The “blame Goldman” defense

August 5, 2009

Sometimes the best defense to a criminal charge is pointing to an even bigger villain. So maybe former Bear Stearns hedge fund manager Ralph Cioffi should look to blame his funds’ spectacular implosion two summers ago on the one Wall Street firm everyone loves to hate: Goldman Sachs.

In two months’ time, Cioffi and his former co-manager, Matthew Tannin, are scheduled to go on trial in federal court on charges they lied to their investors about the financial health of the Bear funds.

The timing couldn’t be worse for Cioffi and Tannin. The media will soon be dominated by stories marking the one-year anniversary of the Lehman Brothers bankruptcy — the event that kicked the financial crisis into overdrive and turned the phrase “bank bailout’ into an obscenity.

It was the collapse of the Bear funds that has been widely seen as the starting point of the crisis. The public’s lust for blood, and desire to have someone pay for all the pain and turmoil the banks have caused since, will be reinvigorated come the fall.

And this is a big problem for Cioffi and Tannin because after all the bailout money that’s been spent to save the banks, the two former hedge fund managers hold the dubious distinction of being the only prominent Wall Street bankers who have been charged with any crime arising from the crisis.

It may not be fair, but there’s a chance that the jury sitting in that courtroom in Brooklyn will hold Cioffi and Tannin to account for all the collective sins of Wall Street.

So what better way to turn things around then by heaping blame on Goldman for the Bear funds’ demise? Right or wrong, Goldman, with its outsized profits and seemingly above-it-all arrogance, is emerging as the new villain on Wall Street.

Did anyone say vampire squid?

With the start of the trial drawing near, the lawyers for Cioffi and Tannin aren’t talking. Yet a “blame Goldman” defense strategy isn’t as far-fetched as it may seem.

Not many know that Goldman sold a $300 million slug of a now-toxic collateralized debt obligation called “Timberwolf 1″ to the Bear funds in March 2007 — a time when the hedge funds were already teetering on the brink.

Timberwolf was a Goldman deal through and through. Goldman was the sole underwriter on the $1 billion CDO, and the underlying mess of subprime-backed mortgage bonds was managed by Greywolf Capital, an investment firm formed by a group of former Goldman bond traders. (Greywolf declined to comment.)

The Bear funds were the single biggest investor in the Timberwolf deal.

There was some internal dissension within the Bear funds about the timing and size of the transaction. Still, people who were close to the Bear funds say Cioffi pushed ahead with the deal despite those internal reservations.

But here’s the interesting thing: within two weeks of selling off pieces of the Timberwolf CDO to the Bear funds, Goldman began marking down the value of some of the securities it had just brought to market.

Goldman’s actions had far-reaching ramifications for the Bear funds because it forced Cioffi’s team to similarly mark down the value of other CDOs that the funds owned. Those mark-downs ultimately fed upon each other and may have hastened the Bear funds’ rapid demise, the people close to the Bear funds say.

In hindsight, the move by Goldman to mark down the value of the Timberwolf CDO deal likely was a reaction to the rapidly deteriorating condition of the U.S. housing market in the spring of 2007.

Even a person who was close to the Bear funds’ operations says that the Goldman mark-down wasn’t beyond the pale. It may have been a bit brutal, but not unethical.

And the Goldman mark-down, of course, came well after prosecutors say Cioffi and Tannin began lying to investors about their funds’ condition. But the point of the “blame Goldman” strategy isn’t to explain everything away; it’s to get a jury to focus on a bigger and more menacing fish.

For Cioffi and Tannin, it may be the best card to play in a weak hand.

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