Reuters Breakingviews journalists Jeffrey Goldfarb, who wrote a piece arguing Goldman Sachs’ “gold dust” is gone, and Richard Beales say Goldman is in danger of appearing average, trading at a reduced premium of 1.1 times book value, amid headaches involving the Securities and Exchange Commission and an industry slowdown. (more…)
Archive for the ‘Investment Banking’ Category
Reuters Breakingviews columnists say metrics used to track hedge funds â€“ such as the Sharpe ratio â€“ could help U.S. regulators spot proprietary trading by banks. The idea is that prop trading is volatile and so banks engaged in prop trading would have low Sharpe ratios. (more…)
At about 3:30 p.m. Eastern time on Tuesday, as I was tuned in to the Goldman Sachs hearings on Capitol Hill, I received an email Real Estate Disposition LLC, a real estate auction firm. I don’t remember ever receiving an email from REDC before, but this one caught my eye.
REDC had sent me its “Deals of the Week” list, which was essentially a list of 11 successful foreclosure auctions that REDC had handledâ€”11 among 125 that the firm is conducting over 65 days.
There was the 1,466 square-foot house in Sacramento, Calif., that sold for $99,750, or 32 percent of its previous high selling price of $310,000. A 1,275 square-foot home in Charlotte, N.C., sold for $20,000, or 17 percent of its previous high selling price of $114,000. A six-bedroom, 5,434 square-foot house in Stockton, Calif., sold for $173,250, or 19 percent of the $908,000 it once fetched.
It was for me a reminder of why the red-faced Carl Levin, Democratic senator from Michigan, and his colleagues on the Senate Permanent Subcommittee on Investigations spent 11 hours haranguing occasionally flustered but generally defiant and visibly unconcerned executives from Goldman Sachs about that firm’s mortgage securities transactions. The trail of blame for the collapse of the housing market, and the broader economy, is long and wide.
Comparisons, made more than once during the hearing, between Goldman Sachs and Las Vegas pit bosses, and between the mortgage securities market and gambling in general, are more appropriate and meaningful than perhaps was intended. As a criticism of Goldman and its role in this episode as a market maker and seller of securities backed by dubious collateral, the gambling metaphor is rhetorical cheap shot.
Las Vegas is a place to which many have flocked in search of easy riches, but relatively few have been rewarded. It is the unofficial capital for a nation with many people who believe they are entitled to get something for nothing, or next-to-nothing. In his book “The City in Mind,” author James Howard Kunstler called Las Vegas a “utopia of clowns.” He has the chapter on Vegas posted online. If you read the opening, and insert the phrase “investment banking” where you see “Las Vegas,” you get sentences like “Even the casual observer can see that [investment banking] is approaching its tipping point as a viable [â€¦] system, particularly in the matter of scale,” and “This is the predicament of [investment banking]. Its components have attained a physical enormity that will leave them vulnerable to political, economic and social changes that are bearing down upon us with all the inexorable force of history.”
It’s not a perfect metaphor, but you get the idea.
Yesterday, as the senators on the dais unleashed their tirades and ignorant loaded questions upon the witnesses, the Goldman executives defended their decisions as correct and appropriate at the time they were made. You can say that you disagree with Goldman marketing securities to clients, such as IKB Deutsche Industriebank AG, that it privately believed would fail, and I would agree with you. It’s bad behavior, similar to a used car salesman selling a car he knows has a high probability of breaking down.
But such transactions are not unusual in the investment banking world, nor are they illegal (probably). And on the other side of that used car transaction, just as in the mortgage securities transaction, is the buyer, whose responsibility includes having the vehicle or security examined by a knowledgeable and reputable third-party. In the case of the car, that’s an independent mechanic. In the mortgage securities case, that third party would have been the bond rating agencies, but they really weren’t third parties, given that Goldman was paying them to rate the securities. It is safe to say in hindsight that the rating agencies’ reputations and knowledge also were questionable, but that was not necessarily known then. The fact that they were being paid to rate securities by the same people structuring and marketing those securities was known; it was just accepted.
Clients who bought the riskiest portions of mortgage-backed securities composed of questionable loans or synthetic collateralized debt obligations based on same had to know the risks. Risk is, in fact, what they sought. They could have purchased as a hedge the same credit protection that Paulson & Co. bought.
Is it Goldman’s responsibility to say, “Hey, we’ve got a synthetic CDO you might be interested in. Here’s the list of securities underlying it. Oh, and by the way, all of those securities are crap.” Or is it the responsibility of the investor to understand what those securities represent and the risks involved? The SEC’s civil fraud lawsuit against Goldman might answer that question, from a legal standpoint at least. Separate lawsuits against the rating agencies may answer other questions.
But let’s go back even one step farther on the trail of blameâ€”to the banks or loan companies that originated the mortgages on which Goldman’s “shitty” securities were based. How ethical is it to approve a mortgage or a refinance loan for a party whose ability to pay is in question from the start? On April 22, The Wall Street Journal published a story examining some of the mortgages that went into the ABACUS deal.
“Some of the people whose mortgages underpinned Mr. Paulson’s wager were themselves taking a gambleâ€”that U.S. housing prices would continue to march upward, making it possible for them to eventually pay off loans they couldn’t afford,” the Journal reported.
“One mortgage in the Abacus pool was held by Ms. Onyeukwu, a 43-year-old nursing-home assistant in Pittsburg, Calif. Ms. Onyeukwu already was under financial strain in 2006, when she applied to Fremont Investment & Loan for a new mortgage on her two-story, six-bedroom house in a subdivision called Highlands Ranch. With pre-tax income of about $9,000 a month from a child-care business, she says she was having a hard time making the $5,000 monthly payments on her existing $688,000 mortgage, which carried an initial interest rate of 9.05%.
“Nonetheless, she took out an even bigger loan from Fremont, which lent her $786,250 at an initial interest rate of 7.55%â€”but that would begin to float as high as 13.55% two years later. She says the monthly payment on the new loan came to a bit more than $5,000.
“She defaulted in early 2008 and was evicted from the house in early 2009.
“Fremont didn’t respond to requests for comment.”
Yeah, I bet it didn’t. Maybe Fremont should be forced to respond to a subpoena from the Senate investigations subcommittee.
And let’s take one more step back along the blame trail, to the individual borrowers. No doubt some were conned by shady mortgage companies into signing for loans with terms they did not understand. But plenty of others were simply opportunistic, looking to get something for nothing, or at least very little. Buy a house for $125,000, sell it a year later for $300,000. It was almost-free money, given the ridiculously low interest rates and down payment requirements. And thanks to lax income verification standards, encouraged by mortgage lenders looking to process and get paid for as many mortgages as possible before shoving those loans off their books and into the securitization maw, almost anybody could play, regardless of their ability to pay. Many did, and they got burned. Recall the Journal story: people betting they could use home equity generated by rising home prices to pay off loans they could otherwise not afford.
That’s the “long” part of the blame trail. The “wide” part includes Realtors and their public relations arms that somehow managed to pervert the notion of the “American Dream” from everyone having an equal shot at succeeding, no matter his or her background, to owning a home. Home ownership may represent part of the American Dream, but it is not the dream.
It includes real estate agents more intent on cashing in than on finding people good homes they could realistically afford.
It also includes some of the same legislators pointing fingers at Goldman, who voted to relax capital requirements for Fannie Mae and Freddie Mac to further a policy decision made during the Clinton administration to increase home ownership rates.
And it doesn’t even begin to touch on the ways banks used the ratings agencies and accounting tricks to circumvent the capital requirements and weak accounting rules that were in place.
All this was going through my mind yesterday as I watched the Goldman grilling on the Hill. Couple it with the realization that for all the bloviating everyone in that room on Tuesday stands to benefit more from the status quo than they do from any change, and the fact that Goldman has not been all that affected by any of the criticism leveled against it and I wonder, what was the point of it all? Eleven hours, all that oxygen consumption, and for what? What’s going to change?
Back to Kunstler’s piece on Las Vegas. Near the end, he writes, “A nation in denial of all its bad habits and lapsed standards of decency wanted to believe that Las Vegas was a perfectly wholesome place to take children. The themed spectacles just provided an excuse. The fact that Las Vegas pulled it off with hardly a peep from society’s moral guardians attests to the flimsy pretense of family values politics.”
Against considerable evidence to the contrary, we have believed that investment banking in its current form was, if not wholesome, at least necessary. Nobody said anything, at least, nobody credible. The clowns in the jail costumes at the Goldman hearing represented nothing more than pointless political theater, which these days is a visually appealing substitute for substance.
All the lecturing and debating and finger pointing in the world won’t change the reality that we all allowed the current systemâ€”Goldman, Paulson, securitization, etceteraâ€”to become what it is, and for a good while we all enjoyed the benefits. So unless we’re ready to really blow it up, and by that I mean mandate smaller banks that are required to keep loans on their books and remain properly capitalized and incentivized to act in the best interests of their clients as opposed to shareholders, and required to follow strict accounting rulesâ€”for startersâ€”we should drop the pretense of outrage at Goldman’s actions.
If the goal of the marathon Senate grilling of Goldman Sachs was for Sen. Carl Levin (D-Mich.), to prove that Goldman was net short the housing market in 2007, then yes, despite Lloyd Blankfein’s futile attempts to downplay the big short, split hairs, net things out, or plainly obfuscate, at the end of the hearing, the very end, the bitter end, papers shuffling, lawyers whispering, hearts pounding, a biblical tediousness raining down on the Dirksen Senate building, it was clear: Goldman was short, in 2007, at the peak of the housing bubble, and profited, substantially.
Instead of trying to posture Goldman as neutral market maker (and not market mucker upper, as Sen. Claire McCaskill, a Democrat from Missouri said) or arguing that the longs and shorts were always to be considered alongside each other over rolling periods, Blankfein might have been better off saying “you’re damn right I ordered the code red!”
Or at least smiled and said, Senator, all due respect, we’re a for-profit business, but yeah, we pushed some bad deals out the door and injected some high stakes craziness into the financial system. We are Long-Term Capital Management, and they are us, and this time we have learned our lesson. Goldman has delevered. There are no more synthetic CDO-squared products sold by Goldman or anyone else, and that has nothing to do with Levin’s line of questioning. What’s the next scheme? One man’s scheme is another’s dream, and for millions of people it’s the same thing, to make money. Goldman need not be embarrassed by that.
Halfway through the Goldman Sachs grilling Tuesday, Sen. Carl Levin (D-Mich.), scowled at former trader Dan Sparks and unleashed a barrage of questions centered around an infamous CDO called Timberwolf.
That’s the one that had been described in an email sent by another former Goldman staffer as “shitty.”
“You sold hundreds of millions of that deal after your people knew it was a shitty deal,” Levin said. “Does that bother you at all?”
Sparks, seemingly miffed, hemmed, hawed and then murmured, then evaded the question before shuffling some papers, and finally avoiding the question altogether.
“Your top priority is to sell that shitty deal!” Levin emphasized, holding up a phone book sized dossier of exhumed emails.
“Come on, Mr. Sparks! Would Goldman Sachs be trying to sellâ€”and by the way, it sold it, a lot of it, after that dateâ€”should Goldman Sachs be trying to sell the shitty deal? Well, can you answer that one yes or no?”
The room was silent, save for a faint chorus of Meatloaf’s “Paradise by the Dashboard Light” running collectively through the audience’s subconscious. Let me sleep on it, baby, baby, let me sleep on it …
“There are prices in the market [at which] people want to invest in things,” Sparks answered. “I didn’t use that term with respect to that deal.”
That deal: Timberwolf Ltd., a $1 billion collateralized debt obligation holding pieces of other CDOs. A CDO squared, the financial engineering equivalent of a KFC doubledown sandwich. Timberwolf’s manager was Greywolf. Greywolf was co-founded by a former staffer at Goldman.
In an email in June 2007 to Sparks, Tom Montag, Goldman’s former head of sales and trading, wrote:
“Boy that Timberwolf was one shitty deal.”
Montag, who would go on to join Merrill Lynch, would prove prescient.
Within five months, Timberwolf lost 80 percent of its value.
One firm that bought pieces of Timberwolf from Goldman was Bear Stearns Asset Management, specifically two of BSAM’s credit hedge funds.
Those funds eventually went belly up, as did Bear, sparking the wider credit crisis resulting in a near systemic failure of the financial system and the worst recession in a generation.
Levin, later, to Sparks: “You’ve got no regrets? You ought to have plenty of regrets. I don’t think you’re willing to acknowledge them, but you ought to have them.”
During the first half of Tuesday’s Senate grilling of current and former Goldman Sachs employees, much of the heat was on Dan Sparks, the former mortgage desk chief 2006-2008, as well as Fabrice Tourre, the young trader charged in the SEC’s fraud case against the besieged Wall Street powerhouse. Early on the hearing got testy, even scatological, with Sen. Carl Levin (D-Mich.) pressing Sparks on an email he got in 2007 from a former executive at Goldman who called one particular deal “shitty.” Sen. Ted Kaufman (D-Del.) was aggressive in challenging the firm on why they sucked up so many loans for securitization that were mostly based on borrower’s stated income, a risk factor in the conveyor belt that, Kaufman stressed, the venerated investment bank must have seen as troubling if not possibly rife for fraud.
All of the members of the Goldman contingent, which also included Josh Birnbuam, former head of structured product trading and Michael Swenson, the current head of that group, were asked whether they felt they had a role in the financial crisis of 2008. Not surprisingly, there was some hedging.
Sparks: “Regret means there was something you feel like you did wrong. I don’t have that. We made mistakes, though, and we made poor business decisions in hindsight.”
Sparks: “Wrong to me means a qualitative judgment on something inappropriate. I think we made mistakes but we I do not think we did anything inappropriate.”
Tourre: “I am sad and humbled by what happened in the market in 2007 and 2008 and the whole financial crisisâ€¦. I firmly believe that my conduct was correct.”
Birnbaum: “We’re all sympathetic to the negative impact of that bubble. There’s a lot of pain and human suffering that came from the bursting of the bubble and to the extent that investment banks may have extended too much credit at a certain time, then it’s possible.”
Swenson: “I do not think that we did anything wrong. There’s things we wish we could have done better in hindsight, but at the times we made the decisions I don’t think we did anything wrong.”
Watch the hearings here.
On Saturday I read Felix Salmon’s article on the Fabacus deal, one in which Salmon explains nuances and complexities that I just had not been able to understand no matter how hard I tried. So I read his piece and then re-read it, and then read it again, until I understood the deal from the perspective of Goldman and from Paulson and from an investor (ACA in this case) hungry for yield yet still attune to downside risk and expecting fair treatment.
Salmon’s walk off line was indeed a killer, and it’s what kept me circling back and back again:
“Here, then, is arguably Goldman’s biggest lie of omission: it never told ACA that the equity tranche didn’t exist. If it was being a true and honest broker, it should have done. End of story.”
But most intriguing was Salmon’s use of the ABACUS pitch book’s structural diagram to underscore the cluesâ€”to whether Goldman was or was not trying to pull a fast oneâ€”embedded within the credit-linked note’s ontology. The key concept to latch on to when you read the post is the “Super Senior Amount” which is not what a septuagenarian pays for coffee at McDonald’s but rather a separate entity/point of reference/arrangement that is both distinctly a part of ABACUS and yet apart from it, as pictorially the SSA has no chart line tethering it to the main event, ABACUS, in much the same way humans, as spine possessing vertebrates, are not ontologically linked to giant squids. However, since we all came up from gobs of molecules we’re cousins. In pitching the deal, Salmon explained, Goldman carved out a special place for SSA:
“If you’re ACA, looking at this structure, you know that as the deal is being put together, you’re negotiating to insure the Super Senior Amount which exists in this picture as a semi-fictional entity outside the structure and inside a grey dotted box. In other words, while you know it’s not a formal part of the Abacus structure, you also know that it exists.”
Through Salmon’s effort, it’s now apparent that there was a side car attached to this vehicle, with its own license plate, SSA. And there was still yet another side, grey boxed reference point/side car: the First Loss Amount.
Back to Salmon’s walk offâ€”Goldman did not tell ACA there wasn’t an equity tranche connected to the SSA/FLA components of this transaction, in which parties bought and sold default protection. As a buyer of the protection, Paulson cleaned up. But as far as the first loss amountâ€”there was no equity investor there to endure the first losses, as was the standard practice. Not Paulson, not Goldman.
ACA in doing its homework should not have assumed that there was, but this evidently had been the case with a similar deal put together with Magnetar, one that had closed just prior to the creation of ABACUS and its cousins, the grey SSA/FSA sidecars.
So in the end, it may not come down to whether Goldman told ACA that Paulson was going long the equity tranche tied to this deal. He couldn’t have. It did not exist.
Watching Goldman Sachs executives testify on Capitol Hill before the Senate Permanent Subcommittee on Investigations, I can’t help but think that the people at the tables are a lot less worried about keeping their jobs in the long term than some of the people up on the dais. Although interestingly, of the nine members on the subcommittee only two are up for re-election this year, and both are Republicans: John McCain of Arizona and Tom Coburn of Oklahoma. Only McCain seems to be facing a tough re-election bid.
So maybe nobody is concerned about his or her job. Maybe It’s All Good up on the Hill today, and the parties are playing their roles secure in the knowledge that at the end of the day everyone will go home and nothing will change. Because there is one thing that the Goldman executives and the politicians have in common: the status quo benefits them all.
UPDATE, 2:55 p.m. ET - I’m listening to the hearing. Words I’m thinking of to describe the two sides of this verbal transaction today … for the questioners: “ignorant,” “combative,” “condescending,” “posturing,” “preachy,” “hypocritical,” “grandstanding”. For the respondents: “obfuscating,” “delaying,” “denial,” “insincere,” “annoyed,” “defiant,” “unconcerned.”
UPDATE, 3:15 p.m ET - I neglected to note that Ted Kaufman, Joe Biden’s replacement in the senate, is subject to a special election on Nov. 2.
UPDATE, 4:45 p.m. ET - The subcommittee just took a break so the senators could attend a test vote on financial regulation. But not before Goldman Sachs’ David Viniar got off the line of the day in response to a persistent, if poorly-worded, question from Carl Levin. Levin was trying to get Viniar to speak to whether Goldman customers had a “right” to expect securities sold by Goldman to “succeed.” What he was getting at was should Goldman customers believe that, because Goldman was marketing a deal, that there was an implicit expectation that Goldman wanted the deal to make the customer money. Viniar was having trouble getting his mind around the question, and so Levin read back a comment from an email written by a Goldman salesperson that referred to one of the subprime deals in question as “a shitty deal.”
How did Viniar feel, hearing that a Goldman salesperson wrote that, Levin asked.
Viniar replied that he felt it was regrettable such a sentiment was expressed in an email.
How much money Goldman made and vagaries relating to how they made it took a back seat this morning, as analysts focused on the legal case. There were some interesting exchanges.
The WSJ’s quick take on the Goldman conference call:
That’s a wrap. Palm and Viniar stayed on two essential messages: 1) That ACA and IKB (the long investors in the CDO) knew what they were doing because they’d done similar deals in the past. 2) ACA knew Paulson was involved in selecting the collateral for the CDO.
The one thing Goldman didn’t seem to answer as clearly was why ACA didn’t know Paulson was shorting the CDO (emphasis added). Palm argued that Goldman made all appropriate disclosures and pointed out that in the end it didn’t matter which mortgages went into the CDO because most loans, regardless of who chose them, eventually went bad. Still, some analysts questioned why ACA wasn’t told about this by Goldman, who was brokering the deal.
The NY Times’ quick take on the Goldman conference call:
David A. Viniar, chief financial officer of Goldman Sachs, said the firm had no real warning of the Securities and Exchange Commission’s case. “We were somewhat surprised that this was filed as complaint and no one told us in advance,” he said.
Mr. Viniar also provided more specifics about the losses at Goldman from the transaction that the S.E.C. challenged. “There were also collateral securities that we managed on which we lost money and other aspects of the transaction,” he said. “When you added them all up, the net loss losses to Goldman Sachs were over $100 million.”
Mr. Viniar said the firm did not have to have “skin in the game” but had to balance out the long and the shortsâ€”the long side was not balanced with the short side so Goldman filled in the gap as the broker. So Goldman could have had to take a short side position if the portfolio was too heavy on the long side.
“We obviously didn’t have to do a transaction if we weren’t willing to sit there and hold this long position â€” which is what we did,” he said. “Now whether or not we were going to sell it in the future or try to sell it or whatever else, all that could be true. But when we did the transaction, we obviously held the position and we kept holding the position.” (Emphasis added.)
Greg Palm, Goldman’s general counsel, said the firm discloses every major investigation, but not necessarily every Wells notice it receives from the S.E.C. “We do not disclose every Wells we get simply because that just notâ€”that wouldn’t make sense. Therefore, we just disclose it if we consider it to be material.”
Mr. Palm also denied that ACA was led to believe that Mr. Paulson would be buying into the fund instead of shorting it.
“The S.E.C. complaint also alleges that ACA was led to believe that Paulson would be buying an equity position, rather than taking a contrary position against the portfolio. which skewed ACA’s approach to dealing with Paulson,” Mr. Palm said. “We simply do not believe that the evidence cited by the SEC demonstrates that ACA was misled into believing that Paulson was going to be buying an equity position; and the term sheets and offering certainly did not reflect an equity tranche (emphasis added).
One of the analysts, Guy Moszkowski, of Bank of America, posed an interesting question with an observation embeddedâ€”regarding Goldman’s losses, which Goldman is holding out as exhibit A that they did not design a deal meant to self destruct; Moszkowski suggested in his phrasing of the question that perhaps the only reason Goldman took losses is the fact that they got caught with some underwriting positions they couldn’t distribute, or put another way, in a game of high stakes hot potato Goldman couldn’t offload positions which even a few months earlier they would have happily offloaded.
Viniar: “We obviously didn’t have to do a transaction if we weren’t willing to sit there and hold this long position â€” which is what we did,” he said. “Now whether or not we were going to sell it in the future or try to sell it or whatever else, all that could be true.” (Emphasis added.)
BLAKE (unheard on call): YES, IT COULD HAVE BEEN THAT TRUE THEY MIGHT HAVE SOLD IT. IT MIGHT HAVE BEEN TRUE THEY COULD HAVE SOLD IT, AND IT SEEMS ALMOST DEFINITE THEY WOULD HAVE SOLD IT HAD THE MORTGAGE MARKET NOT JUMPED THE SHARK.
Viniar:“But when we did the transaction, we obviously held the position and we kept holding the position.”
One analyst, not sure who (Barclays?) asked point blank: “How typical is it [in the world of CDO underwriting, my paraphrase] for a hedge fund manager to meet with a third party, is that common?
From Reuters: Goldman Sachs charged with Fraud by SEC.
The government is accusing Goldman Sachs of defrauding investors in its disclosures about securities it sold tied to subprime mortgage securities as the housing market was faltering.
The SEC announced Friday civil fraud charges against Goldman Sachs and one of its vice presidents. The agency alleges that the company marketed complex subprime mortgage securities and failed to disclose to investors that a major hedge fund had bet against the securities.
Just saw on CNBC that Goldman is saying the SEC’s charges are “completely unfounded in law and in fact.”