Saturday :: Jul 4, 2009

Goldman Sachs: Rogue Company


by Mary

Matt Taibbi has a blockbuster of a piece in RollingStone on the part that Goldman Sachs had in creating the economic disaster the world faces today. Excepts of the piece as well as some clips of Taibbi have been published, but for the full piece one needs to buy the magazine. (Not a bad suggestion, because this clearly is a way to help keep RS going.)

How did Goldman Sachs respond to the piece? They categorically denied they did what Taibbi accuses them of:

We reject the assertion that we are inflators of bubbles and profiteers in busts, and we are painfully conscious of the importance of being a force for good.

Funny how such an innocent company just keeps finding itself in such bad situations.

Because as Matt Taibbi notes, Goldman Sachs knew these loans were garbage, but they sold them anyway.

Citing various sources, I also noted that some people had complained that its move to short the mortgage market in 2006 even as it was selling those same types of instruments proved that the bank knew the weakness of its mortgage products, and asked if the bank had an answer for that.

And was Goldman Sachs the innocent bystander it claims? Well, recall the fascinating piece by Michael Lewis last year and the role Goldman Sachs played in that?

Eisman knew subprime lenders could be scumbags. What he underestimated was the total unabashed complicity of the upper class of American capitalism. For instance, he knew that the big Wall Street investment banks took huge piles of loans that in and of themselves might be rated BBB, threw them into a trust, carved the trust into tranches, and wound up with 60 percent of the new total being rated AAA.

But he couldn’t figure out exactly how the rating agencies justified turning BBB loans into AAA-rated bonds. “I didn’t understand how they were turning all this garbage into gold,” he says. He brought some of the bond people from Goldman Sachs, Lehman Brothers, and UBS over for a visit. “We always asked the same question,” says Eisman. “Where are the rating agencies in all of this? And I’d always get the same reaction. It was a smirk.” He called Standard & Poor’s and asked what would happen to default rates if real estate prices fell. The man at S&P couldn’t say; its model for home prices had no ability to accept a negative number. “They were just assuming home prices would keep going up,” Eisman says.

...Later, when I sit down with Eisman, the very first thing he wants to explain is the importance of the mezzanine C.D.O. ... “You have to understand this,” he says. “This was the engine of doom.” Then he draws a picture of several towers of debt. The first tower is made of the original subprime loans that had been piled together. At the top of this tower is the AAA tranche, just below it the AA tranche, and so on down to the riskiest, the BBB tranche—the bonds Eisman had shorted. But Wall Street had used these BBB tranches—the worst of the worst—to build yet another tower of bonds: a “particularly egregious” C.D.O. The reason they did this was that the rating agencies, presented with the pile of bonds backed by dubious loans, would pronounce most of them AAA. These bonds could then be sold to investors—pension funds, insurance companies—who were allowed to invest only in highly rated securities. “I cannot fucking believe this is allowed—I must have said that a thousand times in the past two years,” Eisman says.

...[Eisman] was already short the stocks of mortgage originators and the homebuilders. Now he took short positions in the rating agencies—“they were making 10 times more rating C.D.O.’s than they were rating G.M. bonds, and it was all going to end”—and, finally, the biggest Wall Street firms because of their exposure to C.D.O.’s. He wasn’t allowed to short Morgan Stanley because it owned a stake in his fund. But he shorted UBS, Lehman Brothers, and a few others. Not long after that, FrontPoint had a visit from Sanford C. Bernstein’s Brad Hintz, a prominent analyst who covered Wall Street firms. Hintz wanted to know what Eisman was up to. “We just shorted Merrill Lynch,” Eisman told him.

“Why?” asked Hintz.

“We have a simple thesis,” Eisman explained. “There is going to be a calamity, and whenever there is a calamity, Merrill is there.” When it came time to bankrupt Orange County with bad advice, Merrill was there. When the internet went bust, Merrill was there. Way back in the 1980s, when the first bond trader was let off his leash and lost hundreds of millions of dollars, Merrill was there to take the hit. That was Eisman’s logic—the logic of Wall Street’s pecking order. Goldman Sachs was the big kid who ran the games in this neighborhood. Merrill Lynch was the little fat kid assigned the least pleasant roles, just happy to be a part of things. The game, as Eisman saw it, was Crack the Whip. He assumed Merrill Lynch had taken its assigned place at the end of the chain.

And if you want to know more about Goldman Sachs role in creating the engine of doom, you can read about how AIG found itself taken for a ride by playing with the big kid in Michael Lewis's latest piece which you can read at The Big Picture. Money Quote?

If you were going to be on the other side of a trade from Goldman Sachs, you better know what, exactly, Goldman Sachs was up to.

And it turns out, AIG FP didn't understand the game they were getting into either.

A.I.G. F.P.'s willingness to assume the vast majority of the risk of all the subprime mortgage bonds create in 2004 and 2005 had created a machine that depended for its fuel on subprime-mortgage loans. "I'm convinced that our input into the system led to a substantial portion of the increase in housing prices in the U.S. We facilitated a trillion dollars in mortgages," says one trader. "Just us." Every firm on Wall Street was making fantastic sums of money from this machine, but for the machine to keep runing the Wall Street firms needed someone to take the risk.

When A.I.G. F.P. said they were getting out of the business, Wall Street kept the machine going by assuming the risk in 2006 and 2007 because the money was so good. During that time, lending standards dove off the cliff, housing prices kept rising and Wall Street made out like bandits. Then the machine stopped. But Goldman Sachs had another trick up its sleeves.

What no one realized is that Joe Cassano, in exchange for the privilege of selling credit-default swaps on subprime-mortgage bonds to Goldman Sachs and Merrill Lynch and all the rest, had agreed to change the traditional terms of trade between A.I.G and Wall Street. In the beginning, A.I.G. F.P. had required its counter-parties simply to accept its AAA credit: it refused to post collateral. But in the case of the subprime-mortgage credit-default swaps, Cassano had agreed to several triggers, including A.I.G.'s losing its AAA credit rating, that would require the firm to post collateral. If the value of the underlying bonds fell, it would fork over cash, so that, for instance, Goldman Sachs would not need to be exposed for more than a day to A.I.G. Worse still, Goldman Sachs assigned the price to the underlying bonds -- and thus could effectively demand as much collateral as it wanted. In the summer of 2007, the value of everything fell, but subprime fell fastest of all. The subsequent race by big Wall Street banks to obtain billions in collateral from A.I.G. was an upmarket version of a run on the bank. Goldman Sachs was the first to the door, with shockingly low prices for subprime-mortgage bonds - prices that Cassano wanted to dispute in court, but was prevented by A.I.G. from doing so when he was fired. A.I.G. couldn't afford to pay Goldman off in March 2008, but that was OK. The U.S. Treasury, led by the former head of Goldman Sachs, Hank Paulson, agreed to make good on A.I.G.'s gambling debts. One hundred cents on the dollar.

Taibbi is to be commended for his exceptionally good reporting on Goldman Sachs. Buy the magazine and listen to Matt as he walks through what evil Goldman Sachs will do to make money, including buying much of our government.

What we need is a FDR to bring this monster to heel.

Mary :: 3:52 PM :: Comments (4) :: Digg It!