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Spitzer & Black: Questions from the Goldman Scandal



April 27, 2010 – Comments (2)

More description regarding GS's fradulent activity in the CDO market


Spitzer & Black: Questions from the Goldman Scandal
Monday, 04/26/2010 - 6:37 am by Eliot Spitzer and William Black


Spitzer and Black argue that the Goldman revelations underscore the need for serious financial reform.

For those who have spent years investigating fraud, it was no surprise to hear that Goldman Sachs, the (self-described) jewel of Wall Street, is the latest firm to emerge from the financial crisis with tarnished reputation. According to a lawsuit brought by the Securities and Exchange Commission, Goldman misrepresented to its customers the quality of the toxic assets underlying a complex financial derivative known as a “synthetic collateralized debt obligation (CDO).”

As you may now have heard, the story involves a pair of Paulsons. As CEO of Goldman, Hank Paulson oversaw the buying of large amounts of CDOs backed by largely fraudulent “liar’s loans.” When he became U.S. Treasury Secretary, he went on to launch a successful war against securities and banking regulation. Hank Paulson’s successors at Goldman saw the writing on the wall and began to “short” CDOs. They realized that they had an unusual, brief window of opportunity to unload their losers on their customers. Being the very model of a modern investment banking firm, they thought that blowing up their customers would be fine sport.

John Paulson (unrelated), who controls a large hedge fund, also wanted to short CDOs and he, too, recognized that there was a narrow window for doing so. The reason there was a profit opportunity was that the “market” for toxic mortgages only appeared to be a functioning market. It was, in reality, a massive bubble in which ratings and “market” prices were grotesquely inflated. The inflated prices were continuing only because the huge players knew that the prices and races were fictional and were covering it up through the financial equivalent of “don’t ask; don’t tell.” According to the SEC complaint:

In January 2007, a Paulson employee explained the company’s view, saying that “rating agencies, CDO managers and underwriters have all the incentives to keep the game going, while ‘real money’ investors have neither the analytical tools nor the institutional framework to take action.”

We know from Bankruptcy Examiner Valukas’ report on Lehman that the Federal Reserve knew that the “market” prices were delusional and refused to require entities like Lehman to recognize their losses on “liar’s loans” for fear that it would expose the cover up of the losses. Valukas reports that Geithner explained to him when interviewed (p. 1502) that:

The challenge for the Government, and for troubled firms like Lehman, was to reduce risk exposure, and the act of reducing risk by selling assets could result in “collateral damage” by demonstrating weakness and exposing “air” in the marks.

Goldman and John Paulson worked together. One of the key things to understand about shorting is that it is extremely valuable if other major players short similar targets at the same time. By helping Paulson take advantage of Goldman’s customers (the ones that lacked “the analytical tools” to avoid being hosed), Goldman not only earned a substantial fee, but also aided its overall strategy of shorting the toxic paper.

Goldman created a deal in which John Paulson played a major role in selecting the toxic paper that would underlie the investment. He picked assets “most likely to fail - quickly” and studies show that he was particularly good at picking the losers. At this juncture, there is some dispute as to whether ACA was complicit with John Paulson and Goldman in picking losers (ACA initially invested in the synthetic CDO, but then transferred the risk of loss to German and English taxpayers).

What isn’t in dispute is that Goldman, ACA, and Paulson all failed to disclose to purchasers of the synthetic CDO that it was designed to be most likely to fail. The representation was the opposite: that the assets were picked by an independent entity with their interests at heart (ACA). Goldman claims it’s a victim because while it intended to sell its entire position in the synthetic CDO to its customers, it was unable to sell a chunk. One feels the firm’s pain. Goldman tried to blow up its customers to the tune of over $1 billion, but were unable to sell them the last $90 million in exposure.

2 Comments – Post Your Own

#1) On April 27, 2010 at 10:58 AM, outoffocus (23.80) wrote:

Ok so we have 20/20 hindsight into all the risky mortgage trash that had overinflated ratings and pricings.  What are we going do do about all the risky stocks and bonds that have overinflated ratings and pricings?  When is someone going to investigate that? When is someone going to investigate the overinflated price and rating of US Treasury debt? If I were a rating agency I would rate it BBB at best.  Does Goldman Sachs have outstanding CDSs on US Treasuries?

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#2) On April 27, 2010 at 11:26 AM, binve (< 20) wrote:

outoffocus ,

>>When is someone going to investigate the overinflated price and rating of US Treasury debt? If I were a rating agency I would rate it BBB at best.

Amen to that!

>>Does Goldman Sachs have outstanding CDSs on US Treasuries?

They had massive CDS on Greek debt, yet at the same time were advising the Greek government. This makes an essay by GS titled: "What's the Right Measure of US Government Debt?" all the more suspicious:  GS has lost all credibility for being objective. Neither are the others for that matter..

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