The Securities and Exchange Commission's civil fraud charges against Goldman Sachs will no doubt help stoke populist anti-Wall Street sentiment. But the specifics of the complaint, if they turn out to be true, are also a blow to the intellectual underpinnings of anti-regulatory philosophy. And it could give Democrats the advantage in pushing their financial reform measures over the top.

Wall Street has looked pretty foolish over the past three years, but there was a certain comfort in knowing that there were a few smart guys who took the right side of the trade. Like hedge fund manager John Paulson, who became famous for his winning "short" position on mortgage securities.

As long as there are people like Paulson willing to bet against market euphoria, the argument goes, markets should be able to regulate themselves, at least most of the time. People won't be able to sell dubious securities for very long, because the shorts will hop in to make a profit and in the process bring that stuff down. Maybe there weren't enough Paulsons to prevent the "hundred-year flood" that led to this financial crisis. But the fact that there were a few suggests that the system basically works, and just needs some tweaking at the edges -- maybe just some more transparency.

But what if, as the SEC charges, the guys who make the toxic stuff are working with the ones who bet against it? The complaint says that Paulson's fund wasn't merely taking the other side of the bet. As Fortune.com explains,

The SEC's civil fraud complaint alleges that Goldman allowed hedge fund Paulson & Co. — run by John Paulson, who made billions of dollars betting on the subprime collapse — to help select securities in the CDO.

Goldman didn't tell investors that Paulson was shorting the CDO, or betting its value would fall. When the CDO's value plunged within months of its issuance, Paulson walked off with $1 billion, the SEC said.

Got that straight? According to the SEC, Goldman devised a financial product and sold it to investors without telling them that someone who had helped them devise that product was betting on its failure. In that scenario, it's sort of like neglecting to tell a farmer that the hen house you sold him was designed by a fox.

Fortune.com notes that Goldman Sachs, in a statement, calls the SEC's charges "completely unfounded in law and fact." Earlier this month, the company devoted part of its annual report to shareholders to defending its role in the mortgage-securitization market.

Paulson and his firm aren't named in the charges, an SEC official told the Wall Street Journal, because they didn't have a duty to disclose to other investors. (Paulson, by the way, is not related to Henry Paulson, former Goldman CEO and former Treasury Secretary.)

We'll see what happens. But as of today it's a lot harder to argue that ruthless competition in markets makes regulation redundant. It's ruthless out there, all right. But competitive? Maybe not so much.

By the way, if this happened the way the SEC says it did, it probably wasn't unique. ProPublica and NPR's This American Life broke a similar story last week about "the Magnetar trade." It's a ripping yarn. And there's already a musical! This pretty much sums the mechanics, with a catchy tune:

Bet Against the American Dream from Alexander Hotz on Vimeo.

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