Stephen Foley: Sharks turn on Wall Street's 'vampire squid'

US Outlook: Every way you look at it, the fraud charges laid against Goldman Sachs are devastating for the investment bank.

While the public took up pitchforks against the company, and the media labelled it a "vampire squid wrapped around the face of humanity", Goldman maintained that its reputation with clients – the reputation that really matters – has only been strengthened by the credit crisis. Not any more. The deception of which it was accused yesterday was no fraud on the US people, it was a fraud whose victims were some of its biggest clients. That was why its shares slumped more than 12 per cent, as officers from the Securities and Exchange Commission painstakingly set out their allegations.

Goildman is no stranger to sniping about conflicts of interest, particularly as it has became more and more active trading on its own account. Conspiracy theories about the firm are common currency on rival trading desks, but these never seem to dent its powerhouse franchise. Goldman plausibly counters that the sniping is motivated by jealousy, and that its traders simply do a better job for their clients. Well, not in the case of Abacus 2007-AC1 they didn't.

Lloyd Blankfein, the Goldman chief executive, took an impatient, schoolmasterly tone when he appeared before the Financial Crisis Inquiry Commission in January. To questioners he clearly thought were idiots, he explained how his firm simply brought together sophisticated investors who reasonably wanted to bet against the subprime mortgage market with equally sophisticated investors who reasonably wanted to bet on its continued growth.

Now it stands accused of allowing one of its big hedge fund clients to secretly manipulate the make-up of a mortgage portfolio at the heart of one of these transactions. While Paulson & Co was stacking the decks on the downside of the deal, the hapless European banks on the other side were about to get stuffed with securities that tanked in value almost immediately. It's not even possible to dismiss Abacus as an insignificant, rogue deal, since one of the big victims was IKB, the German bank whose difficulties in July 2007 were the first sign that Europe had been poisoned with toxic US housing debt.

Goldman has always been wrong to dismiss the impact of its dreadful reputation with the wider public. We are already seeing Wall Street's lobbyists losing battles on Capitol Hill over regulatory reform because of the political capital that has been lost.

But the impact of being singled out by the SEC will be of even greater import to the balance of power on Wall Street. Goldman responded to the charges by saying they were completely unfounded, but the legal niceties will be less important than the clear impression that the bank favoured a major hedge fund client over others. It is the worst thing that can happen to an investment bank, that it becomes seen not as an honest broker, but as a dishonest one.