Goldman’s outperforming mortgage CDOs

By Felix Salmon
March 25, 2010
Stephen Gandel had an interesting post this weekend about the now-famous Harvard thesis upon which Michael Lewis based a lot of his latest book, and whether it partially exonerates Goldman Sachs from the charge of deliberately building CDOs which were designed to go bad, to the profit of Goldman Sachs.

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I’m a bit late to this, but Stephen Gandel had an interesting post this weekend about the now-famous Harvard thesis upon which Michael Lewis based a lot of his latest book, and whether it partially exonerates Goldman Sachs from the charge of deliberately building CDOs which were designed to go bad, to the profit of Goldman Sachs.

Gandel gets comments from both Janet Tavakoli, who will never admit that Goldman is anything but pure evil, and from AK Barnett-Hart, the author of the thesis, who keeps a certain amount of scholarly caution while agreeing that Gandel basically read the thesis correctly.

Here’s what he found:

One thing Barnett-Hart examines is how the CDOs of different investment banks performed. Turns out Goldman wasn’t the worst CDO underwriter after all. Quite the opposite.  Barnett-Hart looked at CDO deals underwritten by investment banks from 2002 to 2007, and found that out of about 700, Goldman’s CDOs performed better than every other major underwriter of the investment product on the street. Through the end of 2008, just 10% of the bonds that Goldman packed into its CDOs had gone bad. J.P. Morgan’s rate of default was about four times that, making it the worst U.S. investment bank in the CDO game. But plenty of others had similarly bad numbers. Merrill and Bear came in at a default rate of about 35%, and Citigroup posted a similarly depressing 30%. Barnett-Hart goes on to praise Goldman’s CDO underwriting prowess.

Of course, the likes of Merrill, Bear, and Citigroup never went short mortgages, so they can’t possibly be accused of deliberately constructing highly-toxic CDOs in the knowledge that those CDOs would end up defaulting. It’s hard to be evil when you’re fundamentally incompetent. But as the Lewis book shows, it was really Deutsche, not Goldman, which was most cognisant of the coming subprime collapse. And Goldman’s decision to go short came really rather late in the game.

Lewis is a storyteller, not a historian, so when it comes to finding evil intent at investment banks, absence of evidence is not evidence of absence. But Lewis also clearly has no love for Goldman, and the Goldman press office, for one, is upset with the contents of the book. Given the book’s subject matter and Lewis’s sourcing, I’m sure he would have loved to include a Goldman plot to rip off its own buy-side clients. But in fact it seems that Goldman’s clients were better served than the clients of other sell-side players in the CDO market.

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