Monday, April 19, 2010
More on the enforcement action
For those who care to peruse it, here are the responses to the Wells Notice that Goldman Sachs received last September. The response was filed by lawyers at Sullivan & Cromwell, outside counsel for Goldman Sachs, also in September.
Over at ZeroHedge, anti-Goldman blogger Tyler Durden offers his rebuttals to the Wells responses. Somewhere, somebody will make book on the case, so that we can all place bets on the outcome. At this moment, I would predict a small settlement (less than $100 million) before the end of the year.
GS stock closed up a couple of points today.
Also, Bloomberg reports that the vote at the SEC to sue Goldman was split 3-2 along party lines, with both Republicans voting no.
Eliot Spitzer, who knows something about the intersection of the worlds of politics and finance, and the, er, resulting intercourse, says that the timing of the filing of the suit by the SEC was not a coincidence.
Democrats in the House pile on, seeking a criminal inquiry, and the Senate Majority Leader slaps around the Senate Minority Leader for being so obtuse as to have had a recent meeting with Wall Street executives.
It is interesting that Democrats believe that there is a great deal of political hay to be made by using Goldman as a whipping boy. I suppose that Democrats are counting on the long-outdated stereotype of Wall Street as a bastion of Republican conservatism. As long as this link at OpenSecrets doesn't go down the memory hole, informed Americans might view this as an intra-family spat.
UPDATE: My apparent agnosticism on the enforcement action should not be mistaken for a "blind spot." If anything, I am disappointed that the case does not appear that strong, and that the SEC chose it as its first move in dealing with the securities aspect of financial crisis, in what should be its strongest case -- but, at best, it provides the most political theater and ammunition, in my cynical view.
On CNN tonight, Michael Lewis (author of "The Big Short") expressed the view that he has no idea whether Goldman violated the '33 or '34 Acts, but the better question might be why banks create synthetic securities for clients and then participate in a long or short position in that security for more than a moment in time (i.e., when an investment bank underwrites an equity offering, it is necessarily long that position for a brief period, until the new shares are fully distributed). Lewis is advocating consideration of the Volcker Rule, which would partly restore the agency model on Wall Street. The casino would still be open, it just would not be attached to large financial institutions. The theory is that the blow-ups would then be 1998 LTCM-sized conventional bombs, not 2008-sized hydrogen bombs. I will defer to others such as co-blogger Mindles H. Dreck, with vastly more experience in fixed income and/or structured finance, to point out the dangers of the wrong kind of new regulations for derivatives -- we don't want our generals preparing for the last war -- which is not the same thing as advocating no regulations.
STILL MORE (from TigerHawk): It will be interesting to see whether this book
about John Paulson and "the greatest trade ever" holds up, or indeed supports the case against Goldman. Anybody here read it?50 Comments:
By 
, at
Mon Apr 19, 07:36:00 PM:
I would like to see more explanation of Paulson's role in the securitization. This seems quite bizarre.
I see no defense. If it's not illegal, it ought to be.
I can't see on any plausible theory how this is correct.
This has nothing to do with timing. That's all beside the point. Did Paulson have a role? If so, throw the book at them.
By , at
Mon Apr 19, 07:39:00 PM:
LOL. Asking Eliot Spitzer any question in any forum, and citing to him, is nigh well absurd. He has been so thoroughly discredited, for good reason, that I'm surprised anyone cares what he says.
By 
MTF, at
Mon Apr 19, 08:04:00 PM:
It's always tough to keep up with the split threads around here but for what it's worth we've been discussing these documents in the other thread.
By , at
Mon Apr 19, 08:46:00 PM:
Republicans, including the writers of this blog, seem to have a blind spot a mile wide when it comes to misdeeds in the financial sector. I can't understand it.
Let's be very clear: in exchange for a hefty fee from Paulson, Goldman allowed Paulson to structure a CDO that his research indicated would fail specifically so that he could short it. Goldman then packaged the CDO and sold it to dumb investors without disclosing to the dumb investors that Paulson structured the CDO and was shorting it. The CDO failed. Paulson scored a cool billion on the short and the dumb investors lost lost a cool billion on the long.
At minimum Goldman's role oozed with sleaze. Whether it was fraud within the meaning of the '33 or '34 act may turn on the technicality of whether Goldman had a duty to disclose Paulson's role to the dumb investors.
The Obama administration may have been holding this card for months. So what? The Bush administration handed them the card to hold. Where the Hell was the SEC from 2004-2007 while these deals were being structured and closed?
My money bets that Blankfein takes the fifth when he visits the Hill. At that point I think he is so compromised that he has to step down. Good riddance.
I'm all for allowing financial markets to take risk, but our financial firms have morphed from agents that provide risk capital to fuel economic growth to nothing more than predatory traders. This transaction is exemplary. This transaction accomplished nothing other than to transfer wealth from the purchasers of these CDOs to Paulson and Goldman. No jobs were created. No one started a company to chase a cure for cancer or build a better cell phone. This was a pure financial play, a con that effected a wealth transfer. The perception that Republicans are willing to let this go by with a wink and a nod is a kiss of death for the party.
By Bomber Girl, at
Mon Apr 19, 09:22:00 PM:
I feel it incumbent upon me to point out the best headline of the day from ZeroHedge: EU sues Goldman for volcanic ash fallout.
:)
Now, back to our regularly scheduled programing.
By Kinuachdrach, at
Mon Apr 19, 10:34:00 PM:
"dumb investors lost lost a cool billion on the long."
That kind of thing tends to happen to "dumb investors". Back when the Romans were throwing Christians to the lions for entertainment, they issued the injunction: caveat emptor
Nowadays, buyers beware by paying lawyers & accountants to do Due Diligence BEFORE they invest a billion dollars.
If European bankers were too dumb to follow millenias-old Roman advice and too cheap to pay for serious Due Diligence, I for one have no sympathy for them. Doesn't make what Goldman Sachs did right, but no system devised by man can prevent a fool and his money from being separated.
By , at
Mon Apr 19, 10:37:00 PM:
Predictions:
"SEC v Goldman I" is only a preview of coming attractions. It will never settle, at least not while Lloyd and Obama are both in office. It'll likely only be a sideshow in a month.
"CDO Buyers v Goldman I to XLVII." With the SEC having broken the trail, buyers will sue Goldman on this and many other similar deals. A few other banks have similar exposure.
Other pending litigations. Last week's story in the WSJ was nearly totally wrong: banks still have a lot of exposure in still pending securities litigations. These cases are now even less likely to settle early and cheap.
Levin Senate Committee. Big casino! Lloyd has some 'splaining to do. The Committee has subpoenaed tons of stuff already. At the least, Lloyd will be made out to look a weasel. 50%/50% that he'll be forced to plead the Fifth ... because lurking in the background is ....
Andy Cuomo. The NYAG has the Martin Act -- a license to kill. Thus, Cuomo can turn any of this criminal. Cuomo will do what Obama tells him to do. Obama will order the hit, if the public gets stoked enough.
Obama already has approval of Financial Services Reform secured. The trifecta is to put all the blame for the bad economy onto Wall Street, and by extension onto George Bush, by turning Lloyd into Dr Evil. Can you say Sam Insull.
Developing .....
By , at
Mon Apr 19, 11:06:00 PM:
To Kinuachdrach,
1) On the law, you're wrong. Our securities laws are more "seller beware." There's reasons for this. I'll explain, if you don't think this self-evident.
2) The US created a multi-trillion dollar mortgage securitization regime that relied heavily on rating agencies. When you buy stuff that says "AAA" you're not supposed to have do much diligence -- that's the point of it. But we fucked this up royally. If we don't get this corrected, we'll never get our mortgage market righted.
3) To get this righted, Goldman shouldn't get a pass. I agree with Anon 8:46pm -- many here have a blind spot.
By Gary Rosen, at
Tue Apr 20, 01:11:00 AM:
The Wall Street Journal asserted quite vehemently in an editorial today (Monday) that it believes the action against Goldman has little substance. Among its points:
1) ACA, not Paulson had final say on the contents of the CDO.
2) The investment was a so-called "synthetic" CDO which has a short side intrinsic to the transaction and the investors had to have known this was the case (i. e. that somebody was shorting it but not necessarily who). This is where I'm totally out of my league.
3) Paulson was not a big enough player at the time for it to have made a difference to the long investors even if they had known who it was (as opposed to, say, Warren Buffet as hypothesized by the WSJ).
4) Goldman itself lost money playing the long side of the transaction.
As I've said before I'm a babe in the woods on this stuff so I have no clue as to how substantive these arguments by the WSJ are, but I bet some of the others here have their own opinions.
By Gary Rosen, at
Tue Apr 20, 01:17:00 AM:
To clarify a point in my post above, the Journal of course didn't place Warren Buffet within a million miles of this deal, they just cited him as an example of a successful, respected investor whose position might have influenced others.
By , at
Tue Apr 20, 01:41:00 AM:
@ Gary:
As to point 1: My understanding is that this is accurate but incomplete and misleading. Paulson picked a set of securities, from which ACA chose a subset. Paulson defined the universe in which the game was played.
As to point 2: The key piece of information withheld was that Paulson, the person who defined the universe, was also the person shorting. Would you not consider that information material?
As to point 3: I don't see how this is relevant. Again, the critical omission was that the person who designed the portfolio was shorting it. Big, little, who cares.
As to point 4: Goldman allegedly lost $3 million on the long side, but Paulson paid them $15 million to structure the portfolio. Goldman is up $12 million out of the chute. I do not know, but I suspect Goldman shorted the Hell out of Abacus 2007 too. I would have.
It's pretty shocking how fast this PoS CDO unwound. In less than a year it was all over. From the complaint:
"The deal closed on April 26, 2007. Paulson paid GS&Co approximately $15 million for structuring and marketing ABACUS 2007-AC1. By October 24, 2007, 83% of the RMBS in the ABACUS 2007-AC1 portfolio had been downgraded and 17% were on negative watch. By January 29, 2008, 99% of the portfolio had been downgraded. As a result, investors in the ABACUS 2007-AC1 CDO lost over $1 billion. Paulson’s opposite CDS positions yielded a profit of approximately $1 billion for Paulson."
To his credit, Paulson called the trade exactly right.
Another interesting tidbit: Paulson approached Lehman, but they refused to do the deal because it was considered unethical.
By Gary Rosen, at
Tue Apr 20, 02:09:00 AM:
According to the WSJ, Goldman lost $90 million on ABACUS.
By , at
Tue Apr 20, 06:47:00 AM:
"Paulson approached Lehman, but they refused to do the deal because it was considered unethical."
I heard Bear Stearns too. Both logical choices. Paulson had worked at Bear.
By , at
Tue Apr 20, 07:01:00 AM:
Re: Financial Services Reform. Obama will get it approved, and mostly on his terms. I fear that it won't solve the real problem: that we can either (1) allow casino banking, or (2) enable "too big to fail", but having both just invites another crisis, probably within the next decade.
On regulating credit default swaps, isn't the following correct?:
They should have been regulated as insurance products -- with capital requirements -- all along. I'd love to run an insurance business without any capital regulation. It's a license to print money .... until the hurricane hits.
It's insane that the likes of Goldman are still doing what they do now that they're a bank holding company. Lloyd & Co can't have it both ways. They got their bacon saved with the bailout -- that should never happen again.
By Robert Arvanitis, at
Tue Apr 20, 07:35:00 AM:
Government is incompetent to regulate financial markets, much less micro-manage the economy.
The only possible role for government is to enforce the premises of free markets (many small, independent agents, free flow of information, no subsidies, tariffs or other distortions; no monopolies; and no "too big to fail"). Then we let the markets operate, rewarding winners and punishing losers.
Instead, government in its vanity tries to manage where it is unfit. Regulations invariably create not only unintended consequences, but outright contradictions. In math terms, the equations are over-determined. Thus the best minds are drawn to regulatory arbitrage, which has far greater profit that real business.
Even worse, the regulatory edifices created by government invite, nay beg for, regulatory capture. Only when there is a large bureaucracy in place, is it profitable to seduce and suborn it. (Here only Goldman had the foresight to have its very own Treasury Secretary.)
And then, when it all goes bad, the answer is not a chastised modesty and withdrawal to enforcing the premises. No, the answer is always yet more regulation, offering up yet more arbitrage opportunities, and new apparatus for capture. Case: What was the price to auditors for failing to find Enron's fraud? Why, yet more work under the useless Sarbanes-Oxley.
The feedback mechanisms are misaligned, designed to hold no one accountable, to give each player maximum flexibility and minimal responsibility.
By , at
Tue Apr 20, 07:47:00 AM:
Previews of coming attractions, indeed:
"It is “not beyond the realm of comprehension” that Goldman Sachs misled investors on collateralized debt obligations apart from the one cited last week by the Securities and Exchange Commission, Democratic Representatives Elijah Cummings and Peter DeFazio said in a letter to be sent to SEC Chairman Mary Schapiro. AIG, rescued by the U.S. in 2008, insured about $6 billion of Goldman Sachs CDOs named Abacus.
“Should any of these transactions be found to include fraudulent conduct, any resulting contractual payments from AIG- issued credit-default swaps could be viewed as ill-gotten gains,” Cummings and DeFazio wrote. “It is imperative that the SEC pursue the recovery from Goldman Sachs of any fraudulently obtained AIG payments.” "
Expect this to be dug into at the Levin Committee.
Pigs get slaughtered ....
By TigerHawk, at
Tue Apr 20, 08:28:00 AM:
First time I remember agreeing with Eliot Spitzer!
By Cardinalpark, at
Tue Apr 20, 08:34:00 AM:
There is an amusing quality to the cognitive dissonance people suffer when they wrestle with the amorality of finance.
Investors are either stupid if they lose money (sometimes its alleged to be criminal stupidity) or venal and dishonest (again criminally) if they make it. But either way it's resented. How peculiar. Too many lawyers.
Let's try this.
Goldman positioned a trade - a synthetic CDO. ACA and IKB, and it seems Goldman (whether by accident or on purpose) took the long side, Paulson the short. Paulson may have selected a universe, but ACA had just as much diligence and selection opportunity. Even moreso than Paulson. And they didn't have to play. ACA met with Paulson. The market was cracking already (the Bear Stearns mrtage hedge funds were already publicly cratering). By the way, Paulson had raised a new fund who's entire marketing pitch was shorting this crap. It wasn't a bloody secret.
The whole thing is a bit absurd to tell you the truth. No widows or orphans. No retail schmucks. Just grownups on both sides.
If ACA had been right and Paulson wrong, who would get sued then?
This isn't a blind spot - for the person who made that observation. It speaks to the frivolity of our regulatory system. Its built for politics, not effectiveness. Madoff navigates the regulatory system, literally ripping people off in as thorough a fraud as is humanly imaginable, the SEC has it reported to them repeatedly and either won't or can't figure it out. and here they launch what is a remarkably weak case which doesn't purport to really accomplish squat in terms of investor protection.
If ACA and IKB were properly aggrieved and felt they had a case, why didn't they launch it?
Because it's not serious. They don't have a case. It's theater.
Full disclosure, I'm a formner Goldman employee, left in 98, manage an investment business. I have a fairly simple view of regulatory lawyers. They dream of making their careers taking down somebody important. That's it. They have a tremendous incentive to try.
By , at
Tue Apr 20, 09:13:00 AM:
Exactly. They built a product and found a market for each side of a trade. Perfectly straightforward, legal and honest.
It was obvious to each side of the deal that there were others on the other side of the trade. Goldman made money, as they should.
This is a particularly ham-handed political persecution, pure and simple.
Now, having said that I venture to guess that Goldman doesn't object to these sorts of prosecutions. They are willing to pay the occasional fine, probably thinking of it as a sort of tax the politicos exact every now and then. After all, Goldman plays at a political level themselves, and the company understands that every now and then the government wants their piece of the action; it's a reverse rent-seeking of sorts.
What they probably most object to is the assertions that they somehow "cheated" clients. That hurts, and it affects their ongoing ability to conduct business. If the SEC wants money from Goldman, that's one thing-- the agency is certainly free to trump up some charge or another and collect. They hardly have any idea what they're doing anyway, so Goldman would probably help them if necessary in making whatever regulatory point they want to make. But the SEC will have to somehow back down from this reputation bashing.
Instead of attacking Goldman over a transaction where both sides knew exactly what they were doing at all times, the SEC should busy themselves trying to attack real crime, like the Bernard Madoffs of the world, that affect average investors, people who very much do not know what they are doing in investments and are taken advantage of every day. This is ridiculous, even sort of uncomfortably embarrassing to watch, like a bad TV drama.
By , at
Tue Apr 20, 09:55:00 AM:
The last two comments miss the bigger picture, I submit respectfully. This isn't just about the one ABACUS deal, I expect. In a month, we'll know.
There's a lot of anger out there. Obama wants to put it on Wall Street. Lloyd and Goldman -- in their arrogance -- have set themselves up. Fuck 'em.
There will be lots of collateral damage, unfortunately.
By Kinuachdrach, at
Tue Apr 20, 10:07:00 AM:
Mad as Hell said: "When you buy stuff that says "AAA" you're not supposed to have do much diligence -- that's the point of it."
OK -- then the object of the SEC's righteous wrath would logically be the ratings agency which issued the (inappropriate) AAA rating. But instead, the SEC is going after Goldman Sachs.
Obviously, mis-representation is morally wrong and should be (usually is, except in politics) legally wrong. But this case seems to have involved serious players on both sides who were supposedly capable of taking care of their own interests, not little old ladies buying securities from smooth-talking door-to-door salesmen.
The reputation that should be damaged here is that of the European banks, which did such a poor job of looking after the money with which they had been entrusted. Any lawyer want to consider an action against those European banks?
By MTF, at
Tue Apr 20, 10:10:00 AM:
No, I see the bigger picture (for some reason my comment registered as anonymous). It's clear as day, even if it remains to be seen if the Democrats will pull it off and successfully distract the voters by blaming the banks for all our troubles. It's a classic strike back when politicians want to distract the voters from their own failures, to blame the banks and the bankers. We are awfully close to seeing them bring some antisemitic themes into the fight.
The merits of the specific complaint against GS still is worth exploring, though only tangentially to this bigger picture, and that's what I was doing.
By , at
Tue Apr 20, 10:44:00 AM:
@ CardinalPark
>> Goldman positioned a trade - a synthetic CDO. ACA and IKB, and it seems Goldman (whether by accident or on purpose) took the long side, Paulson the short. Paulson may have selected a universe, but ACA had just as much diligence and selection opportunity. Even moreso than Paulson. And they didn't have to play. ACA met with Paulson. The market was cracking already (the Bear Stearns mrtage hedge funds were already publicly cratering). By the way, Paulson had raised a new fund who's entire marketing pitch was shorting this crap. It wasn't a bloody secret.
1. That description of the facts is not consistent with facts being reported in the press. Goldman did not simply act as an intermediary to arrange a trade between one party (Paulson) who wanted to short an instrument and another party who wanted a long position. Rather, Goldman created a structured finance product which it sold to third-party investors, primarily ABN Amro and IKB.
2. Your post seems to imply that ACA was one of the major purchasers of the structured product. That does not appear to be correct. The two major purchasers were ABN and IKB. I am confused by your characterization of the roles of the parties.
3. Paulson paid Goldman for the privilege of defining the set of securities from which ACA, the selection agent, was permitted to select the securities that went into the portfolio.
4. Goldman was aware that Paulson intended to short the product.
5. Goldman failed to disclose to the third party investors, ABN and IKB, that Paulson, whose interests were directly contrary to the interests of ABN and IKB, influenced the selection of the portfolio.
6. Federal securities laws are based on disclosure of material information. Goldman's failure to disclose is the basis of the SEC action.
If the facts were as you presented them, namely that ACA was the party on the other side of the trade, I would agree with you. I think you have your facts wrong, which has led you to characterize this as a simple trade. It wasn't.
By all means feel free to correct me if you think I am wrong.
By MTF, at
Tue Apr 20, 10:47:00 AM:
Todays WSJ reminds us of who really should be paying the piper for our financial meltdown.
By , at
Tue Apr 20, 10:58:00 AM:
"then the object of the SEC's righteous wrath would logically be the ratings agency "
It should be, in an ideal world. But the rating agencies are getting a big pass. We can survive with a gelded Goldman, but we can't survive the rating agencies going down... seems to be the thinking. The SEC is literally re-writing Regulation AB right now to require the data to allow independent diligence on securitizations. Old Reg AB was rating dependent. ... closing the barn door.
"not little old ladies buying securities from smooth-talking door-to-door salesmen."
The Europeans -- and others -- can rightly say they were ripped off. 1) They were told AAA ... but got CCC. 2) But it's really about "conflicts" and the lack of disclosure of same. This is where Goldman has gone wrong, not just with ABACUS.
"no justice ... no peace"
We'll get neither, unfortunately. But excusing Goldman is a losing game plan.
I have WABC 770 on in the background. It's the local Rush Limbaugh channel in NYC. The guy who came on at 10 am wants to blow up Goldman and salt the ground. This is the local arch anti-Obama radio station -- not Air America. Wall Street -- and Goldman -- have a real problem here. Obama's playing this hand to his advantage, but others handed him the cards.
By MTF, at
Tue Apr 20, 02:30:00 PM:
I'd like to chime in here, if I may.
"Goldman did not simply act as an intermediary to arrange a trade between one party (Paulson) who wanted to short an instrument and another party who wanted a long position. Rather, Goldman created a structured finance product which it sold to third-party investors, primarily ABN Amro and IKB"
Those are the same things: the distinction you draw has no difference.
GS found parties who had opposing views of the future value of the types of securities in question. Via a process acceptable to all sides, the bank constructed a (synthetic) portfolio and one group took one side of the trade and another the opposing view. An everyday occurrence.
The SEC argues that John Paulson's name was a material fact in the deal, as was the fact that he had some input into the construction of the actual portfolio of underlying assets (forget the "synthetic" part for a moment). The other side of the trade could have rejected the process or the individual assets, and not chosen to participate, but did not do so.
By the way, there is no evidence yet seen in the press that those investors didn't themselves hedge all or part of this risk, or enter into the transaction in question as a hedge for something else. That is a question for another day. The only material fact is that these were highly sophisticated investors who willingly entered into this trade for reasons of their own. They are not Madoff investors who depend on the SEC to do certify the characters of the firms and people with whom they choose to do business.
Goldman argues that Paulson's name was not material and that his involvement in the specific assets under discussion was similarly not material.
These are questions of fact, not opinion, and GS is confident they have the factual basis pretty solidly in hand. Since the SEC has never brought this sort of prosecution before, and talked but little to GS in bringing this one, I'd guess the SEC has a steep hill to climb.
From my years in investment banking (not securities law) and personal investing this looks like an everyday, normal series of events (so far). My opinion may not be worth anything to you, and I could obviously be wrong; these can be complicated deals and we only are seeing what the SEC wants us to see so far. But if this is all they have got against Goldman I wish them good luck, because it looks like a colossal loser of a case to me.
By PD Quig, at
Tue Apr 20, 03:29:00 PM:
I'd say that any politician receiving $10,000's from the financial services industry has a blind spot. That would include the King of the Blind--Barack Obama ($954K from GS alone), The Keeper of the Holy Brail--Chris Dodd and Jack of Hearts--Barney Frank...and, yes, a lesser bunch of Republicans as well.
I'm sure Anonymous #1 just forgot to address how the Dems stopped the Bush Administration efforts to Raines-in out of control Democrat playthings Fannie and Freddie. Barney said the Bushies were attempting to 'destroy affordable housing.' I also didn't read his discussion of Jamie Gorelick's and Rahm's roles in those $400 billion dollar (and counting) failures.
By , at
Tue Apr 20, 06:42:00 PM:
@ MTF
Appreciate your perspective. Thanks.
>>Those are the same things: the distinction you draw has no difference.
From a legal perspective, offering securities for sale is definitely not the same thing as brokering a trade. Offering securities for sale triggers legal obligations under 10(b) to disclose all material information relating to the securities. Big difference.
>> GS found parties who had opposing views of the future value of the types of securities in question. Via a process acceptable to all sides, the bank constructed a (synthetic) portfolio and one group took one side of the trade and another the opposing view. An everyday occurrence.
Your position that the process was "acceptable to all sides" is not accurate, or at least not complete. Goldman withheld from ABN and IKB a key element of that process, namely that the universe of underlying mortgage obligation securities from which the CDO was structured was selected by Paulson, and that Paulson had shorted the portfolio through Goldman.
I understand your position that ABN and IKB knew (or should have known) that someone was taking a short position on the CDO, but I don't find it compelling. To use a boxing metaphor, every boxer knows going into the ring that there are some fans betting against him. But Paulson wasn't just another fan. He was more like the referee, or at least like the promoter who hired the ref.
>> The SEC argues that John Paulson's name was a material fact in the deal, as was the fact that he had some input into the construction of the actual portfolio of underlying assets (forget the "synthetic" part for a moment). The other side of the trade could have rejected the process or the individual assets, and not chosen to participate, but did not do so.
I'm not sure the SEC considers Paulson's name as being all that significant. Rather, I believe it is because Paulson had input into selection of the underlying assets. And again, from a legal perspective the issue is not whether ABN and IKB could have rejected the process. The issue is whether Goldman made a full and complete disclosure of the material facts in their possession about the securities in the CDO. They did not.
I am not an investment banker. I am an attorney, but do not practice securities law and know only enough about the topic to be dangerous. I have to admit I am completely blown away by the position that you, CardinalPark, and to a lesser extent Escort81 and TH take on these issues. There are similar duties of disclosure in my technical practice area an in discovery procedures. Without question, I would get censured or disbarred for failing to comply with disclosure requirements in a manner analogous to Goldman's failure.
Again, I appreciate your perspective, but after reading your comments and the comments from Gary, CardinalPark, Escort81, and TH I confident that Goldman is going to lose on this one, assuming they get before a jury. To Joe the Plumber on the jury Goldman pulled the old sawdust in the transmission trick on the used car lot. As an attorney, I have to admit that it would be a lot of fun to listen to Goldman's counsel explain to a jury just why Goldman didn't have to tell their clients that the car they just bought was a clunker with sawdust in the transmission and would die as soon as they drove it off the lot.
I'm a pretty free market oriented guy, but our securities markets are not completely free markets. They are qualified free markets, and the qualification is full and complete disclosure of material information by the issuers of securities.
Thanks again for your comments. I learned a lot in this exchange.
By Bomber Girl, at
Tue Apr 20, 07:34:00 PM:
This is from the Interfluidity piece on the topic and seems to blow a hole in this excuse that there is always someone on one side and someone on the other and it's just part of the business that doesn't need to be disclosed:
"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."
As a salesperson, I never sold CDOs so can't speak to them professionally (and I'm sure all the lawyers in this crowd will correct me) but as just your typical old salesperson - capable of passing basic securities law exams - to me it seems that this deal was structured for Paulson and it was material information what his position in it would be. It would seem to be both unethical and bad business to treat the other side of the trade that way, even if GS manages to legally wiggle out of the charges. No matter how much disclosure they did, they sure missed that "little detail".
By Kinuachdrach, at
Tue Apr 20, 09:14:00 PM:
"Typically there is no identifiable “seller”."
First -- a great big thank you to everyone who has contributed to this thread. Really informative.
I am (fortunately) not a lawyer, but I may be representative of the kind of person in the jury pool. If a lawyer tried to argue that there was no "seller", he would have just lost all credibility with us ordinary Joes in the jury box. Peter can't buy something that isn't being sold by Paul.
And the purchaser was ABN -- an organization of such incredible incompetence that its collapse managed to bring down the once-fabled Royal Bank of Scotland! There is clearly a pattern of greed/shortsightedness/incompetence on the buyer's side.
Now those politically well-connected Europeans are seeking to have their Administration puppets win a regulatory judgement against Goldman Sachs to prepare the way for the sore-loser Europeans to sue to get back the money they gambled & lost.
I can imagine a closing speech to the jury that would would be remembered as long as Bryan's "Cross of Gold"!
By Bomber Girl, at
Wed Apr 21, 06:39:00 AM:
K: I agree with your reflection on the use of the word "seller"; I think what the author/blogger was trying to get across (and it is more clear in the longer piece) is that most of these deals are structured with a selected set of securities that meet certain criteria...and the issue here is the key criteria was the preference of one particular non-disclosed participant.
By Cardinalpark, at
Wed Apr 21, 08:30:00 AM:
Anon above - your facts are wrong. ACA was the selection agent and a huge buyer. ABN intermediated a swap.
You should read the Goldman responses to the SEC Wells notices. The facts are incredibly clear. TH posted them further on. They're a good read (S&C is a great law firm).
By Bomber Girl, at
Wed Apr 21, 09:25:00 AM:
Interestingly, in today's press, GS seems to bolster (or at least acknowledge) the SEC's case: “It’s all going to be a factual dispute about what he remembers and what the other folks remember on the other side,” Greg Palm, Goldman Sachs’s co-general counsel, said in a call with reporters yesterday, without naming Tourre. “If we had evidence that someone here was trying to mislead someone, that’s not something we’d condone at all and we’d be the first one to take action.”
While on the other hand, it has been alleged by CNBC that a Paulson employee did in fact make ACA aware of its intentions....which would shoot down the material non-disclosure case.
These guys should really talk. Just sayin'.
By MTF, at
Wed Apr 21, 10:02:00 AM:
To Anon:
"Your position that the process was "acceptable to all sides" is not accurate, or at least not complete. Goldman withheld from ABN and IKB a key element of that process, namely that the universe of underlying mortgage obligation securities from which the CDO was structured was selected by Paulson, and that Paulson had shorted the portfolio through Goldman."
This is your judgement, and not demonstrable fact. Goldman's position, and also Paulson's position (and since his firm is a cooperating witness it is probably, eventually, the SEC's position) is that Paulson did not select the portfolio. Here's Paulson's public statement saying exactly that.
It is worth remembering a key fact about the period. At the time mortgages were the safest of safe investments, and these securities were rated AAA. In hindsight you can say that the world should have known better, but Paulson was a brave man to step up and place an enormous bet against the mortgage market. Everyone on the long side probably thought they had found an easy mark in Paulson, who at the time was just another hedge fund manager, just as a superficial point.
Unless the government has more than I've read about so far I just don't see the problem.
I was never employed at GS, competed against them and disliked the firm. I have no skin in this game at all. Moreover, I'm strongly in favor of trying to reform the SEC, in an effort to resolve their bungling missteps over the last several years. The Bush Administration provided essentially no leadership to the agency and obviously allowed mediocrity to become the peak expectation there. But this case looks so far like a very bad start back to respectability.
By MTF, at
Wed Apr 21, 11:23:00 AM:
WSJ makes some similar points, quoting Paulson.
By MTF, at
Wed Apr 21, 12:03:00 PM:
Megan McArdle politely sniffs at the "weak" SEC case, even while supporting some financial reform.
By , at
Wed Apr 21, 04:12:00 PM:
I have a post above that reaches a provocative prediction about what to expect next week. You can get to it here
By , at
Wed Apr 21, 04:30:00 PM:
@MTF
>> This is your judgement, and not demonstrable fact. Goldman's position, and also Paulson's position (and since his firm is a cooperating witness it is probably, eventually, the SEC's position) is that Paulson did not select the portfolio. Here's Paulson's public statement saying exactly that.
I don't mean to pick nits here, but I did not say that Paulson picked the securities in the portfolio. I said that Paulson picked a set of securities from which ACA selected a subset. I do not believe any of the parties are disputing the fact that Paulson selected the universe of securities from which the CDO was constructed.
Yes, Paulson will maintain that he did not select the portfolio and that ACA had final selection authority. Based on the facts, I do not find that argument remotely credible or persuasive, nor do I believe a jury will buy that argument. Moreover, his involvement in establishing the CDO certainly appears to be material to the securities and should have been disclosed.
Again, I appreciate your perspective on this. I have learned a lot.
By MTF, at
Thu Apr 22, 08:12:00 AM:
But, again, if you read the news reports you see that isn't the case. The portfolio did include a significant number of mortgages he wanted but not all and the portfolio included securities he did not want or suggest. Moreover, Paulson expressly informed ACA that his purpose in working with Goldman was to specifically find a set of mortgages that he could short. Everyone knew what the deal was here: ACA, Goldman, and the investors on the other side.
They all seem to have thought Paulson was a chump. If they were at anytime concerned he was right and they were wrong, they could have not closed the deal or-most importantly- they could easily have hedged their trade after the fact. They did not: not ACA, not Goldman, and not the investing banks. A second mistake for them, but also one that conclusively proves the strength of their own intentions in this deal.
You are right about one thing though, in my own opinion, and that is that this is a nit. All of the securities had to be acceptable to him, to the other side and to ACA. All of them. That's inherent in the construction of a deal. On top of that, all the terms of the structure of the instrument also had to be mutually agreeable. That's how you get a deal closed.
In this instance, it seems to me the SEC is trying to argue that simply because he was right in his view of the future of those mortgages and the other side was wrong, Goldman somehow did something reprehensible in constructing the pool, or even (as the Democrats are now saying) criminal. You called it: this is a nit. To me, so far, it looks like a ridiculous nit of a complaint.
By MTF, at
Thu Apr 22, 10:08:00 AM:
CNBC reports on all these points, and more, providing damning evidence that the SEC has again screwed up royally.
Let's move away from the SEC mess for a moment, and get to the larger issue. Demonizing banks is a time tested strategy for failing regimes and as MAH has said repeatedly in this thread there is a welcoming audience for this kind of politics in America right now. You can see that in the comments on this very thread. No one likes rich banks or bankers, and there is something vaguely distasteful in the profession that has, over the stretch of history, made the industry a frequent target. Politicians will exploit that.
But if the administration and the Democrats continue down the path of making bankers the enemy the strategy looks more and more like demagoguery, pure and simple. The Democrats llok like they are using the power of state action against citizens and businesses. If this continues we are in deep doodoo. Even supporters of the administration should be frightened if this continues.
By MTF, at
Thu Apr 22, 10:19:00 AM:
Probably no one is reading this thread anymore, but if you do read this you should definitely listen to the entire CNBC report. It takes the SEC case down completely. There's even a bonus at the very end, having to do with the lack of a hedge I mentioned earlier. It turns out there was one hedge put on by one party to the deal. One player in the deal protected themselves from the downside risk that has the SEC up in arms What a great trade.
By , at
Thu Apr 22, 10:48:00 AM:
"But if the administration and the Democrats continue down the path of making bankers the enemy the strategy looks more and more like demagoguery, pure and simple."
Yes and no. I have a harangue elsewhere here with some predictions. Here's another version.
"SEC v Goldman" has turned into a "bid/ask": It was only sleazy / It was an actionable fraud.
But the SEC charges are only an opening Obama & Co gambit.
Obama gets his soapbox today. If you argue against him, you're arguing that sleaze is OK. This is demagoguery, but it's effective.
On Tuesday I predict Lloyd Blankfein will be put on the spot: He knew in 2007-2008 of systemic problems in the mortgage market. Did he try to warn us ... to stop the bleeding? No ... instead he and Goldman put on a big short. Lloyd got paid a boatload.
But late in 2008 -- when things got really bad -- Goldman orchestrated a government bailout to save their bacon.
Look, you can be a pirate like John Paulson ... or part of the plugged-in establishment. They both have a place ... but the likes of Goldman can't have it both ways. Not unless we want banana boat crony capitalism.
McCain is on Tuesday's Committee. Before the end of day on Tuesday, I predict McCain will have to be physically restrained ... lest McCain charge the bench, rip off Lloyd's leg and then beat him to death with it.
By , at
Thu Apr 22, 12:13:00 PM:
@MTF:
Again, thank you for your insights and engaging in a fact-based and reasoned analysis. My responses to your post are as follows:
>> The portfolio did include a significant number of mortgages he wanted but not all
Agreed.
>> and the portfolio included securities he did not want
Disagree. The Wells Fargo securities were removed from the portfolio at Paulson's insistence. But I agree with you that it is implicit that all parties had to agree to the ultimate portfolio contents.
>> Moreover, Paulson expressly informed ACA that his purpose in working with Goldman was to specifically find a set of mortgages that he could short.
Disagree, completely. This is the first time I have ever seen this assertion, which I do not believe is correct. To the best of my knowledge neither Paulson nor Goldman has asserted this to be fact. Do you have a source for this?
This assertion is directly contrary to the allegations and supporting facts in the SEC complaint. It appears that ACA was under the impression that Paulson's economic interests were aligned with ACA's. This is described in paragraphs 44-51 of the SEC complaint.
Further, to the best of my knowledge Goldman's response has been only to assert that they did not affirmatively mislead ACA into believing that Paulson was long.
The facts appear to be that Goldman (1) knew that Paulson was shorting the portfolio; (2) failed to provide this information to ACA or IKB; and (3) failed to correct ACA's apparent misunderstanding that Paulson was long the equity tranch of the portfolio. This was a clear omission of a material fact associated with the issuance of the securities. Such an omission is impermissible under 10(b)(5).
>> Let's move away from the SEC mess for a moment, and get to the larger issue. Demonizing banks is a time tested strategy for failing regimes and as MAH has said repeatedly in this thread there is a welcoming audience for this kind of politics in America right now. You can see that in the comments on this very thread. No one likes rich banks or bankers, and there is something vaguely distasteful in the profession that has, over the stretch of history, made the industry a frequent target. Politicians will exploit that.
I don't disagree with anything you said. My original point was was more political than legal: too many Republicans have a blind spot to misdeeds in the financial sector, which in turn allows Democrats to paint the Republican party as the party which represents Wall Street interests.
I'm an attorney but not a finance guy. I've read the SEC's complain, Goldman's defense, Paulson's letter, and assorted writing on the case. To someone outside the IB industry this case appears to be a slam dunk. It is political suicide for Republicans to step into this steaming pile of flop on Goldman's behalf.
By MTF, at
Thu Apr 22, 12:38:00 PM:
You are misstating the facts, as they have been described in the press and most recently by CNBC. There you will find reporting that directly contradicts your assertion inthe two instances where you say you disagree. I encourage you to view the video, where you will hear my points repeated and specifically supported.
By , at
Thu Apr 22, 12:57:00 PM:
"It is political suicide for Republicans to step into this steaming pile of flop on Goldman's behalf."
Agreed.
Obama & Co have a real talent at "managing the narrative." Today, Obama is literally on a soapbox at NYC's Cooper Union. If you disagree with him today, you're going to look awfully wrong after the "revelations" we're going to hear during the Senate Investigations hearing this coming Tuesday, I suspect. This is by design.
Sadly, we need "financial services reform" but I'm skeptical that we're going to get the right prescription.
"I encourage you to view the video, where you will hear my points repeated and specifically supported."
MTF, you may be right. Or there may be spin going on. But I've lost interest in SEC v Goldman, per se. By the time we see motion papers, the world will mostly have moved on. There will be legislation -- there will be a lot more litigation. SEC v Goldman will be a side show. Goldman has already lost if the bid/ask is "they were sleazy" / "they committed fraud."
By MTF, at
Thu Apr 22, 02:47:00 PM:
I agree with both of you in this instance, in that there is nothing for Republicans go gain in defending Goldman Sachs. I saw a Rasmussen poll today saying an astounding 75% of Americans are pretty sure GS is guilty of something. Goldman plays at a political level and knows full well that every now and then they will face enforcement actions, even be scapegoated a bit. And I have no problem with that. It's having Goldmans reputation pilloried that doesn't feel right to me in this instance.
This case will settle for all the reasons discussed above, and GS will be happy to just end the misery, but you can't help but think they will spend a lot of time trying to get the SEC enforcement division to rectify this problem. Good luck with that!
By , at
Thu Apr 22, 04:10:00 PM:
"It's having Goldmans reputation pilloried that doesn't feel right to me in this instance."
Why? They asked for it. That's one of my points.
Here's the witness list for Tuesday, recently announced. The Fabulous Fabrice will get quality face time with the Big Boss.
I've become Johnny One Note, I know ... but this witness list is consistent with my thesis that this hearing will be "Goldman on trial" ... Developing......
Panel 1
DANIEL L. SPARKS
Former Partner, Head of Mortgages Department
The Goldman Sachs Group, Inc.
MICHAEL J. SWENSON
Managing Director, Structured Products Group Trading
The Goldman Sachs Group, Inc.
JOSHUA S. BIRNBAUM
Former Managing Director, Structured Products Group Trading
The Goldman Sachs Group, Inc.
FABRICE P. TOURRE
Executive Director, Structured Products Group Trading
The Goldman Sachs Group, Inc.
Panel 2
DAVID A. VINIAR
Executive Vice President and Chief Financial Officer
The Goldman Sachs Group, Inc.
CRAIG W. BRODERICK
Chief Risk Officer
The Goldman Sachs Group, Inc.
Panel 3
LLOYD C. BLANKFEIN
Chairman and Chief Executive Officer
The Goldman Sachs Group, Inc.
By Cardinalpark, at
Thu Apr 22, 04:53:00 PM:
If anyone is still checking this thread --
Paolo Pellegrini, formerly John Paulson's partner (now uberrich and started his own hedge fund), has now publicly stated that he (Paulson's rep at the time) told ACA they were shorting Abacus. And he says he testified as such to the SEC.
Good night case.
By MTF, at
Thu Apr 22, 07:00:00 PM:
Yes indeed.
Check out the CNBC video from this morning CP, it nails the door shut even more firmly with more recent information.
By Claudia, at
Mon Apr 26, 01:58:00 AM:
Well being new here I don't know what is the discussion about??
Can somebody help on this?
Stretch Marks
