The US Congress will debate new financial legislation this week, but the real action in financial reform started last Friday with the fraud lawsuit filed by the Securities and Exchange Commission against Goldman, Sachs & Co. That case opens the litigation floodgates for more suits based on subprime mortgage fraud, and smart investors know it. Goldman's market value fell $12bn during trading on Friday, more than 10 times the losses alleged in the case. Shares of other major banks, such as Bank of America, Citigroup and Morgan Stanley, lost more than 5 per cent. JPMorgan Chase was also hammered last week and announced a $2.3bn increase in its reserve for litigation expenses.

These declines reflect two important consequences of the Goldman case. First, it shows how fraud allegations about complex subprime mortgage deals can be made simple. Although the SEC focused on an arcane synthetic collateralised debt obligation known as Abacus 2007-AC1, its complaint is a spare 22 pages. The heart of the document is one straightforward claim: that Goldman misrepresented the role played by Paulson & Co, a hedge fund. Goldman allegedly told investors that Paulson was investing in the deal, when instead Paulson bet against it. Goldman also allegedly hid from investors Paulson's significant role in selecting the subprime mortgage securities referenced in the trade. Thus, the SEC cast a supposedly incomprehensible derivatives trade as a morality tale: the investors were gingerbread boys who weren't told about the fox.

A trillion dollars or more of CDOs could face similar litigation. Goldman did two dozen deals under the Abacus label; the SEC's case involves just one. ProPublica, a non-profit news group, recently identified 26 CDOs sold by various banks in which Magnetar, a Chicago hedge fund, allegedly bet that portions would fail. Magnetar has denied any wrongdoing.