Musings On The Goldman Sachs CDO Complaint: The $1 Billion Technicality That The SEC Missed?

18th Apr '10 by Andrew Butter

2 comments 2304 reads

Goldman Sachs is “vigorously” protesting their innocence against the SEC complaint. Here is their second press release: http://finance.yahoo.com/news/Goldman-Sachs-Makes-Further-bw-754781372.html?x=0&.v=1

Of course they are correct; there is no case to answer and unless the politicians can get to the Judge, it will likely be thrown-out at the first hearing. A CDO is a wager between two consenting adults. In this case the “long-end-of the stick” was betting $1 billion that US house prices would go on going up forever, the “short-end-of-the stick” (held by John Paulson) was betting $15 million that wouldn’t happen. Everyone knew what they were doing and all disclosures of fact were perfectly in accordance with all SEC and other regulations. No one “pressurized” ACA Management to do something stupid, and in any case they were “professionals”, so even if they did, they should have made the right call, and no-one “pressurized” Moody’s to stamp AAA on its backside either. Paulson won the bet; the odds interestingly were 66.6 against – the Antichrist number; that’s pure Wall Street; the value of anything is what you can get someone dumber than you to pay; so much for “God’s Work”.

But there is one little weak point in Goldman’s story which the SEC appears to have not noticed. Nothing to do with Monsieur Tourre; who simply remarked to a friend, what everyone knew in Goldman, which was that house-prices were tanking and so was the financial system.

It’s got to do with motive.

Goldman said:

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.

Well that’s true, up to a point, Paulson was “in the market”, and if he hadn’t bought CDS (shorting the housing market) from Goldman starting late 2005 or early 2006 he had been sleeping, and all the evidence is that he was not.Other people had been buying CDS from Goldman including Michael Barry, who was the guy who worked everything out, Greg Lippmann learned the “trade” from him; its quite probable John Paulson either learned the trade, or picked up clues from Burry. You can read all about that in “The Big Short”, and if the SEC wants to win this thing, they will read that account with care. ^[1]

Burry…

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marben100

18th Apr '10

Of course they are correct; there is no case to answer

This is fundamentally INcorrect, from my reading. There most definitely IS a case to answer - how could the SEC have brought a case otherwise? Who will win the case remains an open question. From the article you reference:

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.

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.

These are ASSERTIONS by Goldman, not proven facts. The courts will decide whether these assertions are factual or not. A clear line of attack for the prosecution could be that the securities were SPECIFICALLY created so that Paulson & Co could short them. Had ACA & other long investors known this, would they have been likely to co-operate with Paulson & Co? Not disclosing this fact could be considered misrepresentation.

ISTM (and many others) that there is a clear case to answer and the courts will decide what was and was not within US law. Many details are yet to emerge.

Regards,

Mark

Andrew Butter

People bring cases all the time, in America they have refined that to an art form. As you correctly point out it's up to the judge to decide, and sure, perhaps the judge won't throw it out. But it doesn't look very strong to me based on the evidence they say they have, plus I don't think they will get Paulson to squeal, even if what they are saying about him is true.

Goldman were market makers - like "heavenly matchmakers" dealing with both parties, I find it inconceivable that they did not take care to stay within the letter of the law, particularly since I suspect this was not a little $15 million in fees deal for them, this was a $1 billion emergency.

But hey ..."see-you-in -court".

The main point I was trying to make is that I think that it matters a lot WHERE Goldman got the CDS that they used to construct the CDO from. If they went out and bought them in the marketplace - OK, fair enough. But if they had previously written $1 billion of "insurance" they wanted to get off their books fast, well there is something that is illegal because it would have represented a real conflict of interest against the buyer of the long position if they had not fessed up and said "this is junk we think is too hot to hold and we are going to unload it on you".

Follow the money - my view the KEY the SEC getting a conviction is finding out who owned the CDS in the pool before they went in the pool.

Musings on the Goldman Sachs CDO Complaint: The $1 Billion Technicality that the SEC Missed?

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Andrew Butter

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