A great explanation of Goldman's Abacus deal

Yes, I found that post odd. It seemed as though you were throwing your faithful commenters under the bus and I marked my calendar with the day Ezra went DC native. Good to know it was not intentional!

I'm still confused - since this involved a "synthetic CDO," didn't it consist of CDS's, which have to have a counterparty betting the other way? So didn't the investors have to know they were making bets, and that there would be parties betting against them?

Here you go telling us how brave you are in defending Goldman at the point of losing out politically, a little negative feedback and you're backtracking on your words.

As Dan Rather used to say, "Courage".

(and don't let your poor writing skills get in the way of a cute media career, darling! Those aging lady news anchors think your a lil mensch, word has it. ;-)

We are at a point where uncontrollable greed is taken as a given in Wall Street. And we have commentary that seeks to find explanations, justifications, whatever to argue away the excesses. Let's face it: Wall Street has no moral compass. People have lost their homes are living in shanty towns and in their cars (if they manage to hang on to them). Has someone explained the way Wall Street works to them?

yes Ezra you wouldn't want to disappoint your faithful readers.

I'm sure we'll see plenty of "conservatives throwing out Crist" today and little to no talk of Greece's issues, Spain's 20% unemployment, the BP mess that's now approaching Exxon Valdez territory that had the government working with the speed and precision that they did during Katrina.

I'm sure we'll get your take on each of those issues today. I have faith. Well, misguided faith but still faith.

This piece in ZeroHedge today adds some new wrinkles. Paulson was shorting the whole financial sector- even $GS. Bear Stearns was the largest shareholder in ACA. ACA was the real idiot here, they let a trader make a deal that blew up the firm.

http://www.zerohedge.com/article/did-paulson-have-2-billion-bear-stearns-cds-short-late-2006-novel-observations-abacusgate

weirdly enough, the Abacus piece of Big Sh*tpile was one of the few items in AIG's portfolio the then President of the NY Fed did not payout at full par. I wonder if the US Attorney for the Southern District of New York will be asking our current Secretary of the Treasury how and why he made that particular assessment?

Sorry, Ezra, this explanation is hardly "great," it's actually terrible. Just a couple of the problems... First, Goldman was not acting as an advisor to any of the parties therefore was not on the side of any of the parties. GS was acting as a market maker and underwriter, essentially it introduced the parties and structured the deal. The fact that there was a prospectus is irrelevant (just the convenience of structure), the deal was not marketed outside the named parties. Second, IKB asked that ACA be its advisor in picking the securities. ACA was the sole arbiter in deciding what securities were included in Abacus, not GS. And ACA knew that Paulson both helped pick the securities and was going short (these two met directly with and without GS present).

If you want to hate GS, you need to find another reason beyond the fact that 2 of its clients chose wrong and lost money while another chose right and made money.

I liked this letter at the WSJ:

"The real irony in this whole episode is that Mr. Paulson's act of synthetically shorting collateralized debt obligations of subprime bonds prevented the housing bubble from growing further than it did. By shorting through CDOs he created more bonds to satisfy the market demand for subprime bonds without having to make any actual real loans. Think about that for a minute. No matter how many bad loans were given out during the boom, the bond market wanted more than could be produced. If those loans were made to satisfy investors' demand, the housing bubble most likely would have been perpetuated for years and the ultimate crash would have been far more devastating for homeowners and investors. "

http://online.wsj.com/article/SB10001424052748703876404575199974155645494.htm

These are not markets.

That's the realization that hit me while reading "The Big Short." Among the several Webster defintions for "market," this one seems the most basic: "the area of economic activity in which buyers and sellers come together and the forces of supply and demand affect prices."

The place where synthentic derivatives are bought and sold is not a market because buying and selling them does not affect prices. Can there be a "market" for backroom deals? Seems to me, no.

I was disappointed in the questioning of Blankfein by Congress. They kept asking the wrong questions over and over, doing Blankfein a favor by obfuscating the deals for him.

Proponents of finance reform should stop saying they want to regulate these "markets." The message should be: We want to turn these backroom deals into markets.

Shane, Omaha

bjw143 is incorrect. What Goldman did was create a synthetic CDO. The short side was essentially Goldman as underwriter. The long side was whoever was going to eventually invest and get the income stream. Abacus wasn't a deal between ACA and Paulson. The two never dealt directly (in terms of buyer and seller).

Paulson went short two ways. First he took out protection from Goldman on the same reference portfolio of securities before the Abacus deal. Then he bought Goldman's short side of Abacus after the deal.

The prospectus is not at all irrelevant. Goldman had a legal duty to disclose everything material to the deal.

The fact that ACA was involved in picking the portfolio, and then later also invested in part of Abacus, doesn't affect Goldman's disclosure requirements in the prospectus to potential investors.

If Goldman told prospective investors that Paulson was going long rather than short, that would affect the price they would be willing to pay.

Similarly with the third deal, the protection Goldman bought through ABN Amro.

This was a way for Paulson to go short without just buying protection on the individual securities, using Goldman's underwriting reputation as a buffer and using the CDO structure as a way to get a better price. The SEC has every right to be looking at it very suspiciously.

That letter from the WSJ quoted above gets it backwards. They gave mortgages to anyone who wanted them, and it still wasn't enough. The pool of potential home-buyers had about run dry. By using synthetic CDOs the whole problem was magnified many times. Paulson was having new stuff created for people to buy. This made things worse, not better.

It really is a very silly argument. Things would have been much better without naked credit default swaps and synthetic CDOs. The downside would have been limited by the size of the housing market.

Sorry, Mujokan but what you're saying is either wrong or not particularly relevant. That a prospectus exists or that Goldman underwrote the deal has nothing to do with the need for disclosure. The first only had to do with the structure of the transaction. A prospectus would allow GS greater flexibility to sell on any portion of the deal that it decided to keep. GS would have had to make sure that material facts were disclosed regardless. The two material facts were that Paulson proposed, but didn't have the power to select, some of the securities and that Paulson was the party on the short side. Both were disclosed in the meetings.

Being an underwriter just means that GS initially was long before selling on (as agreed) to IKB its investment.

This was a "club" deal, the parties came together expressly to do this deal. Paulson wanted short exposure so it asked GS if they knew someone who wanted to go long. GS knew IKB wanted long exposure so those parties were in the deal. IKB asked that ACA pick the securities. That's how the 3 got together, specifically to do this deal.

ACA wasn't just "involved" in picking the securities, the had the sole ability to decide which securities went in the deal. IKB, Paulson and GS all knew this, it was disclosed. And ACA didn't just later invest in the deal, like IKB, they were always going to invest in the deal.

Further, GS would never have put information about what another client would do in a prospectus for an offering of securities. It's simply not the appropriate method and so was disclosed otherwise.

Lastly, the bit about pricing, you seem to be thinking about a broadly marketed offering where a red herring is issued, price levels are taken from potential investors then the underwriter decides final price based on that market feedback. Again, this was club deal, not broadly marketed and the terms were agreed directly between the parties or there would have been no deal.