Deutsche Bank and CDO disclosure

By Felix Salmon
April 26, 2010
John Carney and Teri Buhl have a tantalizing story up at the Atlantic today:

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John Carney and Teri Buhl have a tantalizing story up at the Atlantic today:

Traders at Deutsche Bank sold similar collateralized debt obligations (CDOs) — built from credit protection on a portfolio of mortgage-backed securities selected in consultation with hedge fund manager John Paulson — to the German bank. And like Goldman, Deutsche Bank didn’t reveal Paulson’s role in the construction of the CDOs.

Two questions I think are key here. First, was there a Magnetar-style disclosure that the sponsor of the deal might have a net short position in the deal? And second, was there a nominally-independent CDO manager, like ACA, which claimed to have chosen the entire portfolio with an eye to making it high quality, but who in fact was severely constrained by the input of Paulson?

The key problem with the Abacus deal was not so much that Goldman didn’t disclose Paulson’s name. It’s that Goldman didn’t disclose the role of the sponsor to the nominally-independent CDO manager. And given that the manager was also an investor in the deal, that’s a significant omission when it comes to disclosure.


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Will SEC’s Robert Khuzami’s hands be tied in terms of looking at Deutsche Bank since he used to work for them?

Posted by DanHess | Report as abusive

So when these professional investors buy CDOs, did they not look at the underlying securities? Was that typical for a hedge fund manager or bank, to buy complex securities without really understanding what they were buying? Wouldn’t that be considered negligence? And since it resulted in the losses of billions (if not hundreds of them) of dollars, wouldn’t this negligence be criminal?

Did purchasers of other CDOs ever get told who decided what bonds they were betting on? If they usually were told who constructed the CDOs, and weren’t in this case, why would they still purchase them? And if they were never told who constructed the, why does it matter now? Were they forced to buy them? Was John Paulson such an investment god (before he made billions on these bets) that everybody would have been scared to be on the other side? If that’s the case (which it wasn’t), then how would any very successful trader ever continue to make successful trades, because nobody would ever want to be on the other side of the deal from them?

Everybody wants a villian, and the guilty parties are doing a great job at getting the media (and politicians) to re-direct the blame. But when will the conversation shift to exposing the absurdly overpaid investment professionals who negligently invested other people’s money?

Posted by OnTheTimes | Report as abusive

OnTheTimes — Are you for real?

Who is trying to redirect blame? Are you proposing that we criminalize stupidity?

Buyers were apparently very stupid but it is not a crime to be stupid. For a dull-witted person, deep diligence involving great effort might be equivalent to what a brighter person could figure out in minutes.

Is it criminal negligence to make mistakes in a job you were lucky to get now that you are in over your head? If so, we may need to lock up at least the two most recent US presidents and probably much of the workforce.

On the other hand, security law (SEC Rule 10b-5) says that you can’t provide material misrepresentations and omissions in inducing a person to buy securities. It appears that Goldman Sachs broke that law by telling buyers that the portfolio in Abacus was selected by an independent third party. This is the assurance the buyers were looking for and so it was very material to their purchase decision. Paulson, who played a major role in the selection, was not an independent third party. This was a false and misleading statement. Hence the fraud charge.

Posted by DanHess | Report as abusive


Its possible. Khuzami certainly couldn’t be on any case investigating securities he oversaw or worked on, and DB might plausibly argue that he learned so much about their practices for developing these securities as their attorney that he shouldn’t be allowed to use that expertise against them now.

If that were the case, he’d just recuse himself and another official would take over for him.

Posted by AnonymousChef | Report as abusive

Referring to the firms as ‘seasoned professionals’ or ‘dprks’has little to do with the case, as in the long run that is not what this case is about. Using that as a defense is pure deflection.

Calling Paulson an ‘independent third party’ or ‘transaction sponsor’ doesn’t disclose that he is also the one who approached Goldman and was going short..

The Mob can still be charged even if it dupes rubes who are seasoned professionals, correct? Regardless of the outcome, it can’t be seen as anything but a toxic, contrived mess, no matter how ‘professional’ the unethical dealer/dealings were.

Dan Hess said it much better but I had 2 cents in my pocket and I liked throwing in ‘dupes rubes.’

Posted by hsvkitty | Report as abusive

Dan, yeah, I’m for real. I read a lot about how Goldman is to blame for the mess, but nothing about all the people who got on the wrong side of the losing bet. when you are a paid professional, it is reasonable to expect certain levels of performance. If you are entrusted with other people’s money, I think a professional should know better than to effectively lend that money to people with absolutely no chance of paying it back. Making those kinds of investments is beyond a mistake, it is incredibly negligent, especially when the managers either don’t know or don’t care about what they are investing in besides pieces of paper.

If you are unwilling to hold them accountable, then I think it’s unfair to prosecute the middleman, as selfish and greedy as they are.

Posted by OnTheTimes | Report as abusive

OnTheTimes, I think those people who got on the wrong side of a massive losing bet have been punished thoroughly. If it was their own money, they have lost their shirts and if it was other people’s money they have surely lost their jobs and reputations. What more can you do?

There is nothing to charge these bad money managers with, as far as I know. I suppose it would be cool to be able to charge bad fund managers with felony laziness or criminal dimwittedness but I don’t think there is any basis in US code.

Posted by DanHess | Report as abusive

Dan, yeah, if they lost their own money, they shouldn’t be punsihed. But I doubt if most of them lost their jobs. And they surely didn’t give back any of the bonuses they were paid before their incompetence was exposed. Should they be prosecuted? I don’t know, but my main point was they were more responsible than Goldman for their mistakes, and if you’re going to prosecute Goldman (I really don’t like the idea that my position on this issue portrays me as a defender of Goldman, any more than the ACLU likes nazis because they defend their right to speech – and I’m not comparing Goldman to nazis here), then these guys are just as culpable.

All of this talk about whether Goldman is responsible for the mess, and the search for someone (with deep pockets) to blame is detracting away from the more important issue of how to prevent the same thing from happening.

Posted by OnTheTimes | Report as abusive

DanHess, ACA was the manager and selector of the investments in the CDO. That another party was pushing them to put this vs that in the CDO is surely neither here nor there – THEY selected it as we know because ACA kicked out some of the bets Paulson wanted included. It is pretty hard to say GS somehow HID the fact that Paulson was involved and short given that no only met repeatedly with ACA but also TOLD ACA they were short the transaction. This is before you even argue if Paulson’s views on the market are material and should or would have made any difference to ACA’s view of the securities.

Posted by Danny_Black | Report as abusive

“That another party was pushing them to put this vs that in the CDO is surely neither here nor there – THEY selected it as we know because ACA kicked out some of the bets Paulson wanted included.”

So, really, when you get right down to it, Paulson didn’t have a major role, even though he actually took the first pass at selecting, before ACA? Haha! Nice!

Posted by DanHess | Report as abusive

Felix – The Atlantic story says that Deutsche Bank traders admit that there was not an independent CDO manager on the Paulson deals they sold to IKB. Why do think IKB didn’t need a thrid party manager when it bought from DB but they did when they bought from GS?

Posted by oldtrader | Report as abusive