Showing posts with label Goldman Sach. Show all posts
Showing posts with label Goldman Sach. Show all posts

Friday 29 March 2013

Buffett And Goldman Sachs Do Sweetheart Deal


Buffett And Goldman Sachs Do Sweetheart Deal

Tickers in this Article » BRKB, GS, WFC, IBM, KO, AXP, SPY

Goldman Sachs (NYSE:GS) announced March 26 that in October it will issue to Berkshire Hathaway (NYSE:BRK.B) exactly the number of shares equal to Warren Buffett's profit from the 2008 warrants he got as part of his $5 billion investment in the investment bank. The deal is a win/win for both companies. What does it mean for stockholders?

Deal History
Think back to September 23, 2008, when the two parties made their original deal. Goldman Sach's stock was trading at $125.05, 24% less than just three weeks earlier. Its reputation in question after the collapse of Bear Stearns and Lehman Brothers, investors were skeptical about most investment banks. Warren Buffett rode in on his big white horse providing Goldman Sachs with the reputational shot in the arm it needed. Berkshire Hathaway bought $5 billion in perpetual preferred shares that paid a 10% dividend.

As part of the deal it received warrants giving it the right to purchase 43.5 million shares of Goldman stock at $115 each anytime up to October 1, 2013.

Goldman was paying $500 million in dividends annually on the preferred shares--an untenable amount--so it bought back the shares for $5.5 billion plus a special, one-time dividend of $1.64 billion. What happens next depends on what Goldman's stock does between now and October 1. For example, should the 10 trading days prior to October 1 average $150 per share, Berkshire Hathaway's profit would be $1.52 billion, meaning it would receive 10.15 million shares of Goldman Sachs. Buffett ends up with approximately 2% of the investment bank and a $2.14 billion profit while Goldman reduces its potential dilution by 77%.

Shareholders
Regardless of what happens to Goldman's stock price over the next six months you have to consider Berkshire Hathaway shareholders are the big winners. Its annualized total return from the deal over the last five years is 11.6%. That's 180 basis points higher than the SPDR S&P 500 (ARCA:SPY). But of course that's not the final tally. Should Buffett hang on to its stock perhaps even building a larger position, then it could become the gift that keeps on giving. Time will tell how enthusiastic he is about owning Goldman but clearly it's not red hot because if it were he'd force the issue and buy the 43.5 million shares outright at $115 each. If I had to guess I'd say it will become one of the billion-dollar holdings we read about in every Berkshire Hathaway annual report but not one of his big four - Wells Fargo (NYSE:WFC), IBM (NYSE:IBM), Coca-Cola (NYSE:KO) and American Express (NYSE:AXP).

As for Goldman Sachs, it gains a partner and loses a quasi-lender. It was an expensive deal for the company but one that probably needed to be done. By coming up with a creative solution, Goldman Sachs reduces its dilution by 33 million shares and Berkshire Hathaway reduces its cash outlay by $5 billion, which it can now put toward one of those "elephant" deals Buffett always speaks of. If Berkshire had to buy all 43.5 million shares in order to crystalize its profit, it's very possible the company could have sold its entire investment. This way Buffett stays in the game which is good news for Goldman Sachs shareholders.

Bottom Line
Warren Buffett didn't get to where he is by being stupid. In Goldman, he's acquired a piece of one of banking's biggest and well known firms. Even better, Berkshire Hathaway was paid $2.15 billion over five years to do so. Anytime someone offers to pay you to acquire something they own, especially when it has real value, the answer should always be yes.

If you're a Berkshire Hathaway shareholder this is just another example why you already own its stock. If you're a Goldman Sachs shareholder, and have been for some time, this is the end of a very difficult time in the company's history. Would I own either stock? I'd have no problem owning Berkshire Hathaway. As for Goldman Sachs, I'd consider its stock but only if Buffett remains a shareholder.

http://www.investopedia.com/stock-analysis/032713/buffett-and-goldman-sachs-do-sweetheart-deal-brkb-gs-wfc-ibm-ko-axp-spy.aspx?utm_source=coattail-buffett&utm_medium=Email&utm_campaign=WBW-03/28/2013

Friday 22 June 2012

Investor's Checklist: Banks

The business model of banks can be summed up as the management of three types of risk:  credit, liquidity, and interest rate.

Investors should focus on conservatively run institutions.  They should seek out firms that hold large equity bases relative to competitors and provision conservatively for future loan losses

Different components of banks' income statements can show volatile swings depending on a number of factors such as the interest rate and credit environment.  However, well-run banks should generally show steady net income growth through varying environments.  Investors are well served to seek out firms with a good track record.

Well-run banks focus heavily on matching the duration of assets with the duration of liabilities.  For instance, banks should fund long-term loans with liabilities such as long-term debt or deposits, not short-term funding. Avoid lenders that don't.

Banks have numerous competitive advantages.  They can borrow money at rates lower than even the federal government.  There are large economies of scale in this business derived from having an established distribution network.  the capital-intensive nature of banking deters new competitors.  Customer-switching costs are high, and there are limited barriers to exit money-losing endeavors.

Investors should seek out banks with a strong equity base, consistently solid ROEs and ROAs, and an ability to grow revenues at a steady pace.


Comparing similar banks on a price-to-book measure can be a good way to make sure you're not overpaying for a bank stock.


Ref:  The Five Rules to Successful Stock Investing by Pat Dorsey


Read also:
Investor's Checklist: A Guided Tour of the Market...


Tuesday 26 October 2010

Goldman investment to make Warren Buffett $1.5bn – in just two years

Warren Buffett's reputation as one of the world's canniest investors looks set to receive its latest boost as the 'Sage of Omaha' prepares to generate a $1.5bn (£956m) profit by selling his stake in Goldman Sachs.


Goldman investment makes Warren Buffett $1.5bn ? in just two years
Goldman investment makes Warren Buffett $1.5bn ? in just two years
The US investment bank is close to paying back the $5bn Mr Buffett invested in Goldman at the height of the financial crisis in 2008.
Berkshire Hathaway, Mr Buffett's investment company, has already received $1bn in annual dividend payments from Goldman and is now set to scoop a further $500m buyout premium when the loan is repaid. The payments mean the annual return on the two-year investment will be 12.5pc.
The precise timing of the buyback has yet to be decided and Goldman declined to comment on its plans.
Mr Buffett's investment was made in September 2008, just days after Lehman Brothers declared bankruptcy, and was seen as a major vote of confidence in Goldman at a time when the market was concerned that it could be close to collapse.
Under new US capital rules, Berkshire Hathaway's $5bn of preference shares will no longer contribute to Goldman's loss buffer and a bank source said it was now seen as "expensive" funding.










http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/8079106/Goldman-investment-to-make-Warren-Buffett-1.5bn-in-just-two-years.html

Thursday 10 June 2010

Aussie firm sues Goldman over 'shitty deal': Basis Yield Alpha Fund (Master) v. Goldman Sachs Group Inc

Aussie firm sues Goldman over 'shitty deal'

June 10, 2010 - 6:42AM

An Australian hedge fund is suing Goldman Sachs Group over an investment in a subprime mortgage-linked security that contributed to the fund's demise in 2007.

The lawsuit, filed Wednesday afternoon, New York time, accuses Goldman of misrepresenting the value of the notorious Timberwolf collateralized debt obligation, which garnered a lot of attention during a recent congressional hearing.

Basis Yield Alpha Fund sued Goldman to recoup the $US56 million ($67.5 million) it lost on the CDO, said Eric Lewis, a Washington-based lawyer for the fund. The suit also seeks $US1 billion in punitive damages.

The litigation is the latest in a string of legal and public relations headaches for Goldman. In April, US securities regulators charged the powerful Wall Street bank with civil fraud in connection with the structuring and sale of another CDO called Abacus 2007.

The hedge fund decided to file suit after months of settlement talks with Goldman broke down. Reuters on Tuesday first reported on the likelihood of a lawsuit. The suit was filed in US District Court for the Southern District of New York.

The 36-page complaint opens with a rhetorical flourish that repeats a Goldman executive's description of the Timberwolf CDO as "one shitty deal."

The suit alleges that Goldman pitched the Timberwolf deal to Basis even as the bank's sales force and mortgage traders knew the market for CDOs could soon crumble. In June 2007, Basis paid $US78 million for two pieces of the CDO with a face value of $US100 million.

Basis, which financed the transaction with a loan from Goldman, said it lost more than $US50 million when the bank began making margin calls on the product just weeks after selling the deal. Basis said the margin calls quickly forced it into insolvency.

"You can't say you are basically selling a strong performing high-yielding security that you know is going to tank," said Lewis, a partner with the law firm Baach Robinson & Lewis.

'Misguided attempt'

Goldman called the suit "a misguided attempt by Basis ... to shift its investment losses to Goldman Sachs."

Michael DuVally, a Goldman spokesman, said, "Basis is now trying to recoup its losses based on false allegations that it was misled about aspects of the transaction and market conditions."

The $US1 billion Timberwolf CDO and the aggressive tactics Goldman employed to sell the deal were a focal point of an April hearing by the Senate Permanent Subcommittee on Investigations. One of the documents unearthed by the panel was an email in which former Goldman mortgage executive Thomas Montag called Timberwolf "one shitty deal," just days after the firm completed the sale to Basis.

The hedge fund's lawsuit, which draws on other documents introduced by the Senate panel, alleges that Goldman misrepresented the value of the Timberwolf securities and failed to disclose that Goldman's trading desk had a role in working with Greywolf Capital Management in picking Timberwolf's underlying securities.

Goldman coordination

During the Senate subcommittee hearing in April, Goldman Chief Executive Lloyd Blankfein said the bank's employees are often unaware of what strategies are being employed elsewhere at the firm.

"We have 35,000 people and thousands of traders making markets throughout our firm," Blankfein said in response to a question from Senator Carl Levin. "They might have an idea. But they might not have an idea."

But the Basis lawsuit raises new questions about the coordination between Goldman's trading desks and its sales staff.

David Lehman, who joined Goldman in 2004 and worked as a managing director in Goldman's mortgage trading operation, met with representatives of Basis to convince them that the prices Goldman was selling the Timberwolf deal at were fair and legitimate.

The lawsuit alleges that Goldman's sales and trading desks worked together to sell the deal, while Goldman itself was betting against the performance of the CDO.

"This is not a bad case for dealing with the whole issue of how Goldman was conducting its business," said Lewis. "They were selling bonds like they were used cars, in that you say what you need to get it done."

More lawsuits?

Other investors in Goldman's CDO products are likely to keep a close eye on the Basis case.

"If they can prove there is some smoke there, many investors could feel they have a right to say they were also harmed in some way," said Matt McCormick, a portfolio manager and banking analyst at Bahl & Gaynor Investment Counsel in Cincinnati.

Still, lawsuits against firms over the marketing of toxic CDOs have been rare.

Scott Berman, a partner with Friedman Kaplan Seiler & Adelman who frequently represents institutional investors, said it's a bit of mystery that the financial crisis hasn't spawned more private litigation over CDOs and other exotic investments.

"Some of it may be being dealt with in private arbitration rather than litigation," said Berman. "It's also possible that many institutions are simply wary of suing each other."

The case is Basis Yield Alpha Fund (Master) v. Goldman Sachs Group Inc, US District Court, Southern District of New York, No. 10-04537.

Reuters

Wednesday 19 May 2010

Golman Sach's 14 principles that outline the firm’s best practices.

Our clients' interests always come first. 
Our experience shows that if we serve our clients well, our own success will follow. 
Our assets are our people, capital and reputation. 
If any of these is ever diminished, the last is the most difficult to restore. We are dedicated to complying fully with the letter and spirit of the laws, rules and ethical principles that govern us. Our continued success depends upon unswerving adherence to this standard. 
Our goal is to provide superior returns to our shareholders. Profitability is critical to achieving superior returns, building our capital, and attracting and keeping our best people. Significant employee stock ownership aligns the interests of our employees and our shareholders. 
We take great pride in the professional quality of our work. 
We have an uncompromising determination to achieve excellence in everything we undertake. Though we may be involved in a wide variety and heavy volume of activity, we would, if it came to a choice, rather be best than biggest. 
We stress creativity and imagination in everything we do. While recognizing that the old way may still be the best way, we constantly strive to find a better solution to a client's problems. We pride ourselves on having pioneered many of the practices and techniques that have become standard in the industry. 
We make an unusual effort to identify and recruit the very best person for every job. 
Although our activities are measured in billions of dollars, we select our people one by one. In a service business, we know that without the best people, we cannot be the best firm. 
We offer our people the opportunity to move ahead more rapidly than is possible at most other places. 
Advancement depends on merit and we have yet to find the limits to the responsibility our best people are able to assume. For us to be successful, our men and women must reflect the diversity of the communities and cultures in which we operate. That means we must attract, retain and motivate people from many backgrounds and perspectives. Being diverse is not optional; it is what we must be. 
We stress teamwork in everything we do. 
While individual creativity is always encouraged, we have found that team effort often produces the best results. We have no room for those who put their personal interests ahead of the interests of the firm and its clients. 
The dedication of our people to the firm and the intense effort they give their jobs are greater than one finds in most other organizations. We think that this is an important part of our success. 
We consider our size an asset that we try hard to preserve. 
We want to be big enough to undertake the largest project that any of our clients could contemplate, yet small enough to maintain the loyalty, intimacy and the esprit de corps that we all treasure and that contribute greatly to our success. 
We constantly strive to anticipate the rapidly changing needs of our clients and to develop new services to meet those needs. We know that the world of finance will not stand still and that complacency can lead to extinction. 
We regularly receive confidential information as part of our normal client relationships. 
To breach a confidence or to use confidential information improperly or carelessly would be unthinkable. 
Our business is highly competitive, and we aggressively seek to expand our client relationships. 
However, we must always be fair competitors and must never denigrate other firms. 
Integrity and honesty are at the heart of our business. We expect our people to maintain high ethical standards in everything they do, both in their work for the firm and in their personal lives. 





When new hires begin working at Goldman, they are told to follow 14 principles that outline the firm’s best practices. “Our clients’ interests always come first” is principle No. 1. The 14th principle is: “Integrity and honesty are at the heart of our business.”


But some former insiders, who requested anonymity because of concerns about retribution from the firm, say Goldman has a 15th, unwritten principle that employees openly discuss.


It urges Goldman workers to embrace conflicts and argues that they are evidence of a healthy tension between the firm and its customers. If you are not embracing conflicts, the argument holds, you are not being aggressive enough in generating business.

http://www2.goldmansachs.com/our-firm/our-people/business-principles.html




Related:
Clients Worried About Goldman’s Dueling Goals

Clients Worried About Goldman’s Dueling Goals

Clients Worried About Goldman’s Dueling Goals
By GRETCHEN MORGENSON and LOUISE STORY
Published: May 18, 2010


Questions have been raised that go to the heart of this institution’s most fundamental value: how we treat our clients.” — Lloyd C. Blankfein, Goldman Sachs’s C.E.O., at the firm’s annual meeting in May



As the housing crisis mounted in early 2007, Goldman Sachs was busy selling risky, mortgage-related securities issued by its longtime client, Washington Mutual, a major bank based in Seattle.

Although Goldman had decided months earlier that the mortgage market was headed for a fall, it continued to sell the WaMu securities to investors. While Goldman put its imprimatur on that offering, traders in the same Goldman unit were not so sanguine about WaMu’s prospects: they were betting that the value of WaMu’s stock and other securities would decline.

Goldman’s wager against its customer’s stock — a position known as a “short” — was large enough that it would have generated at least $10 million in profits if WaMu collapsed, according to documents recently released by Congress. And by mid-May, Goldman’s bet against other WaMu securities had made Goldman $2.5 million, the documents show.

WaMu eventually did collapse under the weight of souring mortgage loans; federal regulators seized it in September 2008, making it the biggest bank failure in American history.

Goldman’s bets against WaMu, wagers that took place even as it helped WaMu feed a housing frenzy that Goldman had already lost faith in, are examples of conflicting roles that trouble its critics and some former clients. While Goldman has legions of satisfied customers and maintains that it puts its clients first, it also sometimes appears to work against the interests of those same clients when opportunities to make trading profits off their financial troubles arise.

Goldman’s access to client information can also give its traders an advantage that many of the firm’s competitors lack. And because betting against a company’s shares or its debt can create an atmosphere of doubt about a company’s financial standing, Goldman because of its size and its position in the market can help make the success of some of its wagers faits accomplis.

Lucas van Praag, a Goldman spokesman, declined to say how much the firm earned on its bets against WaMu’s stock. He said his firm lost money on its bets against the other WaMu securities. In an e-mail reply to questions for this article, he said there was nothing improper about Goldman’s wagers against any of its clients. “Shorting stock or buying credit protection in order to manage exposures are typical tools to help a firm reduce its risk.”

WaMu is not the only Goldman client the firm bet against as the mortgage disaster gained steam. Documents released by the Senate Permanent Subcommittee on Investigations show that Goldman’s mortgage unit also wagered against Bear Stearns and Countrywide Financial, two longstanding clients of the firm. These documents are only related to the mortgage unit and it is unknown what other bets the rest of the firm made.

Goldman also bet against the American International Group, which insured Goldman’s mortgage bonds, and National City, a Cleveland bank the firm had advised on a sale of a big subprime mortgage lender to Merrill Lynch.

While no one has accused Goldman of anything illegal involving WaMu, National City, A.I.G. or the other clients it bet against, potential conflicts inherent in Wall Street’s business model are at the core of many of the investigations that state and federal authorities are conducting. Transactions entered into as the mortgage market fizzled may turn out to have been perfectly legal. Nevertheless, they have raised concerns among investors and analysts about the extent to which a variety of Wall Street firms put their own interests ahead of their clients’.

“Now it’s all about the score. Just make the score, do the deal. Move on to the next one. That’s the trader culture,” said Cornelius Hurley, director of the Morin Center for Banking and Financial Law at Boston University and former counsel to the Federal Reserve Board. “Their business model has completely blurred the difference between executing trades on behalf of customers versus executing trades for themselves. It’s a huge problem.”

Goldman has come under particularly intense scrutiny on such issues since the financial and economic downturn began gathering momentum in 2007, in part because it has done so well, in part because of the power it wields in Washington and on Wall Street, and in part because regulators have taken a keen interest in its dealings.

The Securities and Exchange Commission filed a civil fraud suit against the firm last month, contending that it misled clients who bought a mortgage security that the regulators said was intended to fail. Goldman has said it did nothing wrong and is fighting the case. Legislators in Washington are also considering financial reforms that limit potential conflicts of interest in the way that firms like Goldman trade and invest their own money.

Still, Goldman’s many hats — trader, adviser, underwriter, matchmaker of buyers and sellers, and salesperson — has left some clients feeling bruised or so wary that they have sometimes avoided doing business with the bank.

During the early stages of the mortgage crisis, Goldman seems to have unnerved WaMu’s former chief executive, Kerry K. Killinger, according to an e-mail message that Congressional investigators released.

In that message, Mr. Killinger noted that he had avoided retaining Goldman’s investment bankers in the fall of 2007 because he was concerned about how the firm would use knowledge it gleaned from that relationship. He pointed out that Goldman was “shorting mortgages big time” even while it had been advising Countrywide, a major mortgage lender.

“I don’t trust Goldy on this,” he wrote. “They are smart, but this is swimming with the sharks.”

One of Mr. Killinger’s lieutenants at Washington Mutual felt the same way. “We always need to worry a little about Goldman,” that person wrote in an e-mail message, “because we need them more than they need us and the firm is run by traders.”

Mr. Killinger does not appear to have known that Goldman was selling short his company’s shares. His lawyer did not respond to requests for comment. But because Bear Stearns, National City, Countrywide and WaMu all were hammered by the mortgage crisis, any bets Goldman made against each of those firm’s shares were likely to have been profitable.

Even though Goldman had frequently shorted the shares of other firms, it, along with another bank, Morgan Stanley, successfully lobbied the S.E.C. in 2008, at the height of the mortgage collapse, to forbid traders from shorting financial shares, sparing its own stock.

CONFLICT OF PRINCIPLES

As Trading Arm Grows, a Clash of Purpose

When new hires begin working at Goldman, they are told to follow 14 principles that outline the firm’s best practices. “Our clients’ interests always come first” is principle No. 1. The 14th principle is: “Integrity and honesty are at the heart of our business.”

But some former insiders, who requested anonymity because of concerns about retribution from the firm, say Goldman has a 15th, unwritten principle that employees openly discuss.

It urges Goldman workers to embrace conflicts and argues that they are evidence of a healthy tension between the firm and its customers. If you are not embracing conflicts, the argument holds, you are not being aggressive enough in generating business.

Mr. van Praag said the firm was “unaware” of this 15th principle, adding that “any business in any industry, has potential conflicts and we all have an obligation to manage them effectively.”

But a former Goldman partner, who spoke on condition of anonymity, said that the company’s view of customers had changed in recent years. Under Lloyd C. Blankfein, Goldman’s chief executive, and a cadre of top lieutenants who have ramped up the firm’s trading operation, conflict avoidance had shifted to conflict management, this person said. Along the way, he said, the firm’s executives have come to see customers more as competitors they trade against than as clients.

In fact, Mr. Blankfein and Goldman are quick to remind critics that Wall Street deals with sophisticated investors, who they say can protect themselves. At the bank’s shareholder meeting earlier this month, Mr. Blankfein said, “We deal with the most demanding and, in some cases, cynical clients.”

Even Goldman’s mortgage department compliance training manual from 2007 acknowledges the challenges posed by the firm’s clients-come-first rule. Loyalty to customers “is not always straightforward” given the multiple financial hats Goldman wears in the market, the manual notes.

In addition, the manual explains how Goldman uses information harvested from clients who discuss the market, indicate interest in securities or leave orders consisting of “pretrade information.” The manual notes that Goldman also can deploy information it receives from a wide range of other sources, including data providers, other brokerage firms and securities exchanges.

“We continuously make markets and take risk based on a unique window on the market which is a mosaic constructed of all of the pieces of data received,” the manual said.

Mr. van Praag, the Goldman spokesman, said that the “manual recognizes that like many businesses, and certainly all our competitors, we serve multiple clients. In the process of serving multiple clients we receive information from multiple sources.”

“This policy and the excerpt cited from the training manual simply reflects the fact that we have a diverse client base and give our sales people and traders appropriate guidance,” he added.

CREATIVE DESTRUCTION

Fostering a Market Then Abandoning It

Even now, two years after a dispute with Goldman, C. Talbot Heppenstall Jr. gets miffed talking about the firm.

As treasurer at the University of Pittsburgh Medical Center, a leading nonprofit health care institution, Mr. Heppenstall had once been pleased with Goldman’s work on the enterprise’s behalf.

Beginning in 2002, Goldman had advised officials at U.P.M.C. to raise funds by issuing auction-rate securities. Auction-rate securities are stock or debt instruments with interest rates that reset regularly (usually weekly) in auctions overseen by the brokerage firms that sell them. Municipalities, student loan companies, mutual funds, hospitals and museums all used the securities to raise operating funds.

Goldman had helped to develop the auction-rate market and advised many clients to issue them, getting an annual fee for sponsoring the auctions. Between 2002 and 2008, U.P.M.C. issued $400 million; Goldman underwrote $160 million, while Morgan Stanley and UBS sold the rest.

But in the fall of 2007, as the credit crisis deepened, investors began exiting the $330 billion market, causing interest rates on the securities to drift upward. By mid-January 2008, U.P.M.C. was concerned about the viability of the market and asked Goldman if the hospital should get out. Stay the course, Goldman advised U.P.M.C. in a letter, a copy of which Mr. Heppenstall read to a reporter.

On Feb. 12, less than a month after that letter, Goldman withdrew from the market — the first Wall Street firm to do so, according to a Federal Reserve report. Other firms quickly followed suit.

With the market in disarray, the interest rates that U.P.M.C. and other issuers had to pay investors skyrocketed. Rather than pay the rates, U.P.M.C. decided to redeem the securities.

Although Goldman had fled the market, it refused to allow a redemption to proceed, Mr. Heppenstall said, warning that its contract with the hospital barred U.P.M.C. from buying back the securities for at least another month.

U.P.M.C. had to continue paying lofty interest rates — as well as Goldman’s fees, even though the firm was no longer sponsoring the auctions, according to Mr. Heppenstall.

Goldman had been U.P.M.C.’s investment banker for about six years, Mr. Heppenstall noted in an interview, but this incident marked the end of that relationship. He said that the other Wall Street firms that had underwritten U.P.M.C.’s auction-rate securities, Morgan Stanley and UBS, had allowed it to redeem them. Goldman was the only firm that did not.

“This conflict was the last straw in our relationship with Goldman Sachs and we no longer do any business with them,” he said.

Mr. van Praag, the Goldman spokesman, declined in his e-mail message to respond in detail to U.P.M.C.’s complaints, other than to say that a contract is a contract and that governed how Goldman interacted with the hospital.

“The legal agreements that governed U.P.M.C.’s A.R.S. securities did not allow U.P.M.C. to bid for its own securities in the auctions,” he said.

MUNI MANAGEMENT

Brokering State Debt and Advising Against It

A state assemblyman in New Jersey named Gary S. Schaer also has had unsettling encounters with Goldman.

Mr. Schaer, who heads the New Jersey Assembly’s Financial Institutions and Insurance Committee, said he became wary in 2008 when he learned that Goldman, one of the state’s main investment bankers, was encouraging speculators to bet against New Jersey’s debt in the derivatives market. (At the time, a former Goldman chief executive, Jon Corzine, was New Jersey’s governor).

Goldman had managed $4.2 billion in debt issuance for the state since 2004, receiving fees for arranging those deals.

A 59-page collection of trading ideas that Goldman put together in 2008, and which was reviewed by The New York Times, shows the firm recommending that customers buy insurance to protect themselves against a debt default by New Jersey. In addition to New Jersey, Goldman advocated placing bets against the debt of eight other states in the trading book. Goldman also underwrote debt for all but two of those states in 2008, according to Thomson Reuters.

Mr. Schaer complained to Mr. Blankfein in a letter in December 2008. A response came back from Kevin Willens, a managing director in Goldman’s public finance unit; he argued that Goldman maintained impermeable barriers between its unit that had helped New Jersey raise debt and another unit that was urging investors to bet against the state’s ability to repay that debt. Mr. Schaer replied that he doubted the barriers were impenetrable.

“New Jersey taxpayers cannot be expected to pay tens of millions of dollars in investment banking fees while another department of the very same firm — albeit one clearly and strategically walled off — actively or aggressively advocates the sale of the very same or similar bonds in the aftermath,” Mr. Schaer wrote.

Mr. Schaer said in an interview that he tried to get regulations passed to prevent banks from playing such dual roles in state finances, but has made little headway.

“I hope the federal government will undertake this problem, and it is a problem,” he said. “It’s unrealistic to think the wall — no matter how thick or how tall — will be effective.”

Goldman’s many financial roles have raised concerns well beyond the state level. Over the years, it has played the role of adviser and fund-raiser for a diverse range of countries, while occasionally drawing criticism for simultaneously betting against the ability of some countries, like Russia, to repay their debts.

TRADING MATRIX

As Client Positions Sour, Goldman Defends Own

Goldman’s powerful and nimble trading desk has become a reliable fountain of profits for the firm. But it has also instilled fear among some clients who say they believe, as Mr. Killinger and others at Washington Mutual did, that Goldman trades against the interests of some of its clients.

Trading desks make big bets using the firm’s and clients’ money. Goldman’s trading operation has grown so pivotal and influential that many analysts say the firm as a whole now operates more like a hedge fund than an investment bank — another benchmark of the firm’s internal evolution that can create new friction with clients.

For example, if Goldman makes a proprietary bet in a particular market, as it did in early 2007 when it amassed a huge wager against mortgages, what stops it from positioning itself against clients who operate in that market?

Bear Stearns, a now defunct investment bank, is a case in point.

With the housing crisis gathering steam in March 2007, Goldman created and sold to clients a $1 billion package of mortgage-related securities called Timberwolf. Within months, investors lost 80 percent of their money as Timberwolf plummeted.

Bear bought a $300 million slice of Timberwolf through some of its funds, and the investment was disastrous. The funds collapsed under the weight of Timberwolf and other errant investments, beginning a downward spiral for Bear itself that ended a year later with the firm forced into the arms of JPMorgan Chase to prevent a bankruptcy.

Goldman, however, benefited from the problems its securities helped to create, Congressional documents show. Around the same time that Bear was investing in Timberwolf, Goldman was placing a bet that Bear’s shares would fall. Goldman’s short position in Bear was large enough that it would have generated as much as $33 million in profits if Bear collapsed, according to the documents.

Mr. van Praag, a Goldman spokesman, declined in the e-mail message to say how much the firm earned on those bets or whether they were still on when Bear finally collapsed.

Goldman was busy with other clients as well during 2007, including Thornburg Mortgage, a high-end lender. Goldman was one of 22 financial companies that lent money to Thornburg; it was using about $200 million of a Goldman credit line backed by mortgage loans.

In August 2007, Goldman was the first firm to begin aggressively marking down the value of Thornburg assets used as collateral for the loan. Goldman said the assets were not valuable enough to repay the loan if Thornburg defaulted. Goldman demanded more cash to shore up the account.

According to five people briefed on the relationship who requested anonymity because they didn’t want to damage continuing business relationships, Goldman told Thornburg that the request was justified because the value of similar mortgages traded by other parties had been priced at lower levels. But Goldman, according to two people with knowledge of the situation, had not actually seen such trades.

Thornburg officials, however, pushed back on Goldman’s request, questioning the values the firm put on Thornburg’s portfolio. “When we tried to negotiate price, they argued that they were aware of transactions that were not broadly known on the Street,” said a former Thornburg employee briefed on the talks with Goldman. “That was their justification for why they were marking us down as aggressively as they were — that they were aware of things that others were not.”

Even as Goldman pressured Thornburg for cash, a Goldman banker pitched Thornburg to hire the firm to help it raise new funds. Thornburg turned elsewhere.

Thornburg wasn’t the only firm Goldman pressured this way. It made similar demands — using similar arguments — of A.I.G., the insurer that stood behind many of Goldman’s mortgage securities. Ultimately, Goldman’s demands drained the insurer of so much cash that a hobbled A.I.G. required a taxpayer bailout in September 2008. Meanwhile, Goldman had been buying protection against a possible debt default by A.I.G. at the same time that it was pressuring A.I.G. to pay it additional cash. Because Goldman’s own cash demands were weakening A.I.G., Goldman had a front-row seat to the distress the company was experiencing — giving Goldman added insight that buying default insurance on A.I.G. was probably a shrewd investment.

Although Goldman’s financial insight derived from proprietary dealings with A.I.G., and included facts that others in the market most likely didn’t have, Mr. van Praag, the Goldman spokesman, said that his firm was not capitalizing on nonpublic information.

Like A.I.G., Thornburg found that arguing with Goldman was fruitless, because the firm had favorable contracts with Thornburg governing disputes. So Thornburg accepted Goldman’s valuations, but then established credit lines with other banks.

Although Goldman lost a customer, its mortgage unit had gained a victory: the firm could cite the valuations that Thornburg accepted as proper pricing for mortgage securities when it got into similar disputes with other clients.

“If they could move our positions, they could then argue with A.I.G. or some of their other big positions that our marks were where the market was,” the former Thornburg employee said. “They could have this sort of client arbitrage going on.”

Mr. van Praag, the Goldman spokesman, said his firm’s dispute with Thornburg was about differing standards for valuing collateral, nothing more.

“We are a ‘mark to market’ institution and we mark our positions on a daily basis to reflect what we believe is the current value for a security if we decided to sell it,” he said. “Those marks are verified by our controllers department, which is independent from the securities division.”

Goldman said that the mortgage collapse and Thornburg’s financial problems vindicate the posture it took on how to value Thornburg’s collateral. “Subsequent events clearly indicated that our marks were accurate and realistic,” Mr. van Praag said.

Indeed, soon after Goldman demanded more funds from Thornburg, analysts began downgrading its shares on news of the collateral calls. Beaten down by the broader mortgage collapse, Thornburg filed for bankruptcy protection on May 1, 2009.


A version of this article appeared in print on May 19, 2010, on page A1 of the New York edition.
http://www.nytimes.com/2010/05/19/business/19client.html?ref=business&pagewanted=all

Wednesday 5 May 2010

Another View: Market Makers or Market Gamers?

INVESTMENT BANKING
Another View: Market Makers or Market Gamers?
May 4, 2010, 1:56 PM

Michael Stumm, the chief executive of Oanda, argues that weak requirements on transparency and disclosure have enabled a conflict-of-interest culture to dominate the financial industry.

Now that the securities fraud investigation of Goldman Sachs has reached the Justice Department, the financial industry has hit a new low in public opinion. It’s never been easier to hate the banks.

The leaders of governments around the world have taken note and are using this anger to court favor with voters. Naturally, they’re pushing for greater legislative control over the banking system.

It remains to be seen if Goldman Sachs did knowingly and fraudulently sell junk securities to unsuspecting clients, or if, as Goldman contends, the firm did nothing wrong in the mortgage-related deal and provided proper disclosure. I would argue that the final outcome of the Securities and Exchange Commission’s civil fraud suit matters little. The fact that an American regulator is questioning the trustworthiness of a sterling Wall Street firm means we’ve already crossed the Rubicon.

There is no doubt that serious changes are coming. They will be expensive and complicated, and they may not even fix the problems they’re intended to solve. And when these changes come, we in the industry will have no one to blame but ourselves. It may be trite to say this now, but it did not have to be this way.

Most of the world’s leading industrialized countries, with the notable exception of Canada and Japan, have come out in support of new fees and taxes for the banking system. One such idea is the “Tobin tax,” which would attach a fee to every financial transaction. Another is set out in a document recently leaked from the International Monetary Fund, which advocates for two new taxes on the banking system. Money from these would pay for a potential future economic crisis.

To our industry’s discredit, some of the largest names in the business have earned reputations for relying on questionable practices to make oversized profits. As President Obama warned in his recent address to Wall Street, if your business model is based on bilking your customers, it is time to change how you do business.

Transparency is the distinction between making a deal or a market, and gaming a deal or a market. A business that shows its customers how things work behind the scenes is able to prove its operations are honest. Transparency ultimately equates to fairness.

There are times when a market maker must take the opposite side of a client’s position to ensure an active market. However, this should be accomplished through technology that automates the process to ensure there is no conscious manipulation to bet against clients. If the firm offering the security holds a position — or if any affiliated entity holds a position — this information must be made available to the prospective buyer. Full disclosure with respect to the underlying securities must also be published.

In the case against Goldman Sachs, the S.E.C. contends the firm deliberately suppressed information about the quality of the underlying securities and did not disclose that the hedge fund firm Paulson & Company was taking a short position. If true, it means Wall Street’s most respected investment bank sold a product to clients at worse odds than if those clients walked into a casino and bet their money on a single spin of a roulette wheel — worse odds because casinos at least acknowledge to their patrons that the odds are stacked in favor of the house.

It is shameful that the investment industry has been reduced to deliberate attempts to prey on the vulnerabilities of investors in order to profit. Gone are the days, it seems, when banks and investment firms operated on principles of adding value to the investment process. Now these firms make the majority of their profits through proprietary, or “prop,” trading, in which in-house traders conduct transactions on behalf of the firm. This is an inherent conflict of interest that has propagated a new operating philosophy based on making money any way possible, even if it means taking advantage of your client.

The weak requirements around transparency and disclosure have enabled this new culture to dominate the industry. But I can tell you firsthand that fairness and profit need not be mutually exclusive. Oanda’s core value is transparency, so we publish open and short positions for each supported currency pair on our foreign-exchange trading platform. These are positions held by actual clients, and having access to this information makes it possible for traders to gauge real market sentiment.

In contrast, those who attempt to profit by gaming the market will obfuscate the truth — or purposely misrepresent facts — to prevent customers from making informed decisions. Too many market makers fall prey to this temptation. They increase their rate of “wins” over clients by hiding information or using technology in what I can only describe as a perverse way.

The investment industry continues to concentrate development efforts more on creating advantages for themselves, rather than committing to an efficient market. There is a technology “arms race” under way on Wall Street, as evidenced by the adoption of high-frequency trading that favors those with the largest information technology budgets. Deals with exchanges that allow for an early look at market prices or the creation of dark pools that hide the trading activity of the large firms have served only to put smaller traders at a disadvantage.

Transparency and fairness for all market participants? Hardly.

Such government moves as extracting new taxes and taking aim at executive bonuses, while undoubtedly proving immensely popular with a jaded public, detract from the main issue. Though it may sound naïve and even a bit simplistic, what is needed is greater transparency to force a change in the way business is conducted. While it is impossible to mandate “fairness” as a business requirement, transparency can be both legislated and measured, and this will do more to level the field than any other administrative requirement.

The current investigation against Goldman Sachs is still in the early stages, but the damage to the industry’s reputation has already taken its toll. I remain optimistic however, that the day is coming when transparency is seen by financial executives as a competitive goal to strive for, rather than something to avoid.

Michael Stumm is the chief executive of the Oanda Corporation, a provider of online foreign currency exchange trading and services and the source of the currency rates used by leading institutions including PricewaterhouseCoopers, Ernst & Young and KPMG.

http://dealbook.blogs.nytimes.com/2010/05/04/another-view-market-makers-or-market-gamers/?ref=business

From Buffett, Thought-Out Support for Goldman

By ANDREW ROSS SORKIN
Published: May 3, 2010


Why is Warren Buffett sticking his neck out so far in defense of Goldman Sachs?
That was the question so manyBerkshire Hathaway shareholders, some in disbelief, kept asking here over the weekend, after Mr. Buffett offered his full-throated support of Goldman and its chief executive, Lloyd C. Blankfein, as they fight a civil fraud suit brought by regulators.
Yet by the end of Berkshire’s annual meeting, at least some of the 40,000 shareholders in attendance who had been skeptical of Goldman had come to the same conclusion: Mr. Buffett may actually be right.
“I don’t have a problem with the Abacus transaction at all, and I think I understand it better than most,” Mr. Buffett declared with nonchalance late Sunday afternoon, referring to the mortgage derivatives deal at the center of the lawsuit. He had just finished playing Ping-Pong with Ariel Hsing, a top-ranked 14-year-old junior table tennis player. (He lost 2 to 1.)
His comments echoed the strong view he had offered just the day before: “For the life of me, I don’t see whether it makes any difference whether it was John Paulson on the other side of the deal, or whether it was Goldman Sachs on the other side of the deal, or whether it was Berkshire Hathaway on the other side of the deal,” Mr. Buffett said.
Have we all been thinking about this the wrong way?
Mr. Buffett’s view — conventional, perhaps, on Wall Street but contrarian on that mythical place called Main Street that Mr. Buffett usually occupies — is worth considering for at least one reason: No one else of prominence has spoken out so publicly in support of Goldman. In his trademark way, he made a plain-spoken case that makes sense.
Cynics might regard Mr. Buffett’s statements as predictably self-serving. After all, his company owns about $5 billion in preferred stock in Goldman. What’s more, ever since he made a big investment in Goldman during the thick of the financial crisis, his priceless reputation has been hitched to the firm.
But remember that he has been a consistent and unapologetic critic of Wall Street, especially in the wake of the financial crisis. And besides, his stake in Goldman is more a loan than an investment, so he’ll no doubt be paid no matter what happens with the Abacus suit.
But on the facts of the Securities and Exchange Commission’s civil fraud case against Goldman, Mr. Buffett — he was questioned on this topic over the weekend by shareholders and a panel of three journalists, including me — was resolute. (He did not directly address reports that the Justice Department was conducting a criminal inquiry into Goldman’s mortgage deals, but his positive view of the firm is obvious.)
To him, investors should make their investment decisions based on the quality of the securities, not on who helped put them together or who else was betting for or against them. He suggested those factors were irrelevant.
“I don’t care if John Paulson is shorting these bonds. I’m going to have no worries that he has superior knowledge,” he said, adding: “It’s our job to assess the credit.” The assets are the assets. The math either works or it doesn’t.
In its suit, the S.E.C. has accused Goldman of not disclosing that the Abacus instrument was devised in part by a short-seller, John Paulson, who stood to gain by betting against it.
IKB, one of the buyers, and ACA, which acted as the selection agent and insured the transaction, said they didn’t know Mr. Paulson was on the other side of the deal and had influenced which mortgages were chosen. Together, IKB and ACA lost nearly $1 billion in the deal.
Mr. Buffett, who has always approached investing as a dispassionate exercise based on his reading of the numbers, said IKB and ACA had all the relevant facts that any investor would need. They were able to see all the mortgages, which were referenced in full, and yet they made what turned out to be a very bad bet.
“It’s a little hard for me to get terribly sympathetic,” he said. When he makes his investments for Berkshire, he said, “we are in the business of making our own decisions. They do not owe us a divulgence of their position.”
On Sunday, Mr. Buffett said that the case against Goldman seemed to be based only on hindsight.
“It’s very strange to say, at the end of the transaction, that if the other guy is smarter than you, that you have been defrauded,” he said. “It seems to me that that’s what they are saying.”
Indeed, many securities lawyers have said from the start that the case against Goldman might be hard for the S.E.C. to win, for many of the reasons spelled out by Mr. Buffett in his defense of Goldman.
One Berkshire shareholder who has been a regular in Omaha is Bill Ackman, an outspoken hedge fund manager who has made a career of railing against bad corporate practices. He spent years, for example, trying to get people to pay attention to the failures of the rating agencies before the crisis became full-blown.
In recent days, he has gone even further than Mr. Buffett in his defense of Goldman, suggesting it would have been unethical for the firm to disclose Mr. Paulson’s position in the Abacus deal. He says that Goldman, as the market maker, had a duty to protect the identity of both sides of the transaction.
He agrees with Mr. Buffett that as an investor, he would not have considered it necessary to know that Mr. Paulson had helped select the securities.
If that is really the case, it makes you question all of the outrage being directed at Goldman over this transaction. “The country wants to hang somebody,” one Berkshire board member told me.
With so many easy targets of the financial crisis — Fannie MaeFreddie MacA.I.G.Bear StearnsLehman Brothers — it does seem odd that the government, and the public, has chosen to vilify one of only a couple of firms that made fewer mistakes than the rest.
Still, the chorus of Goldman opponents has become so loud that, predictably, some people have called for Mr. Blankfein’s head.
On that subject, Charles Munger, Mr. Buffett’s vocal sidekick and vice chairman, put it bluntly: “There are plenty of C.E.O.’s I’d like to see gone in America. Lloyd Blankfein isn’t one of them.”


http://www.nytimes.com/2010/05/04/business/04sorkin.html?src=me&ref=business

Saturday 17 April 2010

Goldman Sach and CDOs: Banks Bundled Bad Debt, Bet Against It and Won


December 24, 2009

Banks Bundled Bad Debt, Bet Against It and Won



In late October 2007, as the financial markets were starting to come unglued, a Goldman Sachs trader, Jonathan M. Egol, received very good news. At 37, he was named a managing director at the firm.

Mr. Egol, a Princeton graduate, had risen to prominence inside the bank by creating mortgage-related securities, named Abacus, that were at first intended to protect Goldman from investment losses if the housing market collapsed. As the market soured, Goldman created even more of these securities, enabling it to pocket huge profits.

Goldman’s own clients who bought them, however, were less fortunate.

Pension funds and insurance companies lost billions of dollars on securities that they believed were solid investments, according to former Goldman employees with direct knowledge of the deals who asked not to be identified because they have confidentiality agreements with the firm.

Goldman was not the only firm that peddled these complex securities — known as synthetic collateralized debt obligations, or C.D.O.’s — and then made financial bets against them, called selling short in Wall Street parlance. Others that created similar securities and then bet they would fail, according to Wall Street traders, includeDeutsche Bank and Morgan Stanley, as well as smaller firms like Tricadia Inc., an investment company whose parent firm was overseen by Lewis A. Sachs, who this year became a special counselor to Treasury Secretary Timothy F. Geithner.

How these disastrously performing securities were devised is now the subject of scrutiny by investigators in Congress, at the Securities and Exchange Commission and at the Financial Industry Regulatory Authority, Wall Street’s self-regulatory organization, according to people briefed on the investigations. Those involved with the inquiries declined to comment.

While the investigations are in the early phases, authorities appear to be looking at whether securities laws or rules of fair dealing were violated by firms that created and sold these mortgage-linked debt instruments and then bet against the clients who purchased them, people briefed on the matter say.

One focus of the inquiry is whether the firms creating the securities purposely helped to select especially risky mortgage-linked assets that would be most likely to crater, setting their clients up to lose billions of dollars if the housing market imploded.

Some securities packaged by Goldman and Tricadia ended up being so vulnerable that they soured within months of being created.

Goldman and other Wall Street firms maintain there is nothing improper about synthetic C.D.O.’s, saying that they typically employ many trading techniques to hedge investments and protect against losses. They add that many prudent investors often do the same. Goldman used these securities initially to offset any potential losses stemming from its positive bets on mortgage securities.

But Goldman and other firms eventually used the C.D.O.’s to place unusually large negative bets that were not mainly for hedging purposes, and investors and industry experts say that put the firms at odds with their own clients’ interests.

“The simultaneous selling of securities to customers and shorting them because they believed they were going to default is the most cynical use of credit information that I have ever seen,” said Sylvain R. Raynes, an expert in structured finance at R & R Consulting in New York. “When you buy protection against an event that you have a hand in causing, you are buying fire insurance on someone else’s house and then committing arson.”
Investment banks were not alone in reaping rich rewards by placing trades against synthetic C.D.O.’s. Some hedge funds also benefited, including Paulson & Company, according to former Goldman workers and people at other banks familiar with that firm’s trading.

Michael DuVally, a Goldman Sachs spokesman, declined to make Mr. Egol available for comment. But Mr. DuVally said many of the C.D.O.’s created by Wall Street were made to satisfy client demand for such products, which the clients thought would produce profits because they had an optimistic view of the housing market. In addition, he said that clients knew Goldman might be betting against mortgages linked to the securities, and that the buyers of synthetic mortgage C.D.O.’s were large, sophisticated investors, he said.

The creation and sale of synthetic C.D.O.’s helped make the financial crisis worse than it might otherwise have been, effectively multiplying losses by providing more securities to bet against. Some $8 billion in these securities remain on the books at American International Group, the giant insurer rescued by the government in September 2008.

From 2005 through 2007, at least $108 billion in these securities was issued, according to Dealogic, a financial data firm. And the actual volume was much higher because synthetic C.D.O.’s and other customized trades are unregulated and often not reported to any financial exchange or market.

Goldman Saw It Coming

Before the financial crisis, many investors large American and European banks, pension funds, insurance companies and even some hedge fundsfailed to recognize that overextended borrowers would default on their mortgages, and they kept increasing their investments in mortgage-related securities. As the mortgage market collapsed, they suffered steep losses.

A handful of investors and Wall Street traders, however, anticipated the crisis. In 2006, Wall Street had introduced a new index, called the ABX, that became a way to invest in the direction of mortgage securities. The index allowed traders to bet on or against pools of mortgages with different risk characteristics, just as stock indexes enable traders to bet on whether the overall stock market, or technology stocks or bank stocks, will go up or down.

Goldman, among others on Wall Street, has said since the collapse that it made big money by using the ABX to bet against the housing market. Worried about a housing bubble, top Goldman executives decided in December 2006 to change the firm’s overall stance on the mortgage market, from positive to negative, though it did not disclose that publicly.

Even before then, however, pockets of the investment bank had also started using C.D.O.’s to place bets against mortgage securities, in some cases to hedge the firm’s mortgage investments, as protection against a fall in housing prices and an increase in defaults.

Mr. Egol was a prime mover behind these securities. Beginning in 2004, with housing prices soaring and the mortgage mania in full swing, Mr. Egol began creating the deals known as Abacus. From 2004 to 2008, Goldman issued 25 Abacus deals, according to Bloomberg, with a total value of $10.9 billion.

Abacus allowed investors to bet for or against the mortgage securities that were linked to the deal. The C.D.O.’s didn’t contain actual mortgages. Instead, they consisted ofcredit-default swaps, a type of insurance that pays out when a borrower defaults. These swaps made it much easier to place large bets on mortgage failures.

Rather than persuading his customers to make negative bets on Abacus, Mr. Egol kept most of these wagers for his firm, said five former Goldman employees who spoke on the condition of anonymity. On occasion, he allowed some hedge funds to take some of the short trades.

Mr. Egol and Fabrice Tourre, a French trader at Goldman, were aggressive from the start in trying to make the assets in Abacus deals look better than they were, according to notes taken by a Wall Street investor during a phone call with Mr. Tourre and another Goldman employee in May 2005.

On the call, the two traders noted that they were trying to persuade analysts at Moody’s Investors Service, a credit rating agency, to assign a higher rating to one part of an Abacus C.D.O. but were having trouble, according to the investor’s notes, which were provided by a colleague who asked for anonymity because he was not authorized to release them. Goldman declined to discuss the selection of the assets in the C.D.O.’s, but a spokesman said investors could have rejected the C.D.O. if they did not like the assets.

Goldman’s bets against the performances of the Abacus C.D.O.’s were not worth much in 2005 and 2006, but they soared in value in 2007 and 2008 when the mortgage market collapsed. The trades gave Mr. Egol a higher profile at the bank, and he was among a group promoted to managing director on Oct. 24, 2007.

“Egol and Fabrice were way ahead of their time,” said one of the former Goldman workers. “They saw the writing on the wall in this market as early as 2005.” By creating the Abacus C.D.O.’s, they helped protect Goldman against losses that others would suffer.

As early as the summer of 2006, Goldman’s sales desk began marketing short bets using the ABX index to hedge funds like Paulson & Company, Magnetar and Soros Fund Management, which invests for the billionaire George SorosJohn Paulson, the founder of Paulson & Company, also would later take some of the shorts from the Abacus deals, helping him profit when mortgage bonds collapsed. He declined to comment.

A Deal Gone Bad, for Some

The woeful performance of some C.D.O.’s issued by Goldman made them ideal for betting against. As of September 2007, for example, just five months after Goldman had sold a new Abacus C.D.O., the ratings on 84 percent of the mortgages underlying it had been downgraded, indicating growing concerns about borrowers’ ability to repay the loans, according to research from UBS, the big Swiss bank. Of more than 500 C.D.O.’s analyzed by UBS, only two were worse than the Abacus deal.

Goldman created other mortgage-linked C.D.O.’s that performed poorly, too. One, in October 2006, was a $800 million C.D.O. known as Hudson Mezzanine. It included credit insurance on mortgage and subprime mortgage bonds that were in the ABX index; Hudson buyers would make money if the housing market stayed healthy — but lose money if it collapsed. Goldman kept a significant amount of the financial bets against securities in Hudson, so it would profit if they failed, according to three of the former Goldman employees.

A Goldman salesman involved in Hudson said the deal was one of the earliest in which outside investors raised questions about Goldman’s incentives. “Here we are selling this, but we think the market is going the other way,” he said.

A hedge fund investor in Hudson, who spoke on the condition of anonymity, said that because Goldman was betting against the deal, he wondered whether the bank built Hudson with “bonds they really think are going to get into trouble.”

Indeed, Hudson investors suffered large losses. In March 2008, just 18 months after Goldman created that C.D.O., so many borrowers had defaulted that holders of the security paid out about $310 million to Goldman and others who had bet against it, according to correspondence sent to Hudson investors.

The Goldman salesman said that C.D.O. buyers were not misled because they were advised that Goldman was placing large bets against the securities. “We were very open with all the risks that we thought we sold. When you’re facing a tidal wave of people who want to invest, it’s hard to stop them,” he said. The salesman added that investors could have placed bets against Abacus and similar C.D.O.’s if they had wanted to.

A Goldman spokesman said the firm’s negative bets didn’t keep it from suffering losses on its mortgage assets, taking $1.7 billion in write-downs on them in 2008; but he would not say how much the bank had since earned on its short positions, which former Goldman workers say will be far more lucrative over time. For instance, Goldman profited to the tune of $1.5 billion from one series of mortgage-related trades by Mr. Egol with Wall Street rival Morgan Stanley, which had to book a steep loss, according to people at both firms.

Tetsuya Ishikawa, a salesman on several Abacus and Hudson deals, left Goldman and later published a novel, “How I Caused the Credit Crunch.” In it, he wrote that bankers deserted their clients who had bought mortgage bonds when that market collapsed: “We had moved on to hurting others in our quest for self-preservation.” Mr. Ishikawa, who now works for another financial firm in London, declined to comment on his work at Goldman.

Profits From a Collapse

Just as synthetic C.D.O.’s began growing rapidly, some Wall Street banks pushed for technical modifications governing how they worked in ways that made it possible for C.D.O.’s to expand even faster, and also tilted the playing field in favor of banks and hedge funds that bet against C.D.O.’s, according to investors.

In early 2005, a group of prominent traders met at Deutsche Bank’s office in New York and drew up a new system, called Pay as You Go. This meant the insurance for those betting against mortgages would pay out more quickly. The traders then went to the International Swaps and Derivatives Association, the group that governs trading in derivatives like C.D.O.’s. The new system was presented as a fait accompli, and adopted.

Other changes also increased the likelihood that investors would suffer losses if the mortgage market tanked. Previously, investors took losses only in certain dire “credit events,” as when the mortgages associated with the C.D.O. defaulted or their issuers went bankrupt.

But the new rules meant that C.D.O. holders would have to make payments to short sellers under less onerous outcomes, or “triggers,” like a ratings downgrade on a bond. This meant that anyone who bet against a C.D.O. could collect on the bet more easily.

“In the early deals you see none of these triggers,” said one investor who asked for anonymity to preserve relationships. “These things were built in to provide the dealers with a big payoff when something bad happened.”

Banks also set up ever more complex deals that favored those betting against C.D.O.’s. Morgan Stanley established a series of C.D.O.’s named after United States presidents (Buchanan and Jackson) with an unusual feature: short-sellers could lock in very cheap bets against mortgages, even beyond the life of the mortgage bonds. It was akin to allowing someone paying a low insurance premium for coverage on one automobile to pay the same on another one even if premiums over all had increased because of high accident rates.

At Goldman, Mr. Egol structured some Abacus deals in a way that enabled those betting on a mortgage-market collapse to multiply the value of their bets, to as much as six or seven times the face value of those C.D.O.’s. When the mortgage market tumbled, this meant bigger profits for Goldman and other short sellers — and bigger losses for other investors.

Selling Bad Debt

Other Wall Street firms also created risky mortgage-related securities that they bet against.

At Deutsche Bank, the point man on betting against the mortgage market was Greg Lippmann, a trader. Mr. Lippmann made his pitch to select hedge fund clients, arguing they should short the mortgage market. He sometimes distributed a T-shirt that read “I’m Short Your House!!!” in black and red letters.

Deutsche, which declined to comment, at the same time was selling synthetic C.D.O.’s to its clients, and those deals created more short-selling opportunities for traders like Mr. Lippmann.

Among the most aggressive C.D.O. creators was Tricadia, a management company that was a unit of Mariner Investment Group. Until he became a senior adviser to the Treasury secretary early this year, Lewis Sachs was Mariner’s vice chairman. Mr. Sachs oversaw about 20 portfolios there, including Tricadia, and its documents also show that Mr. Sachs sat atop the firm’s C.D.O. management committee.

From 2003 to 2007, Tricadia issued 14 mortgage-linked C.D.O.’s, which it called TABS. Even when the market was starting to implode, Tricadia continued to create TABS deals in early 2007 to sell to investors. The deal documents referring to conflicts of interest stated that affiliates and clients of Tricadia might place bets against the types of securities in the TABS deal.

Even so, the sales material also boasted that the mortgages linked to C.D.O.’s had historically low default rates, citing a “recently completed” study by Standard & Poor’sratings agency — though fine print indicated that the date of the study was September 2002, almost five years earlier.

At a financial symposium in New York in September 2006, Michael Barnes, the co-head of Tricadia, described how a hedge fund could put on a negative mortgage bet by shorting assets to C.D.O. investors, according to his presentation, which was reviewed by The New York Times.

Mr. Barnes declined to comment. James E. McKee, general counsel at Tricadia, said, “Tricadia has never shorted assets into the TABS deals, and Tricadia has always acted in the best interests of its clients and investors.”

Mr. Sachs, through a spokesman at the Treasury Department, declined to comment.

Like investors in some of Goldman’s Abacus deals, buyers of some TABS experienced heavy losses. By the end of 2007, UBS research showed that two TABS deals were the eighth- and ninth-worst performing C.D.O.’s. Both had been downgraded on at least 75 percent of their associated assets within a year of being issued.

Tricadia’s hedge fund did far better, earning roughly a 50 percent return in 2007 and similar profits in 2008, in part from the short bets.



Goldman Sachs Responds to The New York Times on Synthetic Collateralized Debt Obligations
December 24, 2009

Background: The New York Times published a story on December 24th primarily focused on the synthetic collateralized debt obligation business of Goldman Sachs. In response to questions from the paper prior to publication, Goldman Sachs made the following points.

As reporters and commentators examine some of the aspects of the financial crisis, interest has gravitated toward a variety of products associated with the mortgage market. One of these products is synthetic collateralized debt obligations (CDOs), which are referred to as synthetic because the underlying credit exposure is taken via credit default swaps rather than by physically owning assets or securities. The following points provide a summary of how these products worked and why they were created.

Any discussion of Goldman Sachs’ association with this product must begin with our overall activities in the mortgage market. Goldman Sachs, like other financial institutions, suffered significant losses in its residential mortgage portfolio due to the deterioration of the housing market (we disclosed $1.7 billion in residential mortgage exposure write-downs in 2008). These losses would have been substantially higher had we not hedged. We consider hedging the cornerstone of prudent risk management.

Synthetic CDOs were an established product for corporate credit risk as early as 2002. With the introduction of credit default swaps referencing mortgage products in 2004-2005, it is not surprising that market participants would consider synthetic CDOs in the context of mortgages. Although precise tallies of synthetic CDO issuance are not readily available, many observers would agree the market size was in the hundreds of billions of dollars.

Many of the synthetic CDOs arranged were the result of demand from investing clients seeking long exposure.

Synthetic CDOs were popular with many investors prior to the financial crisis because they gave investors the ability to work with banks to design tailored securities which met their particular criteria, whether it be ratings, leverage or other aspects of the transaction.

The buyers of synthetic mortgage CDOs were large, sophisticated investors. These investors had significant in-house research staff to analyze portfolios and structures and to suggest modifications. They did not rely upon the issuing banks in making their investment decisions.

For static synthetic CDOs, reference portfolios were fully disclosed. Therefore, potential buyers could simply decide not to participate if they did not like some or all the securities referenced in a particular portfolio.

Synthetic CDOs require one party to be long the risk and the other to be short so without the short position, a transaction could not take place.

It is fully disclosed and well known to investors that banks that arranged synthetic CDOs took the initial short position and that these positions could either have been applied as hedges against other risk positions or covered via trades with other investors.

Most major banks had similar businesses in synthetic mortgage CDOs.

As housing price growth slowed and then turned negative, the disruption in the mortgage market resulted in synthetic CDO losses for many investors and financial institutions, including Goldman Sachs, effectively putting an end to this market.

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