Goldman (and DeutscheBank) as Predator

One of the things that has been striking as revelation of bad behavior in the collateralized debt market has gotten more press is that a number of commentators who had taken the “nothing to see here, move on” stance have gotten religion.

Even more dramatic has been the change in perception of Goldman. The firm has had its vocal critics (including yours truly) but they seemed an ineffective minority. Goldman’s arrogance seemed only to confirm its “Government Sachs” connections, that it could do as it pleased and thumb its nose at the rest of us to boot. It compounded the public outrage over its record 2009 bonuses through its hamhanded, narcissistic rationalizations. Lloyd Blankfein’s “We’re doing God’s work” has come to epitomize what is wrong with the financial services industry post-crisis the same way Chuck Prince’s “We’re still dancing” did for the bubble era.

So the has been more that a little bit of schadenfreude at work. The press and public sentiment against Goldman has become widespread and heightened with the SEC lawsuit over Abacus AC1 2007. Even the supposedly bipartisan Senators were on the same page in Tuesday’s marathon hearings.

Now some point out, correctly, that Goldman is being singled out. On the one hand, there was a lot of bad behavior in the industry that has yet to be scrutinized closely. On the other, collateralized debt obligations were the ground zero of the crisis, and the banks like Goldman that were particularly “innovative” are now looking to have been too clever by half. As I discuss in some detail in ECONNED, these vehicles were spectacularly leveraged. Comparatively small amounts of capital produced greatly disproportionate systemic effects. Both our own contact with structured industry experts, and other accounts of subprime short strategies make clear that DeutscheBank was at least as aggressive as Goldman as far as real-estate-related CDOs were concerned. For instance, Deutsche was also creating synthetic CDOs on behalf of subprime short John Paulson; it had its own version of Goldman’s Abacus program (Deutsche’s was called Start).

A striking point of the hearings was that Goldman kept claiming that it was a mere market-maker, while the Senators kept asserting that the firm had a duty to customers. While Goldman arguably did not have a fiduciary duty, it most certainly is required to make accurate disclosures as an underwriter, and that is the basis of the SEC’s suit. Moreover, even if Goldman’s actions were narrowly legal, markets operate on trust. What happens to capital formation if investors increasingly regard markets as a shark pool?

What is stunning is that the Wall Street Journal defends Goldman (its headline labels the hearing an “inquisition”), and chooses to ignore the applicable regulations to do so. The piece disingenuously and inaccurately asserts that the Senate was trying to apply an incorrect standard to Goldman’s conduct, a “consumer narrative”. A representative section:

On one side was a Senate committee preaching a populist narrative that’s only been boosted by the Securities and Exchange Commission’s lawsuit against Goldman. Goldman bet against its clients. It sold mortgage securities to sometimes unwitting buyers, without disclosing that the broker or important clients were betting the other way. That fueled the mortgage crisis by dumping more junk into the system. It was also disingenuous.

Senators tried to make the case that this wasn’t the fair dealing customers expect in our consumer society. In this narrative, a customer or client buys a television from Best Buy and both the seller and the manufacturer carry some responsibility that the product will do what it’s supposed to do. The consumer can return it. There are warranties.

Wall Street doesn’t work that way. That was the point made by Goldman officials including Mr. Sparks, Josh Birnbaum, Michael Swenson, Fabrice Tourre—the trader named in the SEC case against Goldman—and at the end of the day, Lloyd Blankfein, Goldman’s chief executive.

The consumer narrative isn’t the one at work at Goldman or anywhere on Wall Street. It’s a pure caveat emptor market. Buyers carry the responsibility of knowing that products carry risk. They may not work as advertised. They know that Goldman, or any broker/dealer will work to line up investors to short the deal, or take that position itself. There are no guarantees.

Yves here. This is patent rubbish. It is a sign of the lousy state of the press in America that a politically-oriented blog, FireDogLake, does a better job of describing the applicable rules than the self-styled preeminent business newspaper in America. Oh, but we forget. That paper is opposed to the idea that commerce should be subject to rules.

As FireDogLake explained:

The staff of the Permanent Subcommittee on Investigations put together a memo explaining the basics of the transactions. After defining the terms related to securitized debt instruments, the memo explains that Wall Street firms can act as “underwriter” for the issuance of new securities.

If an investment bank agrees to act as an “underwriter” for the issuance of a new security to the public, it typically bears the risk of those securities on its books until the securities are sold. By law, securities sold to the public must be registered with the Securities and Exchange Commission (SEC). Registration statements explain the purpose of a proposed public offering, an issuer’s operations and management, key financial data, and other important facts to potential investors. Any offering document, or prospectus, given to the investing public must also be filed with the SEC. If a security is not offered to the general public, it can still be offered to investors through a “private placement.” Investment banks often act as the “placement agent,” performing intermediary services between those seeking to raise money and investors. Solicitation documents in connection with private placements are not filed with the SEC. Under the federal securities laws, investment banks that act as an underwriter or placement agent are liable for any material misrepresentations or omissions of material facts made in connection with a solicitation or sale of the securities to investors.

Firms can also act as market-makers:

Investment banks sometimes take on the role of “market makers” for securities and other assets that they sell to their clients, meaning that, in order to facilitate client orders to buy or sell, an investment bank may acquire an inventory of assets and make them available for client transactions. In addition, investment banks may buy and sell assets for their own account, which is called “proprietary trading.” The largest U.S. investment banks engage in a significant amount of proprietary trading that generates substantial revenues. Investment banks generally use the same inventory of assets to carry out both their market-making and proprietary trading activities. Investment banks also typically have an inventory or portfolio of assets that they intend to keep as long term investments.

GS wants everyone to interpret the ABACUS 07-ACI transaction and similar deals as if GS were a market-maker. The fact is GS acted as an underwriter. Underwriting is the creation and sale of new securities.

Yves here. Before readers try arguing “these were not securities,” CDOs are legal entities, mini-banks with asset and liability sides. Some tranches of the Abacus deal (the liability structure) was placed in the form of notes, which most assuredly are securities.

Legal issues aside, it isn’t merely the great unwashed public that is taking an increasingly dim view of Goldman. What is striking is the change in sentiment among professionals.

Recall Goldman’s reputation: that of being the best managed firm on the Street, and its boasting about its risk management as key to its superior profits (cynics will note that Goldman nevertheless needed to be rescued along with every other major financial player). Thus Goldman cannot readily shift blame for its mortgage market misdeeds onto staff; its obsessiveness about communication makes it well nigh impossible that any of its staffers were acting without authorization. And its once-vaunted risk management, which led observers to believe that Goldman was doing a better job of managing exposures, now increasingly looks like the firm was simply more systematic and aggressive than its peers in not just shifting risks onto customers but engaging in further profit-maximizing strategies that look downright predatory.

For instance, Bruce Krasting, who has often taken issue with me over credit default swaps and is generally of the view that like love and war, all is fair in markets, took a very dim view of a revelation by Josh Birnbaum. Per a post by Tom Adams:

Senator Coburn turns to short positions that Goldman took in companies that were sensitive to mortgages, including Merrill and Bear Stearns. Senator Coburn notes that after Goldman sold Timberwolf to Bear Stearns, they took a short position in the stock of Bear Stearns. This seems pretty devastating,

Yves here. Note that these positions were NOT taken on a equity desk (based on, say, a house view that all mortgage-related credits were a short, including, say, homebuilders). They appear to have been taken within (or at least credited to) Birnbaum’s group, the Structured Products Group. Krasting elaborates:

In 2007 the SPG had gains from hedges of ~$3b and losses of ~$2b on write down of inventory. It was described that the hedges included (1) shorts on the ABX index (2) shorts on single name ABS (3) long CDS against a variety of single names and (4) they shorted common stock of companies that had a high beta to a downfall of the Sub-Prime/Alt.A market.

We know from the testimony Bear Stearns was on that “short” list. That entire list is public. I have not seen it so I will just guess that in the fall of 2007 GS was shorting the likes of New Century, WaMu, the mono lines, Countrywide, Bear Stearns, and Lehman. That list could have been broader; it might have included Fannie Mae and Freddie Mac, Citi, and BoA, even the likes of a Northern Rock or RBS.

One aspect of the collapse of 2008 was how destructive capital markets had become. The shorts pushed equities down so fast that managements and regulators lost control. The shorts were clearly predators. For me it was the shorts that destroyed the equity values. It was a near daily event.

My questions on this is (A) How much of this did Goldman do? (B) How much did the rest of the market do? (C) Did this exceptional demand for short interest in financial stocks accelerate the collapse of Bear, Lehman and all the others?

Yves here. Krasting focuses on the equity short, but the CDS single name longs were if anything even more destructive (even the Wall Street Journal described CDS as a great vehicle for bear raids). Buying CDS protection in volume pushes up yields on bonds. The rating agencies respond to market signals (this is a dirty secret). If the market yield on a bond is too far out of line with their rating, they feel pressured to downgrade. The downgrade confirms the suspicions of those who have doubts, leading to either sales of the bonds themselves or purchases of CDS by new parties, further pushing up yields. And for highly leveraged companies, rising interest rates translate pretty quickly into diminished profits, again putting pressure on ratings.

Now admittedly Lehman was beyond redemption, but had it decayed in a more gradual fashion, it might at least have filed for a long-form bankruptcy, or possibly even gone through a good bank-bad bank restructuring (the sort of deal the Fed was trying to broker that failed at the 11th hour). And had Lehman not collapsed, September and October 2008 would have looked very different.

Moreover, industry participants believe DeutscheBank was engaged in similar activity. One industry participant who had the vast misfortune to be long some of the CDOs that Deutsche pedaled recalls in 2007, when Deutsche came to his firm proposing a hedge against some of those deals, recalls his board asking point blank, “Are you short our company?” and not getting a straight answer.

Goldman is increasingly beleagured. Its lobbyists are now pariahs. More private lawsuits are coming to the fore. There are rumors it is in settlement talks with the SEC. But the once-storied firm apparently turned its well oiled machine to ruthless profit-seeking. It is an open question how much damage the firm will sustain from the well-deserved backlash, and whether it can change its conduct.

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  1. readerOfTeaLeaves

    Those Goldman hearings revealed an scorched-earth ethos at GS, and an obsession on ‘market activity’ and ‘market making’ completely divorced from real world problems that most Americans have to grapple with in any given week.

    And FWIW: I’m a huge fan of FireDogLake; it appears that a few++ FDLers have heard about you via FDL and now check you on our list of quick blog-check-in’s throughout the day.

    Too bad about the WSJ.
    Maybe it thinks it is a ‘News Maker’ in the same way that GS insists that they are ‘Market Makers’. It’s just more narcissistic delusion; sad, really.

    1. CS

      If one hasn’t figured out that Murdoch’s News Corp sells a commodity, perhaps they can’t read. For Murdoch, credulousness of readers, not veracity of content is the moneymaker.

  2. student

    “It is an open question how much damage the firm will sustain from the well-deserved backlash, and whether it can change its conduct.”

    I think this will be good for Goldman in the long term. They have to look at the mirror and see what they have become and they can now change. Change is hard but you need some big event to force change.

    Now it’s up to Goldman to show what they are made of.

  3. AnonymousMonetarist


    Reposting this from a couple posts back.

    Perhaps you might contact someone from the ‘old days’ and ask them how an equity tranche would be in the initial but not in the final and how that would not be a material misrepresentation, these structures went through iterations when going for the AAA prior to the final i.e, when the bonds were circled.

    Not a soul is covering that…

    You might be surprised by the answer.

    Heard about Ritholz’s commentary on Goldie through Honest Abe in Barron’s…

    He makes 1 point, ‘The claim Paulson & Co. were long $200 million dollars when they were actually short is a material misrepresentation — that’s Rule 10b-5, and its a no brainer. The rest is gravy.’

    My understanding was that the equity tranche was not part of the final deal, so not sure what the point is. The reference to Paulson being long was conditional, in some initial memo. Yes? Was it in the final structure? Don’t think so. That’s damn weak stuff. Folks didn’t read the final deal? Seriously?

    The late great Mark Pittman once wryly noted that almost no one in the media knew what yield was. What do you think the odds are that these same folks have any clue as to how a structured offering is circled?

    What other point does Ritholz make?

    ‘What you don’t see are all the emails, depositions, interrogations, phone taps, etc. that the prosecutors know about and GS does not’. Uh.. well neither does Ritholz, so again, what is the point?

    For folks that have never participated in a structured bond offering, who never saw the gurus whip up iterations on the back of napkins, who never witnessed slivers of equity being presented as burnt offerings to the rating agency Gods, the current pablum narrative would appear to be unassailable.

    Now I wasn’t privy to this deal getting circled but will hazard a guess as to what the equity tranche (Paulson going long in the intial) was all about…

    Paulson was more than willing to put down a sliver of equity in order to secure the AAA, but once it was confirmed that the rating agencies would give the pixie dust lipstick without it, it went buh-bye…

    The ratings agencies are the enemies of the people, the rest was ‘enabled’ noise.

    The ’selection’ process on almost any comparable structured product was a reverse engineering of the rating agencies ‘models’ that had been tinkered over time in collusion with their fee-paying clients for the end goal of getting the AAA on the selected pig.

    Will Goldie be found greedy before guilty by an impartial jury? That first assumes you can get an impartial jury, but yeh sure why not? The whole system was guilty of this. This was the game.

    However if every other bankster is not brought up on similar charges than this episode is nothing more than a political diversion, the political palliative of misdirection through scapegoating in order to quell the ‘counterproductive’ populism of bankster bashing.

    1. Capricorn

      AM, I think that most readers of this blog, and most of the general public, are pretty unhappy with the way the whole FIRE sector has been operating. I am, for sure. They may not be totally responsible for the GFC – the Gov’t push to help people buy homes gave rise to sub-prime – but they sure as hell turned a point problem into a global disaster.

      There needs to be a change in ethics in the whole FIRE sector. Goldman may not have done anything illegal, but they sure as hell did a lot of damage!

  4. Gary Anderson

    While Goldman is a pathological company, the method of operation of ponzi scams comes from much higher pedegree than Goldman. Goldman is merely a footsoldier. I would like Goldman to be indicted for racketeering, if it can be shown that the business model frauded over and over.

    But clearly, the banking cabal as a whole is a scam as I write here:

    Not only is it a scam, but it is a scam with a purpose and with intent. The entire ponzi central bank scam is racketeering.

  5. Capricorn

    Minor point, maybe, but I think still relevant —
    In C-Span’s video of the Hearing, Levin was clearly out for blood. But I thought McCain’s inquiries were a complete sham! More than once McCain initiated a line of questioning which looked like it was reaching for a critical point, only to have him back off before the denouement. Preserving his campaign funding?
    As for Blankfein’s refusal to “understand” Levin’s questions, that footage HAS to be marvellous source material for cartoonists!

  6. craazyman

    It’s always a festive observational occassion when the basic psychological structures experience an upheavel due to the superego’s attempt to obstruct and shape previously unrestrained Id energy. There is always a sense of sudden and public shame, naive surprise, judgmental anger and the sudden amplification of a previously nonexistant but suddenly powerful righteous indignation at the cultural level — which is empowered by a current of the id energy being suppressed and channeled into the creation of what can loosely be called “civilization”. yes, this is right out of Freud. But we have a ringside seat. The tribal superego has just had an earthquake, overwhelmed by pain from the extremities of the universal mind. It’s all a big beehive, and the Queen is a metaphor who sits in the clouds like a bright star in the 87th dimension and has two faces, one male, one female. Like some ancient diety. It’s all beyond good and evil, like Freddie said before he hugged the horse ’cause he saw too bright for even his own eyes, and it’s the physics of the timeless hierachies of the communal mindspace. I would attempt a 10-bagger out of it, but the problem is not so much the trajectory itself, but like the Heisenberg Uncertainy Principle, you can know only the position or the momentum with enough certainty to risk your dumb ass long or short. Better to just hang tight and find your pleasure in the setting of the sun and a few beers and a surfboard. LOL. It’s all explained in the Golden Bough, which runs several thousand repetitive pages of Victorian prose. Better to take that in chunks with a few glasses of sherry by the fire, like a civlized gentleman.

    1. Skippy

      Sometimes I see it like, see: Ramsey theory, named after Frank P. Ramsey, is a branch of mathematics that studies the conditions under which order must appear

      “how many elements of some structure must there be to guarantee that a particular property will hold?”


      To which Graham’s number, named after Ronald Graham, is a large number that is an upper bound on the solution to a certain problem in Ramsey theory.


      Of which I’ve heard it said, that if you took all the matter in the universe and converted it to ink, it would not be enough to write the number down.

      Skippy…But we know it ends in 7, smoke some of that before your next session a dawn bro…lolz.

      PS. Pearls are bad, but TOADs and Maytag’s suck.

      1. Vinny


        Do you have a link to a Hollywood version of this Ramsey theory thing? One with with Angelina Jolie in it would be nice. The wikipedia version you so gracefully provided looks a bit tiresome for this lazy Friday evening by this filthy beach, in this new member of the Third World, called Greece :)


        1. Skippy

          Sorry Vinny, just got back form volunteering as a driver for wife in central Queensland (ambulance/paramedic).

          The old brain pan is pretty clean now but, don’t you worry, a few weeks in the big smoke and all will be undone.

          Skippy…absurdity incoming.

    2. Vinny

      Hey craazyman,

      GS people have no superego at all, in my assessment. Just a very demanding Id and a compliant ego immediately fulfilling its criminal wishes. But then again, that’s also the psychological makeup of most politicians, so the spectacle of one type of criminal “investigating” another provided a rare and worthwhile source of entertainment this week.


  7. RHS

    “Buying CDS protection in volume pushes up yields on bonds. The rating agencies respond to market signals (this is a dirty secret). If the market yield on a bond is too far out of line with their rating, they feel pressured to downgrade. The downgrade confirms the suspicions of those who have doubts, leading to either sales of the bonds themselves or purchases of CDS by new parties, further pushing up yields.”

    I wont lie Yvess, we raters look at the CDS and sometimes act, not on the spikes though, its the trend. No one in a rating committee is ever going to say the CDS is high so lets downgrade, it is more like the committee members see the CDS and start to weight the negative credit factors more and the postive factors less. Also it takes normally 2-3 days for a non-event based rating action to go from conception to publishing, so if you see a spike in CDS on the same day of the rating action it is either coindence or someone managed to figured out when we would downgrade.

    There are many a time we ignore it just because of the possibility that it can be used as a speculative vehicle. Though most people do not see that because they are focused on the defaults and not on the non-defaults. Of course there are those cases we ignore it and it defaults usally because the current criteria has to change in order for a downgrade to occure or because that analysts is just simply wrong and will be spending more time with their family in the near future.

    CDS main power with the agecnies is in confirming suspecions that are already present much in the same way rating downgrades cofirm suspecions of market participants. This creates some simultaneity as you observed which we are acutly aware of.

  8. Otto

    Yves it seems that you have a goulish hatred for GS. Did they do something to you in the past?You lash out at everybody who doesn’t share your contempt for GS. Why don’t you wait till the civil suit is settled.
    I think that the big question for the average Joe like me is why did we have this financial crisis.Why don’t you go after AIG like you do GS. Their actions seem to be the cause of the crisis. In fact they received the lion share of our TARP money.What is an insurance company who sold over 80 million life insurance policies to the general public doing playing around with CDSs on toxic assets.If you want to help out the general public dig deep into AIG.


      I certainly can’t speak for Yves, but it seems quite apparent to me that GS’s actions were in no way characterized by or proceeding from accepted standards of morality or justice. What was once only suspected predatory behavior is now becoming confirmed predatory behavior…Goldman’s gift comes in the form Pandora’s box, and it sure looks like it WILL keep on giving.

      “Federal prosecutors in New York have been examining transactions by Goldman Sachs Group Inc., accused of fraud by U.S. securities regulators, to determine whether to pursue a criminal case…”

      There’s no doubt that there are many other high profile players involved, but I haven’t seen anything to suggest the same level of inbreeding and corrupt cronyism, which has been on open display between GS its government regulator.

      You can’t just go around advising your clients to invest, disbursing, in volume, the toxic the garbage that you helped create, installing your own pups as your regulators, betting against your same clients, getting bailed out while your largest competitor is left to crash and burn, and then expect to be rewarded and help up as a symbol of true, justice and American way…or can you?

      The system certainly appears to have been “gamed” at each an ever level, and by one firm in particular. Conflicting interests, predatory behavior, pay-to-play, moral hazard, and serious agency problems aren’t limited to the realm of the US legislative branches, but this is what we get when the incentives of the system have been misaligned to the interest of the markets themselves. I have to wonder if Greenspan still believes that bigger really better when the well informed are replaced by the incentivized uninformed.

      AIG and others do need to be investigated, but it’s truly unfortunate that this has to be demanded by the bloggers, and in hindsight. Meanwhile, so called “reforms” are pressed forward in every effort to set up the next shell game (carbon credit exchange)…Any thoughts on how this concept might be going in Western Europe (Kyoto Protocols)?

      So, here we go, the “big shorts” of the future…can anyone smell the blood in the water yet?


      Origins of carbon economy and carbon finance

    2. Yves Smith Post author

      You seem to have a perverse need to defend Goldman. It is hardly “ghoulish hatred” to criticize behavior that by any commonsense standard is fraudulent, particularly when the perp continues to defend it, brazenly.

      1. Otto

        I am not defending GS at all. I am chump public and never heard of a synthetic CDO until recently, so how can i defend someone’s actions when i don’t even know what their actions entails.It just seem to me as an outsider that you have a vendetta against GS by your articles, it seems to consume you.All I said was let our judicial system do its job, but you just lash out at everyone who doesn’t call GS the devil and that is not rational especially when there were bigger players that caused the financial meltdown like AIG.They, I think, have more effect on the general public(billions in all those 401k stable value funds)than GS.Again how can an Insurance company with those close ties to chump public’s 401K savings be involved in selling insurance on toxic assets.I just think the public would be better served if a more rational analysis of the financial meltdown was more evident at this website.

        1. monday1929

          The only reason the judicial system MIGHT be forced to “do its job” is because Yves has focused attention on some dirty corners. AIG was probably set up as the patsy all along, but if you have enough interest, set up your own site to examine that issue. And someone can criticize YOU for not going after JPM, who has 80 trillion in derivatives.
          There is enough criminality to go around. Read and learn from this site. Then speak.

          Lee S.

          1. Otto

            ‘JPM, who has 80 trillion in derivatives.” Sounds interesting, carry on my learned friend. As I have said many times, I would like to learn why we had the financial crisis. So in your own words can you tell me what caused the financial crisis?

        2. Yves Smith Post author

          This is purely your projection. I do not hate Goldman, nor do I spend much time thinking about them. If you read my book ECONNED, you will see virtually no mention of them (Morgan Stanley and Lehman get more air time), which would hardly be the case if I were fixated on them.

          I suggest you read my blog posts in 2007 and 2008. When any topic on my beat becomes newsworthy (the Bear hedge fund meltdown, the monolines, Lehman’s bogus accounting, CDOs, to name a few) I cover it in depth. That’s why I have a readership, I treat topics in the news in a fair bit of detail. You choose to mischaracterize it, which suggests you have a vested interest or at a minimum identify with Goldman.

          1. Otto

            Again as i have told you before i have no affiliation with GS. I am an old retired engineer,( worked in the avionics radar business for 40 years) with perhaps too much time on my hands.
            I am on the waiting list for your book at my local library.
            Hope in goes into detail on why we had the financial meltdown and maybe you could shed some light on that subject at this website.Again i am not defending GS, but i just don’t see that how they caused the financial meltdown.
            If you do, please explain.
            Have your staff use Wordle ( your articles to see how often you use the word GS, predator, fraud, greedy,etc.

          2. Richard Smith

            Hi Otto,

            (Kid Dynamite thinks I’m the staff, and that’s good enough for me). These are your basic options:

            a) wait for your library copy of ECONned to become available.
            b) buy your own copy (it is around $30 if I remember correctly)
            c) if you’re too cheap for b) and too impatient for a) and have a bit of time on your hands, then you could read posts from Naked Capitalism on the following subjects, or read the whole thing in chrono order from say early 2007. The number in brackets is the number of posts that touch on each subject.

            * Banking industry (1619)
            * Credit markets (1673)
            * Derivatives (313)
            * Doomsday scenarios (150)
            * Federal Reserve (666)
            * Free markets and their discontents (218)
            * Hedge funds (258)
            * Investment banks (588)
            * moral hazard (65)
            * Regulations and regulators (1320)
            * Risk and risk management (252)
            * Social values (314)
            * The dismal science (237)

            As you can see, it is a large subject, and, because you haven’t read the thousands of posts dissecting the crisis as it happened, your impression of Yves’s account of GS’ role in it is quite wrong. As you may also be able to see, there is a lot more to it than the activities of the former investment bank, Goldman Sachs.

            d) Now, it will take much more than $30 worth of my effort or Yves’s to provide you with the summary you are requesting. However, if your sudden interest in the crisis mechanisms persists for a couple of weeks longer, I’ll be doing a series of posts on that very subject. NO blame will be attributed, I’m sorry to say, however tempted I might feel; I am more interested in the nuts and bolts than in any political angle.

            But it will be totally free of charge, which I hope you will like.

          3. Yves Smith Post author

            Otto, nowhere does this post or any post I have written say Goldman caused the financial crisis. You keep engaging in straw man arguments.

    3. DownSouth

      Ghoulish hatred? Yves?


      Let me give you an example of what “ghoulish hatred” looks like, so you won’t come across as being so ridiculous, which is the effect your nonsensical exaggerations have:

      ….Lorenzo’s revenge had not been excessive, though that cannot be said of Denmark’s Keng Christian II, who invaded Sweden early in 1520. In January, Stern Sture, Sweden’s leader, was killed in action. Heavy fighting continued throughout the year, however, and it was autumn before Sture’s widow, Dame Christina Gyllenstjerna, surrendered. Christian had promised her a general amnesty, but a king’s word wasn’t worth much then. He immediately broke his, and in spectacular fashion. First two Swedish bishops were beheaded in Stockholm’s public square at midnight, November 8, while eight of their parishioners, who had been summoned to witness the execution, were butchered where they stood. The Danish king then disinterred Stern Sture’s remains. After ten months in the grave they were scarcely recognizable. Rotting, crawling with maggots, emitting a nauseous stench, the corpse was nevertheless burned. Next Sture’s small son was flung—-alive—-into the flames. Then Dame Christina, who had been forced to watch all this, was sentenced to live out her days as a common prostitute.
      –William Manchester, A World Lit Only by Fire

      1. Francois T

        Could we put forth the hypothesis that this gentleman harbored a grudge of some sort?

      1. teamti

        Otto – you’re retired so presumably you have a lot of time on your hands.

        You were an engineer so presumably you’re not an idiot.

        You’re posting here so presumably you’re curious.

        Perhaps you should do some reading on the subject matter instead of asking to be spoonfed. Suggested articles have already been provided – for free.

  9. VenusVictrix

    I’m reposting comments previously made to Edward Harriman’s outstanding piece on Goldman’s Public Purpose, because the points seem relevant in the context of Goldman’s claim to be “merely market makers”. It seems Goldman was creating assets that they knew would not retain value long enough for a secondary market to develop.

    Here’s the evidence:
    Economist Gary Gorton is the genius who supposedly aided AIG by creating the program they used to price their credit default swaps. In a report titled The Panic of 2007, Gorton makes this statement:

    “The defining characteristic of a subprime mortgage is that it is designed to essentially force a refinancing after two or three years.” (p. 12)

    So the defining feature of a subprime loan is that it will either be prepaid, or it will probably default. Those characteristics do not lend themselves to a security that will hold much value over time. Obviously Goldman Sachs had to have known this – especially since the consultant to their CDS counterparty knew it. Also, it’s hard to imagine a “defining feature” that they securities underwriter was unaware of.

    Goldman was not making a market – they were dumping toxic assets. Further evidence of Goldman as Predator.

    1. charles

      Your commentary reminds me we should not forget to pay a
      ‘tribute’ to Blythe Masters / JP Morgan

      “They had parties, we got the hangover”

      ‘Apart from Gillian Tett herself, who has been the most prescient British financial journalist on the credit crunch, the most fascinating is Blythe Masters, a blonde, porcelain-faced Tilda Swinton lookalike who has the dubious distinction of having devised the first credit default swap…’

  10. ab initio

    After much kabuki in DC and politicians making campaign speeches to “clean up” Wall Street – we will find that GS shareholders take the hit in a “settlement” with the SEC. Management will continue in their merry way and after the elections the politicians will continue feeding at the Wall Street trough.

    And more kabuki after the next collapse. It seems that we cannot learn the Greenspan put and now the Bernanke put only creates the next asset inflation that inevitably crashes. Three times in a single decade and we keep at it.

  11. Lyle

    Did anybody see the article where the german banks that took the long side of Abacus then sold pieces of it to King County Washington, leading to the county taking a 50 million dollar bath? Sen Snow in yesterdays hearing with the SEC chairman speculated on putting a fiduciary duty on broker dealers beyond just individuals to pension funds and municipalities. This makes sense we have a number of examples in the US such as Orange Co Ca, and Jefferson Co Al, where the wall street wheeler dealers bamboozled the county treasurers and let the county down the garden path (see also Narvik Norway in house of cards). Since this is taking advantage of taxpayers in a but in a different way put a fiduciary duty on the sellers of the stuff and then you can make them pay.

  12. Percy

    Yves’ emphasis on the underwriter function performed by Goldman and the consequences its status as an underwriter is, as seems to be said too often these days, spot on. All that nonsense about being a market maker in these insturments and having no duty to anyone is just that: nonsense — down a rabbit hole created by lawyers as a possible way to do what an underwiter could never do. Tough luck, Goldman: you were either misinformed or, perhaps because of the money, ignored better advice.

  13. Tim

    CDO’s need banned. Naked CDS needs banned.

    Ritholtz commercial idea is an excellent one.

    More importantly – there needs to be ONE website where there are 5 -7 items clearly spelled out for the masses to grasp and raise hell about to their Senators.

    Deconstructing Abacus from interfluidity includes Alea’s take and the prospectus, and more.

  14. Doc Holiday

    I conclude that SIFMA is now doing God’s work and that, God is dancing with Obama to re-shape the way that things are going down.

    Three parts of Yves story helped me see the light:

    1. Lloyd Blankfein’s “We’re doing God’s work” has come to epitomize what is wrong with the financial services industry post-crisis the same way Chuck Prince’s “We’re still dancing” did for the bubble era.

    2. What is stunning is that the Wall Street Journal defends Goldman (don’t forget the God awful Washingtom Post scumrag).

    3. In seeking to make its case to lawmakers and their aides, the bank has been largely relying on trade groups, like the Securities Industry and Financial Markets Association, the American Banking Association, or the Financial Services Forum, to plead its case about concerns in the financial legislation, industry officials said.

    So says the good book, and let there be light upon the faces of the evil people associated with this sack of crap…. and may they shine like beacons, shine like warnings, shine like the bald head of the horn’d CEO of the evil firm which will cease to exist, the firm whos name we shall not speakth of… Amen Sister!

    1. Vinny

      “shine like the bald head of the horn’d CEO of the evil firm”

      Thanks for this classic line :)


  15. Amit Chokshi

    Hardly a surprise re WSJ, that paper is toilet paper, it’s for the tea baggers at this point. Op-ed page was always a steaming pile of crap but now it’s fully out of reality. When a guy that should have been tried for treason or any number of crimes (Karl Rove) is a regular columnist and then the AEI’s roster of bozos and fools like Luskin get press time it’s total and utter garbage.

    The sheen is coming off GS. Having worked at MS and RBS I can say that there’s always that GS envy people on the street have but also that level of suspicion as in there has to be some shady stuff going on there. It’s a similar pool of people across the street so the fact that GS always came out on top would just make some people half joke about the stuff these guys pool. As in the flow of information, lack of Chinese wall, etc or maybe as the hearings showed, a warped ideology and aggressive interpretation of compliance such that they could push rules that most other firms wouldn’t. Even in Lowenstein’s When Genius Failed, there was plenty there suggesting GS as hijacking LTCM’s systems and interesting how they were the ones gettng the chance to “help” LTCM.

  16. mess

    One of the things that is so much crap is the alleged “Chinese walls” that separate one part of a company from another. I would like to see more comments from people who know better because I find it hard to believe “as in I don’t” that one guy doesn’t talk to another guy letting them know when a client has just be an idiot and they don’t say “Guess what this idiot just bought” IE Timberwolf sold to Bear. The prop desks of all the investment bank companies have been screwing everyone (they can because of no fiduciary duty) forever.

    1. Peripheral Visionary

      As someone who does have direct exposure to this issue, I can say that I do think the “Chinese firewalls” are more fiction than reality. These people work alongside each other, eat meals together, go to company parties together, and never talk about what they’re doing? Nonsense.

      Of course they talk, and of course the advisory group comes under pressure from the capital markets group (which in most of the largest firms is the where the real power in the company lies.) The fiduciary responsibility to clients is seriously compromised by virtue of the fact that the company as a whole puts its own interests (and specifically its own trading book) first.

      I totally agree with suggestions being floated that the artificial lines between fiduciary and market-making capacity be erased, and that any company with a fiduciary duty to clients be required to maintain that standard throughout all of the operations of the company.

  17. Peripheral Visionary

    @Krasting: “The shorts were clearly predators. For me it was the shorts that destroyed the equity values.”

    Ugh, not this line again. Shorts may drive down the price of the equity in the short term (although it takes a LOT of short-selling to move the needle), but in the long term, there is precious little they can do to damage the company other than cast vague doubts on its reputation.

    Yves’ point on CDS is more valid; massive CDS trades that blow out the spread can move ratings agencies to reconsider the company’s viability, and can move bondholders to consider pushing for higher yields (and a certain amount of arbitrage speculation may follow.) But even then, it’s a secondary effect.

    The fact is, companies are most vulnerable, not from an equity perspective or from a derivatives perspective, but from a debt perspective. Companies that have tremendous amounts of debt are extremely vulnerable to changes in demand for their debt, and conversely, companies with little or no debt are bullet-proof. Let the shorts hammer away at a company like MSFT all they want, they won’t make a dent. Let them take the short side of the CDS and pour their money down a hole as the company makes every bond payment on time, it will not affect the viability of the company in any way. Contrast that with the typical financial company, which is so heavily indebted that it lives or dies on the rates it pays for debt, with a move of even a couple of percentage points meaning the death of the company.

    The best defense that companies have against “predatory” trading strategies (listening, Dr. Byrne?) is to be making money and have a conservative debt to equity ratio. Strong companies will kill the shorts every time, it is only the money-losing and/or heavily indebted companies that have to worry about the credit markets.

    1. Andrew Bissell

      <iThe fact is, companies are most vulnerable, not from an equity perspective or from a derivatives perspective, but from a debt perspective. Companies that have tremendous amounts of debt are extremely vulnerable to changes in demand for their debt, and conversely, companies with little or no debt are bullet-proof.

      Yeah, I have a pretty hard time believing that a company like Lehman — which was basically leveraged into the housing market 35:1 — could possibly have had a gradual, long-form unwind if only it wasn’t for all those nasty shorts. In fact, they were lucky they lasted as long as they did. Plenty of commentators had figured out the stock was worth $0 as early as spring 2008.

      1. jdmckay

        (…)a company like Lehman — which was basically leveraged into the housing market 35:1 — could possibly have had a gradual, long-form unwind if only it wasn’t for all those nasty shorts.


        But… how did we get to this point? Currently, especially among those “Joe Q. Citizens” who are unaware of the process leading to “crisis” (see commenter OTTO on this thread), all the GS headlines seem to be creating latest media-generated stir suggesting ultimate question: did GS cause the crisis or not?

        This was a systemic corrosive symbiotic process involving Congress, Fed regulators/Treasury & their ties to titans of WS, banks (really bad loans), skim-over-the-top MSM which fed the bubble rather than digging into it’s cause, really bad accounting practices… etc. etc.

        That balanced economic activity: eg. real value produced was displaced at accelerating rate by bogus books (good starting point IMO is ENRON), portraying false profit while underlying economy (eg: real value produced) was being eviscerated… it was a long process and participated in by many who knew or should have known better.

        My point is current snap-shot-in-time debate about whether the “shorts” caused the mess… pretty much misses forest for the trees. If things had functioned even relatively in conformity w/some kind of moral core, this imbalance wherein shorts are betting against massive sector of US economy upon which mortgage “securities” had progressively become more and more weighted in toxic and unreal proportions… then opportunity for “shorts” to play in way they did never would (or should) have existed.

        The whole “shorts”, “GS caused it”, etc. etc. is tail coming back to smack the head. This was/is systemic corruption in manifold ways, has yet to be detailed in a manner general public can grasp, and has enough pieces left in place to exercise another catastrophe while congress debates one tree in a diseased forest they don’t seem to understand.

  18. Brett

    A few things:

    As nice an essay on the predatory aspect in ABACUS 2007 ACT. I’ve read the flipsheet, but haven’t gotten to the prospectus as of yet. Suffice it to say that if the CDO market is useful, necessary, and worth keeping around then this episode contradicts this. Never mind the housing market, people knew that was a bubble. It sounds to me exactly as if GS had decided, back in 2007, that the market for CDO’s was unsustainable and was intended to get out.

    It seems obvious that GS doesn’t give a damn about repeat business either.

    All of which goes toward my main point: if capital markets are essential, then zero-sum trading like the ABACUS deal is the quickest way to kill the whole shebang. As you pointed out, even those trading in the pits of the Merc abide by both code and rules.

  19. Brett

    Well, maybe the forensics will see the light of day after all:

    U.S. Said to Open Criminal Inquiry Into Goldman.

    On the other hand, maybe this is a backhanded bailout:

    “Federal prosecutors would face a higher bar in bringing a criminal case against Goldman, whose role in the mortgage market came under sharp scrutiny this week during a marathon hearing in the Senate. In contrast to civil cases, the burden of proof is higher in criminal ones, where prosecutors must prove their case beyond a reasonable doubt.”

    1. Francois T

      A criminal inquiry? In the USA circa 2010?


      When it comes to people with wealth, prosecutors consider that any punishment (other than performing deep sodomy on the wallets of hapless shareholders) otherwise deemed obvious for any member of the unwashed masses is unthinkable.

      Sounds extreme?

      Let’s see a sample from recent evidence:

      Guidant corp is a medical device maker. They sell implantable cardiac defibrillators; yup! the sort of stuff one has inside their thorax. This kind of gizmo calls for rather strict quality controls and design. (One hopes!)

      Alas, the reality was this:

      Guidant executives allegedly knew that ICDs made from 2000-2002 were at risk for short-circuiting and failing, thus making them unable to deliver potentially life saving electrical shocks meant to prevent cardiac arrests, but the company only revealed the problem in 2005. By failing to notify physicians and the public, Guidant executives let expensive and profitable, but potentially useless devices to continue to be implanted, potentially increasing the risk of sudden death for the patients who received them. Then here we noted reports that Guidant continued to ship <failure-prone devices even after it had designed and started to manufacture new ICDs that were supposed to be less likely to fail.

      As an FYI, there has been 6 documented patient deaths as a result of this affair.

      Lawyers from the govermin get in the case, time elapsed and gna gna gna!

      Anyone would like to venture a guess about the outcome of this case?

      Here is what Judge Donovan W. Frank had to chew on as the core “settlement”:

      – The settlement seemed to ignore the most egregious misconduct alleged:

      Recently, prosecutors charged in court papers that Guidant had knowingly sold potentially flawed defibrillators. But that issue was not addressed in the plea agreement. Instead, the company agreed to plead guilty to two misdemeanor charges that related to the completeness and accuracy of its filings with the Food and Drug Administration.

      – It was not really the Guidant subsidiary that was going to plead guilty, but a new entity apparently constructed solely to “take the rap.” The company created to enter Guidant’s plea, Guidant LLC, existed only on paper.

      Res ipsa loquitur, no?

      I could provided to numerous other cases like this one. And that would be only in the health care field, mind you.

      So, the hope of US govermin contemplating a criminal inquiry into Goldman Sachs, is very quickly converted into an irrepressible laughter every time I look at what is happening in the particular corner of my professional universe.

      1. Brett

        Well, I never had high hopes for any SEC or DoJ action against GS. California had the 5th largest economy in the world and was still humbled in court by insurance companies. What this criminal news reminds me of is the oft used Bush administration tactic of preventing public discussion of the case for fear of prejudicing an official investigation it never intended to pursue.

        Resulting in Levin not getting another chance to release any more emails, for instance.

        * * *

        Wasn’t it Yves who wrote about law seminars for federal judges on how to protect the “free market?” Run by someone out of the U Chicago law school?

        Where did our president teach, anyways?

        So I assume the deck is stacked against federal prosecutors who will be held to impossible standards of evidence, among other roadblocks. Better a public investigation, not run by sitting members of congress, but by a lawyer like Ferdinand Pecora.

  20. Bob the Builder

    Yves, As a once upon a time analyst in the Mort Team at one of the rating agencies, I have to tell you, neither analysts or management have a clue what current market yields are on any security. They just don’t have a clue or know what to do with one.

  21. K Ackermann

    Being superb risk managers, I wonder if Goldman ran simulations on the cost of reputational damage vs. expected gains from Abacus.

    They pulled a Martha Stuart.

    Also, for being masters of the universe, they sure appeared to be just like ordinary people, except with less of the good qualities that make people worth all the trouble that they are.

    They media has to stop saying they are the best and brightest. Not a single one of the first panel struck me as a best or brightest.

  22. MichaelC

    I presume the SPG got out of the shorts against RMBS impaired rivals in time to avoid the squeeze when the no short ban on banks went into effect, and just when it was really paying off.

    Too bad for SPGs equity strategy, nice for GS. Mr Birmbaum must have been pissed to have to sacrifice such easy money, and such a nice hedge against that legacy stuff they couldn’t unload.

    How ironic for GS to gain protection from the shorts through the ban, shorts being such good and valued customers and all.

  23. Steve Diamond


    Goldman was not an underwriter of the ABACUS deal. It was a private placement thus GS was a placement agent and explicitly avoided the potential liability that an underwriter would face. This makes the SEC case harder to win. They have to use 10b-5 not Section 11 and the standards for such cases are tougher as a result of a series of court decisions over the last twenty years or so.

    1. Yves Smith Post author


      I am in contact with a law firm pursuing cases related to CDOs. This is an area with almost no precedents, contrary to your assertion (heretofore investors have not litigated structured credit deals). This is why the SEC is pursuing what they argue is a misrepresentation, which should be easier to prove than an omission.

      You have misrepresented the extracted text, which comes from the Senate, not me. It contemplates both private placements and underwritings.

      1. Steve Diamond

        Here is the excerpt from the SEC Complaint citing 10b and 10b-5:

        “By engaging in the misconduct described herein, GS&Co and Tourre directly or indirectly engaged in transactions, acts, practices and a course of business that violated Section 17(a) of the Securities Act of 1933, 15 U.S.C. §77q(a) (“the Securities Act”), Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. §78j(b) (“the Exchange Act”) and Exchange Act Rule 10b-5, 17 C.F.R. §240.10b-5. The Commission seeks injunctive relief, disgorgement of profits, prejudgment interest, civil penalties and other appropriate and necessary equitable relief from both defendants.”

        Here is the appropriate excerpt from the class action filed by one of the major class action firms:

        “The claims asserted herein arise under §§10(b) and 20(a) of the 1934 Act, 15 U.S.C. §§78j(b) and 78t(a), and SEC Rule 10b-5.”

        The reason they have to use 10b of the 34 Act – which is harder for plaintiffs – is that the ABACUS deal was a private placement NOT an underwritten deal. Thus under Reg D and Rule 144A Goldman is exempt from liability under harsher Section 11 claims.

        I don’t mean to question your experience or your ability Yves but speaking as a securities lawyer myself for fifteen years and as a law professor who has taught securities law for ten years this is pretty straightforward. The larger point is the securities laws have become swiss cheese over the years and it may allow Goldman to escape in this situation (by the way, I think the case is very weak).

  24. Steve Diamond

    Also, why do you think it is so unusual that a bank like GS acts as both market maker and underwriter? It happens every day. The bankers at GS put together IPOs and the broker-dealers act as market makers to bring together buyers and sellers. That is the nature of banking.

    1. Yves Smith Post author


      Your remark implies I do not know the business. My first jobs were on Wall Street, I was running a profit center before the age of 30. I understand the difference between market making and placement of new issues, whether on an underwritten or a private placement basis.

      Goldman is arguing for a market-making standard for a new issue when it is involved in creating the deal and responsible for the disclosures. That simply does not wash from a common sense or legal standpoint.

      1. Steve Diamond

        I am certainly not calling into question your experience Yves. I am only suggesting that there is another way to see this transaction. Goldman has within it as does any bank several operations, including market making, underwriting, etc. If the walls between these were blurred then there is a problem.

        But when a willing buyer of CDS like Paulson is put together with a willing seller of CDS like ABN or a willing buyer of the notes like IKB then I think they are behaving as a market maker.

        When they create and market the SPV that issues the notes then they are acting as a placement agent.

        Their legal duties in each role differ. If they blurred the lines internally that is a problem but I have seen no evidence of that in the public domain.

        Btw, it appears that IKB is hardly an innocent here. The LA Times is running a story that they funded their purchases of the ABACUS notes through CP sales. Since CP is exempt from securities law coverage too that may be the real crime since that may have allowed them in essence to go long the bubble in housing with money from unsophisticated investors.

      2. steelhead23

        As a mere spectator, I have no business intervening in a spat between a journeyman lawyer and a journeyman investment banker, but I offer a simple observation. One problem I see in U.S. jurisprudence is that it is based on “the letter of the law” not the principles behind it. This leads to the Swiss cheese Mr. Diamond describes as crafty lawyers devise schemes by which their clients can wildly violate moral principles while abiding by the letter of the law. That is, securities lawyers find and help their clients exploit those holes in the cheese. Another observation for Mr. Diamond, I have noticed that in interviews securities lawyers often evade answering questions regarding right and wrong – morality based assessments – and often offer up responses regarding the letter of the law. Like much of the apologies offered for GS’s horrid behavior, this does not raise my impression of the FIRE industry and suggests that participation in it may be bad for one’s soul.

        1. Francois T

          You put a capsaine-coated finger directly into the open wound. (Trust me, it does hurt aplenty!)

          I’m starting to believe that, when it comes to financial law, the whole American legal paradigm is flawed. We will have to either migrate to a principle-based system, or adopt a variant of what The Epicurian Dealmaker recently suggested, that is a Mandarin-lead** regulatory system:

          Many observers of the smoking wreckage which now passes for our banking system have opined that, in addition to being hobbled by a fragmented regulatory system riddled with overlapping and ill-defined responsibilities, the regulators who were supposed to be watching the chicken coop were woefully overmatched by the foxes. Staffed primarily by lawyers, on government pay scales, the SEC almost by definition is not up to the task of monitoring Goldman Sachs, JPMorgan, or anyone else, if by “monitoring” we should expect true informed oversight and control. If Harry Markopolos couldn’t get the SEC Enforcement Division to understand and investigate what appears to have been a particularly simple—if breathtakingly successful—Ponzi scheme, how can we possibly get comfortable that our government watchdogs can effectively oversee the hugely complicated, mind-numbingly sophisticated, globally distributed trading operations of a modern investment bank?

          This shortfall in regulatory intellect has been exacerbated by what the Japanese call amakudari, or “descent from heaven”: from time immemorial, a steady stream of former regulators has resigned their posts to assume positions on Wall Street, sometimes at the very firms they had been charged with overseeing. There is very little incentive to push a little harder or dig a little deeper into a question if it irritates a powerful firm that might be your future employer. Furthermore, this practice provides a steady stream of inside knowledge on current regulatory focus, practice, and ignorance that is of tremendous value to oversight-minimizing investment banks.

          The answer, of course, is obvious, if politically difficult to put into effect. Staff the SEC, or whatever “Super Regulator” the government decides to deputize to oversee this mess, with a bunch of highly-paid, tough-as-nails, sonofabitch investment bankers. You will have to pay them millions, just like regular bankers. (You can tie their incentive pay to improvements in the value of securities held under TARP and TALF, if you like.) Pay them well, and investment bankers won’t be able to treat them like second-class citizens at the negotiating table. Pay them like bankers, and your regulators won’t hesitate to read Jamie Dimon or Lloyd Blankfein the riot act, because they won’t give a shit about getting a job from them later.

          Trust me, these are the kind of people you will need on your team: highly educated, financially sophisticated, psychotically hard-working, experienced professionals who know or can figure out CDOs, SIVs, balance sheet leverage, and credit default derivatives just as easily as the idiots who created and trade this shit. Leading your enforcement and supervision teams you need a bunch of smooth, smart, plausible, grandiosely self-confident senior bankers who will not hesitate to tell Vikram Pandit to go fuck himself, his mother, and the cow she rode in on if he ever tries to fuck with the United States government, the US taxpayer, or the pizza delivery boy again. You know: psychopaths.

          This is not a new idea. For yonks, the Brits have known that the best person to hire as gamekeeper on your ancestral estate is a former poacher, someone who knows what they know, how they think, and where to punch them in the genitals to get maximum negotiating effect.

          **The function, not the language.

        2. Steve Diamond

          The swiss cheese I referred to is the series of Supreme Court decisions and SEC rule making that laid the ground work for much of the current crisis. These have cut the heart out of the New Deal protective legislation that we used to enjoy.

          For example, in 1990 the SEC put in place Rule 144A which was used by Goldman for the ABACUS deal. It allows an investment bank to avoid being termed an “underwriter” (magically they are a “placement agent”) which frees them of the harsh penalties of Section 11 and Section 12a2 of the 33 Act.

          Pile on top of that two Supreme Court cases authored by Justice Kennedy in the 90s that eliminated private lawsuits against aiders and abettors like investment banks and also narrowed the coverage of Section 12a2 to just public offerings.

          Without these deregulatory moves by the Court and the Commission the housing bubble likely would not have occurred or would not have been as severe.

          1. Yves Smith Post author

            Apologies for getting sharp with you. I got unduly prickly. I don’t have much sympathy with Goldman’s market-maker argument, but you were raising some additional issues. And your Swiss cheese remarks are well taken.

          2. jdmckay

            I appreciate your detailed explanation of applicable legalese in this episode. However, your statement…

            Without these deregulatory moves by the Court and the Commission the housing bubble likely would not have occurred or would not have been as severe.

            … IMO, really cuts more to the heart of the matter. This is precisely what I have in mind w/my comment above.

            There has been a long process whereby WS interests have persuaded banking/security (etc.) law w/arguments which do not meet muster. In fact the whole deregulation fervor across most every affected market has resulted in similar results: eg. “profits” based on distorted value with industry responsibility, which was proffered as sufficient check & balance, to be weighted heavily towards corporate interests w/public hazard often entirely ignored.

            We have current snapshot: poor engineering in Louisiana oil spill, all kinds of processed food shenanigans, the Countrywide loans… on & on.

            My own view is there are just too many well heeled crooks about to support any deregulation theories, and moral resulting hazards have left a trail of corpses supporting my view. That current arguments seem to focus on legality w/in current framework (“we did nothing wrong”) w/out considering the trail of corpses suggests to me publics will get to enjoy a few more similar go-arounds before any meaningful correction occurs.

            First time I’ve seen your blog, I bookmarked it.

  25. maniam

    we are taken to the cleaners.but in the sewers we have this;

    re;”army of rats invades Manhattan’s upper east side’
    briefly on article;
    …looks like the street’s moving.’s just wild.
    ..we are,until 2018,in a living hell.

    what gs did=above.

  26. a

    “Underwriting is the creation and sale of new securities.”

    This seems wrong. Traditionally at least, underwriting is the sale and marketing of securities, not the creation of them. GS’s role in selling the securities to IKB and others involved underwriting. However, its role in actually creating the securities (e.g., selecting the CDOs, notes, etc to include in the product to be marketed or constructing the synthetics) is beyond the scope of traditional underwriting.

    To me, the role of creating the securities makes GS the issuer, not merely the underwriter. IMO GS should have additional duties (beyond its duties as market maker or underwriter) when it constructs the security/derivative/financial product to be sold. I think it’s important to not conflate its many roles in the various transactions. That’s what GS itself is trying to do because it allows it to avoid fulfilling each and every role in a prudent and fair manner (as it should be required to do both legally and ethically).

  27. Sechel

    One of your best pieces to date on Goldman. Yes they were a placement agent and not acting as a market maker. This is obfuscation number one on the part of Goldman. The second obfuscation is that every long in a synthetic has to know their is a short(not entirely accurate). Some synthetic CDO’s were banks looking to hedge an actual portfolio while others had every cds put out for BWIC for best execution price and had multiple parties taking the short credit position. And yet another obfuscation was that the parties harmed were “sophisticated investors” which just confuses a legal term with dumb money. ACA like the monolines was dumb money that was out of their league and Goldman took advantage of that; This wouldn’t be so bad if ACA was a private hedge fund, but htey were a regulated monoline that required a bail out, similar to AIG, IKB, etc.

    I don’t know if Goldman acted illegally, but their actions don’t pass the smell test. Would love to be the fly on the wall at the dinner table of some of their customers.

  28. NS

    Excellent work Yves as usual. Thank you.

    The truth of the matter is this is but one tiny slice of the double down dirty dealing prevalent throughout the industry and hardly limited to Goldman. Goldman is a poster child however of a predatory culture who are so disconnected they don’t even ‘think of it’ as Blankfein said referring to one question during the hearings about their relationship with clients and the expectation they are working in their interest.

    The Caveat Emptor is a viral plague and as one professor of business recently said, “not a business plan”. The cheer of winning at the very real cost to those who have nothing to do with the securities industries (or any industry) reveals the rotten core of relying on this philosophy. What isn’t said must be considered as well as what is said in documents, relationships; legal and otherwise. How can one conduct business if the entire relationship is hostile and a world of what you don’t know and our well hidden plan will cost you dearly?

    Finally with reform front and center; one cannot legislate morality or ethics. This is why overly complex legislation which is so full of special deals, hidden holes and lobbyists dreams isn’t adequate. Restructuring banking and the securities industry is what is required.

    The little folks need a way to safely save money, stay up with inflation that government will not recognize. Banking for the little people should return to its previous utilitarian functions. Since the passage of the GLBA and CFMA gigantic markets were created that formerly had functioned but with limitations that protected against manipulation and the very real perverse incentives we see today. Both are a mere 11 years old since passage, the markets targeted by them operated just fine previously.

    Nothing, absolutely nothing short of restructuring these markets will do and yes, Basel III for conformity internationally in setting the same structures and level playing fields. The clock is ticking and its getting late.

  29. aet

    I suppose it’s too much, to expect Equity from the Courts, in the face of this onslaught of Legality.

  30. been there done that

    Many a desk mimic the rather questionable position that acting as placement agent permits a lower standard of care, as opposed to being underwriter (and even the typical CDO desk understands that has nothing to do with being a market maker). Business people in this sector frequently believe they are smarter and more resourceful that securities and disclosure counsel. The business people are sophisticated and do understand that they want to limit their exposure and minimize their fingerprints on a transaction. For example, if you called the asset manager the “selection agent” as opposed to the collateral manager, many a desk thinks that the actual naming of the function supercedes the actual duties and responsibilities of the role. If it walks like a duck……………..Inside baseball but perhaps it illustrates how these guys think. The big guys get that transforming the discussion from disclosure to market making may be a winning strategy – I submit, that is why they are doing it.

  31. Siggy

    From what I have read it appears that the buyers of the Abacus deal were customers of GS and not necessarily clients and in that view it seems that GS holds to the ethos of caveat emptor.

    Having read the SEC filing it is my view that despite the defense of there being an absence of a duty for certain disclosures, GS has a difficult problem and there is a good probability that the SEC will prevail. That outcome, however will depend on what definition of materiality is applied. Also, as I read the SEC filing, its most damming allegation is that of misrepresentation.

    If GS and DB etal are predators, who are their prey? Are they retail investors, or speculators, or pension funds or other fiduciaries? In nature, predation operates to maintain an ecological balance. In a market driven economy predation can operate to initiate the redistribution of capital to other activities. Not infrequently predation is an exercise of theft by fraud.

    If we as a society hold to the view that there are institutions that are systemically vital and thereby too big to fail, in that belief we invite predation. More crudely, we invite fraud and that is precisely what has transpired. We have allowed self evident fraud to run rampant.

  32. itzybitter

    “There are rumors it is in settlement talks with the SEC.”

    But what does the SEC really want from Goldman? What’s on the settleman table?

  33. wjs

    I find your entire arguement very weak. I wouldn’t mind seeing GS go down and I won’t disagree that GS probably is guilty of technically violating the disclosure rule as an underwriter/placement agent. However, I think your implication that GS was taking adavantage of clients and acting predatory is very revisionist about what occured at the time.

    I have run structured products books for both the buy and sell side. I was on the busyide in mid 2000s and was pitched sythentic CDOs as both a collateral manager and investor. Anyone involved in these products knows that the synthetic exposures are created by someone shorting the exposure into the structure. Most of the time its the underwriter until they can offload the tranched risk to other counterparties. Where GS has an issue is not disclosing the collateral manager had inupt from a 3rd party (paulson). However, IKB knows that somoene is shorting the risk that they are buying, I would guess they assumed it was GS or ACA and I wonder if they even asked (I have not seen the docs so dont know exact structure details). The point being is that paulson’s involvement shouldn’t have had an impact on IKB’s buying decision. As GS said in testimony, the collateral is the collateral and the collateral performs indpendent of who is long or short the risk. The only impact and probably the real reason it wasn’t disclosed is for fear of buying something being shorted by someone you think is smarter or more informed. Not sure I would consider that predatory nor should it absolve IKB or any investor if its poor purchase.

    I think you are way off base on your view of GS’ hedging / prop shorting activity. I have not worked on a desk that trades in size that doesn’t actively hedge its exposure, you would be fired and put your firm at risk if you didn’t. Especially on a sell side structured desk where you tend to be long risk from u/w or market making and very often don’t have a way to directly hedge your exposure. In this case you are forced to proxy hedge in any manner you can, which includes shorting equity / debt of firms with similar large long exposures. I agree GS did more than hedge, they took prop positions as well but the point trading is to make money and every firm does it. On the buyside I short the banks I trade with all the time and if my firm were public I bet my counters would do the same. My long winded point is that this activity did not cause the collapse and is a non issue. Further, you seem to imply that buying single name CDS can cause a death debt spiral. I have traded this product for almost 10yr now and have yet to see one instance where buying single name CDS caused a company to go b/k. If anything, single name CDS (via basis trades) has allowed firms to get more debt at artficially low rates.

    1. DownSouth

      ► “If anything, single name CDS (via basis trades) has allowed firms to get more debt at artficially low rates.”

      Not only “firms,” but households, and sovereigns too.

      You seem to miss the forest for the trees.

      It is this orgy of unsustainble debt—-household, business and sovereign—-that lies at the heart of the global financial crisis.

      Your argument is self-defeating.

      1. Otto

        wjs ‘s point was that “hedging / prop shorting activity” did not cause the collapse.Your response was ” this orgy of unsustainble debt—-household, business and sovereign—-that lies at the heart of the global financial crisis.” I can’t get the connection.Please explain.Maybe wjs can also tell us what he thinks caused the collapse.

    2. been there done that

      wsj – did your desk hedge or did the prop desk hedge on your behalf bc mgt had limits on your desk that you had either exceeded or was charging you in a manner that made your long book rather expensive for you? and how did the price of your hedge options inform your decisions as to what to hedge and with whom? did the cost of your hedges come out of your pnl or the top of the house? My point is, to people who do not do this for a living, it is easy for those of us that do to continue to present the ‘facts” that are self-serving at worse and self censored at best. Don’t mean to jump down your throat but I think you will agree with me – it is complicated, there are a lot of moving pieces and there is a self interest to preserve and justify the status quo – and do it by telling everyone else they misunderstand.
      Yeah, I agree that the misrepresentations are the key and it appears to be the case there was misrep’s. But this tap dance on the edge of a knife about inferring GS told only a little lie is wrongheaded and consequential. Don’t lose sight of the fact that the misrepresentations allowed for the progression of other acts that were integral to the whole pie.

      Remember, leverage and lies should never hang out together. They are both bad influences………..

      1. wjs

        Ben There – No worries. I agree it is complicated. I have no interest in preserving the status quo, I think many things about how the banks, their clients, and the regulators operate need to be significantly changed. Thats a big part of why I believe Yves, and many others, are wrong on this GS issue. First, it takes the commentary and focus away from other more substanital perverse bank practices. Second (and I have taken much criticism for this), while I belive GS legally was wrong I don’t think they were wrong, for lack of a better word, “morally”. All the information to make a sound investment decision and to understand the underlying collateral / security structure was disclosed. I think that is evident by the fact that there were firms that declined to be involved. I guess the question to me would be did GS act in best interest of its client. To me they disclosed the information to evaluate the security to the buyers and did it without hurting Paulson’s position who was also a client in the transaction (either directly or indirectly). As a client of GS, I am ok with that as long as if I asked the question directly about collateral selection and was told Paulson involved. As I mentioned, I guess that IKB didn’t ask and assumed was ACA or GS. If that is not the case, then obviously that is a much different issue and GS probably should be facing criminal charges.

        DownSouth – I should have been more explicit. By mentioning the artificial low rate I was trying to imply the role CDS plays in misallocation of capital and investor complancency. I believe that is the bigger problem opposed to what Yves claimed. I think either issue is easily resolved by making CDS trade more like futures, thus having leverage limitations.

    3. Yves Smith Post author


      In early 2009, there was evidence that CDS were being used in a predatory fashion against weak financial players, Citi in particular.

      And you have made my point:

      I agree GS did more than hedge, they took prop positions as well but the point trading is to make money and every firm does it. On the buyside I short the banks I trade with all the time and if my firm were public I bet my counters would do the same.

      Most people would regard it as unethical to bet on your customers’ failure, particularly, as is alleged with Goldman and Deutsche, you were also selling them toxic product, that is, profiting both from unloading dreck onto them, then also seeking to profit from the damage that the purchase of the dreck caused.

      You are also falling back on the market maker defense, which I addressed in the post.

      My posture on CDOs is hardly revisionist. I have long said I believe them to have been more central to the crisis than is commonly believed. I discuss them at length in my book, which went to press in October 2009. I have also long been critical of Goldman, although I have also shredded some critiques of them which I thought were off base (the charge that their marks on AIG’s CDOs were aggressive and contributed to their death spiral. While the latter may be true, Goldman’s marks look realistic and the rest of the big banks look to have been in denial).

      I suggest you look at my record rather than make baseless accusations.

      1. wjs

        Yves – I apologize, it wasn’t my intention to offend. Revisionist was a poor choice of words. I am aware of your track record (although haven’t read your book, its on my list) and generally agree with many of your views, just not here. What I was trying to describe was I believe everyone’s perception has been greatly colored by what happened after the fact. At the time, these securities didn’t require some magicial calculus to understand or evaluate and there were some shops who easily recognized they were not worthy of their ratings and price. However, many firms only cared that they could earn an excess 30bps on AAA and how can we get bigger allocations. I have no love for street firms but don’t agree they acted predatory and painting it that way gives the buyers an excuse for their lack of fiduciary duty. I say that not as a criticism of you but of the general discussion of the CDO business.

        Don’t think I was falling back on the market maker defense, I actually agreed with you that they were acting as an underwriter and are guilty of non disclosure.

        I don’t have an ethical issue with them hedging as a market maker even if it is by proxy and on a client. I do agree it is unethical to take prop bets on clients (long and short). Not sure if you are trying to make the point they intentionally sold them toxic products hoping to profit from them failing or its just even greater abuse they ended up making money both ways? I am undecided on whether I believe they were actually betting on their failure. Just because they bought CDS on a client doesn’t mean they expected them to fail but really just a technicality because they obviously expecting them to have “issues”. The easy answer is to not allow them to prop trade, but will be much harder to define.

        I remember middle of last year reading many reports/studies of CDS and their predatory use in the collapse. I will just say I am very skeptical of the evidence and don’t believe you can short a good company with a good balance sheet into b/k.

    4. scraping_by

      Let’s see…

      graph 1: “technically violating the disclosure rule”

      As a general thing, loophole diving is held in lower regard than pimping. Claiming that a crime’s not a crime by relabelling the act doesn’t really fool anyone, not even the judicial pimps who agree. The black letter of the law is absurd on its face; it just suits the powerful to keep repeating it.

      Goldman’s accused of taking several roles, choosing the advantages of each when it suited, ignoring the limitations of each when it suited, claiming they get to pick and choose. Looked at the opposite way, the same act that didn’t violate the rules as an underwriter violated the rules as a market maker, and those okay as market maker violated those as investment advisor, etc.

      graph 2: This is dangerously close to “can’t cheat an honest man.” But if you claim the grifter’s defense, doesn’t that make you a grifter?

      It’s always possible to hide details of any transaction. Said another way, it’s always possible to fool a buyer. Or, in the jargon of the Wall Street Journal, if you win you’re sophisticated. If you get cheated, you’re naive.

      Your solution of mistrust falls apart on its own. No trust, no transaction. The ultimate end of deregulation is an empty field.

      graph 3: “this activity did not cause the collapse and is a non issue.”

      Single cause is a straw man. This is one of the activities that caused the collapse. This is a good representation of the activities that caused the collapse. For the literal minded, perhaps some numbers guy can total the money lost in this game and find its percentage of all the money disappeared in the crash.

      It’s one of a number of “innovations” which were old con games relabelled. It’s now we’re calling things by their true names.

  34. Vinny

    My 2 cents: unless the DOJ gets seriously involved, this is nothing but more bread and circuses for the chumps (one of which I proudly am).


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