Goldman (and Deutsche Bank) as Predator

[Joanne98]

One of the things that has been striking as revelation of bad behavior in the collateralized debt market has gotten more press is that a number of commentators who had taken the “nothing to see here, move on” stance have gotten religion.

Even more dramatic has been the change in perception of Goldman. The firm has had its vocal critics (including yours truly) but they seemed a vocal and ineffective minority. Goldman’s arrogance seemed only to confirm its “Government Sachs” connections, that it could do as it pleased and thumb its nose at the rest of us to boot. It compounded the public outrage over its record 2009 bonuses through its hamhanded, narcissistic rationalizations. Lloyd Blankfein’s “We’re doing God’s work” has come to epitomize what is wrong with the financial services industry post-crisis the same way Chuck Prince’s “We’re still dancing” did for the bubble era.

So the has been more that a little bit of schadenfreude at work. The press and public sentiment against Goldman has become widespread and heightened with the SEC lawsuit over Abacus AC1 2007. Even the supposedly bipartisan Senators were on the same page in Tuesday’s marathon hearings.

Now some point out, correctly, that Goldman is being singled out. On the one hand, there was a lot of bad behavior in the industry that has yet to be scrutinized closely. On the other, collateralized debt obligations were the ground zero of the crisis, and the banks like Goldman that were particularly “innovative” are now looking to have been too clever by half. As I discuss in some detail in ECONNED, these vehicles were spectacularly leveraged. Comparatively small amounts of capital produced greatly disproportionate systemic effects. Both our own contact with structured industry experts, and other accounts of subprime short strategies make clear that DeutscheBank was at least as aggressive as Goldman as far as real-estate-related CDOs were concerned. For instance, Deutsche was also creating synthetic CDOs on behalf of subprime short John Paulson; it had its own version of Goldman’s Abacus program (Deutsche’s was called Start).

http://www.nakedcapitalism.com/2010/04/goldman-and-deutschebank-as-predator.html

[dkf]

1. I hadn't caught this earlier...

"Senator Coburn turns to short positions that Goldman took in companies that were sensitive to mortgages, including Merrill and Bear Stearns. Senator Coburn notes that after Goldman sold Timberwolf to Bear Stearns, they took a short position in the stock of Bear Stearns. This seems pretty devastating,"

[econoclast]

2. Deutsche Bank. (db) is very illuminating

According to Michael Lewis' newest book on the subprime crisis and CDOs, Deutsche Bank ( db ) was a major player in synthetis CDO issuance. They made a TON of money when things tanked. But it was by accident not by design!!!

Here's how a synthetic CDO works...

Synthetics are not composed of the cash assets, but rather of credit default swaps on a selected group of cash assets. In the cases we are discussing here those reference cash assets were MBS securities or cash CDOs of MBS stuff.

Every credit default swap has - by definition - two sides. One side benefits if the reference assets perform well. let's call this the "long" end of the swap. The other side benefits if the reference assets perform poorly. Let's call this the "short" end of the swap. In fact, the long ends of the swaps RECEIVE monthly payments from the holders of the short ends as long as things go well. If the reference assets turn into shit, the holder of long end PAYS a giant sum to the holder of the short end. Got it?

Ok

The synthetic CDO gets populated with the ends of the swaps that benefit if things go well. the long ends. So, the CDO Owners get payments from the holders of the short end of the swaps. As long as things go well, that's how the CDO owners make money.

What happens to the other end of the swaps? The short ends. Initially, they are owned by the Issuer of the synthetic CDO. In this case, Deutsche Bank. But the plan, according to Lewis, was for db to sellthe short ends of the swaps as well. Db would make a piece from issuing the CDO. They would take a cut from selling the short ends of the swaps and they'd be done. No risk left on the books. Just the fees for making the market.

Problem was, they couldn't find ANYONE ot buy the short ends of the swaps!!!!

Now, in 20/20 hindsight, it is abundantly clear that the short ends of the swaps were HUGE winners. But back in 2005, 2006, 2007 the market thought differently. There was a one way bet on housing. Everybody was long. Nobody was short.

Db had a salesman in charge of selling the short ends of the swaps and he canvassed wall St giving presentations trying to sell the short ends of the swaps. There were no takers. And meanwhile thr CDO desk ay db fept cranking out synthetic CDOs for enthusiastic buyers. So the pile of short swaps kept getting bigger because db couldn't sell them. Db was getting a heart attack because THEY were PAYING hundreds of millions of dollars to the CDO holders. And they still couldn't "get rid of" the shorts.

Eventually, as the coming disaster started to become clear....they did find some buyers. Guys like Paulson. But not many. As the end neared, db came to LOVE these short swaps and stopped trying to sell them off. When the underlying reference assets defaulted, db profited handsomely. They made billions of dollars. But that was not the plan at the start