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I'm starting to get a better handle on what is driving the SEC charges against Goldman and why Paulson's involvement matters

 

But first...

 

 

A Little Bit About CDO's, CDS's and Synthetic CDO's

 

CDO's were developed by Mike Milken of Drexel Burn'em fame back in the 80's

 

JP Morgan took the idea a step further in the 90's and created CDS

 

...fast forward to the late 90's and the beginning of synthetic CDO's

 

This is what Paulson was short, a synthetic CDO.

 

Synthetic CDO's are basically the outpoop of an amalgamation of CDS

 

Step [1] Set up a special purpose vehicle (SPV) in say the Cayman's

 

Step [2] Then create CDS's in the fund against a number of companies, usually about 100 (or in the case of Abacus, RMBS).

 

Step [3] Set the default parameters, which state that if 6 companies on "the list" default then the SPV pays the bank 30% of the SPV, if 7 default the bank gets 60% and if 8 or more default the bank gets 100% of the SPV

 

Step [4] Sell ownership of the SPV to investors...but what do the investors get?.....back in the day, about 1-2% annually on the notional amount bought

_______________

 

This is where the Paulson involvement comes in. Being that only several RMBS have to go bust before the Synthetic CDO pays out 100% to the bank (and then to Paulson, as he was short the CDO)....well you get the idea of how important including a few select RMBS was, and why knowing this and that Paulson was shorting this synthetic CDO, would be an important factoid.

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I'm starting to get a better handle on what is driving the SEC charges against Goldman and why Paulson's involvement matters

 

But first...

 

 

A Little Bit About CDO's, CDS's and Synthetic CDO's

 

CDO's were developed by Mike Milken of Drexel Burn'em fame back in the 80's

 

JP Morgan took the idea a step further in the 90's and created CDS

 

...fast forward to the late 90's and the beginning of synthetic CDO's

...

Yeah ha. .. And, remember the synthetic CDOs are not entirely designed for evil, or Paulsons...

 

If I'm a bank, and have issued a sheet load of loans, am and out of capital, but want to write more and more loans, without being seen to sell off existing loans, what do I do?

 

Sell a synthetic, and just keep on lending.

 

Arranging cash is deals just too hard by comparison.

post-2117-12716015951945.png

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Asked and answered your Honor...

__________

 

The issuer (GS) then sells the deal, tranched up nicely, to its clients. The clients are not necessarily dumb but should understand that a AAA ‘bond’ offering 150bps over Swap is maybe ‘not’ AAA - the fact of the matter was that the buyers of the tranches had all (or a lot) of the information to judge the deal, but often did not as they were caught up in the chase/grab for yield (sound familiar?).

 

The notion that qualified institutional investors should have stood up and taken note that the AAA securities were yielding an advantage of 150bps is totally reasonable.

 

On the other hand, my failure at complete due diligence does not absolve you of your lack of material disclosure and/or material misrepresentation. It may - but it doesn't ipso-facto. That would be for a jury to decide given the case and the context.

 

With regard to that context, any qualified institutional investor, I believe, is going to have been assessing all this stuff through the small-minded theoretical tyranny of a portfolio perspective. That is, Big Pensions were all sold the promise of non-correlated returns available from subprime CDOs vis-a-vis the traditional stock/bond blend. They'd all been habituated to non-traditional assets by the non-correlated absolute return experience with different hedge funds styles. Non-correlated returns are the only "free lunch" in economics, so you had a stampede effect (especially after Yale and other places had made bank on these strategies before everyone and their mother piled in).

 

So, you have your MBA graduates sitting across from one another in their $3,000 suits, with one set trying to hawk you this or that tranche of this or that CDO, and the other taking the meeting and entertaining the prospect because they're desperate to get the incremental risk-adjusted return for their 11-figure fund (which is chronically under-funded).

 

The one side is going to pitch this stuff from a portfolio perspective, and the other side is going to assess it from a portfolio perspective... because that's pretty much the cornerstone of larger "prudent investor" and "fiduciary obligation" criteria.

 

For securitization to really possess any functional value from that portfolio perspective, the selection of assets with which to fund the securities must be done with some purposefulness (by the geeky-ass quants who wear the cheap suits and have to keep their socially-dysfunctional mouths shut through client meetings) so that the ensuing sliced & diced tranches have some chance of affording the historic risk-adjusted returns represented in the pitch.

 

In this case (and I've been too busy with real work to review the entire pitchbook but absolutely intend to read every word of it), Big Pension Suits taking that meeting need to have some assurance that those assembling the securities are doing so purposefully to approximate the historic risk-return characteristics they are aiming to provide.

 

"Past performance is no guarantee," obviously, and you can say that anyone still investing in this idiocy at such a late stage can probably only barely be trusted to flip a burger. It seems to me one thing to have been duped by historic performance to believe these credits would perform; or to take a bath because, while even though the investment style is doing well, the specific securities you're backing turn out to be dogs. The Monte Carlo simulation thingie is going to spit out "00" on occasion even for relatively safe investments (e.g., Lehman bond holders).

 

But it is entirely something different from a portfolio perspective if the securities selected are done so with an intention that they will purposefully not provide the historic risk-adjusted returns invoked by all. Should everyone have been doing better due dilligence? Duh.

 

Were these securities ever assembled with the purpose of approximating the non-correlated return of interest to investors? Obviously not.

 

It just seems to me that my lack of due diligence does not absolve you your misdeeds. It may if your attorneys are persuasive. But it mustn't.

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The notion that qualified institutional investors should have stood up and taken note that the AAA securities were yielding an advantage of 150bps is totally reasonable.

 

On the other hand, my failure at complete due diligence does not absolve you of your lack of material disclosure and/or material misrepresentation. It may - but it doesn't ipso-facto. That would be for a jury to decide given the case and the context.

 

With regard to that context, any qualified institutional investor, I believe, is going to have been assessing all this stuff through the small-minded theoretical tyranny of a portfolio perspective. That is, Big Pensions were all sold the promise of non-correlated returns available from subprime CDOs vis-a-vis the traditional stock/bond blend. They'd all been habituated to non-traditional assets by the non-correlated absolute return experience with different hedge funds styles. Non-correlated returns are the only "free lunch" in economics, so you had a stampede effect (especially after Yale and other places had made bank on these strategies before everyone and their mother piled in).

 

So, you have your MBA graduates sitting across from one another in their $3,000 suits, with one set trying to hawk you this or that tranche of this or that CDO, and the other taking the meeting and entertaining the prospect because they're desperate to get the incremental risk-adjusted return for their 11-figure fund (which is chronically under-funded).

 

The one side is going to pitch this stuff from a portfolio perspective, and the other side is going to assess it from a portfolio perspective... because that's pretty much the cornerstone of larger "prudent investor" and "fiduciary obligation" criteria.

 

For securitization to really possess any functional value from that portfolio perspective, the selection of assets with which to fund the securities must be done with some purposefulness (by the geeky-ass quants who wear the cheap suits and have to keep their socially-dysfunctional mouths shut through client meetings) so that the ensuing sliced & diced tranches have some chance of affording the historic risk-adjusted returns represented in the pitch.

 

In this case (and I've been too busy with real work to review the entire pitchbook but absolutely intend to read every word of it), Big Pension Suits taking that meeting need to have some assurance that those assembling the securities are doing so purposefully to approximate the historic risk-return characteristics they are aiming to provide.

 

"Past performance is no guarantee," obviously, and you can say that anyone still investing in this idiocy at such a late stage can probably only barely be trusted to flip a burger. It seems to me one thing to have been duped by historic performance to believe these credits would perform; or to take a bath because, while even though the investment style is doing well, the specific securities you're backing turn out to be dogs. The Monte Carlo simulation thingie is going to spit out "00" on occasion even for relatively safe investments (e.g., Lehman bond holders).

 

But it is entirely something different from a portfolio perspective if the securities selected are done so with an intention that they will purposefully not provide the historic risk-adjusted returns invoked by all. Should everyone have been doing better due dilligence? Duh.

 

Were these securities ever assembled with the purpose of approximating the non-correlated return of interest to investors? Obviously not.

 

It just seems to me that my lack of due diligence does not absolve you your misdeeds. It may if your attorneys are persuasive. But it mustn't.

 

Thanks, Jimi, for the detailed & enlightening analysis of this situation.

 

It certainly does appear to me that the SEC folks may be growing a pair, at least as compared to how they were doing before. Even if GS does get off with only a fine that is peanuts money for them, for the SEC to charge a big player with fraud seems to be more than they have done for decades. Russ in Wall Street Examiner just wrote a good discussion about how SEC examiners "concluded four times from 1997 to 2004, that Texas Ponzi financier Allen Stanford was running a fradulent business, but decided to go no further" because a Stanford crony, who was running the enforcement office in Fort Worth, stopped the investigations.

 

http://wallstreetexaminer.com/

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Last one out is a rotten egg...

 

Take the money and run....while there's still money to take, I guess

____________

 

GOLDMAN SACHS, the world’s biggest investment bank that is now assailed by accusations of fraud, is poised to reignite controversy over bankers’ bonuses by paying its staff more than £3.5 billion for just three months’ work.

 

The bumper payouts will equate to about £110,000 a head for the firm’s 32,500 employees worldwide, with a handful of top traders expected to be in line for multi-million-pound bonuses.

 

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Good article,I have heard these arguments for the past 17 months I have owned muni's,but historically muni's have traded at a lower yield than treasuries in the past.I expect that will happen again before they top out.Went over my portfolio over the weekend and I am deciding what to dump in the next few weeks.

 

I want to be off margin in the next few months at most.I will hold the rest till they can either give me some good profits or till they mature.I would in no way buy funds or closed ends because the portfolio never matures,you get screwed more when rates go up.Most funds will take a hit at some point when the price of their leverage goes up.

 

I see no other way to generate decent yield at this point.Tax changes will keep a bid under my portfolio until the end of the year.

 

 

If anyone has any better suggestions to generate enough income for me to live on,I am all ears.I only need about 5% (taxable) a year on my money to survive,For now I am generating that tax free.I no longer work,this is all I have to live on except for some 6% CD's I locked in several years ago.

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I would think airlines would be a great short right now,Most flights are grounded and probably will be for quite awhile.

 

Many airports in europe totally closed.

Airlines are losing $200M/day.

 

Starting to think that this eruption and the Goldman thing may be the psychological pivot point for a broad mood shift.

 

There's no reason to expect the eruption to stop, and for the airports to reopen, anytime soon. They might, or they might not. Past eruptions have burped and belched on & off for months, even years.

 

Am currently 358th on a waiting list for a transatlantic ship voyage. Get ur 19th century on.

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Airlines are losing $200M/day.

 

Starting to think that this eruption and the Goldman thing may be the psychological pivot point for a broad mood shift.

 

There's no reason to expect the eruption to stop, and for the airports to reopen, anytime soon. They might, or they might not. Past eruptions have burped and belched on & off for months, even years.

 

Am currently 358th on a waiting list for a transatlantic ship voyage. Get ur 19th century on.

 

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