Felix Salmon

Time for contrition from Rubin and Goldman

Felix Salmon
Apr 19, 2010 13:51 UTC

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.


It’s discouraging but pointless to expect these people to have any shame or even express remorse for their actions.

Accountability is for the little people, the suckers.

Clinton and Greenspan have already set the world record for American public figures admitting they were wrong. But they are done with their public lives. Rubin? Summers? Geithner? That’s pushing it. They are still hoping for some big pay days before cashing in their chips.

And no business admits they have ever done anything wrong unless a court requires them to, or it’s a public plea bargain to avoid a court requiring them to. Period.

Posted by LosGatosCA | Report as abusive


Felix Salmon
Apr 19, 2010 04:29 UTC

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


SEC started investigating Abacus in 2008

Felix Salmon
Apr 19, 2010 02:19 UTC

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.


“Where were these people like lezah, who are so concerned about the intrusion of corporate corruption into political life, during the years 2001-2008?”

To be fair, there were a lot of white sheets and hoods to be washed and folded.

Posted by rootless | Report as abusive

Siwoti Sunday: Blodget’s bizarre Goldman apologia

Felix Salmon
Apr 18, 2010 21:44 UTC

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.


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.


I wish the story itself had a “Report as abusive” option and not just the comments because you gave Blodget quite the beat-down!

Posted by gerJohnimo | Report as abusive

How ACA was misled

Felix Salmon
Apr 17, 2010 20:07 UTC

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.


Goldman Sachs is trading at a trailing earnings multiple and a forward earnings multiple in the range of seven. That is atrocious and reflects what the market thinks of the franchise and its earnings quality. By contrast, Berkshire Hathaway, which like Goldman is a kind of hedge fund, has an earnings multiple three times as high.

When a meaningful share of your revenue pie is fraudulently obtained, it contaminates all of your other revenues.

The board needs to throw out Blankfein, Cohn and Viniar. Investment banking needs to revolt until that happens. They are Goldman’s rotten core. Goldman cannot improve until those at the helm amid these ethical disasters are gone.

Posted by DanHess | Report as abusive

Open questions about the Abacus deal

Felix Salmon
Apr 17, 2010 18:52 UTC

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?


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

Posted by TinyOne | Report as abusive


Felix Salmon
Apr 17, 2010 05:00 UTC

Bond Girl on Goldman Sachs — Self-Evident

I think my BNN hit today went quite well, but they didn’t understand my distinction between cash and synthetic CDOs — BNN

Me, talking to Brian Lehrer this morning about the tax code — WNYC

I love this Jake Dobkin photo of the WTC site — Gothamist


Pretty embarrassing that our “premiere” Business News Network journalists didn’t make the distinction between cash vs synthetics, even after FS explains it to them.

Posted by rsteuart | Report as abusive

Parsing the new Goldman statement

Felix Salmon
Apr 16, 2010 20:40 UTC

Good news! Goldman has just released a much longer statement on the Abacus affair. It’s worth delving into:

We are disappointed that the SEC would bring this action related to a single transaction in the face of an extensive record which establishes that the accusations are unfounded in law and fact.

Is Goldman really trying to say here that because its “extensive record” is OK, that gives it license to do what it likes on any given “single transaction”? Certainly it’s repeating its ill-advised assertion that “the accusations are unfounded in law and fact”.

We want to emphasize the following four critical points which were missing from the SEC’s complaint.

* Goldman Sachs Lost Money On The Transaction. Goldman Sachs, itself, lost more than $90 million. Our fee was $15 million. We were subject to losses and we did not structure a portfolio that was designed to lose money.

Goldman goes into no detail here about exactly where the losses came from. But I won’t be impressed if it turns out that they just pulled a $90 million number out of thin air as the value of the equity tranche — which they never even attempted to sell — and then declared that they lost $90 million when it turned out that the equity was worth nothing.

In any case, we’re talking about two different things here, which Goldman is conflating. On the one hand there’s the $15 million in direct fee income, much of which went straight into the CDO desk’s bonus pool. Then there’s the profit-and-loss on whatever part of the structure that Goldman decided to retain: that’s trading-and-investment income, and is a different bucket. It’s entirely conceivable, and indeed probable, that the people structuring the deal cared much more about their fees than they did about the ultimate performance of the CDO.

* Extensive Disclosure Was Provided. IKB, a large German Bank and sophisticated CDO market participant and ACA Capital Management, the two investors, were provided extensive information about the underlying mortgage securities. The risk associated with the securities was known to these investors, who were among the most sophisticated mortgage investors in the world. These investors also understood that a synthetic CDO transaction necessarily included both a long and short side.

If the word “Paulson” isn’t included in the section about “extensive disclosure”, then I don’t think the disclosure can be considered to be extensive. The point here is that neither IKB (which really wasn’t that sophisticated) nor ACA was told by Goldman that this synthetic transaction — which, yes, necessarily includes a short side — was actually architected by that short side. Paulson stacked the deck by giving ACA a pool of toxic assets to choose from, without revealing that they were short. Goldman knew what Paulson was doing, and was complicit in the silence. That’s not “extensive disclosure”, chaps.

* ACA, the Largest Investor, Selected The Portfolio. The portfolio of mortgage backed securities in this investment was selected by an independent and experienced portfolio selection agent after a series of discussions, including with Paulson & Co., which were entirely typical of these types of transactions. ACA had the largest exposure to the transaction, investing $951 million. It had an obligation and every incentive to select appropriate securities.

Except ACA didn’t know — because it wasn’t told — that the securities presented to it by Paulson were specifically chosen to be the ones most likely to default. From the complaint:

In late 2006 and early 2007, Paulson performed an analysis of recent-vintage Triple B RMBS and identified over 100 bonds it expected to experience credit events in the near future. Paulson’s selection criteria favored RMBS that included a high percentage of adjustable rate mortgages, relatively low borrower FICO scores, and a high concentration of mortgages in states like Arizona, California, Florida and Nevada that had recently experienced high rates of home price appreciation.

If ACA had known how these securities were chosen, it would never have agreed to this deal. Simple as that.

* Goldman Sachs Never Represented to ACA That Paulson Was Going To Be A Long Investor. The SEC’s complaint accuses the firm of fraud because it didn’t disclose to one party of the transaction who was on the other side of that transaction. As normal business practice, market makers do not disclose the identities of a buyer to a seller and vice versa. Goldman Sachs never represented to ACA that Paulson was going to be a long investor.

This is hair-splitting. Goldman represented to ACA that Paulson was a “sponsor”, and invariably in this world sponsors are equity investors. What’s more, Goldman told ACA about the equity tranche of the deal in the same transaction summary: the clear implication was that Paulson was holding on to that tranche. And Goldman ended up getting exactly what it wanted: ACA walked away convinced that Paulson was long. It was wrong — and it was therefore misled by Goldman.

Goldman then includes a long “Background” section:

In 2006, Paulson & Co. indicated its interest in positioning itself for a decline in housing prices. The firm structured a synthetic CDO through which Paulson benefitted from a decline in the value of the underlying securities. Those on the other side of the transaction, IKB and ACA Capital Management, the portfolio selection agent, would benefit from an increase in the value of the securities. ACA had a long established track record as a CDO manager, having 26 separate transactions before the transaction. Goldman Sachs retained a significant residual long risk position in the transaction.

IKB, ACA and Paulson all provided their input regarding the composition of the underlying securities. ACA ultimately and independently approved the selection of 90 Residential Mortgage Backed Securities, which it stood behind as the portfolio selection agent and the largest investor in the transaction.

The offering documents for the transaction included every underlying mortgage security. The offering documents for each of these RMBS in turn disclosed the various categories of information required by the SEC, including detailed information concerning the mortgages held by the trust that issued the RMBS.

Any investor losses result from the overall negative performance of the entire sector, not because of which particular securities ended in the reference portfolio or how they were selected.

The transaction was not created as a way for Goldman Sachs to short the subprime market. To the contrary, Goldman Sachs`s substantial long position in the transaction lost money for the firm.

The thing to remember here is that the heart of the SEC has nothing to do with investor losses, be they within Goldman or outside it: instead, it has everything to do with transparency and honesty, or the lack thereof. And the SEC isn’t pulling a Ben Stein, complaining that Goldman was short mortgages and saying that there’s something inherently wrong about that. Whether Goldman was long or short this structure is entirely beside the point. The point is that Goldman treated its clients — ACA and IKB — atrociously. At the very least they deserve a grovelling apology; the SEC makes a strong case that they deserve hundreds of millions of dollars on top of that.


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Goldman’s reputation in tatters

Felix Salmon
Apr 16, 2010 20:05 UTC

It’s not easy to parse a one-sentence statement, but Goldman’s declaration that “the SEC’s charges are completely unfounded in law and fact and we will vigorously contest them and defend the firm and its reputation” seems ill-advised to me, mainly because it’s so obviously untrue. It might be hard to successfully prosecute Goldman — they have a lot of very expensive lawyers, and securities law is murky at the best of times. But there’s enough in the way of smoking guns in the SEC’s complaint that it’s ridiculous to say that it’s “completely unfounded in fact”.

It makes a lot of sense here to do the old-fashioned thing and follow the money. Why was ACA so quiet about the fact that it wasn’t really picking the securities in the CDO it was nominally managing? Because it was being paid millions of dollars for its silence. And why was Goldman so happy to do Paulson’s bidding? Just look at the complaint.

The deal closed on April 26, 2007. Paulson paid GS&Co approximately $15 million for structuring and marketing ABACUS 2007-AC1.

Even by Goldman standards, that’s real money. But the fact is that the investors in the deal had every right to know who was paying the piper — and Goldman went to great lengths to keep that fact secret.

Goldman can and almost certainly will mount a legalistic defense here; Henry Blodget does a good job of glossing what it might look like. Essentially, he says, it’s reasonable to say that ACA picked the securities in the CDO, because it picked them from a list compiled by Paulson. Paulson, of course, having come up with the list in the first place, didn’t really mind which of the securities ACA picked: the game was already rigged by that point, and ACA had no more control over the final outcome than the guy up on stage being asked by the magician to “pick a card”. So long as ACA was playing on Paulson’s field, they were certain to end up losing the game.

But the problem for Goldman here is that even if this kind of defense stands up in a court of law, it’s not going to hold much water with the firm’s precious client relationships. Stephen Gandel has a good take on the whole affair:

Does this end Blankfein’s reign as head of Goldman? I think so. It’s a big deal for an investment bank to be charged with securities fraud. And it is not just a coincidence that Goldman would get hit with a fraud case when Blankfein was CEO. Even though he is not named in the complaint, Blankfein is to blame. He pushed the firm to become less of an investment bank and more of a trading behemoth. And this is the result: A brilliant trade that was so brilliant the Goldman people forgot that it also might be fraud.

Goldman talks ad nauseam about how everything it does it does for its clients, and how any profits it ultimately ends up making are just a result of being “long-term greedy”. But if it attempts legalistic hair-splitting about how its behavior in the Abacus case was technically not illegal, it’s just going to end up looking even more culpable in the eyes of its clients. Goldman, if it was behaving honorably here, would have been open about the whole truth of what was going on. It would have revealed Paulson’s role in structuring the deal to IKB and other investors, and it would have revealed Paulson’s short position to ACA. Instead, it played IKB and ACA for suckers. And that’s just not the kind of behavior that Goldman likes to think that it engages in.

It’s possible, pace Gandel, that if Blankfein goes, that might help placate Goldman’s clients. But I doubt it. The firm is run by traders now, and replacing one trader with another will not make any difference. And Blankfein’s culture is exactly the same as that of just about anybody who might replace him.

In any case, it seems to me that Goldman owes its clients and the public a massive apology. Blankfein has already said that Goldman “participated in things that were clearly wrong and have reason to regret”; he should make it clear that Abacus falls into that category. Instead, he’s trying to brazen it out, and is saying that the SEC’s charges are “unfounded in fact”. That might make sense from the point of view of a legal strategy, but it doesn’t make sense if he’s trying to rescue what remains of his and his firm’s reputation.


Rootless – My initial reaction was that SEC would have a very difficult time making their case for the reasons you cite, i.e. that if IKB is a qualified institutional investor, then caveat emptor largely applies.

Even caveat emptor has limits, though, and they kick in at the word fraud. I still think SEC has something of an uphill battle, but if even one of the pieces of evidence presented in the complaint can constructively be interpreted as a lie, then the line is crossed.

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