Annals of CDS manipulation, Goldman Sachs edition

December 10, 2010
engineer a short squeeze in CDS:

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A politician whipping up a storm over artificial manipulation of the CDS market? So far so boring. But this time it’s different: the politician in question is Senator Carl Levin, and he has explicit emails from Goldman Sachs (oh yes) which show bond trader Michael Swenson trying to engineer a short squeeze in CDS:

Goldman Sachs’ trading activities in the credit insurance market in 2007 have come under attack from a US senator after e-mails revealed a senior trader urged colleagues to “kill” some investors’ positions.

Carl Levin, chairman of the Senate permanent subcommittee on investigations, told a hearing on Wednesday that the alleged activity “looks like a trading abuse to me”, although he added that at the time in question the credit insurance market was unregulated.

If you look a bit closer into this story, it turns out to be doubly ironic. For one thing, the squeeze was meant to drive down the price of credit protection. The WSJ misses this, saying that Goldman “wasn’t the only player in subprime mortgages to bet that the market would suffer”; in fact, the scheme was designed to bolster the market and make it look artificially healthy. If it had worked, Goldman would have made money on bond values going up.

Which raises the second irony: the scheme, in the end, despite being “do-able and brilliant”, in the words of Swenson, the strategy didn’t work. Which allows the bank to wheel out the rare Goldman Sachs Incompetence Defense:

Goldman said on Thursday: “This type of language sounds awful and is very disappointing, but it does not reflect the reality of what happened. There was no short squeeze.”

Which is true, but not for lack of trying.

One question raised by all this, though: was the trade put on by Goldman’s prop desk, or was it the kind of thing which Goldman could still attempt with its present, post-Volcker rule, setup? It’s clearly proprietary trading in fact. But so long as Goldman was giving great prices to clients looking to short the market, it could colorably claim to have been working on behalf of clients all along.


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