Essentially, [investors] found people who would give them insurance on the question of whether subprime mortgages would be paid," says Greenberger. "So every time a subprime mortgage collapsed, it wasn't just the real loss of the mortgage, but it was the loss of all the betting that was done on whether the mortgage would survive or not survive."

As the Goldman case continues to attract attention, the debate about swaps is likely to intensify. Importantly, this will happen right as Congress considers a sweeping financial overhaul package, one which many would like to see take a harder position on swaps and other similar deals.

Still, swaps do have ardent defenders who argue that when used correctly, they can actually reduce the riskiness of investors' portfolios. But as the Goldman case illustrates, these defenders are pitted against an American public that is clamoring for tighter regulations. Says Greenberger, "I think there's been a widespread desire to see some accountability for this horrific crisis."

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