Tuesday, April 20, 2010


Several disparate and conflicting thoughts come to mind over he the SEC allegations against Goldman Sachs.

First, is this the best that the SEC could do? After all this time is this their flagship prosecution? It is essentially a case about improper disclosure.

Second, While Goldman makes a number of statements about how it did nothing wrong and that shielding the counter party identities is par for the course, this is the sort of partial-truth blather that makes them seem more culpable, at least to me.

Third, what it is: What Goldman did, as far as I know, is a first in markets. It set out to design a security that would fall in value almost from Day One and it got investors to buy it. We have seen high-risk initial securities offerings before (interestingly, Michael Milken pioneered original issue junk bonds), but in the past the risk was fully disclosed and was reflected in a higher yield and/or an initially discounted issue price. How do you sell such a thing that is not discounted? Goldman apparently intended to make the issue viable by mining the fact that market participants had vastly different views of the market's path and by not making that facet clear. Goldman's internal meeting describes this deal as accommodating a trade for hedge fund investor, Paulson (aspiring short-seller). An internal memo says that Goldman was effectively working an order for Paulson to buy protection on specific layers of the deal's capital structure.

Red badge of innocence, isn't -- While Goldman lost money in the deal, something it now wears as a red badge of innocence, the wound was self inflicted. Goldman seems to have been bearish on housing at the time it arranged the deal. It may have used securities it already had on its books it wanted to hedge or it just may have been caught holding the deal it could not sell. None of that adds to its 'innocence.' Some old expression about playing with fire comes to mind.

Goldman selected ACA, the credit expert company with a low credit rating itself (the smallest and weakest in its country) to be the independent analyst and selector of assets for the deal. ACA was a self-described expert that seems to have lacked a strong market profile despite describing itself as 'expert.' Arguably Goldman picked a weak 'expert' that could be pushed around. ACA would also insure the $909mln of the deal. But ACA collaborated on asset selection, nonetheless, with Paulson for whom the deal was arranged and intended as a short. ACA did not know that. The trader who arranged the ACA Paulson meeting left the meeting between the two calling it 'surreal.' IKB Deutsche industriebank AG bought a $150 mln slice of the deal it said it would only buy if an independent body picked the assets for it. So ACA's participation and control was crucial, at least to IKB. But due to ACA's weakness when the deal went sour its backing was insufficient as a backstop. Only Paulson seems to have gotten what he wanted, despite being described as being not the party with the authority to pick the assets. No wonder the young Goldman trader Fabbrice Tourre described the ACA-Paulson meeting as 'surreal'. One wonders what else that meeting could have been, given the very different objectives of these two participants one of whom did not know that the other was the enemy.

What ever really happened, whatever people were told or not told, it is pretty clear that Goldman put two adversaries together and did not disclose that to one of them. Two of the main parties to the transaction that worked on it together had very different interests in the design of this product and even though 'only one' had the mandate to select assets, as the other would be involved, it's possible that that ACA felt that some accommodation was called for to placate the other, Paulson. It was a sort of kabuki in which nothing was at it seemed.

One thing seems clear, this was not a normal above the board deal. There was a a lot of surreptitiousness here. While Goldman may have buried everyone with technical details on the securities involved and may wish to wash its hands of any further obligation, there seems to have been an underlying objective that was hidden from some of the key participants that Goldman herded together and some had mis-information about the goals of the others. The case in a legal sense will turn on the issue of, was there a material omission or not.

This deal is very tangled. As we learn more, it may not become that much clearer. One thing we know is the that the very complicated structure of theses deals, from the complex roles of the various counter parties, to the math that defines the security itself, gives all participants some degree of cover. But this is hardly the kind of deal we'd expect an expert market maker like Goldman to have championed. One could have looked at theses participants and at this deal and seen that this was not going to turn out well right from the start. But Wall Street is about doing the deal and raking in the commission. At the end of the day that is what Goldman did. What it took to get them there -guilty verdict, plea bargain, or 'vindication'- it does not matter, it has damaged the Goldman reputation. One thing Goldman has been very good at has been protecting itself. That skill is about to be tested.

1 comment:


I say lets exchange those three piece suits and briefcases that the wall street banksters so proudly show off. With a good pick a shovel a bucket and some pinstripes.