MAKE NO MISTAKE, THIS IS ECONOMIC WARFARE
These thieves are worse than leaches, they contribute nothing to
society, they epitomize the love of money being the root of evil, this is most definitely
evil
Investor Who Made Billions Is Not Target of Suit
By GRETCHEN MORGENSON and LOUISE STORY
April 16, 2010
Eager
to increase his bets against subprime mortgages, the investor, John A. Paulson, canvassed firm after firm, looking for new ways to profit from home
loans that he was sure would go sour.
Only
a few investment banks agreed to help him. One was Deutsche Bank. The other was the mighty Goldman Sachs.
Mr.
Paulson struck gold. His prescience made him billions and transformed him from
a relative nobody into something of a celebrity on Wall Street and in
Washington.
But
now his brassy bets have thrust Mr. Paulson into an uncomfortable
spotlight. On Friday, the Securities and Exchange Commission filed a
civil fraud lawsuit against Goldman for neglecting to tell its customers that
mortgage investments they were buying consisted of pools of dubious loans that
Mr. Paulson had selected because they were highly likely to fail.
By
betting against the pool of questionable mortgage bonds, Mr. Paulson made $1
billion when they collapsed just a few months later, the S.E.C. said.
Investors, who bought what regulators are essentially calling a pig in a poke,
lost the same amount.
Mr.
Paulson, 54, was not named as a defendant in the S.E.C. suit, but his role in
devising the instrument that caused $1 billion in losses for Goldman’s
customers is detailed in the complaint. Robert Khuzami, the director of
enforcement at the S.E.C., explained that, unlike Goldman, the manager of the
hedge fund, Paulson & Company, had not made misrepresentations to investors
buying the security, known as a collateralized debt obligation.
“While
it’s unfortunate that people lost money investing in mortgage-backed
securities, Paulson has never been involved in the origination, distribution or
structuring of such securities,” said Stefan Prelog, a spokesman for Mr.
Paulson, in a statement. “We have always been forthright in expressing our
opinion as to the quality of the underlying mortgages. Paulson has never
misrepresented our positions to any counterparties.
“There’s
no question we made money in these transactions. However, all our dealings were
through arm’s-length transactions with experienced counterparties who had
opposing views based on all available information at the time. We were
straightforward in our dislike of these securities, but the vast majority of
people in the market thought we were dead wrong and openly and aggressively
purchased the securities we were selling.”
Still,
the details unearthed by the S.E.C. in its investigation show a deep
involvement by Mr. Paulson in the creation of the investment, known as Abacus
2007-AC1. For example, he approached Goldman about constructing and marketing
the debt security.
After
analyzing risky mortgages made on homes in Arizona, California, Florida and
Nevada, where the housing markets had overheated, Mr. Paulson went to Goldman
to talk about how he could bet against those loans. He focused his analysis on
adjustable-rate loans taken out by borrowers with relatively low credit scores and turned up more than 100 loan pools that he considered vulnerable,
the S.E.C. said.
Mr. Paulson
then asked Goldman to put together a portfolio of these pools, or others like
them that he could wager against. He paid $15 million to Goldman for creating
and marketing the Abacus deal, the complaint says.
One
of a small cohort of money managers who saw the mortgage market in late 2006 as
a bubble waiting to burst, Mr. Paulson capitalized on the opacity of
mortgage-related securities that Wall Street cobbled together and sold to its
clients. These instruments contained thousands of mortgage loans that few
investors bothered to analyze.
Instead,
the buyers relied on the opinions of credit ratings agencies like Moody’s, Standard
& Poor’s and Fitch Ratings. These turned out to be overly rosy, and investors suffered hundreds of
billions in losses when the loans underlying these securities went bad.
Mr.
Paulson personally made an estimated $3.7 billion in 2007 as a result of his
hedge fund’s performance, and another $2 billion in 2008.
He
was also treated like a celebrity by members of a Congressional committee that
invited him to testify in November 2008 about the credit crisis. At the time, none of the lawmakers asked how he had managed to set up
his lucrative trades; they seemed more interested in getting his advice on how
to solve the credit crisis.
A
Queens-born graduate of New York
University and the Harvard Business School, Mr. Paulson
went to Wall Street in the early 1980s just as the biggest bull market in
history was starting. He joined Bear Stearns in 1984 as a junior executive in the investment banking unit.
Ten
years later, he started his hedge fund with $2 million of his own capital.
During the technology-stock bubble of the late 1990s, Mr. Paulson took a
negative stance on high-flying shares and profited handsomely for himself and
his clients.
By
the end of 2008, Mr. Paulson’s assets under management had risen to $36.1
billion. In an early 2009 interview with The New York Times, Mr. Paulson talked
about his success. “We are very proud of our performance last year,” he said.
“We provided an oasis of profitable returns for our investors in a year where
there were few sources of gains.”
His
investors, which included pension funds, endowments, wealthy families and
individuals, were huge beneficiaries of his strategy, Mr. Paulson added. “They
made four times as much as we did,” he said.
Mr.
Paulson and his investment program was the subject of the 2009 book by Gregory
Zuckerman “The Greatest Trade Ever.” Mr. Zuckerman wrote that Mr. Paulson did
not think there was anything wrong with working with various banks to create
troubled investments that he could then bet against.
“Paulson
told his own clients what he was up to and they supported him, considering it
an ingenious way to grow the trade by finding more debt to short,” Mr.
Zuckerman wrote. “After all, those who would buy the pieces of any C.D.O.
likely would be hedge funds, banks, pension plans or other sophisticated
investors, not mom-and-pop investors.”
Late
last year, Mr. Paulson donated $20 million to the Stern School of Business at
New York University and $5 million to Southampton Hospital in Long Island’s
East End, where he bought a $41 million home in early 2008. He lives with his
wife and two daughters on the Upper East Side of Manhattan.
Amid
criticism of investment strategies that profited from mortgage defaults, home
foreclosures and other miseries, Mr. Paulson has also given $15 million to the
Center for Responsible Lending for a center devoted to providing foreclosure
assistance to troubled borrowers.
At the time of the donation, Mr. Paulson said
of the center and its work, “We are pleased to help them provide legal services
to distressed homeowners, many of whom have been victimized by predatory
lenders.”
A Wall Street Invention; Let the Crisis Mutate
By JOE NOCERA April 16, 2010
Can
it get any worse?
Every time you pick up another rock along the
winding path that led to the financial crisis, something else crawls out. Subprime
mortgages were sold as a way to give low-income people a chance at
homeownership and the American Dream. Instead, the mortgages turned out to be
an excuse for predatory lending and fraud, enriching the lenders and Wall
Street at the expense of subprime borrowers, many of whom ended up in foreclosure.
The ratings agencies, which rated the complex
investments that were built with subprime mortgages, turned out to be only too
happy to be gamed by firms that paid their fees — slapping AAA ratings on
mortgage bonds doomed to fail. Lehman Brothers turned out to be disguising the full reality
of its horrid balance sheet by playing accounting games. All over Wall Street,
firms pushed mortgage originators to churn out more loans that were doomed the
moment they were made.
In the immediate aftermath, the conventional
wisdom was that Wall Street had simply lost its head. It was terrible, to be
sure, but on some level understandable: Dutch tulips, the South Sea bubble,
that sort of thing.
In
recent months, though, something more troubling has begun to emerge. In
December, Gretchen Morgenson and Louise Story of The New York Times exposed the
role that some firms, including Goldman Sachs and Deutsche Bank, played in putting together investment structures —
synthetic C.D.O.’s, they were called — that were primed to blow up. They did
so, reportedly, because some savvy investors wanted to go short the subprime
market.
On Friday, the Securities and Exchange Commission dropped the hammer, charging Goldman Sachs
with securities fraud for its purported failure to disclose that the bonds that
were the basis for one particular synthetic C.D.O. had been chosen by none
other than John Paulson, the billionaire hedge fund investor, who was shorting
them.
Oh, and one other thing is starting to become
clear: synthetic C.D.O.’s made the crisis worse than it would otherwise have
been.
Remember in the months leading up to the
crisis, when the Federal Reserve chairman, Ben Bernanke, and Henry Paulson Jr., then the Treasury secretary, were assuring everyone that the
“subprime problem” could be contained? In truth, if the only problem had been
the actual mortgage bonds themselves, they might have been right. At the peak
there were well over $1 trillion in subprime and Alt-A mortgages that were
securitized on Wall Street. That’s a lot, to be sure — but it was a finite
number. You could have only as much exposure as there were bonds in existence.
The introduction of synthetic C.D.O.’s
changed all that. Unlike a “normal” collateralized debt obligation, which contained the bonds themselves, the
synthetic version contained credit-default swaps — derivatives that “referenced” a particular group of mortgage bonds.
Once synthetic C.D.O.’s became popular, Wall Street no longer needed to feed
the beast with new subprime loans. It could make an infinite number of bets on
the bonds that already existed.
And why did synthetic C.D.O.’s become
popular? One reason was that the subprime companies were starting to run out of
risky borrowers to make bad loans to — and hitting a brick wall. New Century, a
big subprime originator, went bankrupt in early April 2007, for instance. Yet
three weeks later, the Goldman synthetic C.D.O. deal, called Abacus 2007-ACI,
went through, because it was betting on subprime mortgage bonds that already
existed rather than bundling new ones. It didn’t even have to go to the trouble
of repackaging old C.D.O. tranches into new C.D.O.’s, which was also a common
practice. (Goldman has vehemently denied any allegations of wrongdoing,
pointing out that it lost $90 million on the particular Abacus deal that is the
subject of the S.E.C. complaint.)
The second reason, though, is that synthetic
C.D.O.’s gave people like John Paulson a way to short the subprime market. Mr.
Paulson’s bet against the subprime market, which famously reaped the firm
billions in profits, was the subject of a recent book, “The Greatest Trade
Ever.” Boy, I’ll say.
Both Gregory Zuckerman, the author of that
book, and Michael Lewis, who wrote the current best seller “The Big Short,”
make it clear that the heroes of their narratives — the handful of people who
had figured out that subprime mortgages were a looming disaster — were pushing
Wall Street hard to give them a way to short the market. Maybe synthetic
C.D.O.’s would have been created even without their urging, but it seems a
little unlikely. They were the driving forces.
It is important to note that every synthetic
C.D.O. required both investors who were long and others who were short. That
is, there needed to be investors who believed the “referenced” bonds would rise
in value, and others who believed they would fall. Everyone, on both sides of
the transaction, understood that. What makes it feel like dirty pool is the
allegation that Paulson & Company and Goldman Sachs were actively involved
in choosing the bonds that would be bet on — knowing they were going to be
short. In its filing on Thursday, the S.E.C. charged that Goldman never told
investors of Mr. Paulson’s involvement. “Credit derivative technology helped
people disguise what they were doing,” said Janet Tavakoli, the president of
Tavakoli Structured Finance, and an early critics of many of the structures
that have now come under scrutiny.
There appear to be other examples of this, as
well. Last week, Pro Publica, the nonprofit investigative journalism outfit, reported
how a big Chicago hedge fund, Magnetar, helped put together some synthetic
C.D.O.’s — precisely so that it could bet against them. In his book, Mr.
Zuckerman seems to have stumbled onto Abacus and similar deals. One banker, he
writes, “suspected that Paulson would push for combustible mortgages and debt
to go into any C.D.O., making it more likely that it would go up in flames.”
Which is precisely what the S.E.C. is claiming. But in his quest to lionize his
central character, Mr. Zuckerman rushes past what by all rights should have
been the most shocking revelation in his book.
Mr. Lewis, for his part, recounts a dinner,
late in the game, in which one of his heroes, Steve Eisman, is seated next to a
man who is taking the long position on many of the C.D.O.’s he is shorting.
They get to talking, and the man says to Mr. Eisman: “I love guys like you who
short my market. Without you, I don’t have anything to buy.” He adds, “The more
excited that you get that you’re right, the more trades you’ll do, the more
product for me.”
As a reader, it is hard not to love that
moment, rich as it is in irony and foreboding. The guy on the long side — who
was making investments that the housing and mortgage markets would remain
strong — is an obvious fool; Mr. Eisman, on the short side the trade, is
clearly going to be vindicated. (And, by Mr. Lewis’s account, Mr. Eisman never
“helped” a Wall Street firm pick the bonds for the C.D.O.’s he was shorting,
the way the S.E.C. says Mr. Paulson did.)
But on second reading, the passage isn’t
quite so funny. The people on the short side of those trades were truly savvy
investors, who, unlike so many others, did their homework and had insights that
made them a great deal of money. But the rise of synthetic C.D.O.’s that they
pushed for — and their ability to use credit-default swaps to short subprime
mortgage bonds — took an already bad situation and made it worse.
And here we are now, all of us, paying the
price.
Abacus Let Goldman
Shuffle Mortgage Risk Like Beads
April 17, 2010 By Jody Shenn and Bob Ivry
April
17 (Bloomberg) -- From July 2004 through April 2007, as credit markets boomed,
Goldman Sachs Group Inc. created 23 financial transactions called Abacus, the
word for a relatively crude counting tool involving the shuffling of beads.
Yesterday,
the Securities and Exchange Commission sued the bank for securities fraud in
what would be the penultimate offering in the series, according to Bloomberg
data.
The
bank used the deals to off-load the risk of mostly subprime home loans and
commercial mortgages to investors, either as hedges for similar positions or to
bet against securities itself. While the data show New York-based Goldman Sachs
issued at least $7.8 billion of Abacus notes, the risk passed to investors was
multiples higher.
The
Abacus transactions are so-called synthetic collateralized debt obligations,
which marry two financial innovations that contributed to the worst collapse in
financial markets since the Great Depression.
“Investors
needed to ask some questions about synthetics they didn’t need to ask with
other CDOs,” Joseph Mason, a finance professor at Louisiana State University in
Baton Rouge, said in a telephone interview.
The
financial tools, often called technologies, are credit- default swaps, used to
transfer the risk of losses on debt, and securitization, used to slice the risk
in a pool of assets into various new securities.
Abacus deals were filled with default swaps
that offered payouts to Goldman Sachs if certain mortgage bonds didn’t pay as
promised, in return for regular premiums from the bank.
Upfront
Cash
Some
of the cash needed for the potential payouts to Goldman Sachs would be raised
upfront, and essentially placed in escrow, from sales of Abacus CDO notes with
varying ratings. The grades were tied to how many of the underlying securities
needed to default before the CDO classes would.
Such
securitization enabled debt with the lowest investment-grade ratings to be
transformed, in part, into AAA securities that turned out to not be as safe as
that ranking suggested. At least $5 billion of Abacus slices now carry junk
ratings, below BBB-, from Standard & Poor’s, or have defaulted, Bloomberg
data show.
The
SEC said that Goldman Sachs created and sold Abacus 2007-AC1 without disclosing
that hedge fund Paulson & Co. helped pick the underlying securities and
also bet the CDO would default. Paulson was proved correct, and his hedge fund
eventually turned a $1 billion profit and CDO investors lost a similar amount,
according to the SEC.
ACA Management
The
deal was different from most Abacus CDOs in that Goldman Sachs said that a third-party,
ACA Management LLC, was choosing the underlying debt instead of the bank
itself, according to prospectuses.
At
least $192 million of the debt was granted top grades by credit-rating
companies, and an additional $1.1 billion was supposedly even safer, according
to Bloomberg data. The latter, super-senior portions were derivatives and not
securities.
“This
would never have been possible if the ratings had been correct,” said Gene
Phillips, director of PF2 Securities Evaluations, a New York-based advisory
firm. “For these trades to come out so well for Paulson, the ratings agencies
would not have been able to identify as well as Paulson did that these were
crappy assets.”
Synthetic CDOs
An
explosion in synthetic CDOs began in December 1997, with the first of the
so-called BISTRO deals created by a predecessor to JPMorgan Chase & Co..
The transaction involved the bank laying off some of $9.7 billion of its risk
tied to financing for 307 companies, according to “Fool’s Gold,” a book by Gillian
Tett (Free Press, 2009).
Shortly
after that, JPMorgan helped Bayerische Landesbank of Germany unload the risk of
$14 billion of U.S. mortgages and then completed one more mortgage-linked
BISTRO transaction, before stepping out of the market for home-loan deals
because it couldn’t get comfortable assessing the risk it needed to retain amid
a lack of historical data on how the debt would perform, according to the book.
UBS
AG, in a series called North Street from at least 2000 through at least 2005,
and Deutsche Bank AG, through its Start program in at least 2005 and 2006, also
issued synthetic CDOs tied to mortgages, according to Bloomberg data. Doug
Morris, a spokesman for Zurich-based UBS, and Renee Calabro, a spokeswoman for
Frankfurt-based Deutsche Bank, declined to comment.
Goldman’s Role
In
2006 and 2007, the distinction between synthetic mortgage-bond CDOs and “cash”
ones, or those made only of actual debt, broke down as “hybrid” deals, filled
with both securities and credit swaps, began to dominate the market, meaning
that almost every major bank was underwriting CDOs filled in part with their
own bets against homeowners.
Investors
“came to Goldman Sachs and other financial intermediaries to establish long and
short exposures to the residential housing market,” and the bank’s protection
against home-loan bond defaults represented a way to offset risk it took on by
selling the opposite position to clients, Chief Executive Officer Lloyd
Blankfein said in the company’s annual report.
In
2006 and 2007, when the residential and commercial mortgages with the highest
default rates now were made, the bank created more than $4 billion of Abacus
notes, Bloomberg data show.
That
figure doesn’t reflect the fact that banks such as Goldman Sachs often would
retain some of the slices they created. The bank said in a statement yesterday
that it lost $90 million on the transaction the SEC sued it over. The $7.7
billion in Abacus CDOs doesn’t include most of the so-called super-senior
tranches that were supposedly safer even than AAA debt. Super-senior
transactions were often private.
Super-Seniors
For
instance, with Abacus 2005-3, initially 68 percent linked to subprime-mortgage
securities, Goldman planned to create a $1 billion super-senior class along
with $825 million of notes, according to a May 10, 2005, preliminary term
sheet. Super-senior classes, or those in which the cash that would be
potentially paid out to Goldman Sachs wasn’t collected upfront, often made up
larger portions of the deals.
American
International Group Inc., the insurer whose mortgage losses led to its need for
a U.S. bailout, took on the super-senior risk on the 2005-3 deal, along with
six others, according to an internal memo posted on CBS News’s Web site.
That
included the last Abacus deal, which priced April 17, 2007, and focuses on
commercial-mortgage securities, Bloomberg data show. Its most-senior class
below the super-senior one is now rated CCC by Fitch Ratings, its third-lowest
level.
$6 Billion
AIG
guaranteed $6 billion through Abacus deals, a person with knowledge of the
matter said this month. That figure shrank to $4.3 billion by November 2008 as
some of the mortgages linked to the derivatives were repaid or refinanced, the
person said.
The
insurer last year terminated about $3 billion of the swaps with Goldman Sachs
that made up the super-seniors, resulting in $1.5 billion to $2 billion of
realized losses, said the person, who declined to be identified because the
specific transactions weren’t disclosed. AIG, based in New York, has about $1.3
billion in remaining swaps tied to the CDOs, the person said.
The
swaps weren’t included in AIG’s 2008 government rescue because they insured
pools of derivative bets, rather than actual securities. AIG and the Federal
Reserve Bank of New York retired $62.1 billion in swaps by fully reimbursing
bank counterparties in exchange for obtaining the securities, which are held in
a taxpayer-funded vehicle called Maiden Lane III.
Other CDOs
Still,
some Abacus classes are in Maiden Lane III, because they’re held by other CDOs.
One is Davis Square III, a CDO underwritten by Goldman Sachs in 2004 and
managed by TCW Group Inc. that bought $24 million of Abacus slices, including
some created after Davis Square III was, according to Moody’s Investor Service
reports.
Erin
Freeman, a spokeswoman for TCW, a unit of Paris-based Societe Generale, said
none of the CDOs managed by TCW purchased the Abacus deal at the center of the
SEC suit.
The
holdings of CDOs by other CDOs mean that some bond buyers and insurers may not
know they’re exposed to Abacus deals. Royal Bank of Scotland Plc, the bank now
controlled by the U.K. government, was the bigger loser in the deal in which
the SEC alleges Paulson & Co. was involved, paying out $840.9 million to
Goldman Sachs in 2008, most of which it then passed to Paulson’s hedge fund,
according to the SEC complaint.
Even as subprime defaults soared in 2007,
more than $1.1 trillion of CDOs were created, about the same as in 2006,
according to JPMorgan data. The figures, which also include CDOs backed by
assets such as buyout loans and bank capital securities, include unfunded
super-senior classes. Funded issuance totaled about $1.05 trillion during those
two years.
New Investments
Some
of Goldman’s Abacus CDOs were “static,” meaning the portfolio of securities
they referenced didn’t change over time, while others allowed for reinvestment
into different investments as initial holdings paid down, with Goldman choosing
the new securities.
That’s partly because investors including
Dusseldorf, Germany-based IKB Deutsche Industriebank AG, a buyer of part the
CDO the SEC is suing over, asked for the reinvestment because they would be
given higher yields, a person familiar with the matter said earlier this year.
‘Inferior Quality’
A
dispute over replacement collateral involving UBS landed in New York Supreme
Court in 2008. Hamburg-based HSH Nordbank AG, the world’s biggest shipping
financier, said in a complaint that UBS had been “deliberately selecting inferior
quality” assets for a synthetic CDO called North Street 2002-4.
Goldman
Sachs may have lost money on Abacus 2007-AC1 because in at least some Abacus
deals, the bank used the cash raised from note sales, which would be owed to
either the owners or itself, to buy securities including AAA-rated mortgage
bonds and CDOs, according to Fitch and Moody’s Investors Service.
It
then guaranteed that, in most cases, it would buy the escrow account securities
at face value if needed to pay the owners of the Abacus notes, unless those
escrow holdings defaulted, according to the rating firms’ reports. Declines in
the value of the purchased securities could limit how much Goldman Sachs could
pay itself.
--Editors: Mitchell Martin, Richard Bedard
To contact the reporters on this story: Jody
Shenn in New York at jshenn@bloomberg.net Bob Ivry in New York at
bivry@bloomberg.net.
To contact the editor responsible for this
story: Alan Goldstein at agoldstein5@bloomberg.net