Random derivatives musings and the Goldman complaint…



Dave is a part-time blogger that writes about whatever suits him at the time.

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31 Responses

  1. Avatar Simon K says:

    I’m in two minds about this. On the one hand it does seem shady, especially if Goldman misrepresented the position to ACA or to investors.

    But it is Goldman’s job as an investment bank to enable its customers to take the positions they want to take, and that inevitably means they have to deal with people who want long and short positions on the same deal, and they always have the option of picking one of those positions for themselves. They can choose to be neutral but nothing I know of obliges them to be.

    It was genuinely difficult to short the sub-prime mortgage market. Paulson was on of the people who saw problems – there were others – and their main difficulty was in coming up with a short strategy that wouldn’t be incredibly expensive to maintain until the actual crash came. I don’t see anything wrong with Goldman helping Paulson to build and instrument to do it with – he was their customer after all – and nothing obliges them to reveal their position. The only question is, did they mislead ACA or mislead investors? If they did that, I think they may be in trouble.Report

    • Avatar Michael Drew says:

      @Simon K, The thing is, the pure question of whether structuring these things so that they could be shorted and also selling them to clients –that’s all totally above-board; no one’s questioning it (legally). It’s just a question of disclosure of who did the picking that they’re on the hook for (maybe).Report

  2. Avatar North says:

    There’s a lot to be said about the meat of the posting but one thing is very clear to me; Dave doesn’t post nearly enough submissions on the League. This is really well written and thought out.
    I’m gonna mull a bit before I get to the heavy substance though.Report

  3. Avatar Dave says:

    The subjects I am comfortable blogging on are few and most of the conversations at the League fall outside of that scope.

    I consider myself somewhat of an outlier since my background is more business and finance. Conlaw is a hobby so I can make myself sound somewhat intelligent on that when I need to.Report

  4. Avatar Scott says:

    I am fairly certain the timing of the SEC action is to aid the Obama admin’s push to neuter the US financial system.Report

    • Avatar Dave says:


      How is the Obama Administration planning on neutering the financial system?

      I think that’d make a great topic for a Guest Post. I’ll even respond to it. 🙂Report

      • Avatar Scott says:


        The Obama admin wants to regulate the financial industry as much as they possibly can. So they create this GS crisis, which they will use as the perfect example as to why all the new regulation is vital to this country.Report

        • @Scott, You do realize how this theory comes across to those who don’t share your worldview, right?Report

        • Avatar Dave says:


          I think this is the Rahm Emmanuel model of financial reform? Create a crisis so it doesn’t go to waste. Am I missing something?Report

        • Avatar Jaybird says:

          @Scott, dude, I sympathize but you assume a level of planning and competence that normal folks only fantasize about.Report

          • Avatar Scott says:


            Really, how hard is it for the Obama admin to have the SEC go after GS? Not very and it gives Obama a talking point about the necessity of his “reform” never mind the actual validity of the suit. When the suit serves its purpose it can be quietly settled with a final win for the admin. I guess it must be coincidence that the GS investigation was announced just as the finance bill debate is heating up.Report

            • Avatar Jaybird says:

              @Scott, allow me to quote you something here:

              “So they create this GS crisis”Report

              • Avatar Scott says:


                Yes, if the gov’t decided to charge Goldman with something they can’t prove just for political purposes they did create the crisis.Report

              • Avatar Dave says:


                The SEC has been investigating the ABACUS transaction for some time. The timing may be suspect but they have obviously spent time compiling evidence to charge GS with wrongdoing. They have. There is no crisis here.

                Going after Goldman Sachs based solely on political motivation would be akin to career suicide given its prominence and its connection. If the SEC is really THAT stupid, then heaven help us all. I can’t help but give it the benefit of the doubt. Maybe they have their facts wrong but I don’t see that as political motivation as much as botching a potential securities fraud case.Report

              • Avatar Scott says:


                I’m sure the Obama admin would like to have both the fraud prosecution and the propaganda victory for their financial regulation bill but if they had to choose one, which one do you think it would be? Oh, and the heads of the agencies are political hacks who will do whatever it takes to keep themselves employed.It sounds like the suit is having the desired effect.


    • Avatar Michael Drew says:

      @Scott, The neutering I don’t know about, but I would certainly admit the timing is at least fishy. I don’t think that’s enough to make anything ‘certain,’ but yeah, it’s fishy.Report

  5. Avatar CM says:

    Stumbled across your site witjh the magnetar trade. Let me clarify. Synthetic CDO came out of the insurance quants in 2002. I’ve been looking and really have not found anyone in the media that has these right. The short CDS positions that Paulson and Magnetar took are the collateral that make up the CDO they sponsored. In order to do this deal they both went long the 5% equity or first loss piece,which had to be placed to close the deal. The equity piece would have a coupn of somewhere around 10%. This helped them finance the CDS premium on the shorts. It is normal for the equity holder to run the deal. You have to remember that when these deals were done these were speculative and anything but a “lock”. The problem here is that the investors in the AAA pieces did not understand the deal structure, much less the fact that they were long CDS. I’m not sure it really matters who is on the other side of the short. If they had not allowed Paulson and Magnetar to structure the deals, they simply would have filled them with CDS from the trading desk, which would have been basically the same paper since the only thing that anyone wanted to buy protection on were the most risky pieces. I don’t really see how the end result is any different.Report

    • Avatar Dave says:


      I appreciate your insights into a market I only have a cursory understanding of. It provoked a few thoughts of my own:

      The structure makes some sense to me and it is intuitive that the equity holder as the investor holding the riskiest long position would want to participate in the deal given its interest in maximizing its return. However, the Paulson/Magnetar situation seems to throw a monkey wrench into this because the way they intended on making money was betting against their own equity positions. Fair enough and I can’t see institutional investors taking issue with that, but would institutional investors take issue with an equity sponsor which is actually net short? Why would institutional investors who were buying the AAA-rated pieces accept this sponsorship issue when there were assumably other deals in the market that these institutions could have participated in?

      My experience with institutional investors is only on the commerical real estate side of the capital markets, and from that perspective, I see the institutions as being very “check the box” type investors in the sense that they have their investment parameters and they are the equivalent of an impenetrable wall. Most deviations preclude institutional investors from pursuing deals (at least in my business). Maybe structured finance is different.

      If the issue is that the investors in the AAA-rated pieces were clueless (which does seem to the case), then how much did Goldman’s failure to disclose information contribute to the losses the investors incurred since it was the asset class that was ultimately toxic as opposed to the issuance. Had the investors not bought this paper, they’d have bought other junk that led to the same thing.

      I think that’s the point your also making.

      Do you see the disclosure issue as a problem?Report

  6. Avatar Dave says:

    Oh, and the heads of the agencies are political hacks who will do whatever it takes to keep themselves employed.It sounds like the suit is having the desired effect.

    Regarding the suit having the desired effect, I suppose that’s a bit of a shame since I think the Administration should have the balls to push harder outside of this. Better this come out now than after a weak reform package is passed, but I admit bias since I think financial reform is a necessity.

    As far as the policial hacks are concerned, I’m of the belief that if there is (was) a regulatory body captured by the interests it’s supposed to watch over, it was the SEC. Senior level members tend to find cushy employment on Wall Street after their “public service”.Report

  7. Avatar CM says:

    Yes, the disclosure issue is the issue. It really depends what was in the docs on the specific deal. I doubt that Paulson was named, but the transaction was probably described with enough legalese that a good portion of the investors did not read all the docs and went on the AAA ratings, which in some cases in the public market is the only box these guys would check. I can remember being taken to the woodshed by management in 2003 for advising clients NOT to touch these deals.Report

  8. Avatar Chris Dierkes says:

    I hope Dave is right and I’m wrong on the SEC filing against GS. For an argument as to the kind of thing I had in mind as to why it might not matter all that much here via John RobbReport

  9. Avatar Scott says:

    This could make things interesting.


    • Avatar Dave says:


      I expect to see a lot of things coming out of both camps that could make this quite interesting. I expect that this will go on for a while.

      Of course, if it has this testimony, it begs the question why the SEC decided to pursue charges anyway. We can think about these things until we’re blue in the face, but the facts will play themselves out one way or the other.Report