By Tom Adams, an attorney and former monoline executive, and Yves Smith
One issue that continues to puzzle us, in looking at the sudden furor about seemingly duplicitous dealings by investment banks in the real estate related CDO business, is that the focus thus far has been primarily on the investment banks that packaged and sold these toxic investments. On the one hand, that emphasis had a certain logic, since the investment banks profited from these deals in numerous ways (fees for underwriting the CDO itself, the profits that could be attributed to the CDO by virtue of keeping the subprime machines that the various banks were operating going, the opportunity the CDOs gave for at least some of the dealers to set up short positions). That, plus their size, makes them the logical deep pocket to target in litigation.
On the other hand, in the great majority of CDOs, the collateral manager was presented as an independent party whose role was to make sure that the CDO performed well. Its role was to serve all the investors, not just the equity investor/sponsor. Thus the CDO manager can also be argued to have defrauded investors to the extent it acted as a rubber stamp for the wishes of the sponsor, and/or simply served as a marketing device for the investment bank packaging and arranging the deal.
The Abacus 2007 AC1 transaction is atypical as far as the role of the collateral manager is concerned.
While Goldman appears to have chosen the collateral manager, ACA, based on its willingness not to ask tough questions, ACA was acting both as the collateral manager and an investor (through a separate unit). Thus Goldman had every reason to treat ACA like another long investor, and therefore omit or artfully present any information that might lead ACA to get cold feet.
By contrast, as we discuss in ECONNED and Michael Lewis covers in The Big Short, collateral managers were widely seen as being closely tied to investment banks. Some even had former employees of the same investment bank on staff and housed in the same building as the trading operations.
It is also hard to imagine that the collateral managers didn’t understand the intentions of CDO sponsors like Magnetar and Paulson who were using CDOs as a way to establish a short position more cheaply than they might have otherwise. If you look at our list of Magnetar deals, sorted by collateral manager, four firms, Harding Advisory, GBC Partners, Putnam Advisory, and NIBC Credit Management, worked on multiple transactions. How plausible is it that they had no idea of the sponsor’s true aims?
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It may prove that private litigants will blaze the trail as far as CDO managers are concerned, and the SEC may or may not follow.
Richard Smith contributed to this article