Felix Salmon

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”.

Apple has the third-highest market capitalization of any company in the US, after ExxonMobil and Microsoft — TUAW

The full list of comments received by the Basel III committee. Happy reading! — BIS

Love this European/Aviation/Volcanic CO2 emissions chart — Information is Beautiful

Bair’s testimony on WaMu — FDIC

“Superheroes rip their suits off. Real heroes keep them on.” — BBC

Herb Greenberg’s long-awaited return to journalism — CNBC

Posting might be very light tomorrow, it’s a travel day for me

Goldman’s letters to the SEC make for fascinating reading, and I’ve learned quite a lot from them, including where Goldman’s $90 million loss came from: tt’s not an unfunded equity tranche at all!

Here’s Goldman’s first letter to the SEC:

Because Goldman Sachs purchased protection from ACA on a portion (50-100%) of the super senior tranche, but wrote protection to Paulson on the entire (45-100%) super senior tranche, it bore the risk that poor performance of the Reference Portfolio would affect the 45-50% portion.

It’s a bit weird, that Goldman would leave itself with the 45-50% tranche of the Abacus deal, but that seems to have been the case.

More generally, the Goldman defense — which is as sophisticated and well-argued as you’d expect from bankers and lawyers of this caliber — seems to be that ACA was an enormous asset manager which neither knew nor cared about a small fund manager like John Paulson. If they thought about his positioning at all, they would probably have come to the conclusion that he was short, and if they came to that conclusion it wouldn’t have stopped them going forwards with the deal, because they considered themselves to be highly sophisticated when it came to putting together CDOs.

It’s a reasonably strong argument, but it fails utterly to answer the question of why on earth, in that case, Paulson’s role wasn’t disclosed much more transparently. The whole deal came out of a reverse enquiry from Paulson to Goldman: why couldn’t Goldman, bringing ACA into the loop, explain the whole concept in the space of a couple of minutes? Why all the studied ambiguity about equity tranches and sponsorships? Why not just come out and say that Paulson wasn’t taking an equity slice, and was going to be short the entire structure?

Here, for instance, is the disclosure from Magnetar’s Auriga deal:

Initial Preferred Securityholder may enter into credit derivative transactions relating to Reference Obligations or Cash Collateral Debt Securities in the Issuer’s portfolio. On or after the Closing Date, the Initial Preferred Securityholder may enter into credit derivative transactions relating to Reference Obligations or Cash Collateral Debt Securities in the Issuer’s portfolio, under which it takes a short position (for example, by buying protection under a credit default swap relating to such obligation or security) or otherwise hedges certain of the risks to which the Issuer is exposed. The Issuer and Noteholders will not receive the benefit of these transactions by the Initial Preferred Securityholder and, as a result of these transactions, the interests of the Initial Preferred Securityholder may not be consistent with those of Noteholders.

That kind of thing would have gone a long way in the Abacus disclosures — and remember that in the Auriga deal, Magnetar really was long the equity tranche. Goldman desperately tries to say that this disclosure wasn’t worth including because it doesn’t identify Magnetar by name — but a disclosure like this would not have needed to identify Paulson by name, either, in order for ACA to know exactly who it was talking about.

Meanwhile, John Gapper has obtained Magnetar’s letter defending itself from ProPublica’s allegations, which is well worth reading, and which is plausible on its face:

Magnetar’s strategy was in essence a capital structure arbitrage. This type of strategy is broadly employed in corporate credit markets, and is based on the relative value between differing components of a company’s capital structure (in our case the different tranches or classes of a CDO), and on the supply‐demand imbalances which can be exhibited in the pricing of rated and non‐rated tranches. From early 2006 to late 2007, there was a systematic relative value mispricing between the equity tranches of Mortgage CDO structures, which offered approximately 20% target yields, and mezzanine debt tranches of Mortgage CDO structures, on which credit protection could be bought for between 1% and 4% (depending upon which tranche and CDO).

If anything, the story of the Abacus deal makes the Magnetar letter more believable, since if Magnetar really just wanted to go short subprime securities, it could have done so Paulson-style, without taking on the equity tranche at all. ProPublica never really demonstrates that Magnetar was in the business of making Paulson-style directional macro bets, as opposed to clever relative-value plays which paid off very well when correlations unexpectedly went to 1.

That doesn’t mean that the Magnetar Trade was all sweetness and light, however. In trying to maximize the yield on its equity tranche, Magnetar surely influenced the makeup of its CDOs: it had every interest in building structures with high equity yields, and those structures by their nature were likely to be pretty risky. What’s more, Magnetar threw so much money at this trade that it helped to fuel the entire subprime bubble.

But between the disclosures and the long-equity part of the Magnetar Trade, it’s becoming pretty clear that this particular Abacus deal is significantly more egregious than anything Magnetar did. If you take all of the Magnetar deals and put them together, then they become bad by dint of sheer size. But if you’re a lawyer looking to nail a financial market professional for doing something wrong, then you’d do as the SEC did, and pass over both Magnetar and Paulson on your way to Goldman Sachs.

Goldman, after all, has to resort to saying, with a straight face, things like this:

The offering documents contained nothing materially false or misleading about ACA’s role, and no reasonable investor would have needed disclosures describing the participation of Paulson…

The fact that Paulson was unknown to ACA – which, as of May 31, 2007, had 26 CDOs valued at $17.5 billion under management – demonstrates that the fact of Paulson’s involvement would not have been material. Nor is there any evidence that IKB or ABN knew of Paulson at the time or would have changed their investment decisions one iota had they fully understood his involvement…

Similarly, the fact that ACA may have perceived Paulson to be an equity investor is of no moment.

None of this is plausible on its face. Goldman repeatedly says that ACA was a “reasonable investor” in the deal, and ACA clearly needed some disclosures with respect to Paulson’s role. Not because of who he was, but because of his reason for doing the deal in the first place. They thought he was with them, on the long side; instead, he was against them, on the short side. That knowledge, no matter who he was, would surely have greatly affected the back-and-forth between the two sides when they worked out a group of names which was mutually acceptable. Either you’re working with someone, or you’re negotiating against them. The difference is crucial, and Goldman should have made it clear.

Jim Surowiecki is right about one thing: the SEC/Goldman/Abacus story has, at its heart, a story of people who were looking backwards at what had happened in the past, and therefore couldn’t see in front of their noses what was just about to happen in the immediate future.

Yes, I’m talking about ACA, IKB, and the housing crash. But I’m also talking about the relationship between Goldman Sachs and the SEC, and Goldman’s bizarre decision not to disclose the fact that it received a Wells notice in July 2009.

Why didn’t Goldman disclose the existence of the Wells notice? Because it reckoned that the SEC wouldn’t file a suit against it. After all, for years now the SEC has been a comatose beast run by supine Republicans, and, as Joe Weisenthal puts it, elephants love the squid.

And as it happens, both of the Republican commissioners on the SEC voted against suing Goldman. The two Democrats voted in favor, and chairman Mary Schapiro voted with them.

And somehow Goldman failed to notice that there was a Democrat in the White House, that Hank Paulson wasn’t at Treasury any more, and that they couldn’t rely on SEC toothlessness going forwards in the way that they had done in the past. At the very least, they expected that the SEC would give them the heads-up that a suit was coming, and maybe give them the opportunity to settle.

But that’s how the old SEC worked, not the new SEC with a chairman desperate to look tough in public. And Goldman, somehow, was oblivious to the change.

I’m still working my way through the two Goldman Sachs responses to the SEC, as posted by Alphaville — the 49-page September 10 memo, and the 20-page September 25 follow-up. But even without reading the whole thing, it’s easy to dismiss the section excerpted by Henry Blodget, which claims that the kind of disclosure the SEC was looking for “would provide a potential investor with no information the investor did not already know”.

But that’s simply not true, as the first line of Goldman’s own slighly-sarcastic disclosure statement reveals:

The Portfolio Selection Agent has received recommendations as to the content of the Reference portfolio from third parties, including a third party that intends to take a short position with respect to the Reference Portfolio.

Upon reading that disclosure, the Portfolio Selection Agent (ACA) would immediately have learned something about which Fab Fabrice had assiduously kept them in the dark — that Paulson intended to go short the CDO.

At that point, the whole history of meetings with Paulson would start being replayed in ACA’s mind a bit like that shoe-dropping moment at the end of a David Mamet film, where the structure of the con is revealed. Only in this case, it wouldn’t have been too late, and ACA would have run very far and very fast in the opposite direction, vowing never to deal with Paulson, Tourre, or Goldman ever again.

It’s still far from clear whether the SEC can or will attempt to pin conspiracy-to-defraud charges on Paulson — my feeling is that they considered the idea, but dropped it for lack of hard evidence. But it’s very clear that this simple disclosure would have done a lot of good. If ACA knew full well that Paulson, with whom it had gone back and forth so many times putting together the portfolio, was in fact constructing it with the express intention of going short, then at that point no one’s lying any more, and there’s no real case to be answered.

So yes, the addition of that disclosure would have made all the difference. As Goldman well knew, because it carefully left that bit out of both the pitchbook and the formal prospectus. If such a disclosure would have added no new information, then there would have been no reason to leave it out.

Back in 2007, I embarked upon a doomed attempt to explain that asset bubbles were not necessarily speculative bubbles. There might be a bubble in the art world, I said, but it wasn’t speculative. And neither were home-price increases speculative in 2000, before the tech bubble had even burst. (Now that was a speculative bubble.)

In my book, a speculator is someone who buys an asset with the express intention of selling it after it rises in price. (Or, conversely, someone who shorts an asset with the idea of profiting from a downward price move.) A buy-and-hold investor, pretty much by definition, can’t be a speculator.

But Jim Surowiecki seems to have a different conception of what speculation comprises:

The economics of subprime lending, and of C.D.O.s, depended on the assumption that there wasn’t a housing bubble, and that therefore housing prices would not fall sharply. That was a speculative assumption, given the massive runup in housing prices between 1998 and 2006, and if you acted on it you were speculating, even if you described it to yourself by another name.

I think this is a little unfair to the people who invested in CDOs. They didn’t make an explicit assumption that there wasn’t a housing bubble, or even that housing prices would not fall sharply. (These are not the same thing: you can have sharp falls in housing prices without a housing bubble, as anybody in Detroit will be able to tell you.)

Instead, the CDO investors relied on complicated models and Monte Carlo simulations, and the complicated models relied on the history of house prices in the US, and the history of house prices in the US was that although there had been localized drops in price, there had never been a national drop in house prices.

Smart people like John Paulson were clever enough to grok the weakness in the models, and to notice that they resulted in some massively mispriced securities. That insight was ultimately what drove The Greatest Trade Ever. But I think it’s a bit much to say that everybody on the other side of that trade was making a speculative bet, when in fact they were buy-and-hold investors buying triple-A-rated securities paying 85bp or 110bp over Libor.

As far as the bond investors were concerned, the risk and speculation was carefully and deliberately consigned to the equity tranche of the Abacus deal. In fact, there was a line of thought at the time which said that these kind of instruments were actually better investments because the housing bubble was bursting. It seems crazy now, with hindsight, but it’s worth remembering that at the time, everybody thought that the problem of default risk had been solved by overcollateralizing and tranching the CDO so that the default risk was borne by the equity investor. The big remaining risk in any mortgage pool was prepayment risk — the risk that homeowners would pay off their mortgages very quickly, sticking the investor with cash which then might not be able to be reinvested at such a high interest rate.

Since mortgage prepayments mainly came from refinancings, it was seen as good news to mortgage investors that various subprime mortgage originators in California and elsewhere were closing their doors. Fewer originators meant fewer prepayments, and fewer prepayments meant higher and more reliable total returns. The fact is that a housing bubble is bad news for mortgage investors, since if you flip your house, that’s a prepayment, and if you refinance your house, that’s a prepayment too, and prepayments are always the last thing a mortgage investor wants to see. So it’s entirely reasonable to assume that IKB and ACA were happy to see the housing bubble coming to an end. So Jim’s wrong here, I think:

If you were buying subprime C.D.O.s in early 2007, you were betting that the housing bubble wasn’t going to burst, even though in much of the country it already had. That was a dubious bet at best.

My feeling is that if you were buying subprime CDOs in early 2007, you were obviously short-sighted and not very good at doing your due diligence. But I don’t think you had any particular desire for the housing bubble to continue. It’s clear with hindsight that a bursting housing bubble could wipe out the principal not only of the triple-A tranches of CDOs but even of the super-seniors. At the time, though, very few people saw that coming: remember Morgan Stanley’s Howie Hubler, who saw the market collapsing, put on a big bit that the collapse would happen, but then tried to fund that bet by selling protection on the triple-A tranches of the same CDOs. “He was smart enough to be cynical about his market,” writes Michael Lewis in The Big Short, “but not smart enough to realize how cynical he needed to be.”

In other words, even ultrasophisticates like Hubler, who saw the collapse coming and bet on it happening, thought the triple-As were safe. So let’s not say that investors like IKB were making a speculative bet that the housing bubble was not going to burst.

Update: Surowiecki responds. (Hey, if nothing else, I’ve got him blogging again!) He makes the entirely valid points that “this entire system was itself an artifact of the housing bubble”, and that “the bubble mentality was very hard for even sophisticated investors to escape”. Both true. But my point is that just because you’re caught up in the bubble mentality, doesn’t make you a speculator. To quote myself, from 2007:

Not all bubbles are speculative bubbles, and momentum can drive prices upwards even in the absence of speculation. Consider a housing market which has been rising at say 15% per year, or more. When a house comes on the market, a bidding war ensues. Each house that comes onto the market sells for more than previous comps. Sellers get greedy, ask for silly amounts of money, and, surprisingly often, get what they ask for. Buyers get scared about being priced out of the market, and desperately try to buy anything they can, just to get a foot on the property bubble. You know the story: we’ve all seen it happen. But the point is, there’s no speculation: the buyers aren’t buying to flip at a profit, and aren’t motivated by the prospect of selling at a higher price in the future. In fact, their real motivation is fear (of never being able to afford a house), not greed.

Does it make sense to say of these people that they “were betting that the bubble would not burst”? Maybe on some theoretical level it does — but that’s not what they thought they were doing. And if you start describing these people as “speculators”, that weakens the term far too much for those who really deserve the label.

Goldman Sachs has yet another statement out on the subject of the SEC charges against it, which adds little to the last two. But since Goldman is making such a big deal of it, let’s take a closer look at ACA’s “investment” in the Abacus deal.

Here’s Goldman, which doesn’t seem to have put this latest statement up on its website:

ACA Capital Management was both the portfolio selection agent and the overwhelmingly largest investor in the transaction ($951 million, with the other professional investor’s exposure being $150 million)…

ACA, the Largest Investor, Selected and Approved the Portfolio.

And here’s the facts, as laid out in the SEC complaint, none of which have been disputed by Goldman:

ABACUS 2007-AC1 closed on or about April 26, 2007…

On or about May 31, 2007, ACA Capital sold protection or “wrapped” the $909 million super senior tranche of ABACUS 2007-AC1…

The super senior transaction with ACA Capital was intermediated by ABN AMRO Bank N.V. (“ABN”), which was one of the largest banks in Europe during the relevant period. This meant that, through a series of CDS between ABN and Goldman and between ABN and ACA that netted ABN premium payments of approximately 17 basis points per year, ABN assumed the credit risk associated with the super senior portion of ABACUS 2007- AC1’s capital structure in the event ACA Capital was unable to pay.

In English, it seems that Goldman Sachs held on to the super-senior tranche of the Abacus deal for a good five weeks while it was negotiating to lay off that risk to ACA and ABN Amro.

What that says to me is that ACA was not really an investor in the Abacus transaction in the way that IKB was; it certainly never bought any of the Abacus securities. Instead, it insured the super-senior tranche. (I’m unclear on how to account for the difference between Goldman’s $951 million and the SEC’s $909 million.)

If ACA Management had been working on this deal since January, and ACA Capital was always going to insure the super-senior tranche, why did Goldman wait so long after closing to close the wrap? It’s pretty clear that ACA Management, the entity which “Selected and Approved the Portfolio”, was in no sense the “Largest Investor” that Goldman is referring to.

There’s a real difference of fact here between Goldman and the SEC: While Goldman refers to a single entity called “ACA Capital Management”, the SEC talks about three different entities: ACA Management LLC, the CDO manager; its parent, ACA Capital Holdings; and the guarantor, ACA Financial Guaranty Corporation.

It’s also worth noting that when Goldman wrapped the super-senior tranche of the Abacus deal, it did so with ABN Amro, a too-big-to-fail bank, and not with ACA. ABN Amro then laid off that risk onto ACA, but was on the hook for all of it if ACA went bust. As, of course, it did.

Why didn’t Goldman simply wrap the super-senior tranche with ACA at the time the deal closed, and then go ahead and manage its ACA counterparty risk in much the same way as it claims to have managed its AIG counterparty risk? Probably because it sniffed out the cost of buying $1 billion of credit protection on ACA, and it was a lot more than the 17 basis points that it managed to get from ABN Amro by getting ABN to intermediate the wrap.

Goldman, then, seems to be conflating the concepts of insurance and investment — a point made well by Brad DeLong this weekend. And it’s conflating, too, the various different subsidiaries of ACA Capital Holdings. And it’s glossing over its own significant efforts to go through ABN Amro when wrapping the super-senior tranche, precisely because, it seems, it had worries about the creditworthiness of ACA. Once again, Goldman seems to be giving us much less than the whole truth. But that no longer comes as a surprise.

Update: As Sandrew points out in the comments, now that we’ve seen Goldman’s response to the SEC, we can see that ACA did buy $42m of the Abacus deal in security form. Probably because the investor, IKB, required that they have some skin in the game.

The Climate Desk has launched! It’s an exciting collaboration, and I’m pleased to be a part of it. My piece is one of two complementary articles; the other comes from Clive Thompson, and explores a lot of the ways that companies are looking to profit from climate change. I, on the other hand, look at corporate attempts to mitigate the downside of climate change — and find them few and far between.

One case in point can actually be found in Clive’s piece: ski resorts like Aspen have a business model which gets destroyed if they can’t attract lots of skiers during spring break in March. If March skiing goes away, as it well might, they could end up losing a great deal of money.

But what’s Aspen Skiing Company doing about it? Well, it’s lobbying Congress, of course, claiming that the ski resort industry “is as endangered as the Polar Bear” and that if people can’t ski in March, “we go out of business”. But this is a risk it’s very hard to hedge, and maybe all it can do, pace Thompson, is call for a cap on carbon emissions.

In any case, the Climate Desk is only just getting started: expect to see lots more great reporting on climate issues going forwards. And, of course, many thanks to everybody who responded to my blegs on this issue. You were invaluable!

Felix Salmon is a Reuters Blogger. This piece was produced by the Climate Desk collaboration.

About a decade ago, Miguel Torres planted 104 hectares of pinot noir grapes in the Spanish Pyrenees, 3,300 feet above sea level. It’s cold up there and not much good for grapes—at least not these days. But Torres, the head of one of Spain’s foremost wine families, knows that the climate is changing.

His company’s scientists reckon that the Rioja wine region could be nonviable within 40 to 70 years, as temperatures increase and Europe’s wine belt moves north by up to 25 miles per decade. Other winemakers are talking about growing grapes as far north as Scandinavia and southern England.

Torres’ Pyrenees vineyards are a hedge, and may not be necessary. But if climate change redraws the map of Europe’s wine world, he will be prepared. And his company will be one of a very few taking steps to adapt to the future effects of climate change.

How companies are preparing for these changes is a pressing topic, but when I agreed to write this piece I knew I was no expert. I set out to educate myself by posting open requests on my finance blog at Reuters, asking my eager-to-comment audience of business wonks to tell me stories of how big corporations are getting ready.

The idea was that my readers and other bloggers would cheerfully provide me with examples of how companies are preparing for the downsides—not to mention the opportunities—of climate change. I braced myself for the inevitable barrage of responses; what I got was a shocking lack of evidence that the corporate sector is doing much of anything.

Most companies seem to focus solely on mitigating changes to the climate: reducing carbon emissions, improving environmental sustainability, and striving to be enlightened stewards of the planet. Adaptation is the opposite, more-pessimistic approach: It is about ensuring survival in the exceedingly likely event that climate change continues.

The U.S. government is trying to create incentives for businesses and their investors to plan ahead. Newly issued Securities and Exchange Commission regulations mandate that any material risk connected to climate change has to be revealed, in an attempt to bring these issues out into the open and to allow investors to compare the ways that companies see climate risks and adapt their strategies accordingly. (Join a live Grist forum on the new SEC regulations.)

There are, to be sure, a few examples of corporations that are treating climate change as an ominous reality, or even as an opportunity. The biggest funders of Brazilian agricultural projects, state-owned banks BNDES and Banco do Brasil, are looking carefully at whether it makes sense to support projects which might not be viable in 20 or 30 years’ time. Agribusiness giants like Cargill and Monsanto are developing hardier crops, global shipping firms are planning for an ice-free Arctic passage, and power company TransAlta has scrapped potential new plants in the American West because it couldn’t ensure that water rights would be available for the next 40 years.

But those are at the margins. In the mainstream business world, climate change adaptation strategies are scant. The reasons for inaction are sometimes simple, but also counterintuitively complex.

Start with the superficial: Adaptation strategies have essentially zero PR value. They have nothing to do with saving the planet. Instead, they’re all about trying to thrive if and when the planet starts to fall apart. That’s not something any savvy company wants to trumpet to the world.

Then there is the mismatch of time horizons. Climate change takes place over decades, and corporate timescales generally max out in the five-to-seven-year range. Businesses typically won’t spend significant money planning beyond that period, especially because the effects on business models and future profitability are so difficult to predict.

It’s easy to talk about how hotel companies with coastal property might have to face more hurricanes, or rising sea levels. But it’s quite hard to know what is going to happen to any given beachfront resort with a sufficiently high degree of certainty. Given the enormous amount of variability in any complex model, if a company spent a lot of money carefully mitigating the risk of X, it could end up getting blindsided by Y instead.

“There are very difficult models to develop, with more rain here, less rain there,” says Andy Hoffman, associate director of the Erb Institute for Global Sustainable Enterprise at the University of Michigan.

Finally, even if the effects of climate change are foreseeable, they can be impossible to hedge.

Say you’re an electronics manufacturer who is pretty sure that climate change is going to wallop Bolivia, resulting in political unrest and a spike in the price of lithium. All your devices run on lithium batteries, so this is a serious risk, but it’s far from obvious what you can do about it. It’s silly to start stockpiling lithium, and you can’t even bet on rising lithium prices 10 years from now, since it’s not a metal that is heavily traded in the futures markets. Essentially all that you can do is be very clear about the risk in your SEC filings, and go about your business as normal. And identifying a risk is not the same thing as being able to negate it.

A classic hedging strategy is to buy insurance. Reinsurance companies have expensive and sophisticated climate-change models. Pricing such risk is what they do. In many cases, they will make more money as the effects of climate change become increasingly visible and expensive, since they’ll simply raise premiums on everybody while refusing to insure the most vulnerable at any price.

But insurance doesn’t work very well as an adaptation strategy. Policies only last for one year, or at most two. The insurance companies don’t need to charge higher rates now if they see big and nasty things happening to the global climate in 20 years’ time—they can continue more or less as they are for the time being. It’s easy to forget that if you’re simply renewing an insurance policy every year: The existence of the insurance market gives companies a sense of false security that their risks are hedged.

To put it another way, insurance is a highly imperfect hedge for climate change, because it can go away or rise in cost very suddenly. After the Bhopal disaster in 1984, pollution liability insurance first disappeared entirely, and then, when it came back, cost 10 times as much. The risk of rising insurance costs—or insurance becoming impossible to buy at any price—is something so inherently difficult to protect against, most companies don’t even bother trying.

The behavioral economist Dan Ariely, author of Predictably Irrational, likes to say that climate change is a problem that is perfectly designed to make people do nothing: It happens far in the future; its effects will be felt most greatly by other people; and the efforts of any one individual are minuscule.

Companies, too, tend to behave in predictably irrational ways. Executives should try to imagine their companies 30 years down the line, struggling with the deleterious effects of climate change on profitability and corporate survival. But they don’t. That’s a job for the next CEO’s successor’s successor. Right now there are a million other things that seem much more urgent, starting with this quarter’s earnings.

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A man dressed as a city gentleman walks across a tightrope in London’s financial district November 12, 2008.      REUTERS/Stephen Hird

Robert Rubin ought to be feeling a bit uncomfortable this morning, in the wake of public comments from two men he is very closely associated with. First, there’s Bill Clinton:

Clinton acknowledged that he was wrong to take what he now views as bad advice from his Treasury secretaries, Robert Rubin and Larry Summers, who told him the market for complex financial instruments known as derivatives ought to remain unregulated.

“On derivatives, yeah, I think they were wrong and I think I was wrong to take [their advice],” Clinton said.

Then there’s Vikram Pandit:

“All of us at Citi recognize that we would not be where we are without the assistance of American taxpayers. We are gratified that Citi has been able to repay their TARP investment in our company, with a substantial return, as well as create a significant increase in the value of their equity in Citi.

“Still, that is not enough. We owe taxpayers a huge debt of gratitude for assisting us at a critical time.”

The connection here is a direct one: the single biggest reason that Citi needed its US government bailout was its misadventures in the derivatives markets which Rubin played such a central role in deregulating, and which he then sought to exploit when he was at Citi.

Rubin was a huge cheerleader for Tommy Maheras, the fixed-income king at Citigroup; the two of them, together, encouraged Citi’s mortgage desk to take on ever-greater risks and to stuff Citi’s balance sheet full of the nuclear waste that soon became notorious as “liquidity puts” and “super-senior CDOs”. What both of those things have in common, of course, is that they were derivatives against which Citi didn’t need to put up any capital.

So given the clear and forthright apologies emanating from Clinton and Pandit, why is it that Rubin is still so supercilious and unapologetic? I suspect it might be an attitude which he picked up at Goldman Sachs and which was also responsible for their tone-deaf response to the SEC’s case against them.

At this point, both Goldman and Rubin have seen their reputations trashed — but Goldman has a lot more to lose. I know that Rubin is still highly respected in Goldmanite circles, but it’s long past time that these people stopped trying to defend the indefensible and started getting a lot more contrite.

Wherein Pimco wheels out a robot named “Neel Kashkari” which unfortunately fails the Turing Test — Pimco

Wherein the first Edible Los Angeles blog entry in 6 months announces it’s for sale — ELA

DeLong nails “the crux of the SEC’s Goldman Sachs case” – conceptually, if not legally — DeLong

The SEC inspector general’s report on the Stanford affair is devastating. Funny how it came out the same day as the Goldman filing — SEC

Krugman and Avent on financial reform — NYT, Economist

Someone please tell the WSJ that if they replace “bonds” with “IOUs”, that doesn’t make the story any easier to read — WSJ

Quite easy and very tasty ramp soup — Epicurious

YouGov show Liberal Democrats ahead! CON 32%(-1), LAB 26%(-3), LDEM 33%(+4) — UK Polling Report

Genius: the train that never stops at a station — YouTube

So, God can send a sunstorm to destroy my money. What do you want me to do about it? — SSRN

America’s Costliest Tax Break — Yglesias

Sonoma County CA separates elderly gay couple. Shockingly intolerant story devoid of compassion — Bilerico

Talk about Goldman not disclosing material information. I’m not talking about Abacus here, I’m talking about the fact that Goldman knew as far back as last September that the SEC was on the warpath with respect to Abacus, and gave no hint to shareholders that there might be legal trouble afoot.

The WSJ has got its hands on — but, unforgivably, has not posted online — a letter that Goldman Sachs sent to the SEC in September, claiming that the Paulson’s involvement in Abacus was not material. (This, incidentally, should help keep quiet anybody who credits the press in general or the NYT in particular with being central to this story: the SEC was clearly on the case long before the press was.) In fact, the SEC probe dates back all the way to August 2008:

Goldman said it first heard from the SEC about the investigation in August 2008, when it received a subpoena requesting documents related to the transaction…

In July 2009, Goldman and Mr. Tourre received so-called Wells notices from the SEC. Such notices are a formal warning that regulators intend to file civil charges.

The letter clearly wasn’t very convincing, and Goldman surely knew it.

Goldman argued that the facts about Paulson weren’t material. In the response, reviewed by The Wall Street Journal, Goldman asserted that hedge-fund manager John Paulson, today a famed figure on Wall Street, was nearly unknown when the securities were sold in early 2007, and participants were unlikely to have cared about his role.

This is just silly. Paulson’s involvement was material not because who he is, but because a person with enormous control over the contents of the CDO was exerting that control with the express intention of making them as toxic and failure-prone as possible. Goldman isn’t stupid, so they surely understood what the SEC was driving at, and also understood that their response was weak.

It’s the job of Goldman’s lawyers, of course, to fight these SEC charges aggressively. But when they got the Wells notice in July, they surely realized that there was a significant chance charges would arrive at some point. And so they had a duty to reveal that fact to shareholders.

Add this to the lawsuits likely facing Goldman, then: suits from shareholders who suffered a massive loss on their holdings Friday, and who will claim, reasonably enough, that Goldman should have told them about the Wells notice and its discussions with the SEC.

On the other hand, Goldman might have assumed that all SEC lawyers were utterly toothless, at least if the one dug up by the WSJ is any indication:

“This isn’t mom and pop getting taken advantage of,” said Peter Henning, a professor at Wayne State University Law School and a former SEC enforcement lawyer. These clients “might not have known about Paulson, but they had to have known that these securities were extremely risky.”

Yeah, this is the kind of person that the SEC hired as an enforcement lawyer: someone who seems to think that a small state bank in Germany “had to have known” that the CDO was extremely risky, even when it carried a triple-A credit rating. In fact, given the modest yield pick-up that the tranches offered, I think it’s pretty obvious that the investors can’t have known that the securities were extremely risky. If they had, then they wouldn’t have bought them.

In any case, the more we learn about this case, the worse it looks for Goldman. Even if they go to trial and win, they surely face multiple lawsuits. If they settle, they’ll get more. And if they go to trial and lose, then that could be extremely harmful indeed to their franchise.

After covering the Martha Stewart trial for Slate, Henry Blodget delivered his verdict: both Stewart and her broker, Peter Bacanovic, were not guilty on all counts. But at least he disclosed that he was prejudiced and that he “wouldn’t mind seeing the government get egg on its face”:

My potential biases are so salient that I wouldn’t have made it through the first 10 minutes of jury selection. As a result of my own experiences as a defendant, for example, as well as a decade of working on Wall Street, I have a “rooting bias”: I regard corporate America as my home team and the government as the visitors.

Now Blodget is back at it, rooting for corporate America in the SEC case against Goldman Sachs. But while he at least attempted to play it down the middle in his Slate dispatches, he now seems to have gone simply bonkers: his case for the defense is so weak that one suspects it was written more as a pageview magnet than as a sincere reflection of his own beliefs.

Blodget kicks off with what he calls “some important background to keep in mind”. The problem is that Bloget’s “important background” seems to have been lifted from a fictional planet: it certainly doesn’t reflect reality.

For starters, in BlodgetWorld, this CDO was structured in the wake of numerous failed attempts to bet against the housing market. He talks about the “huge losses” which were suffered by “dozens of other investors who bet against the housing market from 2003-2007”, and goes on to reiterate:

Plenty of firms had been betting on the collapse of the housing market for years, and they’d all been wrong.

In 2007, the housing market had not yet collapsed, and everyone who had bet on it collapsing had lost huge amounts of money, gone bankrupt, and/or otherwise been rendered fools.

I have no idea what Blodget is talking about here, and I don’t think he has much of a clue either, because he names no names and provides no links to back up his assertion. People went bankrupt betting on the collapse of the housing market? Who?

The fact is that for most of recorded history it has been pretty much impossible to short houses. At the end of the housing bubble, Robert Shiller tried to create a market in housing futures, but it failed, plagued by low volumes and illiquidity. And until John Paulson came along, it was pretty much impossible to short mortgages, too.

In general, it’s extremely difficult to short any bonds other than Treasuries. That’s one of the reasons that credit default swaps became so popular so quickly: they allowed people to go short credit instruments in a way that was pretty much impossible before. As the housing bubble grew and the quality of subprime mortgages sank, various fund managers, including Paulson, started asking the likes of Goldman Sachs to sell them credit protection on subprime loans. Eventually, as the market in subprime CDS expanded, the ABX index was created, and entire synthetic CDOs started to be constructed out of these derivatives. But there was no such thing as subprime CDS in 2003, or even in 2005, which means that no one was shorting those bonds back then. Let alone going bankrupt doing so.

But if Blodget is wrong about the people who were short this market, he’s laughably, spectacularly wrong about the institutions which went long.

So much money had been made betting on further appreciation of the housing market, meanwhile, that investors were DESPERATE for vehicles that allowed them to make these bets in a more efficient fashion. That’s why the buyers of Goldman’s CDO bought the CDO: They thought housing prices were headed higher, and they wanted to make a killing on it.

This is one of the silliest things I’ve seen in a very long time. The decision to buy into Abacus was not an attempt “to make a killing” by “betting on further appreciation of the housing market”. To the contrary, it was an attempt to lock in a modest yield pick-up over Treasury bonds, in return for accepting a very high degree of illiquidity. That’s why Abacus was carefully structured to get a triple-A credit rating: the buyers of the instrument wanted no risk at all with regards to their payment stream.

Buying triple-A mortgage-backed securities and collecting coupon payments on them is not making money by betting on house prices going up, any more than buying Treasury bonds and collecting coupon payments is making money by betting on tax revenues going up. The whole reason for the overcollateralization and the waterfall structures and the equity tranche and the built-in diversification and all the other bells and whistles which so impressed the ratings agencies was to try to make it impossible that investors in the triple-A part of the structure could lose money. If the investors wanted housing-market risk, they would have bought the equity tranche. They didn’t, and they didn’t. Instead, they wanted to put their money in a structure where their principal was safe, but where they didn’t need to pay the liquidity premium seen in the Treasury market — since they were long-term investors and had no particular need for a liquid investment.

Blodget then continues:

As Goldman has observed, with CDOs like the one in question, there is ALWAYS a short side and a long side: The buyers of the CDO knew that someone was going to be betting against them.

This is true, but also misleading, because the central point of the SEC’s suit is that Paulson was represented to ACA as ACA’s friend and coinvestor in the deal, while in fact they were ACA’s enemy, taking the opposite side of the trade.

But let’s back up a bit and look at the Abacus structure from the point of view of ACA and IKB. Simplifying a little, there were basically three parts to it: equity, bonds, and super-seniors. The bonds were the product of the magic of securitization: triple-A-rated instruments which were inherently safe themselves even if they were made up of risky bits and pieces. The investors buying the credit protection on the underlying securities might get paid out here or there, but never in sufficient quantities to endanger the senior cashflows.

Then there was the equity part of the deal: that was the bit where speculation might be going on. An aggressive hedge fund like Paulson would take the long side, betting that it could make a killing as the underlying mortgages avoided default. (Remember that ACA thought Paulson was long the equity tranche.) Some other hedge fund, or perhaps somebody who was already long housing and wanted to hedge that position, would take the opposite side of the trade, protecting themselves against housing defaults or maybe even making a speculative bet that those defaults would be quite numerous.

In any event, the CDO was designed, in the eyes of ACA and IKB, to confine speculative activity to the equity tranche. Equity investors can lose money — or make a lot. And if they lose, then some unknown short will have gained. The bond investors, by contrast, were the boring ones, clipping coupons and sleeping well at night because they didn’t need to worry about losing their principal.

Finally, there was the super-senior tranche, also known in some circles as the “quadruple-A” tranche. This tranche was so safe, and so low-yielding, that it was never even sold: it was, in the parlance of structured finance, “unfunded”. The risk there was entirely theoretical, and was often laid off onto an insurance company which took in a very low premium in order to make sure all the books balanced.

In reality, however, something very different was going on. It’s a little unclear, but it looks very much as though the equity tranche here was unfunded: Paulson certainly didn’t want it, and Goldman never even tried to find someone so bullish on the subprime housing sector that they would buy it. That’s what Blodget is referring to when he says that “Goldman retained an ownership stake in the CDO and lost money on it”. While Goldman was leading ACA to believe that Paulson was speculating on house prices going up, in fact Paulson was betting that they would go down so much that the entire CDO would be wiped out — not just the equity tranche but also the safe triple-A bits. Even the super-safe unfunded super-senior tranches were at risk.

Goldman knew full well what Paulson was seeing, and deliberately kept its client ACA in the dark as to what Paulson’s motivations were, and what the risks were in the structure. While Goldman was trying to persuade the ratings agencies that the bond part of the structure was perfectly safe, it was also listening to Paulson explain why in fact the structure could blow up spectacularly. Neither ACA nor the ratings agencies ever suspected the true reason for the structure’s existence — because Goldman never told them what it was.

Which brings us to the meat of Blodget’s argument:

If Paulson had had control over which securities were selected for the CDO, this would OBVIOUSLY be fraud: Paulson wanted BAD bonds in the CDO, not good ones. The buyers of the CDO, meanwhile, wanted GOOD bonds. That would be a direct conflict of interest that should obviously have been disclosed.

But…

Paulson did NOT have control over which securities were selected for the CDO.

This seems to me to be tantamount to an admission of defeat. If Paulson controlled which securities were selected for the CDO, says Blodget, then that’s not only fraud but it’s OBVIOUSLY fraud.

Blodget then goes on to explain why he thinks that Paulson did not have such control, but he’s pathetically unconvincing.

The firm that DID have control over which securities were selected, ACA, was a highly sophisticated firm that analyzed securities like this for a living. It had FULL CONTROL over which securities were included in the CDO. We know this because, of the 123 bonds that Paulson proposed for the CDO, ACA only included 55 of them. In other words, ACA dinged more than half of the bonds Paulson wanted in the CDO, presumably because they did not meet ACA’s quality hurdle.

Let’s remember here that in the end there were 90 securities in the CDO. Of those 90, it seems that 55 were chosen by Paulson. In other words, more than 60% of the securities in the CDO were picked, essentially, out of a stacked deck. It didn’t matter which securities ACA chose; Paulson had come up with his longlist of 123 securities precisely because all of them were particularly toxic. That’s a material fact which, if ACA had known it, would surely have sufficed to get them to exit the deal entirely.

But it’s actually worse than that: the fact is that Paulson not only proposed 55 of the 90 securities, but also had veto power over the other 35, and signed off on all of them. The timeline is complicated, and stretches from January 9 to February 26 of 2007, with quite a lot of back-and-forth between ACA, Goldman, and Paulson. And in fact it’s not entirely clear that exactly 55 of the final 90 securities were on the initial Paulson longlist. But what is clear is that whenever ACA proposed adding any new securities, Paulson could and did exclude those it didn’t like from the final structure: on February 5, for instance, it deleted eight of ACA’s names from consideration. And in the end it declared itself happy with every single name in the structure.

Given all that, it makes no sense to say that ACA had full control over which securities were included. Really, it was Paulson which had that control: ACA was confined to tinkering at the margins, and only to the degree that Paulson was OK with their alterations. If and when ACA tried to include securities Paulson didn’t like, Paulson simply removed those securities from the deal. So no, ACA did not have full control over anything.

Blodget tries to paint Paulson as merely “influencing” the contents of the CDO structure, in much the same way that PR flacks, the media, or stock screeners might influence decisions. But none of those influences had veto power over the outcome, or were proactively involved in putting the deal together, or, for that matter, paid Goldman Sachs $15 million in order to get exactly what they wanted from the structure. (It’s worth noting here that Alan Dershowitz has said that Paulson “could easily have been charged with conspiracy to defraud” in this matter.)

At this point, Blodget starts just making stuff up.

ACA, furthermore, did not just pick the securities. It BOUGHT THE CDO. ACA’s parent invested more than $900 million in the CDO.

Er, no. ACA’s parent did not “invest” money in the CDO: it did not take $900 million in cash, and give it to Goldman Sachs in return for securities. The parent that Blodget is referring to here is ACA Capital, the insurance company which insured the super-senior tranche of the CDO. From the complaint:

On or about May 31, 2007, ACA Capital sold protection or “wrapped” the $909 million super senior tranche of ABACUS 2007-AC1, meaning that it assumed the credit risk associated with that portion of the capital structure via a CDS in exchange for premium payments of approximately 50 basis points per year.

ACA Capital no more “invested” $900 million in the CDO than an insurance company is investing $1 million if it starts accepting insurance premiums on a $1 million house. Yet Blodget says that ACA “bet almost $1 billion”. He’s wrong. ACA certainly made a very bad decision when it agreed to write this particular policy. But it never took the best part of a billion dollars and wagered it. Maybe it should have done: the discipline of seeing $909 million disappear out the door would certainly have stopped ACA from writing this policy.

Blodget then says something very interesting:

Goldman argues that the Abacus process was the same process used to construct all of these securities, not just at Goldman–in other words, it was a standard industry practice. A transaction sponsor (in this case Paulson), paid for the CDO to be created, the bank created it and sold it, someone went long and someone went short, and everyone knew all of that.

Has Blodget been talking to Goldman? Because there’s nothing in the official Goldman statement along these lines. Probably because it isn’t true. The fact is that standard industry practice was for the transaction sponsor to take the equity tranche, precisely because that helped to align the interests of the sponsor with those of the CDO manager. In fact, I challenge Blodget to come up with a single other CDO where the sponsor was not an equity investor. This was not a standard deal, by any stretch of the imagination.

Blodget concludes with a conditional statement: “the SEC may criminalize this lack of disclosure in hindsight,” he writes, “but if it was a standard industry practice at the time, Goldman likely has a solid defense.” That’s a very big if. And it’s going to be very hard indeed for Goldman to make the case that it was standard industry practice for a speculative short to be given veto power over a CDO manager’s picks, without the CDO manager knowing of the speculator’s position or motives. Henry might be rooting for his Goldman Sachs home team here, but if this is their best defense, it’s looking decidedly rocky.

Steve Waldman has the single best explanation of what was going on in the Abacus deal and why Goldman is so culpable. He makes a lot of really good points, and it’s well worth reading the whole thing. But it’s especially worth pointing to this bit:

Most of a CDO’s structure was AAA debt, generally viewed as a means of earning low-risk yield, not as a vehicle for speculation. Synthetic CDOs were composed of CDS positions backed by many unrelated counterparties, not one speculative seller. Goldman’s claim that “market makers do not disclose the identities of a buyer to a seller” is laughable and disingenuous. A CDO, synthetic or otherwise, is a newly formed investment company. Typically there is no identifiable “seller”. The investment company takes positions with an intermediary, which then hedges its exposure in transactions with a variety of counterparties. The fact that there was a “seller” in this case, and his role in “sponsoring” the deal, are precisely what ought to have been disclosed. Investors would have been surprised by the information, and shocked to learn that this speculative short had helped determine the composition of the structure’s assets. That information would not only have been material, it would have been fatal to the deal, because the CDO’s investors did not view themselves as speculators.

Steve makes a strong case that there was no reason whatsoever for ACA or IKB to believe that there was a speculative short on the other side of their trade. Quite the opposite: they thought that they were the financial sophisticates providing a supply of derivatives to meet a natural demand. Hundreds of billions of dollars’ worth of subprime residential mortgages were written during the course of the housing boom, and those mortgages had owners, and those owners had every natural reason to want to hedge their exposure or insure against its default. If Goldman could find such owners and put them together with people like ACA and IKB, then Goldman would have been doing exactly what investment banks are meant to do: putting natural sellers of risk together with investors who have cash and want to put it to work.

Steve concludes, rightly:

Investors in Goldman’s deal reasonably thought that they were buying a portfolio that had been carefully selected by a reputable manager whose sole interest lay in optimizing the performance of the CDO. They no more thought they were trading “against” short investors than investors in IBM or Treasury bonds do. In violation of these reasonable expectations, Goldman arranged that a party whose interests were diametrically opposed to those of investors would have significant influence over the selection of the portfolio. Goldman misrepresented that party’s role to the manager and failed to disclose the conflict of interest to investors. That’s inexcusable.

The point here is not just that IKB thought that ACA had carefully selected the portfolio with an eye to optimizing its performance on the long side; it’s also that ACA thought that Paulson had carefully selected its longlist of potential components for the portfolio with exactly the same view to making money by selling insurance to people wanting to hedge their mortgage exposure. Goldman, by failing to disabuse its client ACA of this notion, behaved unethically. Of course ACA knew of Paulson’s involvement: that’s exactly what makes the whole scheme so evil. They knew that Paulson was involved, but they were carefully kept in the dark as to why Paulson was involved, and were encouraged to believe — quite naturally, given Paulson’s role as sponsor of the deal — that their interests were aligned.

Investment banking is all about trust: if you can’t trust your investment banker, you shouldn’t be doing business with him. (And if he refers to himself as “fabulous Fab”, probably it’s a good idea not to trust him.) Fabrice Tourre is not a trustworthy banker, and Goldman should be firing him. Instead of mounting a vigorous and forthright defense of his actions.

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?