Felix Salmon

Goldman’s defense

By Felix Salmon
April 20, 2010

The thing which struck me most about Goldman’s earnings call this morning was how guarded they were. For a company which has happily been talking to the press and leaking the letters it sent to the SEC, no one on the call seemed to want to talk candidly about the SEC lawsuit, the Abacus deal, or anything related to them: once the formal statement was over — which added nothing substantial to the press releases we’ve already seen — the Q&A elicited very little in the way of useful information.

Goldman would clearly love everybody to remain focused on its own talking points, some of which do have some substance to them. This was an isolated deal, they said, and we lost money on it — over $100 million, all told. Our interests were aligned with those of the investors, and the investors ended up losing money not because of the specific securities which were chosen by Paulson, but because the entire market tanked.

Goldman made no mention of the fact that the deal was a particularly bad one — the odds were always stacked against the investors. And the Q&A started off badly, with stonewalling and non-answers. Glenn Schorr of UBS had a great first question, asking how Paulson was characterized when they were introduced, by Goldman, to ACA. No answer. Similar non-answers came to other good questions: has Goldman received any other Wells notices? Is the SEC sniffing over any other securitizations? Why did Goldman retain that slim super-senior slice of the deal?

Other questions served to open holes in Goldman’s legal defense. You’re making a big deal out of the fact that ACA rejected half of Paulson’s proposed bonds, said one — does that imply that if they hadn’t rejected any of the proposed bonds at all, disclosure would have been warranted? Again, no answer.

Indeed, the one question which was answered on the call only served to raise more questions of its own. Goldman said that they did not hold on to the equity tranche of the deal, which raises the obvious question: who owned ABACUS 2007-AC1, and whatever happened to the famous 0-9% equity tranche? If the bonds in the deal had all performed perfectly, where would the excess profits have gone?

But there was also a hint, in this call, of a very aggressive and high-risk possible Goldman defense to the SEC accusations. The SEC says that Goldman misled ACA into believing that Paulson was long. But Goldman’s GC, Greg Palm, said quite explicitly on the call that putting any deal like this together involves negotiating back and forth between the short side and the long side. Goldman has repeated ad nauseam that ACA knew there had to be a short side. It has also said repeatedly that disclosing Paulson’s involvement wouldn’t have made any difference to the outcome of the deal. And here’s Goldman’s letter to the SEC:

The Staff has pointed to two ambiguous statements contained in an e-mail from Goldman Sachs that it contends caused ACA to infer that Paulson would be an equity investor. As an initial matter, it is difficult to reconcile such an inference with the Staff’s theory that Paulson tried to influence ACA to select dozens of riskier Baa2-rated securities, which would have raised questions about Paulson’s true economic interests for any sophisticated market participant.

All of this is pointing towards, if not quite stating, the conclusion that ACA did know — all along — that Paulson was short. Sometimes, it’s in one’s best interests to pretend not to have known something you actually did know at the time.

Which doesn’t answer the question of why Paulson’s involvement wasn’t disclosed. Maybe it’s an IKB thing — remember that IKB wouldn’t do a deal with Goldman directly, wanted an independent CDO manager running the deal, and would have got scared if it knew that a short-seller had had a major role in picking its components. Or maybe Goldman’s being honest when they say that as a matter of principle they simply never disclosed the involvement of participants on either the long or the short sides of the deal. But in any case if Goldman can show that ACA knew that Paulson was short, a massive plank of the SEC case then starts crumbling.

If this goes to trial, expect a lot of interest when ACA executives come onto the stand.

Update: Mark Gimein seems to be thinking along the same lines as Goldman, and sees in the SEC complaint an implication “that ACA knew very well that their goals and Paulson’s could be opposed”.

11 comments so far | RSS Comments RSS

they made the call public and they had a great oppurtunity to tell their side of the story, and all the non answers kinda blew it.

Posted by savo | Report as abusive

It seems to me that since the SEC claims that there was fraud, it is more than likely that ACA has confirmed to the SEC that they did not know Paulson was short. If the actual facts are otherwise then the SEC is going to look very foolish.

Posted by dicktracy150 | Report as abusive

Institutional buyers of debt
Are big boys and deserve what they get,
But if some of those boys
Knew who cobbled their toys,
They may not have invested, peut-être?


Posted by DrGoose | Report as abusive

>But in any case if Goldman can show that ACA knew that Paulson was short, a massive plank of the SEC case then starts crumbling.

http://www.telegraph.co.uk/finance/newsb ysector/banksandfinance/7611457/Goldmans -Tourre-told-main-investor-Paulson-was-s horting.html

But Mr Palm said: “He said Paulson was interested in a transaction of this type, and wanted to take a position on the short side.”

Posted by savo | Report as abusive

Where’s Lucas van Praaaaaaahahahag in all of this? Nothing to contribute to the discussion?

Posted by Uncle_Billy | Report as abusive

The loss Goldman suffered on this deal is irrelevant because it is but one high-risk position presented outside the context of the firm’s comprehensive hedged positioning during that time period. The loss is not evidence of good faith any more than evidence that Goldman was net short the mortgage CDO market at the time would serve as evidence of bad faith.

Posted by Mustard | Report as abusive

This deal was a scam, the idea that one guy picks a collection of crappy securities that Goldman then negotiates a higher rating is fraud by any measure, don’t forget the rating part that provided GS’s main value to Paulson.

But the regulation needs to remove the speculative nonsense like CDO’s and tie risk to the investor where it belongs, the moral hazard is far too great for any individual to resist, even a basically decent man like Blankfein was so blinded he thought he was doing God’s Work.

The last financial guy I knew that said seriously just dropped a couple hits of LSD and was drinking shots of tequila. The chance to make billions with other people’s money will always result in bad outcomes.

Posted by jstaf | Report as abusive

ABN AMRO is a big boy. They knew how CDOs are set up, with a long and short side. NOBODY knew who Paulson was back then, so ABN wouldn’t have pulled. To think that ABN AMRO misunderstood the transaction is plain stupid

Posted by Storyburncom_is | Report as abusive

The re write of trading laws at the end of the Clinton administration specifically excluded CDS from being subject to the gaming laws.

If they were still subject to gaming laws, would a transaction like this be considered gambling? Would GS have made 3 billion plus if they were still a fee based investment bank? Is Blankfein’s latest bonus in shares of stock, or so many dollars worth of stock?

The big earnings will bother a lot of people, because they believe that GS made that money by scheming and gambling with a rigged game, as opposed to making money with hard work and contributing value to the economy.

Posted by randymiller | Report as abusive

I am amazed that the putting together of a product designed to fail then sold as a worthwhile investment to a client isn’t itself fraud, or at least criminal negligence.

Goldman Sachs gets a fee from the buyer of the product, being a client. Thus GS have a responsibility that is actionable if they fail at it.

This means, regardless of the SEC charges, that those who bought and lost money on this product have a clear case just on the above information (if it is accurate).

Clients don’t have to prove fraud to sue, they only have to prove criminal negligence, a deliberate misleading of as to the facts.

It doesn’t matter what the other information is. If GS itself knew that the product was full of rubbish, toxic, very high risk items and failed to tell the client then they toast. It isn’t a defence to say that others didn’t tell the client the risk. If GS knew then they had a responsibility, being the ones offering the product, designing the product and receiving a fee for service on the product.

So it doesn’t matter how the SEC case goes, it is irrelevant to the issues the clients have.

Posted by Kina | Report as abusive

And by the way, if the clients who lost do sue they can go for more than the initial loss. The resultant collateral damage will be collected as well.

Goldman Sachs IF they did as alleged will be up for much much more than $1bn.

Posted by Kina | Report as abusive

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