Felix Salmon

Goldman’s defense

Felix Salmon
Apr 20, 2010 16:15 UTC

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”.


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.

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Felix Salmon
Apr 20, 2010 04:53 UTC

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

The Goldman and Magnetar letters

Felix Salmon
Apr 20, 2010 04:30 UTC

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.


Am I missing something? I read the 2007 ABACUS offering and in the conflict of interest section it explicitly states,
“The Initial Purchaser, the Protection Buyer, the Basis Swap Counterparty, the Collateral Put Provider, the Collateral Disposal Agent and their respective affiliates may hold long or short positions with respect to Reference Obligations and/or other securities or obligations of related Reference Entities and may enter into credit derivative or other derivative transactions with other parties pursuant to which it sells or buys credit protection with respect to one or more related Reference Entities and/or Reference Obligations.”

Again, am I missing something. Seems that GS made all the appropriate disclosures…

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Why Goldman didn’t see the SEC suit coming

Felix Salmon
Apr 19, 2010 20:18 UTC

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.


Nice to see some justice, it is the ancient and only cure for a society deceived by leaders and cheated by bankers. It is a shame, going to be hard to change so until we invent and honest with no greed pill then we need to try to create ever more effective regulators so that markets can be trusted.

Once you have trust then money flows, jobs are created and society prospers, we did it the last century with a safer system to provide financing for businesses and individuals, we need a safer and different set of tools that are up to the task of modern markets.

Moving the CDO’s to Vegas would be a step in the right direction also so that money can be invested in companies instead of hedge funds in bank clothing.

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Would a Goldman disclosure have helped?

Felix Salmon
Apr 19, 2010 19:41 UTC

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.


ACA were paid a fee as selection agent. It’s obvious now that the bonds which Paulson proposed were particularly stinky. But why does his motivation for doing that matter?
Suppose he really had wanted to go long but was particularly useless. Isn’t it the job of ACA to spot that the bonds he chose all seem to be on mortgages in California with no paperwork to back them up? If Paulson could do that based on publicly available information, why couldn’t ACA as an alleged expert.
ACA through a different branch was the biggest single investor. The complaint basically says that ACA (investor) was misled to believing that ACA (selector) had chosen the bonds.
This is laughable. Paulson found that there were a lot of stupid people on the market who were wrong about mortgages overall and who were not willing to do the study of the details which he did. That’s what used to be called “research.”
There are so many dreadful things which the investment banks did to cause the crisis. It’s pathetic that the SEC pick on this one, where a broker observed the principle of client confidentiality.
I understand that people hate Goldman because it has been enormously successful and only exists because the US taxpayer bailed it out. That’s no excuse for this suit.

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Why the Abacus investors weren’t speculators

Felix Salmon
Apr 19, 2010 18:58 UTC

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.


I agree with you, Felix. If you look at the Magnetar Trade described by ProPublica, JPMorgan helped create the CDO and then lost $900M on that deal. In 2007 nearly everyone agreed that the super senior tranche couldn’t lose. I’m not a finance guy, but I’m guessing they wanted a large stack of high-yield AAA securities to help fund themselves in the repo market. So I don’t think they were speculating (i.e. flipping to a greater fool), but were squeezing an extra point out of their borrowing costs.

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Goldman’s misleading statement on ACA

Felix Salmon
Apr 19, 2010 15:30 UTC

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.


In regards to Sandrew’s point, are you going to correct this post Felix – - “It (ACA) certainly never bought any of the Abacus securities”?

Why would you use the term certainly in the first place? Any documentation you can link to or was the merely an unsubstantiated assertion on your part?

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The Climate Desk launches

Felix Salmon
Apr 19, 2010 14:37 UTC

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!


Climate change is a global problem, and yet each one of us has the power to make a difference. Even small changes in our daily behaviour can help prevent greenhouse gas emissions without affecting our quality of life. In fact, they can help save us money!

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Skipping the risk mismanagement

Felix Salmon
Apr 19, 2010 14:06 UTC


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.


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


The day is close where vis major/ force de majeure/ acts of god will become a standard clause, as it is already happening. Insurance is another form of legalised gambling, the bet here claims payouts versus premiums collected, and then of course what happened to AIG.

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