Opinion

Felix Salmon

Open questions about the Abacus deal

By Felix Salmon
April 17, 2010

There are a few questions I’d love to see answered about Goldman’s Abacus deal:

  1. How were the prices of the credit default swaps in the deal determined? We know how the names were determined: Paulson drew up a list, ACA whittled down the list and added some names of its own, Paulson vetoed a few of those names, and ultimately a final list of 92 names was agreed to by both Paulson and ACA. But did those names have prices attached to them at all times? ACA, as the fiduciary, had an obligation to extract as much money out of the buyers of protection as it could. Did it?
  2. Did ACA ever ask Paulson who they thought would be shorting these names? The first question that a professional investor should always ask before making a trade is “who is on the other side of this trade, and why”. Since ACA thought that it was working with Paulson to pick names which would perform well, it seems natural that at some point the question would arise as to who wanted to buy protection on them.
  3. If the SEC nails Goldman on its shady dealings with Paulson, are JP Morgan, Bank of America, Citigroup, Deutsche, and UBS all next in line with respect to their dealings with Magnetar? Or does Magnetar’s decision to go long the equity tranche on those deals help insulate it and its bankers from these kind of allegations?
  4. How often was a synthetic CDO sponsored by an entity which didn’t take any part of the equity tranche? Was Abacus unique in this respect?
  5. Did the equity tranche in the deal exist as securities? Was it funded?
  6. Where did Goldman’s self-reported $90 million loss on the deal come from? Was it from holding onto the (unfunded?) equity tranche?*
  7. Who were the lawyers who drafted the prospectus for the deal and determined that Paulson’s involvement did not need to be disclosed?
  8. Who were the lawyers who decided that Goldman didn’t need to disclose the Wells notice it got from the SEC? Given what happened to Goldman’s share price yesterday, it certainly looks in hindsight as though the investigation was material information.

Finally, Louise Story of the NYT is still reporting that “Goldman did hold some of the negative positions in this investment, which means they were on the other side from the people they were selling this to. They were betting through this investment that housing would get in trouble.”

That’s consistent with what she reported in December, about Fabrice Tourre’s boss, Jonathan Egol:

Rather than persuading his customers to make negative bets on Abacus, Mr. Egol kept most of these wagers for his firm, said five former Goldman employees who spoke on the condition of anonymity. On occasion, he allowed some hedge funds to take some of the short trades.

But it’s not consistent with what Goldman is saying, and the SEC complaint is vague about Goldman’s positioning. I’d love to know what the word “most” means here:

On or about August 7, 2008, RBS unwound ABN’s super senior position in ABACUS 2007-AC1 by paying GS&Co $840,909,090. Most of this money was subsequently paid by GS&Co to Paulson.

The NYT’s editorial today places a huge amount of weight on Goldman’s alleged short position, and seems to think that the alleged crime here has something to do with Goldman betting against the securities it was selling; Ryan Chittum, meanwhile, says that “press coverage was instrumental in this turn of events”, concluding that “fraud charges have finally hit Wall Street, and The New York Times was instrumental in digging it out”.

But the SEC was investigating the Abacus deal long before the NYT story appeared, and I worry that two separate issues are going to end up getting conflated here, to Goldman’s potential benefit. If Goldman can show that it was actually long Abacus rather than short it, that takes a huge amount of wind out of the NYT allegations, without really touching the SEC allegations. I suspect it makes a sense to concentrate on Goldman’s disclosures, here, or the lack thereof, rather than their positioning.

Update: Barry Ritholtz adds his own list of questions.

*Update 2: This seems to have been cleared up: Goldman held the 45-50% tranche. But if that’s the case, who  held the equity? Someone had to own Abacus, no?

Comments
6 comments so far | RSS Comments RSS

Have you seen Sam Antar’s thoughts on the SEC’s tactics?
http://whitecollarfraud.blogspot.com/201 0/04/did-clever-sec-bait-goldman-sachs-i nto.html

He’s the former CFO of Crazy Eddie who was successfully prosecuted by Richard E Simpson, who’s also the lead counsel in this action. His analysis gives me hope they might actually be serious about bringing Goldman Sachs to account on this.

Posted by petewarden | Report as abusive
 

I still think there is a big question mark over ACAs role in all this. Did they really believe that Paulson wanted to go long and invest in all these dodgy housing stocks they were busy selecting with advice from Paulson I am not convinced they are the patsies they are being made out. But they can say they were just as taken in as their client as GS cannot reveal their real involvement without gainsaying its own claims that the deal was all above board.

Also GS seems to be claiming that playing off clients against each other in this way, with the non disclosure involved, is standard practice. Is it?

Posted by usignuolo | Report as abusive
 

It is certainly standard practice when it involves the borrowing of securities from one party for the purposes of shorting those securities by another party.

“The Bank now proposes to act in the capacity of a “conduit lender” to provide additional return enhancements to its securities lending customers. Currently, the Bank’s customer chooses various potential borrowers from a list of usual borrowers. However, the customer may decide not to “approve” all of the borrowers on the list, resulting in some customers that will not permit their securities to be lent directly to certain borrowers. Yet, a certain borrower may desire to borrow securities that only may be found in accounts of customers that have not approved the borrower. To engage in the conduit lending services, the Bank would borrow the desired securities as principal from the customer that had declined to approve the borrower, and then on-lend those same securities as principal to the borrower.”

http://www.occ.treas.gov/law/int1026.pdf

Posted by bidrec | Report as abusive
 

In response to point 2.: “The first question that a professional investor should always ask before making a trade is “who is on the other side of this trade, and why”.”

I suppose pension funds are not run by professional investors but they never know who is selling their holdings short. Indeed the beneficial owner is not the client for the lending agent. The custodian is: “To help our custody clients take advantage of these market opportunities and earn incremental revenue, J.P. Morgan will identify securities that are “trading special” and help [custodian] clients lend these specific securities [to short sellers]…”

http://tinyurl.com/y26xako

Posted by bidrec | Report as abusive
 

2. I paraphrase, “…it seems natural that at some point the question would arise as to who wanted to [lay off risk by shorting] them.”

The SEC laid down the law, “At the start of the year, the SEC, the New York Stock Exchange and the Federal Reserve Bank of New York met with representatives of the Risk Management Association (RMA) and the Securities Industry Association (SIA). On the agenda was the issue of agent client disclosure. From the start, Les Nelson, managing director at Goldman Sachs and co-chair of the SIA’s securities lending division, knew that the regulators were serious.

“They basically gave the industry an ultimatum,” says Nelson. “Agents could either provide increased disclosure to the borrowers or agents would have to act as principal to every single trade with a borrower in the future. I think it took us about one second to make up our minds which route to follow.”"

Resulting in,

“Under the Procedures, a broker-dealer may continue to negotiate and agree to securities loans with Agent Lenders without identifying at the time of the transaction the specific Principals involved. In addition, a broker-dealer may continue to book such transactions without reference to the underlying Principals (i.e., a broker-dealer may book a single contract for a borrowing of securities from the relevant Agent Lender, without identifying or separately booking transactions with each relevant Principal from whom securities are being borrowed).”

http://archives2.sifma.org/ald/documents  /A_-_Z_Guide_Documents/ALD_No-Action_Re quest.pdf p3

Posted by bidrec | Report as abusive
 

Do you find the substantial amount of information we do not know, as this list of questions indicates, incongruous with your other posts pronouncing goldman’s guilt?

Posted by TinyOne | Report as abusive
 

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