naked capitalism

By Tom Adams, an attorney and former monoline executive

The SEC’s complaint against Goldman Sachs on its Abacus 2007 AC1 transaction may have impact beyond just the facts in that particular deal. The case has touched off a firestorm of reaction across the globe now that a government enforcement agency has dared use words like “fraud” and “CDO” in the same sentence. Before Friday if the Obama administration was uncertain of what issues affecting the mood of the country, they certainly have a clearer picture now. One obvious conclusion is that many people, including local attorneys general and European regulators, believe this to be more than an isolated case.

While the SEC is generally perceived to give shallow coverage to a wide mandate, another agency has narrower scope but has been giving much deeper analysis and review to its subject. Neil Barofsky, the Inspector General for the Special Investigation of the TARP (SIGTARP), is charged with reviewing the administration of the Troubled Asset Relief Program. At first blush, the Abacus/ACA case might appear to be outside the scope of the SIGTARP’s mandate. However, we have argued in the past that the SIGTARP has plenty of worthwhile material still to consider which might overlap with the issues and concerns raised in the SEC’s case.

Yesterday the SIGTARP announced that he would be investigating whether fraud was committed on American taxpayers with respect to the Abacus transactions that were insured by AIG. Barofsky cited two areas of inquiry: whether deals Goldman sold to AIG, including 7 Abacus transactions, led to losses at AIG and fraud committed against the taxpayers, and an audit into the role of BlackRock in the TARP, which appears to have its tentacles throughout the program. With respect to BlackRock, he said: “We are considering doing a more overarching audit report on their role throughout the financial crisis.”

If the SIGTARP is looking for some guidance on what issues to consider, he could refer to some of our prior posts, which raised these concerns months ago. Back in February, in response to a horrid puff piece in Vanity Fair on Larry Fink, we noted our concerns about BlackRock’s close relationship with the government . We questioned BlackRock’s many apparent conflicts of interest as the designated manager for so many bailout programs, including the three Maiden Lane transactions, Fannie and Freddie, even while advising Citigroup, AIG, state pension funds and others on their options. BlackRock is also managing its own enormous and overlapping portfolio, which includes several ABS CDO transactions with a balance of at least $4 billion.

In addition, we have previously asked many questions about the Goldman Abacus transactions that were insured by AIG. Why were they excluded from Maiden Lane III? What is their current value and status? Who is managing and overseeing them and at what cost to the taxpayer? One of the Abacus transactions that remained behind with AIG, 2005-CB1, also had a third party manager in the form of C-Bass. Was C-Bass brought in to manage this program for a similar reason as ACA was on the deal that’s subject to the SEC complaint? According to the SEC complaint, ACA was hired as manager because the investors wanted third party oversight but instead got a transaction that was heavily influenced by a sponsor with a contrary position. Did Goldman learn this trick by doing it previously with the 2005 C-Bass deal?

By our count, AIG had six other ABS CDO transactions that were not transferred to Maiden Lane and instead remained on AIG’s balance sheet. As of earlier this year, the ratings on AIG’s exposures ranged from D to BB, so it’s unlikely they were kept because they AIG felt they performing well. The banks on the deals were Goldman, Merrill, Wachovia and UBS; institutions that had key roles in the CDO market prior to the crisis.

The SIGTARP could also consider the relationship among the banks and their counterparties, especially the French connection of Goldman Calyon and Soc Gen. As we have seen in the recent coverage of the Magnetar trades, Calyon played an important role in the Magnetar deals, acting as the bank for the first Magnetar deal and four more after that. Calyon was also a counterparty on $4 billion of AIG CDOs, most of which had Goldman as the banker.

Finally, the SIGTARP could consider the interaction among the CDO manager, the bank and the issuer of the mortgage securities, a question we were wrestling with last November. Much of the commentary and analysis of CDOs, depends on the assumption that, while much of the analysis of the deals was wrong, it was at least an arm’s length market driven by relatively normal supply and demand factors. However, the SEC complaint highlights a considerable lack of transparency in the market as parties such as Goldman and Paulson managed elements of the deal behind the scenes. Did this occur in other transactions? Were there other arrangements between the deal sponsors, the CDO managers and the banks of which investors and insurers were unaware but could reasonably be viewed as material? Considering the cozy relationship between some of the managers and the banks, such as TCW with Goldman, it might be worthwhile to explore who the sponsors were in the transactions and what role they played.

The reaction to the SEC complaint against Goldman has demonstrated that many people, government agencies and investors have a strong demand for more answers and a greater understanding of what happened in the financial crisis. We believe that the CDO market holds the key to many of these questions and that the surface has only begun to scraped with the SEC complaint. We hope that, given its strong reporting to date, the SIGTARP can begin to address some of the many questions suggested by the SEC complaint.