Monday, April 19, 2010

April 19 2010: Did the SEC plant a Goldman bomb?

Marion Post Wolcott Two Girls, One Umbrella August 1940
"Natchez, Mississippi."

Ilargi: Haven’t read enough about Goldman Sachs lately?

Well yes, there’s a curious role of ACA Capital in the SEC-Goldman lawsuit, it had only a CCC rating, not AAA like Ambac or MBIA, but its CEO was married (partnered) to the Goldman general counsel (no, not trivial, a relationship like that has to be divulged to investors, but was not). Here’s thinking ACA might have been just a bit more pliable...

So where is Andrew Cuomo when you need him? Wait a minute, New York's Attorney General is running for governor, in daddy’s footsteps, isn't he? That probably answers my lingering question as to his silence so far in the SEC vs Goldman Sachs case. After all, it’s not like he needs more than the weekend to read up on it, the entire case as filed on Friday comprises a grand total of 22 pages. More on that last bit in .. a bit.

There's some curious things about that SEC case, like who’s actually charged with what. There's no Jonathan Egol, Fabrice Tourre’s partner at Goldman, no hedge funder John Paulson, no Goldman CEO Lloyd Blankfein. Instead, the only person the SEC names -far as I've seen- is Fabrice Tourre, who, at the time the Abacus deal involved played, was all of 28 years old.

That age thing keeps on itching me. It somehow points to the degree of involvement of the likes of Blankfein, Goldman president Gary Cohn and CFO David Viniar. These guys don’t let a mere kid play with billions of their capital without keeping a close watch. They were all down there on the trade floor for extended periods of time, figuring out what exactly transpired, as can be proven.

Moreover, the then (2006-7) 28-year old Tourre was claiming something that was the 180 degree opposite of what other traders at Goldman had a lot of the firms’ money invested in, namely the continued upward growth of the housing market. Tourre’s contrary claims were nothing short of revolutionary, certainly in the eyes of the older, and more bullish, traders. So it should not come as a surprise that the highest echelons of the firm spent a lot of time with Tourre and other traders. They would have been mad not to. That also means, however, that claiming they didn’t know what was going on is not believable. As Louise Story writes in the New York Times:

Top Goldman Leaders Said to Have Overseen Mortgage Unit
[..] ... according to interviews with eight former Goldman employees, senior bank executives played a pivotal role in overseeing the mortgage unit just as the housing market began to go south.

[,,] executives up to and including Lloyd C. Blankfein, the chairman and chief executive, took an active role in overseeing the mortgage unit as the tremors in the housing market began to reverberate through the nation’s economy. It was Goldman’s top leadership, these people say, that finally ended the dispute on the mortgage desk by siding with those who, like Mr. Tourre and Mr. Egol, believed home prices would decline.

By early 2007, Goldman’s mortgage unit had become a hive of intense activity. [..] In addition to Mr. Blankfein, Gary D. Cohn, Goldman’s president, and David A. Viniar, the chief financial officer, visited the mortgage unit frequently, often for hours at a time. Such high-level involvement was unusual elsewhere on Wall Street, [..] . The decision to get rid of positive bets on mortgages turned out to be prescient. Unlike most other Wall Street banks, Goldman profited from its mortgage business as the housing bubble was inflating and then again when the bubble burst.

Goldman’s top ranks changed its stance on housing in December 2006. In a meeting in a windowless conference room on the executive floor, Mr. Viniar, the chief financial officer, and Mr. Cohn, the president, gathered about 10 executives for a briefing. Mr. Sparks, the head of the mortgage unit, walked them through the numbers. The group was unanimous: Goldman had to reduce its exposure to the increasingly troubled mortgage market.

A few months later, in February 2007, senior executives began turning up on the trading floor. The message, one former employee said, was clear: management was watching. "They basically said, ‘What does this department do? Tell us everything about mortgages,’ " this person said. The executives told Mr. Sparks to tell his traders to sell Goldman’s positive bets on housing. The traders’ short positions — that is, negative bets, mostly used to hedge other investments — were placed in a central trading account.

Ilargi: If after all that, Blankfein, Cohn and Viniar still didn't know what went on, they should be fired on the spot by the shareholders. If they did know, which is faaaar more likely (you don’t get to the GS top spots by being complete doofuses), they should be prosecuted to the full extent of the law. Which is where Cuomo should come in, but, yes, he's campaigning... So maybe right now would be an appropriate moment to check out where his campaign donations stem from. We might just find some juice.


Moving on from there, the most interesting piece I read over the weekend comes from San Diego Law Professor Frank Partnoy, who recently co-authored a number of articles with Eliot Spitzer and Bill Black (they would be a great trio to have investigate this case, by the way, if granted full powers.... Mr President?!).

Partnoy opens up a whole new angle on the SEC -civil- lawsuit. Think about it: why civil, not criminal? Why only name Fabrice Tourre, not his partner Egol, or Blankfein, Cohn and Viniar at Goldman, or even John Paulson, or the various ratings agencies? Why a document of only 22 pages, whereas more or less similar cases run into the hundreds, if not thousands, of pages?

What Partnoy hints at, and if you'll allow me, I’ll run away with for a bit in my imagination, is that someone somehow at the SEC, got smart, and figured that the multi-thousand page cases would never go anywhere. The SEC, or Washington as a whole for that matter, doesn’t have the brightest finance lawyers on its payroll; they work for the banks.

But if you can get a case such as this out of the realm of number, make that digit, crunching, and you take it into what Partnoy labels "morality" instead, but what I think you can perhaps just call a common sense interpretation of the law, you might stumble upon a way to go after the Goldmans of the planet without first having to be able to spell out every detail and digit related to the products they used to hand John Paulson $1 billion, and screw -foreign- banks, pension funds, municipalities and private investors out of trillions of dollars while doing it.

And my positive me, for as long as the little man inside can be kept asleep, was thinking over the weekend that perhaps the SEC never intended its case to go far, that it never meant to pursue it through the undoubtedly massive barriers of Goldman legal counsel.

Instead, what the SEC may have done, and in my dream hopes they -or at least one or more individuals in their offices- did intentionally, is to hand a great big giant tool with which the likes of Goldman can be hunted down, to anyone and everyone who feels aggrieved by the sort of practices the SEC has now revealed. Maybe the SEC people realized long ago that they weren’t up to battling Goldman all the way. But they also realized that they had powertools for rent, they had information that some other parties would have killed their mothers-in-law for, but no way to get it to them. Until now. Here's Partnoy in the Financial Times:

Wall Street beware: the lawyers are coming
[The SEC lawsuit] shows how fraud allegations about complex subprime mortgage deals can be made simple. Although the SEC focused on an arcane synthetic collateralised debt obligation known as Abacus 2007-AC1, its complaint is a spare 22 pages. The heart of the document is one straightforward claim: that Goldman misrepresented the role played by Paulson & Co, a hedge fund. Goldman allegedly told investors that Paulson was investing in the deal, when instead Paulson bet against it.

Goldman also allegedly hid from investors Paulson’s significant role in selecting the subprime mortgage securities referenced in the trade. Thus, the SEC cast a supposedly incomprehensible derivatives trade as a morality tale: the investors were gingerbread boys who weren’t told about the fox.

A trillion dollars or more of CDOs could face similar litigation. Goldman did two dozen deals under the Abacus label; the SEC’s case involves just one. ProPublica, a non-profit news group, recently identified 26 CDOs sold by various banks in which Magnetar, a Chicago hedge fund, allegedly bet that portions would fail. Magnetar has denied any wrongdoing.

Many lawyers previously thought such deals were bulletproof. Now, simplified, they look vulnerable. The SEC, by blazing a trail, has shown plaintiffs’ lawyers how they might frame private cases. (If you sue Goldman, they will come.) The potential damages are huge: on average, these CDOs lost more than a billion dollars each. This is why bank shares fell so sharply on Friday.

Goldman has denied the charges, which it said were unfounded "in law and in fact". It will argue that investors were sophisticated and assumed the risks in exchange for higher returns. It will wave a lengthy prospectus and a 66-page pitch book, which disclaimed liability and disclosed a Cayman Islands special purpose issuer, an exchange listing and centrally clearing.

These defences illustrate the second important point of the case: it shows how litigation can fill gaps regulation will miss. Regulators will never keep pace with financial innovation, and bankers run circles around even the best-intentioned rules, especially in derivatives. More fundamentally, Wall Street interprets detailed rules as a shield from liability. If Congress requires only that derivatives be centrally cleared, and those in Abacus were, is that not sufficient to show Goldman complied with the law?

In contrast, the case demonstrates a more effective way to police bankers, because Wall Street cannot outrun a judge. That simple point has been part of Anglo-American common law jurisprudence for centuries. The US judge Oliver Wendell Holmes advised that the law was a prediction about what a judge would do. If bankers consider only whether they are complying with specific legal rules, they will create "alegal" transactions – deals that fit the letter of the law but violate its spirit. But they cannot be certain about how a judge might assess their conduct.

More generally, the suit against Goldman gives Congress a way forward for financial reforms. For example, the credit rating agencies, which rated Abacus 2007-AC1 triple A, were not named as defendants. Nor was Paulson, which issued a statement denying wrongdoing. These are important omissions, especially that of the rating agencies, which should worry about what a judge may say. Congress could ensure that they will by eliminating the protections that have shielded them from liability.

Ilargi: I could continue, but I’m confident you get my point by now. Someone at the SEC last Friday, willingly (as I'm hoping) or not, opened the barn doors just that little fraction of an inch that will allow outsiders to come in and look for themselves. And if it wasn’t willingly, the end result may still be the same. Cue the lawyers.

So, very basically, the SEC provides the tools, or indeed the entire toolbox, for all other afflicted and interested parties to run away with. States, municipalities, banks, pension funds, entire governments, they now have a whole new set of tools to work with. Sue the bleep bleep on intent, not on details.

Let's see who has the guts the pick up on this one. I’m sort of not counting on Andrew Cuomo. The Germans, Dutch and British may yet, though, if they’re awake. Maybe even Jefferson County. There’ll be rich pickings if played well. Something that doesn’t have to be explained to the predatory lawyers. Bring it on!

The US government, in the shape of the SEC, has handed out all the tools you need. It's up to you now.

Goldman Sachs prosecution threatens to open the floodgates on Wall Street
by Andrew Clark

The US government's $1bn (£650,000) fraud prosecution of Goldman Sachs has spurred calls for a wholesale crackdown on the opaque world of derivatives trading, with pressure mounting on the White House to deliver reforms forcing greater transparency in highly complex financial products. President Barack Obama is engaged in a battle with Senate Republicans over an overhaul of financial regulation and has vowed to veto any bill that does not contain strong enough controls on derivatives.

The US government will face demands this week to use its 27% stake in Citigroup as a lever to extract more public information about trading. Citigroup's annual meeting will be held on Tuesday, and a shareholder group has urged the US treasury to vote its shares in favour of a resolution requiring greater disclosure from the bank on its collateral policy and speculative activities. The Interfaith Center on Corporate Responsibility said that an "extraordinary opportunity" was being offered to send a message to Wall Street that "more derivatives disclosure is vital".

Alarm over misbehaviour in the derivatives sphere has been fuelled by a lawsuit taken out by the securities and exchange commission (SEC) against Goldman, which accuses the bank of colluding with a hedge fund, Paulson & Co, to stuff a mortgage-backed security package with specially selected, doomed home loans. While investors including Royal Bank of Scotland lost more than $1bn, the deal led to huge profits at Paulson & Co, which took a "short" position, betting on the transaction's failure. Both Goldman and Paulson & Co deny the allegations.

Analysts say that the case against Goldman could be the tip of an iceberg. A Dutch bank, Rabobank, accused Merrill Lynch over the weekend of a similar misdemeanour, claiming that Merrill marketed a collateralised debt obligation (CDO) while omitting to mention its relationship with a hedge fund betting against the product's success, resulting in a loss of $45m. Merrill called the allegation "unfounded". Merrill, Citigroup and Deutsche Bank were the top three writers of mortgage-related CDOs in 2006 and 2007. All three banks saw their stock drop by more than 5% when the SEC announced charges against Goldman on Friday.

The US treasury secretary, Timothy Geithner, expressed optimism on Sunday that an agreement would be reached with congressional Republicans over financial reform: "I believe that we are very close on this." Speaking on NBC's Meet the Press show, Geithner said that there had been "catastrophic failures of judgement" by people running top Wall Street banks and that reforms would make them pay: "Then taxpayers will not be on the hook for bailing out these large institutions from their mistakes in the future." Oversight on derivatives trading has been a contentious topic for years. Advocates of light-touch regulation argue that the investors involved are sophisticated institutions that are savvy about the risks they are taking.

But the former US president Bill Clinton today expressed regret for listening to such sentiments. He said that he should not have listened to the former treasury secretaries Robert Rubin and Larry Summers, both of whom opposed tight protection when derivatives were gaining popularity during the 1990s. "I think they were wrong and I think I was wrong to take [their advice] because the argument on derivatives was that these things are expensive and sophisticated and only a handful of investors will buy them," Clinton said. The flaw in the argument, he added, was that "sometimes people with a lot of money make stupid decisions and make it without transparency".

Goldman's difficulties, which prompted a call from Gordon Brown for a UK inquiry today, are likely to lead to a flurry of lawsuits in the US from those who lost money in the credit crunch. Paul Geller of the law firm Robbins Geller Rudman & Dowd, which represents a union suing Goldman over mortgage losses, said: "Private lawyers are foaming at the mouth." Among the casualties from Goldman's share slump on Friday was the billionaire stockpicker Warren Buffett, who saw his warrants in Goldman drop in value by just over $1bn.

Pressure on Wall Street banks to allow a clearer picture of the scope and complexity of derivatives trading has come from church groups and unions, which have taken a stronger line on reform than Democrat senators. Unions have blamed lobbying by the banks for legislators' reluctance to take a tough line. Republicans, hopeful of a backlash against healthcare reform in November congressional elections, now fear they will be punished for blocking calls for financial reform.

Meanwhile, the London-based Goldman banker Fabrice Tourre, accused by the SEC of being the mastermind behind the firm's alleged fraud, is becoming a cult figure. Several fan pages have been established to Tourre on Facebook, and for a time on Friday his name was the second-hottest search term on Google. So far, Tourre's only public comment was in response to a phone call from a Bloomberg reporter, to whom he replied: "I need to jump. Thank you, goodbye."

Wall Street beware: the lawyers are coming
by Frank Partnoy

The US Congress will debate new financial legislation this week, but the real action in financial reform started last Friday with the fraud lawsuit filed by the Securities and Exchange Commission against Goldman, Sachs & Co. That case opens the litigation floodgates for more suits based on subprime mortgage fraud, and smart investors know it. Goldman’s market value fell $12bn during trading on Friday, more than 10 times the losses alleged in the case. Shares of other major banks, such as Bank of America, Citigroup and Morgan Stanley, lost more than 5 per cent. JPMorgan Chase was also hammered last week and announced a $2.3bn increase in its reserve for litigation expenses.

These declines reflect two important consequences of the Goldman case. First, it shows how fraud allegations about complex subprime mortgage deals can be made simple. Although the SEC focused on an arcane synthetic collateralised debt obligation known as Abacus 2007-AC1, its complaint is a spare 22 pages. The heart of the document is one straightforward claim: that Goldman misrepresented the role played by Paulson & Co, a hedge fund. Goldman allegedly told investors that Paulson was investing in the deal, when instead Paulson bet against it. Goldman also allegedly hid from investors Paulson’s significant role in selecting the subprime mortgage securities referenced in the trade. Thus, the SEC cast a supposedly incomprehensible derivatives trade as a morality tale: the investors were gingerbread boys who weren’t told about the fox.

A trillion dollars or more of CDOs could face similar litigation. Goldman did two dozen deals under the Abacus label; the SEC’s case involves just one. ProPublica, a non-profit news group, recently identified 26 CDOs sold by various banks in which Magnetar, a Chicago hedge fund, allegedly bet that portions would fail. Magnetar has denied any wrongdoing.

Many lawyers previously thought such deals were bulletproof. Now, simplified, they look vulnerable. The SEC, by blazing a trail, has shown plaintiffs’ lawyers how they might frame private cases. (If you sue Goldman, they will come.) The potential damages are huge: on average, these CDOs lost more than a billion dollars each. This is why bank shares fell so sharply on Friday.

Goldman has denied the charges, which it said were unfounded "in law and in fact". It will argue that investors were sophisticated and assumed the risks in exchange for higher returns. It will wave a lengthy prospectus and a 66-page pitch book, which disclaimed liability and disclosed a Cayman Islands special purpose issuer, an exchange listing and centrally clearing.

These defences illustrate the second important point of the case: it shows how litigation can fill gaps regulation will miss. Regulators will never keep pace with financial innovation, and bankers run circles around even the best-intentioned rules, especially in derivatives. More fundamentally, Wall Street interprets detailed rules as a shield from liability. If Congress requires only that derivatives be centrally cleared, and those in Abacus were, is that not sufficient to show Goldman complied with the law?

In contrast, the case demonstrates a more effective way to police bankers, because Wall Street cannot outrun a judge. That simple point has been part of Anglo-American common law jurisprudence for centuries. The US judge Oliver Wendell Holmes advised that the law was a prediction about what a judge would do. If bankers consider only whether they are complying with specific legal rules, they will create "alegal" transactions – deals that fit the letter of the law but violate its spirit. But they cannot be certain about how a judge might assess their conduct. That worry, not a rule, is what will make bankers tell clients about the presence of a fox.

More generally, the suit against Goldman gives Congress a way forward for financial reforms. For example, the credit rating agencies, which rated Abacus 2007-AC1 triple A, were not named as defendants. Nor was Paulson, which issued a statement denying wrongdoing. These are important omissions, especially that of the rating agencies, which should worry about what a judge may say. Congress could ensure that they will by eliminating the protections that have shielded them from liability.

Congress could also use the threat of litigation to reform derivatives and off-balance sheet transactions. As currently drafted, the new law would do nothing about recently publicised accounting abuses at Lehman Brothers and other banks. The banks’ inaccurate financial statements have generated howls of protest but no successful litigation.

Lynn Turner, the former SEC chief accountant, and I have published a paper* explaining how Congress could reform this area with one simple paragraph requiring that financial statements reflect reality, and by empowering lawyers to enforce that requirement after the fact. Some politicians recoil at the idea of expanding liability, and lawyers have been unpopular among business people since at least Shakespeare’s time. But 1930s financial reform worked for decades because it created a fear of liability.

Even if Congress chooses not to modernise litigation to include credit rating agencies and derivatives, much of the 1930s liability framework remains intact. Both government and private lawyers can be slow, as they were after scandals involving initial public offerings and stock option backdating, but the Goldman case is a signal that, even without reform, the lawyers are finally coming.

* ‘Off-Balance Sheet’, available at

The writer is a law and finance professor at the University of San Diego.

Top Goldman Leaders Said to Have Overseen Mortgage Unit
by Louise Story

Tensions were rising inside Goldman Sachs. It was late 2006, and an argument had broken out inside the Wall Street bank’s prized mortgage unit — a dispute that would reach all the way up to the executive suite. One camp of traders was insisting that the American housing market was safe. Another thought it was poised for collapse. Among those who saw disaster looming were an effusive young Frenchman, Fabrice P. Tourre, and his quiet colleague, Jonathan M. Egol, the mastermind behind a series of mortgage deals known as the Abacus investments.

Their elite mortgage unit is now at the center of allegations that Goldman and Mr. Tourre, 31, defrauded investors with one of those complex deals. The Securities and Exchange Commission filed a civil fraud suit on Friday that essentially says that Goldman built the financial equivalent of a time bomb and then sold it to unwitting investors. Mr. Egol, 40, was not named in the S.E.C.’s suit. Goldman has vowed to fight the S.E.C. But the allegations have left many on Wall Street wondering how far the investigation might spread inside Goldman and perhaps beyond.

Pressure on Goldman mounted on Sunday as two members of Congress and Gordon Brown, Britain’s prime minister, called for investigations into the bank’s role in the mortgage market. Germany also said it was considering legal action against the bank. Mr. Tourre was the only person named in the S.E.C. suit. But according to interviews with eight former Goldman employees, senior bank executives played a pivotal role in overseeing the mortgage unit just as the housing market began to go south. These people spoke on the condition that they not be named so as not to jeopardize business relationships or to anger executives at Goldman, viewed as the most powerful bank on Wall Street.

According to these people, executives up to and including Lloyd C. Blankfein, the chairman and chief executive, took an active role in overseeing the mortgage unit as the tremors in the housing market began to reverberate through the nation’s economy. It was Goldman’s top leadership, these people say, that finally ended the dispute on the mortgage desk by siding with those who, like Mr. Tourre and Mr. Egol, believed home prices would decline. Lucas van Praag, a Goldman spokesman, said that senior executives were not involved in approving the Abacus deals. He said that the executives had sought to balance Goldman’s positive bets on the mortgage market, rather than take an overall negative view. Mr. Tourre, who now works for Goldman in London, declined to comment, as did Mr. Egol, Mr. van Praag said.

Mortgage specialists like those at Goldman were, in a sense, the mad scientists of the subprime era. They devised investments by bundling together bonds backed by home loans, a process that enabled mortgage lenders to make even more loans. While this sort of financing helped make loans available, the most exotic creations also spread the growing risks inside the American housing market throughout the financial world. When the boom went bust, the results were disastrous.

By early 2007, Goldman’s mortgage unit had become a hive of intense activity. By then, the business had captured the attention of senior management. In addition to Mr. Blankfein, Gary D. Cohn, Goldman’s president, and David A. Viniar, the chief financial officer, visited the mortgage unit frequently, often for hours at a time. Such high-level involvement was unusual elsewhere on Wall Street, where many executives spent little time learning the workings of their mortgage businesses or how those businesses might endanger their companies. The decision to get rid of positive bets on mortgages turned out to be prescient. Unlike most other Wall Street banks, Goldman profited from its mortgage business as the housing bubble was inflating and then again when the bubble burst.

At the heart of all of this is the mortgage trading unit that, at its peak, employed several hundred people. As recently as 2007, Goldman’s mortgage division was split into 11 subgroups, each with a specialty, according to an internal Goldman document that was provided to The New York Times by a former employee. Together, these groups stood astride the nation’s real estate market. One group, for instance, handled actual home loans. Another provided mortgage advice. A third syndicated loans among banks. And still another handled commercial real estate.

During the boom, Goldman’s mortgage unit was a leader on Wall Street. In 2006 alone, the bank underwrote $26 billion of collateralized debt obligations, according to Dealogic, a financial data provider. Many C.D.O.’s have since turned out to be bad investments. But in 2006, some inside Goldman began to worry about the fragile state of housing. Daniel L. Sparks, the Texan who ran the mortgage unit, sided with those who believed the market was safe. Two of his traders, Joshua S. Birnbaum and Michael J. Swenson, had placed a big bet that mortgage bonds would rise in value.

But this camp clashed with Goldman sales staff who were working with hedge funds that wanted to bet against subprime mortgages. Mr. Birnbaum told the team to stop promoting bets against some mortgage investments since such trades were hurting the market and Goldman’s own position, according to two former Goldman employees. But a few desks away, Mr. Tourre and Mr. Egol were quietly working on the Abacus deals. They were, former colleagues say, something of an odd couple. A slight man with a flair for salesmanship, Mr. Tourre joined Goldman in 2001, after coming to the United States to study business operations at Stanford. At Goldman, he courted investors like European banks and big hedge funds.

The taller Mr. Egol, a specialist in analytical finance with a quiet but sometimes intimidating demeanor, devised the Abacus investments. He came to Goldman after studying aerospace engineering at Princeton and finance at the Booth School of the University of Chicago. What united them was an unusually negative view on the mortgage market. As far back as 2005, they clashed with Goldman traders who worked with big mortgage lenders like Countrywide to buy and package loans. Their Abacus deals included insurancelike protection that would pay out if certain mortgage bonds soured. Such credit-default swaps were not worth much in 2005, when housing was flying high, but became highly valuable once the market sputtered.

"Egol and Fabrice were way ahead of their time," said a former Goldman worker. "They saw the writing on the wall in this market as early as 2005." Unlike many of their colleagues at Goldman and other banks, they argued that the nation’s mortgage market was far more interconnected than believed, former Goldman employees said. Their view was that if one group of mortgages or mortgage bonds ran into trouble, the entire market might falter. Mr. Tourre and Mr. Egol created a way for a prominent hedge fund manager, John A. Paulson, to bet against risky mortgages.

With Mr. Paulson’s help, Goldman created an Abacus investment that, the S.E.C. now says, was devised to fall apart. By betting against that Abacus investment, Mr. Paulson reaped $1 billion in profit, according to the S.E.C. Mr. Paulson was not named in the S.E.C. complaint. Goldman’s top ranks changed its stance on housing in December 2006. In a meeting in a windowless conference room on the executive floor, Mr. Viniar, the chief financial officer, and Mr. Cohn, the president, gathered about 10 executives for a briefing. Mr. Sparks, the head of the mortgage unit, walked them through the numbers. The group was unanimous: Goldman had to reduce its exposure to the increasingly troubled mortgage market.

A few months later, in February 2007, senior executives began turning up on the trading floor. The message, one former employee said, was clear: management was watching. "They basically said, ‘What does this department do? Tell us everything about mortgages,’ " this person said. The executives told Mr. Sparks to tell his traders to sell Goldman’s positive bets on housing. The traders’ short positions — that is, negative bets, mostly used to hedge other investments — were placed in a central trading account. Not everyone was happy about it. One trader leaving the firm wrote the mortgage unit a one-word e-mail message: "goodbye."

Goldman turned over all these negative positions to Mr. Swenson and Mr. Birnbaum, the traders who had previously been positive on the market. Along with Mr. Sparks, they have been credited for managing the short position that yielded a $4 billion profit for Goldman in 2007. Mr. Sparks retired in 2008. Mr. Birnbaum also left in 2008, to start his own hedge fund. But former Goldman employees said those traders benefited from the short positions that were given to them. And their trading was tightly overseen by senior executives. At one point in the summer of 2007, for instance, Mr. Birnbaum made a case to Mr. Cohn that some mortgage assets were cheap and that Goldman should let him add $10 billion in positive bets. Mr. Cohn said no.

Meantime, Goldman managers instructed Mr. Egol in early 2007 to add insurance against mortgage bonds. By the third quarter of 2007, the mortgage unit was minting money, while Goldman’s rivals were losing big. Mr. Viniar, the chief financial officer, told analysts that the mortgage unit was posting record profits because of its short bets that mortgage investments would lose value. "Our risk bias in that market was to be short, and that net short position was profitable," Mr. Viniar said.

Abacus Let Goldman Shuffle Mortgage Risk Like Beads
by Jody Shenn and Bob Ivry

From July 2004 through April 2007, as credit markets boomed, Goldman Sachs Group Inc. created 23 financial transactions called Abacus, the word for a relatively crude counting tool involving the shuffling of beads. [On Friday], the Securities and Exchange Commission sued the bank for securities fraud in what would be the penultimate offering in the series, according to Bloomberg data. The bank used the deals to off-load the risk of mostly subprime home loans and commercial mortgages to investors, either as hedges for similar positions or to bet against securities itself. While the data show New York-based Goldman Sachs issued at least $7.8 billion of Abacus notes, the risk passed to investors was multiples higher.

The Abacus transactions are so-called synthetic collateralized debt obligations, which marry two financial innovations that contributed to the worst collapse in financial markets since the Great Depression. "Investors needed to ask some questions about synthetics they didn’t need to ask with other CDOs," Joseph Mason, a finance professor at Louisiana State University in Baton Rouge, said in a telephone interview. The financial tools, often called technologies, are credit- default swaps, used to transfer the risk of losses on debt, and securitization, used to slice the risk in a pool of assets into various new securities. Abacus deals were filled with default swaps that offered payouts to Goldman Sachs if certain mortgage bonds didn’t pay as promised, in return for regular premiums from the bank.

Some of the cash needed for the potential payouts to Goldman Sachs would be raised upfront, and essentially placed in escrow, from sales of Abacus CDO notes with varying ratings. The grades were tied to how many of the underlying securities needed to default before the CDO classes would. Such securitization enabled debt with the lowest investment-grade ratings to be transformed, in part, into AAA securities that turned out to not be as safe as that ranking suggested. At least $5 billion of Abacus slices now carry junk ratings, below BBB-, from Standard & Poor’s, or have defaulted, Bloomberg data show.

The SEC said that Goldman Sachs created and sold Abacus 2007-AC1 without disclosing that hedge fund Paulson & Co. helped pick the underlying securities and also bet the CDO would default. Paulson was proved correct, and his hedge fund eventually turned a $1 billion profit and CDO investors lost a similar amount, according to the SEC. The deal was different from most Abacus CDOs in that Goldman Sachs said that a third-party, ACA Management LLC, was choosing the underlying debt instead of the bank itself, according to prospectuses.

At least $192 million of the debt was granted top grades by credit-rating companies, and an additional $1.1 billion was supposedly even safer, according to Bloomberg data. The latter, super-senior portions were derivatives and not securities. "This would never have been possible if the ratings had been correct," said Gene Phillips, director of PF2 Securities Evaluations, a New York-based advisory firm. "For these trades to come out so well for Paulson, the ratings agencies would not have been able to identify as well as Paulson did that these were crappy assets."

An explosion in synthetic CDOs began in December 1997, with the first of the so-called BISTRO deals created by a predecessor to JPMorgan Chase & Co.. The transaction involved the bank laying off some of $9.7 billion of its risk tied to financing for 307 companies, according to "Fool’s Gold," a book by Gillian Tett (Free Press, 2009). Shortly after that, JPMorgan helped Bayerische Landesbank of Germany unload the risk of $14 billion of U.S. mortgages and then completed one more mortgage-linked BISTRO transaction, before stepping out of the market for home-loan deals because it couldn’t get comfortable assessing the risk it needed to retain amid a lack of historical data on how the debt would perform, according to the book.

UBS AG, in a series called North Street from at least 2000 through at least 2005, and Deutsche Bank AG, through its Start program in at least 2005 and 2006, also issued synthetic CDOs tied to mortgages, according to Bloomberg data. In 2006 and 2007, the distinction between synthetic mortgage-bond CDOs and "cash" ones, or those made only of actual debt, broke down as "hybrid" deals, filled with both securities and credit swaps, began to dominate the market, meaning that almost every major bank was underwriting CDOs filled in part with their own bets against homeowners.

Investors "came to Goldman Sachs and other financial intermediaries to establish long and short exposures to the residential housing market," and the bank’s protection against home-loan bond defaults represented a way to offset risk it took on by selling the opposite position to clients, Chief Executive Officer Lloyd Blankfein said in the company’s annual report. In 2006 and 2007, when the residential and commercial mortgages with the highest default rates now were made, the bank created more than $4 billion of Abacus notes, Bloomberg data show.

That figure doesn’t reflect the fact that banks such as Goldman Sachs often would retain some of the slices they created. The bank said in a statement yesterday that it lost $90 million on the transaction the SEC sued it over. The $7.7 billion in Abacus CDOs doesn’t include most of the so-called super-senior tranches that were supposedly safer even than AAA debt. Super-senior transactions were often private. For instance, with Abacus 2005-3, initially 68 percent linked to subprime-mortgage securities, Goldman planned to create a $1 billion super-senior class along with $825 million of notes, according to a May 10, 2005, preliminary term sheet. Super-senior classes, or those in which the cash that would be potentially paid out to Goldman Sachs wasn’t collected upfront, often made up larger portions of the deals.

American International Group Inc., the insurer whose mortgage losses led to its need for a U.S. bailout, took on the super-senior risk on the 2005-3 deal, along with six others, according to an internal memo posted on CBS News’s Web site. That included the last Abacus deal, which priced April 17, 2007, and focuses on commercial-mortgage securities, Bloomberg data show. Its most-senior class below the super-senior one is now rated CCC by Fitch Ratings, its third-lowest level.

AIG guaranteed $6 billion through Abacus deals, a person with knowledge of the matter said this month. That figure shrank to $4.3 billion by November 2008 as some of the mortgages linked to the derivatives were repaid or refinanced, the person said. The insurer last year terminated about $3 billion of the swaps with Goldman Sachs that made up the super-seniors, resulting in $1.5 billion to $2 billion of realized losses, said the person, who declined to be identified because the specific transactions weren’t disclosed. AIG, based in New York, has about $1.3 billion in remaining swaps tied to the CDOs, the person said.

The swaps weren’t included in AIG’s 2008 government rescue because they insured pools of derivative bets, rather than actual securities. AIG and the Federal Reserve Bank of New York retired $62.1 billion in swaps by fully reimbursing bank counterparties in exchange for obtaining the securities, which are held in a taxpayer-funded vehicle called Maiden Lane III. Still, some Abacus classes are in Maiden Lane III, because they’re held by other CDOs. One is Davis Square III, a CDO underwritten by Goldman Sachs in 2004 and managed by TCW Group Inc. that bought $24 million of Abacus slices, including some created after Davis Square III was, according to Moody’s Investor Service reports.

Erin Freeman, a spokeswoman for TCW, a unit of Paris-based Societe Generale, said none of the CDOs managed by TCW purchased the Abacus deal at the center of the SEC suit. The holdings of CDOs by other CDOs mean that some bond buyers and insurers may not know they’re exposed to Abacus deals. Royal Bank of Scotland Plc, the bank now controlled by the U.K. government, was the bigger loser in the deal in which the SEC alleges Paulson & Co. was involved, paying out $840.9 million to Goldman Sachs in 2008, most of which it then passed to Paulson’s hedge fund, according to the SEC complaint.

Even as subprime defaults soared in 2007, more than $1.1 trillion of CDOs were created, about the same as in 2006, according to JPMorgan data. The figures, which also include CDOs backed by assets such as buyout loans and bank capital securities, include unfunded super-senior classes. Funded issuance totaled about $1.05 trillion during those two years. Some of Goldman’s Abacus CDOs were "static," meaning the portfolio of securities they referenced didn’t change over time, while others allowed for reinvestment into different investments as initial holdings paid down, with Goldman choosing the new securities.

That’s partly because investors including Dusseldorf, Germany-based IKB Deutsche Industriebank AG, a buyer of part the CDO the SEC is suing over, asked for the reinvestment because they would be given higher yields, a person familiar with the matter said earlier this year. A dispute over replacement collateral involving UBS landed in New York Supreme Court in 2008. Hamburg-based HSH Nordbank AG, the world’s biggest shipping financier, said in a complaint that UBS had been "deliberately selecting inferior quality" assets for a synthetic CDO called North Street 2002-4.

Goldman Sachs may have lost money on Abacus 2007-AC1 because in at least some Abacus deals, the bank used the cash raised from note sales, which would be owed to either the owners or itself, to buy securities including AAA-rated mortgage bonds and CDOs, according to Fitch and Moody’s Investors Service. It then guaranteed that, in most cases, it would buy the escrow account securities at face value if needed to pay the owners of the Abacus notes, unless those escrow holdings defaulted, according to the rating firms’ reports. Declines in the value of the purchased securities could limit how much Goldman Sachs could pay itself.

Pandora’s Box is Open and Woe to the Financials
by David Goldman

This is on the scale of the Enron case. Except that it could affect every firm involved in subprime securitization. I haven’t read anything in years as racy as the SEC’s complaint against Goldman Sachs for collusion with the Paulson hedge fund to cheat subprime investors out of $1 billion. A billion-dollar fraud is not a small matter. I’m no lawyer, but the granularity of detail and documentation that the SEC has assembled appears extremely impressive.

They have nailed a 32-year-old Goldman vice president who cobbled together the tainted structure, and he appears to be singing. Investment banks aren’t like the mafia. No-one takes twenty-year sentences and keeps their mouth shut. This case very well might open up others. The issue, as the press has reported, is the selection of collateral in a Goldman Sachs synthetic CDO deal. As the SEC reports:
In late 2006 and early 2007, Paulson performed an analysis of recent-vintage Triple B RMBS and identified over 100 bonds it expected to experience credit events in the near future. Paulson's selection criteria favored RMBS that included a high percentage of adjustable rate mortgages, relatively low borrower FICO scores, and a high concentration of mortgages in states like Arizona, California, Florida and Nevada that had recently experienced high rates of home price appreciation.

Paulson informed GS&Co that it wanted the reference portfolio for the contemplated transaction to include the RMBS it identified or bonds with similar characteristics. GS then allegedly packaged Paulson’s picked time bombs into a CDO that it sold to investors while selling protection on the portfolio to Paulson. He pocketed $1 billion, and the investors lost $1 billion.

This opens Pandora’s Box. Investors who lost a trillion dollars in subprime CDO’s now will descend like Harpies upon the banks that packaged them, with subpoenas for every email and internal memorandum involved. The civil suits that could arise from this are potentially innumerable. It’s a good time to get into the bunker where financial stocks are concerned.

Bet Against The American Dream
by Planet Money

Angry bank lambasts charges
by Francesco Guerrera

Documents obtained by the Financial Times throw new light on the rocky relationship between Goldman Sachs and the US Securities and Exchange Commission during the 20-month probe that led to last week's fraud charges against the Wall Street bank. The frayed mood between the bank and the regulators might explain the SEC's decision to file civil charges against Goldman on Friday without warning the bank, as well as the two sides' lack of settlement talks before last week's move.

In a 40-page document written in September last year in response to the SEC's initial accusations, Goldman and Sullivan & Cromwell, its lawyers, say the authorities' case is riddled with "fatal deficiencies" and criticises the regulators for laying blame with the benefit of "perfect hindsight". The document tackles head-on the SEC's central contention that Goldman misled investors by hiding the fact that Paulson & Co, a hedge fund, had a significant input in choosing poor-quality loans that went into a collaterised debt obligation, a mortgage-backed security, so that it could bet against it.

"There is no basis in the law, the record or common sense for such charges," it says.

In a separate document, sent to the SEC a few days later, Goldman refers to "open and robust" discussions with staff of the commission - a glimpse of the tough behind-the-scene talks that went on from July last year when the regulators formally informed the bank they wanted to press charges. The SEC declined to comment on Goldman's documents yesterday. In Goldman's view, it "defies credulity" that ACA, the independent manager of the CDO that also invested in the security, would have taken Paulson's suggestions on the loans if it had any concerns.

Through a series of complex legal arguments and market data, Goldman tries to summarise in its response to the SEC the 8m pages of documents studied by the commission since the beginning of its probe in August 2008. Goldman's efforts appear aimed at persuading the SEC that the bank had neither the incentive, nor the intention, to deceive investors. "There is no evidence whatsoever that Goldman Sachs would have had any intention to mislead investors," the document says. "The record reflects that the [CDO] - which was approved by the mortgage capital committee, an independent committee within Goldman Sachs - was very much routine, and one of numerous CDO transactions underwritten by Goldman."

Goldman argues that it was common practice not to disclose to investors - which in this case were just ACA and the German bank IKB - who would be taking a short position on a CDO. In the bank's view, it would have been a breach of client confidentiality to reveal that Paulson & co intended to short the CDO. Goldman's documents repeatedly stress the ordinary nature of a CDO and emphasise that its fall in value in 2007 was similar to the collapse of many other securities as the US housing bubble burst. According to Goldman, the $1bn-plus losses suffered by ACA and IKB - and the $1bn gain for Paulson & Co - on the CDO were not the result of a cynical ploy to deceive investors.

"There was nothing unusual or remarkable about the transaction or the portfolio of assets it referenced," Goldman writes. "There is no basis to suggest that the portfolio would have performed any differently or that the economic outcome for the participants would have changed in the least had Paulson's role and interest been more transparent." Goldman has also pointed out that, far from being the self-interested middle-man portrayed by the SEC, it lost $75m on the transaction - net of a $15m fee - because it kept a portion of the CDO on its books.

For all the tough talk, at the weekend Goldman's bankers and executives were busy closing ranks around Lloyd Blankfein, its chief executive, and his top lieutenants. Suggestions that the case could cost Mr Blankfein his job after a series of blows to the bank's reputation were forcefully dismissed by Goldman executives. Any change at the top now would be seen as an implicit admission that the SEC's accusations had some merit, insiders said. But they conceded they would be nervously watching the stock price this morning after shares plummeted by more than 12 per cent on Friday.

Goldman Case Hits Hard in CDO Market
by Katherine Greene

Fraud charges against Goldman Sachs Group Inc. threatened to derail a nascent revival in the market for complex securities. Goldman was accused of fraud by the Securities and Exchange Commission for its marketing of similar securities—collateralized debt obligations—before the financial meltdown. The charges came just as that market was finally showing signs of life after being dormant since the crisis began. Goldman has denied the allegations.

At least three deals, including two managed by Goldman itself, were in the works when the SEC said it filed civil fraud charges. They come after Citigroup sold the first such CDO, backed by corporate loans, known as a CLO, in the past few weeks, and Bank of America's $500 million deal with Symphony Asset Management. Several market participants said they had been approached with CLOs packaged separately by Goldman and Citigroup that were scheduled to hit the market as soon as the coming week.

"Credit markets are seeing a sizable impact from the Goldman news," said Bill Larkin, a portfolio manager at Cabot Money Management, in Salem, Mass. "The question is, has the SEC discovered what may have been a common practice across the industry? Is this the tip of the iceberg?" Still, the deals being offered to investors now differ markedly to the CDO at the heart of the SEC's investigation. That deal was pegged to the performance of subprime mortgages and was made up of credit-default swaps linked to that debt.

The new deals are backed by corporate loans and come just as the market was beginning to heat up. Corporate loans, like corporate bonds, have been on a tear of late, giving investors hope that appetite for more complex structures may also improve. Several market participants said the allegations against Goldman, while yet unproven, have shaken many investors. "This is the beginning I hope of the recalibration of risk," said James Camp, managing director of fixed income at Eagle Asset Management. "The financial space is overcooked in terms of debt valuation."

Treasurys rallied Friday as investors sought safety in low-risk government debt on the news about the Goldman charges, and amid continuing worries about debt-laden Greece. Those two pieces of news sparked investors to buy Treasurys as stocks deteriorated, pushing the two-year yield further under 1% and the 10-year yield further away from the key 4% level, which it breached recently for the first time since June. Investors typically seek safety in Treasurys when there is troubling news on the economy or on financial markets.

Goldman Sachs finds $5 billion for pay and bonuses amid fraud investigation
by Ruth Sunderland

Goldman Sachs is expected to earmark about $5bn (£3bn) for staff pay and bonuses this week, days after being accused of securities fraud by the US regulators, fuelling the controversy over bankers' rewards in the teeth of the financial crisis. Chief executive Lloyd Blankfein is expected to unveil revenues of $11bn for the first quarter of this year on Tuesday, up from $9.4bn in the same period of 2009. About 47% of that will go into a "compensation pool" for bosses and employees.

The bank, along with Fabrice Tourre, one of its vice presidents, is the subject of a civil fraud complaint by the US Securities and Exchange Commission (SEC). It denies the accusations and is understood to believe they are the result of a politically motivated witch-hunt – timed to coincide with a drive by President Obama to get tough on banks, and to come just ahead of its results.
The bank has been aware of the SEC's investigation for two years but had not spoken to investigators since September 2009 and is thought to have been taken by surprise by last week's events. Tourre has been interviewed by Goldman's internal compliance department but is still employed by the bank and has not been suspended.

Speculation over Blankfein's future is seen by insiders as "silly". However, the episode is likely to have incurred the ire of US investor Warren Buffett, who lost more than $1bn on paper in 24 hours on warrants held by his Berkshire Hathaway investment fund as Goldman shares plunged. Buffett endorsed the bank by loaning it $5bn at the height of the crisis at 10% interest. He is an outspoken critic of Wall Street sharp practice and excessive pay. Senior Goldman executives have held talks with major investors, thought to include Buffett, over the SEC accusation.

Blankfein is also anticipating tough questioning later this month on Capitol Hill. Along with other financiers he is expected to testify before the Senate's permanent subcommittee on investigations. The panel's head, Democratic senator Carl Levin, said it had discovered levels of greed that were "frankly disgusting". Goldman made record profits of $13.4bn last year, after net revenues more than doubled to $45.2bn, racking up at least $100m in net trading revenues every other working day. This came after the demise of several rivals and despite the bank coming close to disaster itself when the crisis was at its height. It took $10bn of US government money, which it has since repaid.

Amid widespread popular anger against the banks, Goldman last year shrank its bonus pool to 36% of revenues rather than the usual 50%. Despite reining in, however, it still paid out a total of $16.2bn. Blankfein was awarded a $9m bonus in shares in 2009, down from the $68m he received in cash, shares and options in 2007. Due to accounting rules, Goldman sets aside a higher proportion of revenues for staff rewards at the start of the year. The rate at which they are accruing for 2010 overall is likely to drop in subsequent quarters, to end up at about the same as in 2009.

Goldman Sachs Said to Have Been Warned of SEC Suit
by Joshua Gallu and David Scheer

Goldman Sachs Group Inc., which fell 13 percent yesterday after U.S. regulators announced fraud accusations, didn’t disclose that it was warned nine months ago that investigators wanted to bring a case, people with direct knowledge of the talks said. Goldman Sachs responded to the so-called Wells notice from the Securities and Exchange Commission within months and met with the agency officials trying to fend off the civil lawsuit, said the people, who declined to be identified because the talks weren’t public. In March, the New York-based firm said it was cooperating with regulators’ "requests for information."

"The question is whether a general disclaimer like that is rendered misleading because you left out the specifics," said Adam Pritchard, a former SEC attorney who teaches law at the University of Michigan in Ann Arbor. "The prudent, conservative choice is to disclose more," because omissions can lead to shareholder lawsuits, Pritchard said. Lucas van Praag, a spokesman for Goldman Sachs in New York, declined to comment.

Goldman Sachs, the most profitable company in Wall Street history, created and sold collateralized debt obligations tied to subprime mortgages in 2007 without disclosing that hedge fund Paulson & Co. helped pick underlying securities and bet against the vehicles, the SEC said in its suit. The SEC sent the firm a Wells notice in July and the company responded in September, one of the people said. Companies typically disclose legal issues such as regulatory probes in their quarterly and annual financial reports.

Goldman Sachs’s annual report for 2009, filed with the SEC in March, recycled a passage the company used in the previous year’s report to describe regulatory probes involving securities linked to subprime mortgages. In both cases, the firm wrote: "GS&Co. and certain of its affiliates, together with other financial services firms, have received requests for information from various governmental agencies and self-regulatory organizations relating to subprime mortgages, and securitizations, collateralized debt obligations and synthetic products related to subprime mortgages. GS&Co. and its affiliates are cooperating with the requests."

Goldman Sachs, which fell $23.57 to $160.70 in New York trading yesterday, might argue that it reasonably believed the SEC’s warning wasn’t material, Pritchard said. The firm could argue that it thought the regulator wouldn’t sue after Goldman Sachs presented its defenses, he said. "The SEC’s charges are completely unfounded in law and fact and we will vigorously contest them and defend the firm and its reputation," Goldman Sachs said in a statement yesterday.

John Paulson Needs A Good Lawyer
by Simon Johnson

Of all the reactions so far to various dimensions of Goldman fraudulent securities "Fab" scandal, one stands out.  On Bill Maher’s show, Friday night, I argued that John Paulson – the investor who helped design the CDO at the heart of the affair – should face serious legal consequences. 

On the show, David Remnick of the New Yorker pointed out that Paulson has not been indicted.  And since then numerous people have argued that Paulson did nothing wrong – rather that the fault purely lies with Goldman for not disclosing fully to investors who had designed the CDO.

But this is to mistake the nature of the crime here – and also to misread the legal strategy of the SEC.

The obvious targets are Goldman’s top executives, whom we know were deeply engaged with the housing side of their business in early 2007 – because it was an important part of their book and they were well aware that the market was in general going bad.

Either Goldman’s executives were well aware of the "Fab" and its implications – in which case they face serious potential criminal and civil penalties – or they did not have effective control over transactions that posed significant operational and financial risk to their organization.

They will undoubtedly pursue the "we did not know" defense – which of course debunks entirely the position taken by Gerry Corrigan (of Goldman and formerly head of the NY Fed) when I pressed him before the Senate Banking Committee in February.  Corrigan claimed that Goldman’s risk management system is the best in the business and simply superb; the former may be true, but the latter claim will be blown up by Lloyd Blankfein’s own lawyers – they must, in order to keep him out of jail.  (Aside to Mr. Blankfein’s lawyers: the people you are up against have already read 13 Bankers and may put it to good use; you might want to get a copy.)

And don’t be misled by the purely civil nature of the charges so far – and the fact that the announced target is only one transaction.  This is a good strategy to uncover more information – for broader charges on related dimensions – and it allows congressional enquiries to pile on more freely.

As for John Paulson, the issue will of course be the “paper trail” – including emails and phone conversations.  A great deal of pressure will be brought to bear on the people who have worked with him, many of whom now faced permanently broken careers in any case.

Here’s the legal theory to keep in mind.  Mr. Paulson only stood to gain on a massive scale (or at all) if the securities in question were mispriced, i.e., because their true nature (that they had been picked by Mr. Paulson) was not disclosed.  In other words, the Paulson transactions at this stage of the game only made sense if they involved fraud.  The principals involved (Paulson and top Goldman people) are all super smart, with unmatched practical experience in this area; they get this totally.

John Paulson was not the trigger man – it was Goldman and its executives who withheld adverse material information from their customers.  But if the entire scheme was Mr. Paulson’s idea – if he was in any legal sense the mastermind (obviously he was, but can you prove it beyond a reasonable doubt?) – then we are looking at potential conspiracy to commit fraud.  And if he had conversations of any kind and at any time during this period with top Goldman executives, this will become even more interesting - so of course all relevant phone records will now be subpoenaed.

Mr. Paulson should be banned from securities markets for life.  If that is not possible under current rules and regulations, those should be changed so they can apply.  If that change requires an Act of Congress, so be it.

There is fraud at the heart of Wall Street.  It is time to end that.

Paulson & Co. May Face Investor Lawsuits on Goldman Sachs CDO
by Katherine Burton and Saijel Kishan

Paulson & Co. may be sued by investors who lost more than $1 billion on a mortgage-linked deal that regulators say was sold by Goldman Sachs Group Inc. without disclosing the hedge-fund firm’s role, lawyers said. Goldman Sachs yesterday was accused of fraud by the U.S. Securities and Exchange Commission for failing to tell clients that Paulson, run by billionaire John Paulson, helped pick the mortgage-backed securities that underpinned the investment, known as a collateralized-debt obligation.

Neither Paulson nor his firm was accused of any wrongdoing in the SEC’s complaint. Paulson & Co. shorted the CDO, a bet its value would fall, meaning the New York-based firm stood to profit by choosing securities it expected to default, the SEC said in its civil complaint. Goldman Sachs told clients the securities included in the deal were selected by ACA Management LLC, an independent third party, according to the SEC.

"If Paulson was intentionally putting dreck into the CDO, and doing so for the purpose of shorting it, then that could constitute fraud," said Ross Intelisano, a lawyer at Rich & Intelisano LLP in New York who has represented clients in fraud lawsuits against hedge funds. While the case against Goldman is stronger, he said, "if I were repping a Goldman client, I’d likely include Paulson in a suit." The SEC said that it didn’t sue Paulson & Co. because it was Goldman Sachs’s job to disclose to investors how the CDO was constructed. "It was Goldman that made the representation to investors, Paulson did not," Robert Khuzami, enforcement director at the SEC, said yesterday in a conference call with reporters.

"There haven’t been many investor lawsuits on these kinds of deals," said Thomas Adams, a partner at New York-based Paykin Krieg & Adams LLP. "This opens the door to civil claims across a number of transactions," including the Goldman CDO, he said. Paulson & Co. wasn’t involved in the marketing of the investment, called Abacus 2007-ACI, and didn’t have authority over selecting the portfolio of residential mortgage-backed securities on which it was based, the firm said yesterday in a statement.

"Paulson did not sponsor or initiate Goldman’s Abacus program, which involved at least 20 transactions other than that described in the SEC’s complaint," the firm said. Paulson & Co. provided input into the underlying securities of the CDO, along with ACA and investor IKB Deutsche Industriebank AG, New York-based Goldman Sachs said yesterday in a statement. Such discussions were "entirely typical of these types of transactions," and ACA, which also invested in the CDO, chose the portfolio, according to the statement. The SEC’s accusations are "unfounded in law and fact," Goldman Sachs said.

Paulson & Co. is the world’s third-biggest hedge fund, with $32 billion in assets, thanks in large part to its bet that subprime mortgages would tumble. The trade earned the firm roughly $3 billion in fees in 2007. Paulson’s Advantage Plus fund, its largest, jumped 160 percent that year on the back of the subprime wager. The firm’s Credit Opportunities funds, which held the biggest chunk of Paulson’s bet, were up 600 percent.

Paulson, 54, started the New York-based firm in 1994, after stints at Bear Stearns & Co. and Gruss Partners. His initial focus was betting on the shares of merging companies. One Paulson investor said he isn’t worried about the firm’s involvement with the Goldman Sachs CDO. "So far there’s no cause for concern for us with regards to Paulson because he hasn’t been indicted or shown to have done anything wrong," said Jean Keller, chief executive officer of 3A SA, a Geneva-based firm that invests in hedge funds on behalf of clients.

Buffett Rented Good Name to Goldman Too Cheap
by Alice Schroeder

At the height of the financial crisis, Goldman Sachs sold Warren Buffett’s Berkshire Hathaway $5 billion of perpetual preferred stock with a 10 percent dividend and warrants on $5 billion worth of common stock at a strike price of $115 a share. This package gave Berkshire a return of more than 15 percent in exchange for its money and Buffett’s endorsement, which Goldman desperately needed to raise funds to survive the panic.

At first it seemed that Berkshire had gotten a rich price for Buffett’s one-time imprimatur to help Goldman avert failure in a liquidity crunch. Since then, Buffett has been sitting in Omaha, Nebraska, cashing checks for $500 million a year. The preferred is an extremely expensive form of capital that is redeemable at Goldman’s option. It is costing Goldman $100 million to $200 million a year in extra dividends compared with the cost if it refinanced. Goldman can afford it, so why has it not paid this money back?

Meanwhile, instead of regaining its luster since the financial crisis, Goldman has produced a nonstop soap opera of indignities unbefitting a blue-chip bank. Keeping the preferred makes no sense -- unless Goldman values having Buffett’s reputation on call even more, as insurance.

Deals like the preferred-stock investment do present moral hazard. The parties’ interests aren’t only opposed, but Goldman knows far more about its internal problems and risks than Buffett, and has more control over the course of events. Buffett had already been spattered with his share of mud associated with Goldman even before the Securities and Exchange Commission filed civil fraud accusations against it last week for allegedly creating and marketing a collateralized debt obligation that was designed to lose money. (The bank calls the allegations "completely unfounded.")

Last week, one of Berkshire’s directors, Ron Olson, speaking on Bloomberg Television ahead of Berkshire’s annual meeting, defended Goldman, saying that Buffett invested out of belief in "not just the strength of Goldman but its integrity." With horrible timing for Buffett, the SEC filed its suit three days later. Goldman had gotten a Wells notice in July 2009 informing it that the SEC might file civil fraud accusations. It didn’t disclose that to investors. While this disclosure isn’t required, most companies do it. You have to wonder whether Buffett knew.

What else might Goldman Chief Executive Officer Lloyd Blankfein have not told Buffett while Buffett was defending Blankfein as the best person to run the bank? When Buffett struck the deal with Goldman he had never met Blankfein. Some thought Buffett was really investing in his trusted Goldman banker, Byron Trott, who was sometimes mentioned as a possible successor to Blankfein. But Trott left Goldman six months after Buffett made the investment to start his own private-equity fund.

Buffett made a similar deal once before when he invested $700 million of Berkshire’s money in Salomon Brothers in the 1980s on little but faith in its management. The parallels between the two investments are striking enough that it raises the question: What could Buffett have been thinking by investing in Goldman? He was again buying into a business that he once professed to despise. He was again renting out his reputation in a way that subjected him to moral hazard. Salomon had covered up employee misconduct, held back information from its directors, including Buffett, and almost went bankrupt after defrauding the government in Treasury bond auctions.

The Salomon experience, though, may shed some light on why Buffett did it, because it taught him a lesson: that renting his reputation could actually enhance it if the disgraced company recovers. Buffett told Congress he would be ruthless with anyone who lost "a shred of reputation" for Salomon. It survived, and Buffett was credited as the hero. It seemed then as if he could cure a company’s ills simply by associating with it. And so, when Buffett says he invested in Goldman Sachs because of its management’s "integrity," he may really be saying that Goldman must have integrity because he invested in it.

This, I believe, is where Buffett miscalculated. Years ago he became too much of a corporate insider to be truly independent, but for a long time it didn’t seem to matter. This latest metamorphosis is embarrassing. The commercial nature of the transaction is so transparent that it can’t be disguised with talk of integrity. Buffett swapped his reputation at a cheap price. Goldman is holding him to the deal, hanging onto the preferred stock while Buffett’s reputation is still useful. It is painful to watch Buffett behaving like a hostage to Wall Street, damaging himself by defending investment banks and saying flattering things about Goldman in a way that contradicts any principled view of the securities business.

When Goldman’s fortunes eventually reverse, it won’t change anything. Goldman will doubtless be perceived as the blue chip of Wall Street again. The list of problems that occurred after the 2008 financial crisis are nonetheless indelible and will stand alongside the firm’s marketing of closed-end investment trusts before the stock market crash of 1929 as one of the two great black marks in the firm’s history. Berkshire will exercise its warrants, and will pocket its financial gains, which are the price of being associated with Goldman in this episode. The money wasn’t enough. Goldman outsmarted Buffett in this deal.

Goldman’s Staged Explosion Deserves Apology
by Roger Lowenstein

Just how out-of-touch can Lloyd Blankfein be? The Goldman Sachs Group Inc. chief executive officer vigorously denied the Securities and Exchange Commission fraud suit filed Friday against his firm, calling the complaint "completely unfounded in law and fact." The company promised to "defend the firm and its reputation." But head-in-the-sand denials will no longer work. If Blankfein wants to save what is left of Goldman’s reputation, and possibly his job, he should admit that the deal described in the SEC complaint was wrong. Then, he should draw a very firm line so that Goldman doesn’t deceive its customers again.

As only someone from Mars doesn’t know by now, Goldman allegedly sold collateralized debt obligation, or bonds backed by mortgage securities, to institutional investors without disclosing that the specific securities were handpicked by hedge-fund manager John Paulson. Paulson was betting on the securities to fall and, for that reason, structured the securities to include losers -- not winners. For instance, he ordered that no bonds backed by Wells Fargo & Co. mortgages be included in the pool because Wells Fargo was one of the few mortgage lenders that stuck to sound lending.

Goldman says it had no idea whether the mortgage securities would go up or down. Maybe. But the SEC complaint quotes a Goldman employee, also named as a defendant, gleefully chortling, "The whole building is about to collapse anytime now." By the time the deal closed, in April 2007, the subprime market was already in trouble. Defaults were skyrocketing. And by the following January, no fewer than 99 percent of the mortgages in the CDO had been downgraded.

Goldman’s investment forecast matters less than its allegedly faulty disclosure. Internally, it referred to the bonds at issue as "the Paulson portfolio." But outside investors weren’t told that this much-respected -- and much- feared -- short-seller had selected the bonds, or even that he was involved. Instead, Goldman recruited a neutral third party to bless the deal, and investors were told that this party, ACA Management LLC, had selected the mortgages.

It might be that every fact in the SEC complaint is untrue, in which case Blankfein is right to defend and I am dead wrong. But the complaint is rich in detail, and builds on a book, Gregory Zuckerman’s "The Greatest Trade Ever," and on exclusive reporting in the New York Times that laid out a similar story. If the SEC’s facts are true, the case is ugly for Goldman. In capsule form: At Paulson’s urging, Goldman structured a security so Paulson could short the mortgage market. Goldman found patsies to take the other side, and Paulson paid the firm a $15 million fee.

Goldman’s behavior reminds me of NBC television, which in 1992 aired a video of a pickup truck explosion that turned out to have been staged. After a lawsuit by General Motors Co., NBC apologized on air. In the present case, Goldman staged a CDO to explode.

Another example: in 1991, a Salomon Brothers trader lied to the government. Though no investor fraud was involved, the CEO, John Gutfreund, was forced to resign merely because he had waited a few months before reporting the incident. The new interim CEO, Warren Buffett, publicly apologized. He insisted then that in the future Salomon Brothers would be "way, way away from the line." He wanted it to steer clear of any behavior that was even remotely questionable, much less illegal. Should Goldman aspire to any less? The same Buffett’s Berkshire Hathaway is an investor in Goldman. It would be nice to hear Buffett endorse his principles with respect to Goldman now. (Disclosure: I am investor in Berkshire.)

Either way, Blankfein should deliver a public apology. Stonewalling, dissembling or parsing the facts won’t restore Goldman’s name. Goldman may also have to settle with investors who lost money on this and any similar deals. It will cost Goldman money but it will be worth it. Finally, Goldman needs to look in the mirror and ask how a firm long known for its stellar reputation and ethics could have gone so wrong. My own theory is that three steps in the firm’s evolution eroded the class that Goldman once stood for.

First, when the firm was sold, ending its days as a partnership, in 1999, managers gradually began to think of Goldman as a public stock rather than their private firm. Second, Goldman became more of a trader, less an investment banker. Bankers think long-term, traders short-term. Last year, 76 percent of its revenue was from trading and for investing for its own account. Finally, the shift toward trading was duplicated in Goldman’s upper management, which formerly was divided between both camps. Since Blankfein took over in 2006, traders have dominated.

Goldman, of course, will say it still cares about reputation. Tell that to IKB Deutsche Industriebank AG. In 2006, the German bank specifically told Goldman it was no longer comfortable investing in CDOs that didn’t "utilize a collateral manager, meaning an independent third-party," according to the SEC’s complaint. Goldman told IKB it had such a manager -- ACA. It didn’t mention Paulson. IKB lost almost all of its $150 million investment. Goldman’s exploded CDO already may have changed the future of Wall Street. The case seems certain to speed financial overhaul legislation through Congress. The question is whether that CDO will change -- or threaten -- the future of Goldman as well.

Goldman Suit Harnessed by Obama Aides for Internet Ad Campaign
by Patrick O’Connor

President Barack Obama’s political advisers are trying to harness the government’s case against Goldman Sachs Group Inc. to build support for a financial- markets overhaul pending in Congress. A Google Inc. search of "Goldman Sachs SEC" yields an advertisement entitled "Help Change Wall Street" that is sponsored by Organizing for America, Obama’s official political arm outside the White House. "Help Pres. Obama Reform Wall Street and Create Jobs," the ad says. "Families First!"

The ad coincides with the Securities and Exchange Commission lawsuit filed April 16 against Goldman Sachs and a company executive. The civil suit became public as the election- year fight over financial regulatory reform intensifies. Google AdWords allow companies, advocacy groups and politicians to target Internet browsers who enter certain words or phrases in the company’s search engine. Advertisers pay for the traffic those specific search terms generate. Goldman Sachs responded with its own Web ad tethered to the same search words -- "Goldman Sachs SEC."

A search for those three words yesterday afternoon produced both the Obama political ad and a sponsored link to Goldman’s Web site. The link took online readers to the company’s official response to the SEC complaint. "We are disappointed that the SEC would bring this action related to a single transaction in the face of an extensive record which establishes that the accusations are unfounded in law and fact," the company said in response to the SEC lawsuit. The Web page gives readers background on what happened in the company’s view.

Brad Woodhouse, a spokesman for the Democratic National Committee, said the Obama political ad is part of a two-week-old online campaign "which included a wide variety of search terms related to Wall Street and Wall Street reform." "We have all kinds of online advertising up to allow folks who are searching and reading online to get involved with Organizing for America and the president and make a difference on his agenda," Woodhouse said in an e-mail. "We’ve been running online ads since early last year. We watch closely what terms folks are searching and set our ads accordingly."

The ad link takes browsers to a page on that features a picture of the president and the following quote: "We’ve seen and lived the consequences of what happens when there’s too little accountability on Wall Street and too little protection for Main Street. It is time for real change. This online campaign coincides with a renewed push by the president and his allies both on and off Capitol Hill to generate support for an overhaul of the country’s financial regulatory structure. A bill before the Senate would establish a consumer protection agency within the government, require financial firms to plan for their own demise and prohibit proprietary trading by commercial banks.

Senate Majority Leader Harry Reid, a Nevada Democrat, said he plans to bring a bill to the floor this week. All 41 Senate Republicans have complicated that timeline by signing a letter to express their opposition to a bill approved by the Banking Committee. Reid needs at least one Republican to start debate on the package. "I am very confident that we’re going to have the votes for a strong package of financial reforms," Treasury Secretary Timothy Geithner said yesterday on NBC’s "Meet the Press" Program. "I’m very confident we’re going to have a strong bill."

A Glare on Goldman, From U.S. and Beyond
by Gretchen Morgenson and Landon Thomas

Calls for increased scrutiny of Goldman Sachs emerged on Sunday as two congressmen pressed for investigations into possible taxpayer losses generated in securities sold by the firm, and the British prime minister also asked his nation’s securities regulator to investigate the Wall Street powerhouse because of losses suffered by a major British bank. The German government, too, said it was considering taking legal action against Goldman because of a German bank’s losses, a spokesman said.

A civil lawsuit filed against Goldman last Friday contained damaging allegations whose reverberations are just beginning to be felt. In the lawsuit, the Securities and Exchange Commission contends that Goldman misled investors who bought a mortgage-related instrument known as Abacus 2007-AC1 by not disclosing that the security was devised to fail. Goldman has denied the allegations and says it will fight them. The Abacus transaction cited in the S.E.C. case is just one of 25 such securities worth $10.9 billion that Goldman issued during the mortgage mania. Investors in the Abacus 2007-AC1 security lost $1 billion, regulators said.

The beleaguered American International Group also lost money in its dealings with Goldman on other Abacus securities. A.I.G. insured $6 billion of Abacus securities issued by Goldman; since the government rescued the insurer in September 2008, it has posted $2 billion in losses on these securities. A.I.G. received a taxpayer commitment of $180 billion to keep it from failing and causing havoc in markets worldwide.

Because the government has committed so much money to A.I.G., Representatives Elijah E. Cummings, Democrat of Maryland, and Peter DeFazio, Democrat of Oregon, are asking the S.E.C. to investigate all the Abacus deals issued by Goldman, and especially those insured by A.I.G. The congressmen want regulators to determine whether fraudulent conduct by the investment firm contributed to billions of dollars in losses. If such conduct is found, the congressmen are urging the S.E.C. to recoup payments made by A.I.G. to Goldman.

Mr. Cummings and Mr. DeFazio are also asking the S.E.C. to refer matters that appear to involve criminal misconduct on the part of Goldman Sachs to the Justice Department. "We request that S.E.C., with all due haste, pursue investigations into the remaining 24 Abacus transactions for securities fraud, evaluate the extent of any receipt, by Goldman Sachs, of fraudulently generated A.I.G.-issued credit default swap payments, and vigorously pursue the recovery of such payments on behalf of the U.S. taxpayer," the representatives wrote to Mary L. Schapiro, the head of the commission, in a letter dated April 19. Mr. Cummings and Mr. DeFazio are still gathering signatures from other members of Congress to add to their letter, so it has not yet been sent.

A.I.G. collapsed in the fall of 2008 after the mortgage market plummeted. The company was imperiled when it was unable to supply billions of dollars in collateral to its trading partners as required under the insurance it had written on complex mortgage-related securities like Abacus. Goldman Sachs was one of its biggest trading partners. The Abacus securities insured by A.I.G. were not among those that the Federal Reserve unwound in late 2008, paying the insurer’s trading partners 100 cents on the dollar for what they were owed.

A.I.G.’s participation was crucial to the success of many Abacus securities issued by Goldman Sachs. In the Abacus deals, a type of derivative known as credit default swaps were linked to mortgage bonds; those firms underwriting the swaps, like A.I.G., were essentially insuring that the mortgage bonds would perform well. When they did not, the swaps created enormous losses for those who sold them. "We’ve got to look into every aspect of these deals and figure out exactly what went wrong," Mr. Cummings, a senior member of the House Committee on Oversight and Government Reform, said in an interview on Sunday. "And if people were participating in any type of fraudulent activity we need to expose it and they need to be brought to justice and we need to get our money back."

Anger over Goldman’s dealings also surfaced Sunday in Britain, where Prime Minister Gordon Brown accused the firm of "moral bankruptcy." He said that British regulators should investigate, and that he believed banks themselves would be considering legal action, without specifying which banks. "We need a global financial levy for the banks," he said in a television interview Sunday. "We have to quash remuneration packages such as Goldman Sachs’s. I cannot allow this to continue."

The Royal Bank of Scotland and IKB Deutsche Industriebank of Germany lost just less than $1 billion after buying the Abacus investment vehicle constructed by Goldman. The Royal Bank of Scotland inherited a loss of $841 million after taking over the Dutch bank ABN Amro. During the financial crisis, each bank was saved from collapse by their home governments. Together, Germany and Britain pumped about $83 billion into the Royal Bank of Scotland and IKB. Because of those bailouts, and with anti-banker sentiment on the rise as Mr. Brown and Chancellor Angela Merkel of Germany face political challenges, the complaint against Goldman will most likely serve as fodder not only for lawsuits but for proponents of tougher financial regulation.

As Britain prepares for a national vote on May 6 and the German state of North Rhine-Westphalia follows three days later with local elections that will have national implications, politicians in both countries were quick to join the chorus of condemnation against Goldman. The German government has asked the S.E.C. for more information regarding IKB’s part in the scandal and might take legal steps, a spokesman said.

Legal experts said the potential liability of Goldman for losses suffered in the Abacus investments was an issue of debate. Marcel Kahan, a law professor at New York University, said he suspected that much of the story had not yet been told concerning the strength of the S.E.C. charge. But based on what he has read, he said, the allegations against Goldman look bad but might not be illegal. For instance, he said that those who lost money in the deal were sophisticated investors who knew what was in the financial instruments and could check them out for themselves. As such, Goldman may argue that there was no material misstatement or omission in the documents and statements that it provided investors.

Peter J. Henning, a law professor at Wayne State University and a former S.E.C. attorney, said he too believed that Goldman might mount a "blame the victim defense." "To fight the case, they have to focus on the investors," he said. "These were very sophisticated investors who weren’t fooled by these transactions." Adam Pritchard, a law professor at the University of Michigan who teaches securities law, said the S.E.C.’s inclusion of IKB, the German bank, was important. "I think the S.E.C. has a pretty good argument here," he wrote. "Conflicts are presumed, so the fact that Goldman had clients that were betting against these C.D.O.’s is scarcely material. The facts alleged here are different. It is one thing to know that there are others betting against you; it is quite another to know that the people betting against you are selecting the bets."

A spokeswoman for Britain’s financial regulator, the Financial Services Authority, declined to say whether it would start its own investigation into Goldman. It is in contact with the S.E.C. regarding its investigation, she said. Whether the British regulator begins its own investigation would depend on whether the agency came to believe any of the suspect activity took place in Britain or had an effect there.

Germany vs. Goldman Sachs: Government Considering Legal Action Against Company
The German government may consider taking legal action in a case in which Goldman Sachs & Co. is accused of defrauding investors, a newspaper reported Saturday. The U.S. government alleges Goldman Sachs sold mortgage investments without telling buyers they were crafted with input from a client who was betting on them failing. Buyers included German bank IKB Deutsche Industriebank AG – an early victim of the financial crisis that was rescued by the state-owned KfW development bank among others.

The Welt am Sonntag newspaper quoted Chancellor Angela Merkel's spokesman, UIrich Wilhelm, as saying that German regulator BaFin will ask the U.S. Securities and Exchange Commission for information. "After a careful evaluation of the documents, we will examine legal steps," he said, according to the report. There was no immediate confirmation from the government. IKB spokeswoman Annette Littmann said the bank is aware of the charges filed by the SEC, but declined to comment further. The SEC says IKB lost nearly all its $150 million investment. IKB issued a profit warning in 2007, saying it had been hurt by U.S. subprime mortgage investments. IKB was sold in 2008 to Dallas-based Lone Star Funds.

EU’s Investigation of Goldman Will Be 'Profound'
by Ben Sills and Ben Moshinsky

The European Union investigation into Goldman Sachs Group Inc.’s role in providing swaps to the Greek government to help reduce its budget deficit will be "profound and thorough," EU Monetary Affairs Commissioner Olli Rehn said. The investigation relates to "our relationship with Goldman Sachs," Rehn said at a press conference in Madrid today after a meeting of EU finance chiefs and central bankers. "I have asked the Ecofin and Eurostat to conduct a profound and thorough investigation in which the Greek authorities are very well cooperating."

The U.S. bank arranged the swap deal for Greece in 2002. It helped the government to hide the extent of its budget deficit and overall debt level. Greece’s excessive borrowing subsequently engulfed the country in a debt crisis that Morgan Stanley this week said may lead to the break up of the euro region. Goldman Sachs’s spokeswoman Fiona Laffan declined to comment. Gerald Corrigan, chairman of Goldman Sachs’s regulated bank subsidiary, last week told the European Parliament that while the bank would be prepared to repeat such a deal, it would likely execute it differently. "We probably would do it again today," Corrigan said, "but we would do it in a somewhat different manner."

Under the terms of the deal, Greece entered a cross- currency swap agreement with Goldman Sachs on about $10 billion of debt issued in dollars and yen. That was swapped into euros using a historical exchange rate, a mechanism that generated about $1 billion in an up-front payment from Goldman to Greece. The Greek government is scheduled to meet officials from the International Monetary Fund and the euro region on April 19 to discuss the terms and procedures of a proposed 45 billion- euro ($61 billion) bailout loan as it struggles to finance the region’s largest budget deficit.

The crisis is no American invention – the City was in it, up to its neck
by Ruth Sunderland

The Securities and Exchange Commission's decision in the US to go for Goldman Sachs shows it is time for the UK authorities to get real. There could not be a more high-profile target than the Wall Street titan, which until now seemed to be emerging from the crisis with its reputation and finances relatively intact – so much so that the Financial Times named its chief executive, Lloyd Blankfein, as its Man of the Year, for his diligence in carrying out what he – apparently jokingly – described as "God's work".

Goldman prides itself on its moral probity but it is not the first time behaviour at the bank's London office has come under question. In the 1990s it was fined heavily for its business dealings with Robert Maxwell. Eyebrows were raised a few years ago about its involvement in a series of unsolicited takeover approaches to British companies, including ITV, Associated British Ports, Mitchells & Butlers, BAA and Marks & Spencer – none of which stopped Her Majesty's Government from employing Goldman to advise on the abortive sale of Northern Rock.

Fabrice Tourre, the self-styled "fabulous Fab" at the centre of this case, is an executive in London, raising the obvious question of what the UK authorities have been doing. Despite some tough noises from the FSA's Lord Turner, the response here has been so far fairly toothless, with a couple of reports by City insiders like Sir Win Bischoff and Sir David Walker.

A number of characters who loomed large in the financial crisis operated out of the UK. Joseph Cassano ran the London-based division of failed US giant AIG that created many of the products that landed the insurer with huge liabilities. Peter Cummings ran the commercial banking division of HBOS that presented that bank with huge losses. Robert Tchenguiz, the Icelandic banking system's biggest borrower, took €2bn of loans from collapsed Kaupthing, where he was a shareholder, to finance stakes in Sainsbury's, Mitchells & Butlers and Somerfield. The notion that the credit crunch was an import from the US is a ludicrous one. We are in this up to our necks.

Bond Insurer ACA Had a Taste for Risk
by Anusha Shrivastava and Michael Casey

ACA Management LLC, a unit of bond insurer ACA Financial Guaranty Corp., is at the center of the storm unleashed by the civil-fraud charges filed against Goldman Sachs Group Inc.
In its complaint against Goldman Sachs, the Securities and Exchange Commission identifies ACA Management as the third party used to approve the subprime-mortgage bonds that would form the base of a synthetic collateralized debt obligation, or CDO, involved in the case. ACA Financial Guaranty hasn't been accused of any wrongdoing in the case.

ACA Financial Guaranty was never involved in some of the biggest securitization deals because it didn't have a triple-A rating. Its only rating was single-A from Standard & Poor's, which cut it to triple-C in December 2007. A lower credit rating meant it had to pay more to raise capital, and the company inevitably struggled to get contracts in the most coveted deals. As a result, it had to take on bigger risks than its competitors.

"Because ACA didn't have a triple-A rating from Moody's Investors, S&P or Fitch like the other monolines, they couldn't always be as competitive on a lot of transactions. They couldn't deliver enough of a pickup in spread," said a person who worked in the monoline insurance industry at the time. "The perception was therefore that they were willing to take on more risk, that they tended to stretch a little bit," this person said.

During the fall of 2007, ACA Financial agreed to insure $6.7 billion in CDOs underwritten by Merrill Lynch, which was trying to hedge the risk of CDOs sitting on its balance sheet. At the time, ACA was insuring more than $60 billion in debt securities and had only $400 million in capital and other available resources to cover claims. Other firms, including Lehman Brothers Holdings Inc., already had set aside reserves against hedges with ACA, concerned that it would be unable to cover losses in the bonds it insured. ACA didn't return calls to comment.

The SEC, in its complaint, said Goldman failed to disclose to investors that Paulson & Co., a hedge fund, had cherry-picked assets to go into the CDO in question and that it was betting against those underlying assets, unbeknownst to ACA. Paulson wasn't charged in the SEC complaint. A synthetic CDO, invests in swaps or other no-cash assets to gain exposure to a portfolio of fixed-income assets such as bonds, residential or commercial loans.

In a statement Friday, Paulson said it wasn't involved in the marketing of the CDO program in question, and that ACA, as collateral manager, had sole authority over the selection of all collateral in the CDO. "While it's unfortunate that people lost money investing in mortgage-backed securities, Paulson has never been involved in the origination, distribution or structuring of such securities," Paulson said late Friday. Goldman denies the charges against it.

In Friday's complaint, the SEC said Fabrice Tourre, the Goldman executive principally responsible for the transaction, knew of Paulson's undisclosed short interest and its role in the collateral-selection process but "misled ACA into believing that Paulson invested approximately $200 million" in the equity of the transaction. This made it seem as if Paulson's interests in the collateral-selection process "were aligned with ACA's when in reality Paulson's interests were sharply conflicting," the agency said.

As early as 2007, ACA ran into financial trouble. Things took a turn for the worse in December that year when S&P cut the insurer's rating to a junk grade triple-C, saying it had "significant doubt" that the firm could come up with enough capital to meet its obligations. The downgrade required ACA to provide more collateral to back insurance it had written, primarily in the market for credit-default swaps, which provides protection against bond defaults. ACA would have had to post "at least $1.7 billion," according to a company filing with the SEC in November 2008. That figure, it seems, may have risen much higher because credit-risk premiums rose sharply after that.

Amid this crisis, the Maryland Insurance Administration, which had jurisdiction over ACA, had to get involved in a restructuring of the firm. Officials at the Maryland regulator declined to comment on ACA Management, citing the fact that unlike its parent, it wasn't an insurance company. It wasn't the first time ACA had faced financial challenges stemming from the fragility of its credit rating. Back in 2004, S&P put the insurer on watch for downgrade, forcing the firm to turn to an asset-management unit of now-failed investment bank Bear Stearns Cos. for a capital injection.

After Bear Stearns Merchant Banking injected $140 million into ACA, S&P returned its outlook on the insurer's single-A rating to "stable." As part of that deal, the Bear Stearns unit became the single largest shareholder in ACA, and obtained three seats on its 10-member board. Bear Stearns, the holding company, eventually collapsed in March 2008. Its failure, which came on the back of failed investments in the same kinds of structured finance subprime-mortgage securities as those on which the SEC complaint is focused, led the Federal Reserve Bank of New York to engineer a takeover of Bear Stearns by J.P. Morgan Chase & Co.

In Friday's announcement, the SEC cites emails that suggest Goldman knew ACA might be more amenable to its plans while also providing its "brand name" and "credibility" to "help distribute this transaction." Goldman "arranged a transaction at Paulson's request in which Paulson influenced the selection of the portfolio to suit its economic interests, but failed to disclose to investors…Paulson's role in the portfolio selection process or its adverse economic interests," the SEC said. Goldman "recognized that not every collateral manager would agree to the type of names [of securities] Paulson want[s] to use" and put its "name at risk…on a weak quality portfolio," the SEC's complaint said.

Senior Goldman Exec Is Married to Former Head of ACA
by Vicky Ward

Friday, as news of the allegations of fraud at Goldman Sachs spread, I got a call from someone who works in the insurance business. "Check out the former head of ACA" he said referring to the now-defunct and formerly down-graded bond insurer who asked the-not-so-omniscient hedge fund manager John Paulson to choose which securities to put into the CDO, Abacus, that Goldman Sachs subsequently sold to two big clients, the German bank IKB and the Royal Bank of Scotland -- without disclosing that Paulson would be shorting his own hand-picked stocks on the other side of the trade.

Now the SEC's complaint states that ACA had no idea that Paulson was shorting the stocks he'd been asked to select, yet my deepthroat was not so convinced. "ACA had a horrible reputation," he told me, which led me to ask the obvious question so why would Goldman want ACA's stamp as selection manager on the CDO they were marketing? Fabrice Tourre, the 31-year-old named as the architect of Abacus, is quoted as insisting that Goldman wanted ACA's brand name and "credibility" on the CDO. My source told me to check out who the head of ACA was married to. "I think you'll find it's a senior woman at Goldman Sachs," he said. Well, yep, it is.

Alan S. Rosenman took over ACA Capital as president and CEO in 2004 - because -- wait for it -- his predecessor Michael Satz had "personal income tax issues" -- (how murky is this story going to get you must be asking?) According to a Business Week article dated April 3 by David Henry and Matthew Goldstein, Rosenman "immediately began to push ACA into CDO insurance, an area his predecessor, Satz, had only begun to explore." Rosenman's wife, or at least partner -- they are listed as sharing a house together for which they paid $6.1 million in 2005 in New York -- is Frances "Fran" R. Bermanzohn, who is managing director and deputy general counsel at ... Goldman Sachs. Hmmmn.

I called Mr. Rosenman who gave me the illuminating statement: "I am not offering any comment at this time." I asked him, did he ever disclose their relationship to buyers of Abacus? Did she? And Could ACA really therefore not have known about Paulson's activities? "No comment."

One thing that is certainly puzzling is that if ACA did know, then why on earth would it have issued protection on the so-called "superior senior tranche" which turned out to be of course anything but 'super senior," thanks to Paulson betting against it -- and ACA went bust in December last year? But, just as much as the SEC is claiming Goldman should have disclosed that John Paulson had hand-picked stocks he was choosing to short (which means, by the way, in case anyone has missed this point, that Mr. "supposed-good-guy " Paulson just made one billion dollars off the back of the German tax payer who had to bail out the German bank IKB on the back of its collapse) so too this relationship should have been disclosed. That it is not mentioned in the SEC's complaint strikes me as being very odd. I was still waiting for Goldman Sachs to respond as this article went to press.

When I named my recent book on Lehman Brothers, The Devil's Casino, I knew that Wall Street was rigged and that everyone on it was playing with loaded dice. Lehmanites told me they were no different from anyone else on the Street and just as Goldman is saying there is no fraud here with the rigged CDO (and they may be right -- legally) so Lehmanites believe there was no fraud connected with Repo 105. The conundrum is that weak accounting rules enabled both Goldman and Lehman and no doubt every other gambler out there to get away with what they did legally. (I, for one, do not believe will the SEC will win their suit against Goldman because the law protects Goldman). That their actions were arguably immoral? Well, that's a question no one on Wall Street wants to ask of themselves.

Watch closely what happens Tuesday when former Lehman CEO Dick Fuld goes before Harry Reid's committee to explain Repo 105. He will insist he did not break the law, just as Goldman will insist the same - and the problem is that technically they may be right. The bigger question is: how do we stop immoral acts that are technically legal? We need to change the law -- and fast, but carefully. Things that are hidden need to be brought to light, and contorted complex accounting rules about disclosure needs to become far simpler. And people who are married and whose respective firms are doing business together need to disclose it to any third parties.

Is This Why The SEC Announced The Goldman Fraud Charges Friday Morning?
by Henry Blodget

As we noted yesterday, the SEC appears to have acted in an unusual way on Friday morning when it filed fraud charges against Goldman Sachs.  Specifically, it appears to have caught Goldman by surprise, announcing the fraud charges without giving Goldman a heads-up. Normally, the SEC's attorneys are in close communication with the attorneys of its targets.  If the agency intends to file charges, it is customary to tell the target in advance, so the accused party isn't blindsided.  (The same is true in many white-collar criminal proceedings: If an executive is going to be indicted, the executive's attorneys are usually notified in advance.)

The exception is when prosecutors think the target is a flight risk (which obviously doesn't apply here), or when the prosecutors want to maximize the headline value of the charges. Yesterday, for more than an hour after the SEC filed its charges, the SEC had the headlines to itself.  A short Goldman denial appeared around noon, and a longer, more compelling one appeared at the end of the day, when most people had already started checking out for the weekend.  Thus, the SEC's fraud story dominated the headlines all day long.

Now, there are many reasons why the SEC might have chosen to act this way, all of which were understandable:
  • It looks tougher (everyone hates Wall Street these days, and the SEC has looked wimpy)
  • It looks pro-active (for once, the SEC is ahead of the game)
  • It does more damage (by the time people have time to examine the allegations in detail, most people have made up their minds about the accused's guilt).

And then there's another factor that might have affected the timing of the SEC's release. The timing of big announcements is often chosen with the aim of maximizing coverage (or minimizing it, in the case of bad news), or with the aim of pushing other stories out of the headlines. What other stories might the SEC have wanted pushed out of the headlines yesterday? Perhaps another one about the agency's past incompetence and, possibly, corruption. 

Yesterday, amid the Goldman fraud outrage, the results of another investigation into the SEC's failure to spot Allen Stanford's ponzi scheme were published.  They were devastating:
Michael Crittenden and Kara Scannell, WSJ:
The Securities and Exchange Commission suspected Texas financier R. Allen Stanford of running a Ponzi scheme as early as 1997 but took more than a decade to pursue him seriously, according to a report further tarring the agency that missed Bernard Madoff's huge fraud. The report by the SEC's inspector general says SEC examiners concluded four times between 1997 and 2004 that Mr. Stanford's businesses were fraudulent, but each time decided not to go further. It singles out the former head of the SEC's enforcement office in Fort Worth, Texas, accusing him of repeatedly quashing Stanford probes and then trying to represent Mr. Stanford as a lawyer in private practice.?

The former SEC official, Spencer Barasch, is now a partner at law firm Andrews Kurth LLP. He couldn't be reached for comment, but Andrews Kurth managing partner Bob Jewell said the firm believes Mr. Barasch acted properly. The inspector general referred Mr. Barasch for possible disbarment from practicing law.

That sounds bad.  Very bad.  If the SEC hadn't charged Goldman with fraud yesterday morning, THAT story would have dominated the day's headlines.  As it is, the story got nary a mention.

Report Says SEC Missed Many Shots at Stanford
by Michael R. Crittenden and Kara Scannell

The Securities and Exchange Commission suspected Texas financier R. Allen Stanford of running a Ponzi scheme as early as 1997 but took more than a decade to pursue him seriously, according to a report further tarring the agency that missed Bernard Madoff's huge fraud. The report by the SEC's inspector general says SEC examiners concluded four times between 1997 and 2004 that Mr. Stanford's businesses were fraudulent, but each time decided not to go further. It singles out the former head of the SEC's enforcement office in Fort Worth, Texas, accusing him of repeatedly quashing Stanford probes and then trying to represent Mr. Stanford as a lawyer in private practice.

The former SEC official, Spencer Barasch, is now a partner at law firm Andrews Kurth LLP. He couldn't be reached for comment, but Andrews Kurth managing partner Bob Jewell said the firm believes Mr. Barasch acted properly. The inspector general referred Mr. Barasch for possible disbarment from practicing law. Mr. Stanford was indicted last June and accused of orchestrating a Ponzi scheme that swindled investors out of $7 billion. He has pleaded not guilty and denied running a Ponzi scheme.

The U.S. probe into Mr. Stanford kicked into high gear in early 2009, shortly after Mr. Madoff's multibillion-dollar Ponzi scheme came to light in December 2008. SEC Inspector General David Kotz's report suggests the agency's mistakes in the Stanford case were in part the result of a culture that favored easily resolved cases over messier ones. Cases such as the alleged Stanford fraud weren't considered "quick-hit" and "slam-dunk," and examiners were discouraged from pursuing them, Mr. Kotz found. Unlike the Madoff case, in which Mr. Madoff's highly technical descriptions of his supposed trading misled the SEC's examiners, the agency quickly recognized signs of an apparent Ponzi scheme at Mr. Stanford's operation.

Examiners noted that Mr. Stanford was promising to pay investors a return well above the market, without any apparent way of delivering on that promise. In 1997, just two years after Mr. Stanford's businesses registered with the agency, a Fort Worth examination official told her branch chief to "keep your eye on these people"—a reference to Mr. Stanford—"because this looks like a Ponzi scheme to me and some day it's going to blow up." That was among the first such findings, and it was followed by similar conclusions in 1998, 2002 and 2004, according to the inspector general. "The only significant difference in the examination group's findings over the years was that the potential fraud grew exponentially, from $250 million to $1.5 billion," the report said.

SEC Chairman Mary Schapiro said the SEC has improved its examinations since the events recounted in the inspector general's report. "Much has changed and continues to change regarding the agency's leadership, its internal procedures and its culture of collaboration," she said. The inspector general's report came on the same day the SEC brought civil-fraud charges against Goldman Sachs Group Inc., in one of its biggest cases since the financial crisis of 2007-08.

SEC enforcement officials also appear to have ignored warnings from insiders at Stanford's operations. The report said a letter was forwarded to the SEC in October 2003 by the National Association of Securities Dealers. Using all capital letters, it warned that the Stanford businesses "will destroy the life savings of many." The inspector general's office found that enforcement staff "minimally reviewed" the letter, but decided not to investigate or open an inquiry into the matter. The enforcement chief who made the decision told investigators that the decision was made in part to "wait and see if something else would come up."

New Real Estate Regulations From China’s State Council That May Bite. Still No Property Tax
by Bill Bishop

Phoenix News is reporting that China’s State Council has issued a new circular outlining new policies and regulations designed to cool off the property markets (State Council Document Number 10). They will probably make Jim Chanos happy, at least in the short-term, though longer-term these measures may help reign in the growing bubble in time to manage a softer landing. UPDATE6: Chinese investors do not like the new rules: China Developers Fall on Latest Moves to Damp Property Prices.

Of all the rules discussed in the "Document Number 10?, the one that may have the biggest short-term impact is that non-residents of a city can no longer obtain mortgages to buy property in that city unless they can prove that they have paid taxes in that city for at least one year. The new rules also limit mortgages on third or more home purchases. At a minimum this may slow down the Wenzhou buying cliques, though to really stop them the government would need to crack down hard on the underground banking system. The government should also figure out how to stop Hong Kong banks like HSBC and Bank of East Asia from issuing US dollar mortgages at <3% interest to customers they know are using those loans to buy property on the mainland, purchases that may appear as "all cash" to the mainland authorities.

UPDATE2: Similiar restrictions were placed on purchases by foreigners in the Beijing market in late February. It sounds like they will be expanded nationwide. I discussed the Beijing restriction on foreign purchases, as well as a very harsh new rule on foreign-owned commercial space in Beijing in an earlier post-Impact of New Beijing Housing Rules on Foreigners. Since the beginning of 2010 the Beijing Administration of Industry and Commerce no longer accepts registrations of companies, either foreign or domestic, at commercial spaces purchased by foreigners after June 2006.

UPDATE3: A relative who knows a lot of Shanxi coal mine bosses, all big buyers of real estate, suggested several weeks ago that restrictions on purchases by non-residents, not just on foreigners, should be in the cards, as I repeated on Twitter. "Document Number 10 outlines measures to increase the housing supply and build more affordable housing, all things you would expect from a Socialist government. As I wrote yesterday about Wen Jiabao’s essay reminiscing about Hu Yaobang: "Harkening back to Hu Yaobang may be a signal that more substantive and muscular policies are coming that will lead China to act a bit more like a Socialist country." Perhaps they are all related.

UPDATE1: Xinhua has released a brief summary of the new rules in English. I will post the full text when it is translated. Here is the summary:

Commercial banks can refuse to issue loans to buyers of their third home in areas suffering from excess property price rise, said the State Council, or the Cabinet, on Saturday. To curb speculation, banks can also halt loans to those who can’t provide materials to prove they had lived and paid taxes and social insurances for at least one year in cities where they intended to buy houses, according to a statement on the central government’s website. The statement also urged local governments to take any necessary measures to put restrictions on the number of homes to be bought in a certain period of time.

Tax policies should be employed to adjust consumption for housing and earnings on property development, according to the statement. These policies look very smart, and will likely be effective if they are actually implemented. We may still see a property tax at some point, but I am skeptical such a tax will get past the "research" stage anytime soon. There are too many complications around a property tax, including but not limited to the complexities of the technical implementation; asset disclosures that would be required of all the officials who own property that they could never afford on their salaries; objections from powerful interest groups, and resistance from already burdened middle class homeowners.

China Stocks Tumble Most in Eight Months on Property Loan Curbs
by Chua Kong Ho

China’s stocks plunged, driving the benchmark index down the most in almost eight months, on concern a government crackdown on the property market will increase bad loans and damp consumer spending. A gauge tracking Chinese real-estate stocks tumbled 6 percent to a one-year low, led by China Vanke Co. and Poly Real Estate Group Co., after the State Council told banks to stop loans for third-home purchases. Industrial & Commercial Bank of China Ltd. slid 4.7 percent, the most since October 2008. Anhui Conch Cement Co. led losses by construction material companies.

"The market is worried about the impact of government measures to tame property price increases," said Xu Lirong, who oversees about $2.6 billion at Franklin Templeton Sealand Fund Management Co. in Shanghai. "I think more measures will be introduced." The Shanghai Composite Index slumped 126.14, or 4 percent, to 3,004.16 at 2:32 p.m., the biggest decline since Aug. 31. The gauge is the world’s third worst-performing stock market this year, losing 8.3 percent, as the government unwound monetary stimulus to avert asset-price bubbles after banks extended record credit last year.

Stocks across the Asian region declined, dragging the MSCI Asia Pacific Index down by the most in two months, on concern a U.S. suit against Goldman Sachs Group Inc. signals increasing regulatory scrutiny on financial companies. The CSI 300 Index retreated 4.3 percent to 3,213.45, with six of the 10 industry groups declining more than 4 percent. All four contracts on CSI 300 fell on the China Financial Futures Exchange. Vanke, the nation’s biggest property developer, slumped 6.9 percent to 8.42 yuan, the most since Aug. 31. Poly Real Estate declined 8 percent to 17.16 yuan, set for its lowest close in a year. The Se Shang Property Index slid 6 percent, the biggest drop since Aug. 31 and leading declines among the Shanghai Composite’s five industry groups.

China told banks to stop loans for third-home purchases in cities with excessive property price gains and suspend lending to non-residents without tax returns or proof of social security contributions in that city, according to a statement by the State Council on April 17. Local governments may also limit the number of units that can be bought, according to the statement. "These are the most draconian measures on the property market in history," Jun Ma, Deutsche Bank AG’s Greater China chief economist, wrote in a note to clients today. Chinese press reports point to "panic selling" by investors who own more than one home in Shanghai, Beijing and Shenzhen, he said.

China’s latest moves to cool its property market come after previous measures failed to slow gains in housing prices, which rose at a record 11.7 percent in March. The world’s third- biggest economy this year told banks to set aside more deposits as reserves, raised mortgage rates and re-imposed a sales tax on homes. Prices of mid- and high-end properties may tumble 20 percent and monthly transaction volumes may slide more than 50 percent in the coming months, Ma said.

The rally in property prices prompted former Morgan Stanley economist Andy Xie to call the nation’s asset markets a bubble that will burst once the government curbs credit. China is "on a treadmill to hell," with growth driven by the "heroin of property development," hedge fund manager James Chanos said this month. Banks declined on concern non-performing loans may increase. Industrial & Commercial Bank of China Ltd. lost 4.7 percent to 4.67 yuan, the most since Oct. 29, 2008. Bank of China Ltd., the third-largest lender, retreated 2.9 percent to 4.08 yuan. Industrial Bank Co. dropped 8 percent to 31.10 yuan.

"The latest measures on third-home mortgages will exacerbate concerns of asset quality and lower earnings estimates," Chen Qi, a Shanghai-based analyst at CSC Securities HK Ltd., said in a telephone interview today. China has this year targeted a 22 percent reduction in new loans from a record of $1.4 trillion and twice asked lenders to set aside more cash as reserves to prevent the economy from overheating.

Gross domestic product grew 11.9 percent in the first quarter from a year earlier, the biggest gain since the second quarter of 2007, the statistics bureau said last week. Baoshan Iron & Steel Co., the nation’s largest steelmaker, slumped 5.9 percent to 7.19 yuan. Anhui Conch Cement, the largest cement producer, plunged 5.8 percent to 39.42 yuan, a sixth day of losses. Jiangxi Copper Co., the country’s biggest producer of the metal, slipped 5.1 percent to 34.99 yuan. PetroChina dropped 2.8 percent to 12.67 yuan.

Gold futures slumped 2 percent, the most since Feb. 4, to $1,136.90 an ounce in New York. The Reuters/Jefferies CRB Index of 19 raw materials fell 1.2 percent to 276.29, the biggest decline since Feb. 25. Investors should avoid property, banking, steel and construction material stocks as market reaction to the "austerity" measures may be negative in the near term, Jerry Lou and Allen Gui, Morgan Stanley analysts, wrote in a note to clients. They said a property tax is "finally coming close." Shanghai may tax individuals who own multiple properties, the China Times reported, citing an unidentified person close to the Ministry of Finance.

This Bailout Is a Bargain? Think Again
by Gretchen Morgenson

It's way too early to tally the costs of the government’s various efforts to help our nation’s financial institutions survive the credit debacle. But that hasn’t stopped anonymous Treasury officials from claiming in recent days that their Armageddon-avoidance will wind up costing far less than many feared. One Treasury estimate, leaked to The Wall Street Journal last week, put a price tag of $89 billion on the financial bailout. That’s far below the $250 billion the Congressional Budget Office estimated last year or other analyses that put the all-in number at $1 trillion or more.

It is understandable, of course, that Treasury might want to transmit good news about bailouts the same week Americans were rushing to meet the I.R.S.’s tax deadline. And given that Treasury is run by Timothy F. Geithner, the man who doled out bailout billions as president of the Federal Reserve Bank of New York, his current minions certainly have an interest in peddling the view that the price of these rescues has become less onerous. But before we break out the Champagne, let’s look at the costs this estimate included — as well as those it left out.

What the $89 billion included were costs associated with stabilizing Fannie Mae and Freddie Mac, the mortgage finance giants; loan guarantees by the Federal Housing Administration; and liquidity programs offered by the Federal Reserve, such as those authorizing the purchase of mortgage-backed securities from financial institutions. It also included the Troubled Asset Relief Program — which, nameless Treasury officials contended, may someday generate a profit. But if the Treasury wants to provide a full assessment of the costs of this financial debacle, it will have to add some more beads to its abacus.

"If you are going to do a ledger, you have to do a full and complete ledger," said Christopher Whalen, editor of the Institutional Risk Analyst. "To talk about making money on short-term transactions with the TARP while you have this huge cost to the nation is incongruous."

• A major factor missing from Treasury’s math is the vast transfer of wealth to banks from investors resulting from the Fed’s near-zero interest-rate policy. This number is not easy to calculate, but it is enormous. The Fed’s rock-bottom interest-rate policy bestows huge benefits on banks because it allows them to earn fat profits on the spread between what they pay for their deposits and what they reap on their loans. These margins are especially rich on credit cards, given their current average rate of 14 percent and up. The losers in this equation are savers and investors, especially people on fixed incomes. "All interest-sensitive investors have been transferring what they should be receiving to Uncle Sam and the banking industry," Mr. Whalen said. "And you are talking about a lot of money."

• Then there are the losses suffered by the Federal Deposit Insurance Corporation when it has to take over faltering institutions. The estimated cost to its insurance fund is $6.65 billion for the 43 banks that have failed this year. The fund is financed by bank fees. Treasury’s recent figures also don’t reflect hits that may result from loss-sharing arrangements the F.D.I.C. set up with healthy banks to persuade them to take on the assets of failing ones. How much the government might have to swallow as part of that program is unknowable now, but Mr. Whalen said he expects such losses to hit $400 billion when all is said and done.

• There are also costly consequences of our government’s relatively easygoing approach to bank assistance, a practice Mr. Whalen calls "extend and pretend." "The refusal of the Washington political class to address the issue of bank insolvency quickly via restructuring and recapitalization has extended the economic recovery process by years," he said. "Lending will continue to shrink and real economic activity is suffering. The cost of ‘extend and pretend’ goes into the trillions of dollars of lost economic activity."

By allowing the banks to keep bad loans valued on their books at unrealistic levels, the government has prolonged the agony of this downturn. Mr. Whalen suggested that the government should have made the banks write down loans to realistic levels a long time ago, while letting them keep the TARP money as a financial cushion. Instead, the banks were encouraged to pay back TARP and put off the day of reckoning when it came to assessing the real-world value of the toxic assets lurking on their books. And so the shrinkage of the banking system continues.

• Of course, the $89 billion estimate also excludes big costs associated with the implied government guarantees of large, interconnected and clubby financial institutions. Dean Baker, co-director of the Center for Economic and Policy Research in Washington, estimated last year that 18 large banks that the market viewed as too big to fail received advantages — such as artificially cheap funding costs — worth $34 billion a year. Such financial benefits represent yet another cost of the banking crisis and the continuing actions the government is taking to protect our system from the mistakes of megabanks. Even if Treasury doesn’t want to acknowledge them, they’re real.

Andrew G. Haldane, executive director for financial stability at the Bank of England, examined some of these costs in an excellent speech last month before the Institute of Regulation and Risk in Hong Kong. Calling such costs "banking pollution" and the "noxious byproduct" of systemic risk, Mr. Haldane took a stab at measuring some of them. In past financial crises, Mr. Haldane noted, costs appeared to be "large and long-lived, often in excess of 10 percent of pre-crisis G.D.P." But he said that current estimates in the United States that peg bailout losses at around $100 billion represent less than 1 percent of domestic output. (This is the relatively rosy view Treasury is promoting.)

He said low-ball accountings "are almost certainly an underestimate of the damage to the wider economy" as a result of the crisis. World output last year was thought to have been 6.5 percent lower than it might have been had the crisis not occurred. Globally, this translates to $4 trillion in lost output, he said. He also says such losses can be "permanent" or "persistent." "Measures of the costs of crisis, or the implicit subsidy from the state," Mr. Haldane said, "suggest banking pollution is a real and large social problem." Sadly, it is one that our leaders here at home seem more willing to underplay than control.

Munis Bonds Are Riskier Than You Think
by Laura Saunders and Daisy Maxey

With April 15's tax pain still lingering and higher tax rates on the horizon, lots of investors are wondering: Is it time to buy tax-free municipal bonds? Judging from recent trading activity, the answer would seem to be yes. Since the start of the year, investors have poured more than $13 billion into muni-bond funds and exchange-traded funds—nearly twice the amount they have put into all domestic equity funds and ETFs, according to Lipper FMI.

But new investors could be setting themselves up for more pain. "Too much money has stampeded in," says Marilyn Cohen of Envision Capital, a fixed-income money manager near Los Angeles. She and others like Dean Barber, of Barber Financial Group in Lenexa, Kan., now fear that rising interest rates might reverse the stampede and push prices way down. The recent rally isn't the only cause for concern. Many municipalities are struggling to balance their books, raising the chances of default in some places. Bond insurers, battered by the financial crisis, have fled the muni market. And if all of that weren't enough to frighten off investors, little-known tax traps might.

Some former true believers are dialing back. Steve Mitchell, an Encino, Calif., CPA who manages his own muni-bond portfolio of more than $1 million, hasn't bought a bond in six months. "I would love to buy more, but between rising rates and California's fiscal crisis, I'm just not comfortable," he says. Gordon Wood, a retired architect in Overland Park, Kan., has pulled back since two bonds he inherited from his 94-year-old mother got into trouble. "It was a wake-up call," he says. "These bonds are so hard to follow."

On paper, munis couldn't seem more attractive. The top federal rate on capital gains and most dividends will likely rise to 20% next year, while the top rate on income and interest is likely to be 39.6%. Actual rates could be higher because of phase-outs and stealth increases. States are also raising taxes. There's also the looming 3.8% flat tax on investment income for high earners that lawmakers imposed to help pay for health-care reform. The tax is scheduled to take effect in 2013, and as enacted, it doesn't apply to municipal-bond interest. This means, says financial adviser Leon LaBrecque of Troy, Mich., that to a top-bracket taxpayer, a muni yield of 3.8% would be worth 5.8% this year, perhaps 6.3% next year, and 6.7% in 2013, or even more if it is exempt from high state taxes as well.

But munis aren't nearly as cheap as they were at the end of 2008. Back then, muni yields, which move in the opposite direction of prices, were equal to or greater than yields on comparable Treasurys despite their being tax-free. That reversed in 2009 when $78 billion flowed into all muni funds, almost as much as in the previous 10 years combined, according to Lipper. Now yields are hovering at about 85% of Treasurys, roughly the historical average. Then there is the great unknown: the effect of deteriorating state and local finances. "Historically there have been far fewer muni defaults and much higher recovery rates than with corporates," says John Petersen, a municipal finance specialist at George Mason University. But with state and local governments more strapped than at any time since the Great Depression, there will be more defaults, he says.

Only one municipal-bond insurer is now writing coverage, compared with more than half-dozen two years ago. And two credit agencies are "recalibrating" some muni ratings upward to be more comparable to corporate bonds. The result, says Ashton Goodfield of DWS Investments, is that ratings may look better than they are at a time when many state and local governments are struggling. Mr. Barber, the Lenexa, Kan., adviser, worries less about defaults than about investor overreaction to a highly public default. "Panic can cause a liquidity crisis, which is the risk I'm trying to avoid," he says.

Even munis' vaunted tax-free status might not pan out for some investors. People who pay the alternative minimum tax need to steer clear of a subset of often illiquid munis. They are known as AMT bonds because the income isn't tax-free to those to owe this tax and they include some private-activity bonds. Many funds hold AMT bonds. The prospectus for Fidelity Investments' Municipal Income Fund, for example, says that while it aims to keep it 80% of its assets totally tax-free, it reserves the right to "invest all of the fund's assets" in AMT bonds. Even funds that have "AMT-free" in their name sometimes have up to 20% in these bonds.

Munis can cause a tax bite for another reason: because their interest is considered "provisional income" for the purposes of Social Security and Medicare. This can raise income taxes for Social Security recipients and premiums for those on Medicare. There may be other tax surprises as well. If a manager trades a lot to raise returns, that could trigger capital gains to investors, says muni-fund analyst Eric Jacobson of Morningstar. He also worries that a wave of investor redemptions could force managers to sell some bonds, triggering capital gains for those who remain—as happened in 2008 after investors fled funds during the credit crisis.

Individual bond buyers can avoid some of the traps of muni funds. But do-it-yourselfers who don't want to pay the 0.30% to 0.45% fee advisers can charge to manage $500,000 (less for greater amounts) had better plan on devoting lots of time. They will have to work to penetrate the opacity of local government finances and the muni market itself, where spreads can be wide for retail investors. Ms. Cohen suggests checking sales information on before trying out trading platforms offered by discount brokers.

Mr. Mitchell, the CPA who manages his own portfolio, monitors his holdings every day. He constantly gathers information about California state and local finances from friends and associates, scouts Schwab muni-bond listings, and frequently checks, a free muni-industry Web site, for news about material events and current financials. One of Mt. Mitchell's fondest wishes is that the SEC would require a summary at the beginning of a prospectus, "so that it wouldn't take 45 minutes of reading just to figure out how they'll make their payments."

Let's Have a Beer and Talk Derivatives
by Alison Fitzgerald

From a Milwaukee office overlooking the original Miller Brewing plant, Craig R. Reiners haggles over futures contracts for barley, the primary grain in Miller Genuine Draft beer. He also negotiates aluminum futures, because the metal is used in the millions of beer cans the company produces every year, and works out more esoteric deals, such as swaps and collars on the natural gas that fires the brewery outside his window. Reiners' job is to insulate MillerCoors from commodity price fluctuations and ultimately protect the Great American Beer Drinker from having to pay more for a six-pack.

MillerCoors and other brewers also buy massive quantities of wheat, rice, malt, sugar, and corn. The prices of all those commodities can swing wildly, so the financial products known as derivatives—hedges on whether prices will rise or fall—help the brewer lock in a price range that smooths profits. Now the Obama Administration is looking to prevent another financial crisis by regulating the derivatives MillerCoors uses. Reiners says Washington can make his job a lot harder. "It's too bad we're being painted with the same brush as the people who really abused the system," he says.

Beer isn't what comes to mind when lawmakers talk about financial engineering. But MillerCoors, Anheuser-Busch, and other brewers are major users of derivatives, so they are at the center of an esoteric debate over how tightly to regulate the thriving over-the-counter derivatives trade, which occurs outside commodity exchanges. An estimated $605 trillion worth of private contracts are outstanding. This sort of financial contract was a cause of the global meltdown, with American International Group writing billions in credit default swaps, a form of derivative that insures against the failure of corporate or mortgage bonds, which went bad when housing collapsed.

The brewers are lobbying to stop a proposal by President Barack Obama that would force them to trade derivatives on a public exchange or process them through a clearinghouse—a company that executes the trade and settles the contract when it comes due. The White House would effectively require derivatives users to tie up their cash in the form of collateral, which the clearinghouses would collect. Obama says the idea would reduce the risk that cascading defaults could destabilize the financial system, helping avoid a repeat of the $182 billion bailout of AIG.

The brewers say collateral can be costly and unpredictable, changing as the market price of the underlying commodity changes and locking up millions of dollars. Reiners, along with MillerCoors lobbyist Richard Crawford, has traveled to Washington to make the case to lawmakers. "This proposal would tie up well over $100 million a quarter," he says. "That's money that's parked, and you can't use it for anything else."

In December the House exempted brewers and other end users of derivatives from the clearinghouse and collateral rules. Now the Administration is pushing the Senate, which has not yet approved a measure, to narrow this exemption, potentially forcing brewers to ante up collateral. The Senate Banking Committee did not exempt end users in a bill it approved last month; the beer companies hope to change that.

Beer lobbyists have met with the Senate Agriculture Committee staff several times in recent months, arguing that an exemption is justified. They will descend on Capitol Hill again in late April, now that the Senate is about to debate derivatives on the floor as part of the financial regulation bill. "We didn't cause the problem," says Dorothy Coleman, vice-president for tax policy at the National Association of Manufacturers (NAM). "This isn't speculating. We're not making money off these transactions."

As part of their pitch, the brewers remind lawmakers that they buy billions of dollars of farm commodities and employ thousands of union workers. The brewers are planning to come with handouts showing the impact of their industry on each state, says one industry official involved in the congressional visits. The handout for Iowa, for example, shows the beer industry was responsible for 14,325 jobs and $704 million in economic activity in the state in 2008.

Anheuser-Busch controls almost half the U.S. beer market and operates a dozen breweries. It owns 11 distributors and works with 600 independent wholesalers. It buys rice in Arkansas and California, grows hops in Idaho, and makes glass bottles in Texas. MillerCoors, which controls about 30% of the U.S. market, brews in nine states. It buys all its corn and most of its barley—some $500 million a year—in the U.S.

The brewers are also generous donors. Anheuser-Busch's political action committee and employees have given $471,000 to federal candidates and political parties for the 2010 election cycle, according to the Center for Responsive Politics. MillerCoors' PAC contributed $79,000 in the same period. The National Beer Wholesalers Assn. donated $1.7 million. Anheuser-Busch InBev had more than $1 billion in aluminum swaps, $69 million in corn swaps, and interest rate swaps—used to smooth swings in currencies—worth more than $80 billion, according to its financial statements. Anheuser-Busch officials didn't respond to calls for comment.

If aluminum swaps—primarily private contracts between two parties—were forced to go through a clearinghouse, Anheuser-Busch would have to put up as much as 6% of the cost of a contract. "If you impose margin requirements on these companies, you're either taking away their ability to manage their risk or taking away their working capital," the NAM's Coleman says. Anheuser-Busch's $1 billion in aluminum swaps would require collateral whose value could swing by $10 million a day if the price of the metal were to change 1%, says Craig Pirrong, a finance professor at the University of Houston.

Gary Gensler, chairman of the Commodity Futures Trading Commission, which oversees most swaps, says the benefit of a safer capital market outweighs those concerns. "We have a real risk that society is bearing," he says. What does that have to do with the price of beer in Buffalo? Plenty.

Must Germany bail out Portugal too?
by Ambrose Evans-Pritchard

Portugal, not Greece, poses the greater existential threat to Europe's monetary union. The long-drawn saga in Athens can perhaps be deemed a case apart. Greece lied. Its budget deficit was egregious at 16pc of GDP last year on a cash basis. It wasted its EMU windfall, the final chance to bring public debt back from the brink of a compound spiral. You cannot blame the euro for this, although EMU undoubtedly created a risk-free illusion that lured both Athens and creditors deeper into the trap – and now prevents a solution. Nor would an orderly default under IMF guidance along Uruguayan lines necessarily imperil Europe's banks. The Bundesbank hints that letting Greece go would prove a healthier outcome for EMU in the long run, upholding discipline.

However, Portugal did not cheat (much) and did not start as an arch-debtor. It did mishandle the run-up to EMU in the 1990s, failing to offset a fall in interest rates from 16pc to 3pc with fiscal tightening. Boom-bust ensued. But that was a long time ago. Portugal has since settled down to a decade of sobriety. The reward never came. Brussels admitted last week that Portugal's external accounts have switched from credit in the mid-1990s to a deficit of 109pc of GDP. This has been caused by the incentive structures of EMU itself. "The more broadened access to credit induced a significant reduction in the saving rate, while consumption kept growing faster than GDP. This development led to an increase in Portuguese indebtedness," it said.

The IMF's January report said "The large fiscal and external imbalances that arose from the boom in the run-up to adoption of the euro have not been unwound, resulting in the economy becoming heavily indebted and growing banking system vulnerabilities. The longer the imbalance persists, the greater the risk the adjustment will be sudden and disruptive." The IMF noted the "heavy reliance" of banks on foreign wholesale funding, equal to 40pc of total assets. Lisbon reacts with outrage to Greek parallels. "Nonsense without any solid foundation, revealing ignorance," said finance minister Teixeira dos Santos. He was responding to remarks by New York Professor Nouriel Roubini that Portugal might be forced out of the euro, and by ex-IMF chief economist Simon Johnson that Portugal is on "the verge of bankruptcy".

Yes, Portugal's public debt will be 86pc of GDP this year against 124pc for Greece (EC estimates). That is small comfort. Giles Moec from Deutsche Bank said Portugal's private debt reached 239pc in 2008: Greece was 123pc. Total debt levels matter. The last two years have taught us that private excess lands on the taxpayer one way or another. For Portugal, the figure is now is in the danger zone above 300pc. Mr Moec said Portugal has been blighted by entering EMU at an overvalued exchange rate: "Portuguese exporters have never been able to recover". The country has plugged the perma-gap with foreign loans. This cannot go on. The current account deficit is still running at 10pc of GDP, and the patience of global investors is snapping.

Euro enthusiasts are mystified at why Portugal's catch-up growth stalled in the 1990s. Productivity has been stuck at 64pc of the EU-15 level, refuting the cardinal assumption of EMU that North and South must converge over time. This should be no surprise. A study of the Latin Monetary Union after 1865 by Kee-Hong Bae and Warren Bailey showed there was no convergence for half a century. Weak states cheated, inflating stealthily by dumping silver coins on others. The project was kept alive by French subsidies. That is what haunts Germany today.

Let me be clear, Portugal has not been reckless. It has been run better than Britain for the last eight years. Its banks did not go berserk. House prices have been well-behaved. Lisbon has been cutting public sector jobs for year after year. This can be overstated, of course. The IMF says Portugal still has EMU's most rigid labour markets. Social transfers have risen to 22pc of GDP from 18.5pc since 2005. Yet you cannot argue that Portugal is a basket case. It has hit a brick wall anyway.

Brussels is now telling Lisbon to cut yet deeper to reduce its budget deficit, 9.3pc of GDP last year. It is one thing to persuade a country to retrench after a boom, it is another when there has been no boom at all. Portugal must do this under a minority government. Socialist premier Jose Socrates survives on sufferance of conservatives, who are wobbling. Portugal does not face an imminent funding crisis. If Europe's economy grows briskly, it may be enough to lift the country off the reefs. But one thing seems sure: Germany is not going to bail out any more countries, and the IMF is too small to cover.

Everywhere a ripoff
Attorney General Andrew Cuomo's probe of corruption in the state pension fund makes it clearer than ever that Albany is a cesspool of pay-to-play politics. Two investment firms and three lobbyists agreed to cough up a total of $17 million to the state, the pension fund and federal securities regulators to settle charges that they improperly wangled money from the $129 billion pension fund. Among the key players was President Obama's former car czar Steven Rattner. The settlements were the flip side of criminal charges that Cuomo has pursued among the inner circle of former Controller Alan Hevesi.

One Hevesi top aide has pleaded guilty, and Hevesi's long-time political consultant Hank Morris stands indicted. Foremost among the schemers, Morris pocketed tens of millions of dollars as a middleman in pension fund deals overseen by his pal. It didn't matter whether you were a small startup firm or a seasoned money manager. If you wanted a piece of the pension fund, cutting Morris in on the action was the way to go. Morris' lawyer brazenly admitted as much in a stunning response to Cuomo's indictment: "It should come as a shock to no one that 'knowing people' matters, and that individuals with political connections frequently enjoy readier access to government decision-makers than do others." Ain't that the truth?

When Los Angeles-based money manager GKM hired Morris in 2003, for example, it was a young company with $14 million in assets and "virtually no track record," Cuomo's office says. Morris worked his magic and - presto! - GKM was handling $800 million within two years. Then there was Rattner, a top Wall Streeter who founded the Quadrangle Group. When Rattner was angling to win Quadrangle a pension fund contract, he not only paid Morris a cool million but also helped finance "Chooch," a cheesy movie produced by the brother of a top pension fund official. Cuomo's settlement further reveals that Morris leaned on Rattner to donate to Hevesi's campaign fund, and Rattner responded by hitting up a couple of friends to contribute $25,000 each. His reward? A $150 million investment from the pension fund.

Quadrangle rebuked Rattner, saying his actions were "inappropriate, wrong and unethical." Meanwhile, Hevesi's successor as controller, Tom DiNapoli says he has diligently cleaned up the mess he inherited. But at least one smelly deal transpired on DiNapoli's watch. As the Daily News' Ken Lovett reported last year, DiNapoli more than tripled an investment with a firm called InterMedia after a meeting in his office brokered by lobbyist and former Bronx Democratic boss Roberto Ramirez. Also apparently in the room was a partner with Global Strategies Group - a lobbying and political consulting firm well known for its high-profile clients, including Eliot Spitzer and Cuomo.

DiNapoli mewls that the confab took place before he changed the rules to ban middlemen and other pay-to-play practices. So what? As Cuomo's investigation proves beyond a doubt, allowing lobbyists and fixers to come within 100 miles of the pension fund is a recipe for disaster. DiNapoli shouldn't have needed rules to tell him that.


Ed_Gorey said...

Re: The exits from your 401K are being blocked.

from the WSJ:
"When an employee leaves a job, he or she is generally free to [liquidate] or roll over certain retirement accounts like a 401(k) into an individual retirement account. But many employers, for the first time, are trying to hang on to their 401(k) participants.

"Some plan providers and employers .....have even erected barriers to keep people in their plans for a certain number of years......

"With employers seeing the start of the baby boomer retirement wave, large plans "realized they weren't going to be so large anymore......Regulators and lawmakers have lately lent a hand to employers. The Labor and Treasury departments in February asked for public comments on the notion of providing annuities and other income-producing products in employer-sponsored retirement plans...."

So far, we mostly see carrots, but the sticks are not far behind.

jal said...

Look up the stock markets ... Asia down ... E.U. ... down

USA, has the better VIRTUAL WORLD computer programs ... markets are up.

Goldman has one of those programs.

SEC did a “payback time” moment, $10B, last friday.


Frank said...

Ya know Ilargi, if Obama has indeed published the how to manual for the trial (ambulance chasing) lawyers, a traditional Democratic constituency, to go after GS and the other Wall St. bankers, you really need to take back some of your hard words about him.

Wall St. played him for a fool. Yup. He turned loose a couple of thousand bounty hunters on them, at no cost to the taxpayer.

This at best a sounds like a pyrrhic victory for Blankfein and McConnell.

el gallinazo said...

For you geology buffs:

A detailed diagram of the Mt. Goldman volcano:

soundOfSilence said...

Frank said

Wall St. played him for a fool. Yup. He turned loose a couple of thousand bounty hunters on them, at no cost to the taxpayer.

Maybe... At the same time I have to think there’s a measurable chance that when it’s all said and done nothing much comes of it.

Oh yes the “squid” will come out and state that the whole MBS thing was “morally clouded” and all that - but hey it was what it was… past performance is no guarantee of future performance (read the damn prospectus), no one got knee-capped into buying anything, no one is being forced into buying the levitating S&P today. Apologies on page 6 of section B and a fine of a couple percent of last quarter’s net profit.

The masses get all worked up (herd management) and last minute before the vote some language about seizing IRAs and 401Ks among a few other choice bits gets slipped into the financial reform. Mission Accomplished.

What time was it that new of the charges “hit the wire?” I’ve got an email in my inbox (4/16 6:38 AM local time) from barakobama dot com “We can not delay action any longer. It is time to hold the big banks accountable...”

It’s just a little... not a lot... just a little to “choreographed.”

NZSanctuary said...

Organic gardener, from yesterday: why should the proles follow the law?

Because the small fish get arrested. Only the big fish can commit atrocities and get away with it.

Greenpa on herd control – great simplified explanation :)

I am currently stuck in London due to the volcanic activity near by. Perhaps this was Iceland's revenge for the demands by the UK and others that Icelandic taxpayers compensate them for their investment greed and stupidity?

Cassandra said...

I liked this, from a Zero hedge commenter. The whole mess makes me squirm from one butt cheek to the other on a daily basis. Enduring image I know.

"Whoever thinks this is a natural occurrence is sadly mistaken. It was all planned, managed and executed by the people whos names we will never know.

It was an artificial system built upon mathematical concepts and ridiculous equations, false sociological, geopolitical and economic paradigms.

The collapse will be swift, painful and catastrophic for we have for too long relied on abstract complexities to solve millennium long, albeit unsolvable problems. And the more abstract we became in our solutions the bigger were the problems which those same solutions put forth.

It is an inescapable fact of certainty that exponential growth for the sake of exponential growth via proxy usage of FIAT currency and reliance on the apparatus that exploits the inefficiencies of a FIAT currency to provide us with stability and reasonable living comfort for a period of time longer than 200 years, will bring back civilization just a notch above paleolithic gathering societies once the 500 year long trend [which started with merchant bankers in Northern Italy] ends.

The ridiculous philosophical solutions brought forth in theories such as postmodernism and global political unification will not cure the prevalent illness which is deeply rooted, if not the heart, of this system."

Edited slightly for grammar - I wish I could edit the maths :(

Bigelow said...

“The worst-case scenario in terms of precedent here is the 1783-1784 eruption at Laki (a very large eruption of 14km3 compared to the one in Mount St. Helens in 1980 of 1 km3) that had a huge impact on the northern hemisphere, reducing temperatures by up to 3 degrees. This led to catastrophe far beyond the shores of Iceland (where 25 percent of population died), with thousands of recorded deaths in Britain due to poisoning and extreme cold, and record low rainfall in North Africa.”
Why the Icelandic volcano could herald even more disruption

Stoneleigh said...

M and Steve from Virginia (from yesterday),

I don't know exactly what M said because I have a feeling people were responding to something that got deleted before I had a chance to read it (having had very limited internet access for the last several days). However, I gather from other people's responses that M thinks I am trying to cash in on something or might be unemployable elsewhere.

I would like to point out that I am not expecting to make much from doing this, and that is not the point of the tour in any case. The point is to warn people and to bring communities together where possible. I would like not to lose money, but I am not expecting to come close to replacing my former salary or anything remotely like it.

Also for what it's worth, I would be very employable elsewhere. I am quite well known in Ontario power system circles. I prefer the freedom to say what I want though, rather than have to push someone else's agenda, even if it means making very little. I don't like to play the game by other people's rules. Money is not the point, and never has been.

I would never sell out. I remain the same as I always was, with the same motivations. I have no intention of staying in fancy resorts as Steve suggested. So far I have stayed with friends old and new from TAE, which is vastly more fun and rewarding than some faceless hotel.

I am very fortunate to be staying in my third beautiful old NY state farmhouse in three days. Hotels have nothing on these wonderful places with their wonderful company. I intend to avoid hotels as much as possible. When I went to Denver for the ASPO conference I stayed in a youth hostel, which I may do again. Those places have real character, and don't involve pointlessly wasting anyone's money.

I would have liked to do this tour sooner, so as to give people a more timely warning. I worry that it may already be too late for some, but I wasn't in a position to travel earlier. I wish I had been. Still, I will do my best with the time available to me.

Stoneleigh said...

Ed Gorey,

Re: The exits from your 401K are being blocked.

This is indeed a timely warning. Those doors will inevitably closed. Almost no one will then see a penny of what they thought they were entitled to.

Tero said...
This comment has been removed by the author.
bluebird said...

Re: The exits from your 401K are being blocked.

Wouldn't this also apply to IRAs?

Greyzone said...


You can't conclude what you just concluded, Frank. In fact, it could have been the opposite.

Here's another scenario for you. Democrats are getting pounded in polls over the financial fiasco. They pressure Obama to "do something" but he's beholden to GS and other financial firms.

Obama then tells SEC to do something but tells his cronies to do it in a way that GS can easily beat. His cronies, not all well versed in such subterfuge try to control the charges and limit them.

However, some bright lawyer realizes he is being railroaded and writes an even shorter complaint, but disguised in the complaint are the tools needed for others to go after GS. His bosses, not realizing what they are being presented, leap at the chance to get a short 22 page complaint that only names one GS trader... and thus commit themselves to this course allowing the young lawyer to circumvent the intents of his superiors to obfuscate this.

See? I can come up with plausible scenarios too. You just can't credit Obama with this, especially given that Obama still allows Geithner to be Secretary of the Treasury, still allows Summers and Rubin to have access to him, still short changed Volcker, and still supports Bernanke.

I suspect that we will never know the full truth of what happened here in regards to this complaint. But I don't believe that the $Billion$ $Dollar$ $Man$ is the one with a sense of ethics here.

Top Cat said...

"given that Obama still allows Geithner to be Secretary of the Treasury..."

Remember that during Geithner confirmation hearing in the Senate he actually said something to the effect that he didn't properly file his taxes because Turbotax was too confusing for him to understand.

Utter contempt. He might as well have just turned to the camera and flipped us the Bird.

This is Obummer's Man in Treasury.

He put him there with Malice Aforethought.

I always throw this back in the face of Obamatrons trapped in Blind Allegiance to the current 'strong man' meme.

And speaking of worthless placeholders, the state's attorney general's are saying they can't even begin to investigate the financial suicide bankers in their own states because federal law ties their hands.

So where's Obummer's Attorney General?

Eric H. Holder Jr is still trying to comprehend his copy of Robert's Rules of Order for Dummies.


Alex_tring said...

Well still waiting for the deflationary depression to hit the UK. House prices still insane levels here. Lib Dems surge means that it looks as if Gordon Brown will get back in power. Any thoughts on eventual pound dollar level? 1:1 ?

I. M. Nobody said...

I have made a commitment to myself not to attack anyone on this board but I do have an observation to make that if it does happen to offend any individual(s) is just the luck of the draw.

I think it is embarrassing that Stoneleigh felt the need to make the post @ 9:35. It says some rather unpleasant things even about the lowest of animals that anyone would question her right to return home with more money than she left with. I'll go so far as to say that if she doesn't, we don't deserve her.

If you aren't willing to send her off with some cash stuffed in her pocket, I don't think you should invite her. The barter economy isn't quite here yet.

If she makes it here, she will leave with a nice little wad. If she needs it somewhere on the journey, all she has to do is find a Western Union Office. If she needs it before she leaves home, that can be arranged.

So, I put it to the board, what the heck is happening to us?

I. M. Nobody said...

In case anyone hasn't had doom talk yet today, there is a new post by Joe Bageant

Airtoolz said...

Dylan Rattigan speaking with Nomi Prins, who wrote the book “It Takes A Pillage”, and Attorney General of Connecticut, R. Blumenthal.

***Especially watch the second video, at about the 6:30 mark, where the Attorney General says that the Federal Government changed the law whereby state Attorneys-General can no longer go after SEC matters, like Elliot Spitzer used to be able to do. The Federal Government changed the law so that now only the SEC can go after these guys.

That sheds a whole new light on justice. They must not have liked the power that Elliot Spitzer had, so they took it away.

Starcade, now from Siren said...

As I have said about Karl Denninger's main call:

If you "start prosecuting", there's no government, no economy, no currency, no country.

Everything, and I do mean _EVERYTHING_, relies on this criminal scam.

I'm not saying that you _shouldn't_, but the end result of this will take down everything.

It's kind of the same thing that I have said to some LaRouchies I've run in to: OK, put the entire system into bankruptcy. How do you maintain order in the aftermath?

Same thing here, when it's the entire system which _relies on the scam_ for it's continuance.

Your lives are not yours.

Ilargi said...

"Airtoolz said...
Dylan Rattigan speaking with Nomi Prins, who wrote the book “It Takes A Pillage”, and Attorney General of Connecticut, R. Blumenthal. "

See TAE April 17.

Woody said...

Starcade @ 6:13

You're on the same page with Charles Hugh Smith today.

"The gaming mentality is now so deeply woven into the U.S. economy and culture that it is akin to a parasite so interconnected with its host that killing the parasite will also kill the host."

jal said...

The existing rules and regulations and the proposed regulations would not bother me if I was a banker. I would just make sure that the lawmakers would not give adequate budgets to the regulation agencies be able to do the job.
Just like now ... 24 people to oversee the 5 biggest financial institutes.

William K. Black had a few extra comments at the hearing. He is on panel #4.
Here is his report. He did not pull any punches.
Statement by
William K. Black
Associate Professor of Economics and Law, University of Missouri – Kansas City
before the Committee on Financial Services United States House of Representatives regarding

"Public Policy Issues Raised by the Report of the
Lehman Bankruptcy Examiner"
April 20, 2010 

Greenpa said...

Good old-fashioned herding-

scary, looking out ahead.

Ed_Gorey said...

Re: Is today's business news useful?

I love to read old business articles that dramatically reveal just how much of the daily news media and analysis is utter nonsense.

Here's a gem from the NYTimes and that little worm Andrew Ross Sorkin back in 2006, a time when Lehman Brothers was quietly bankrupting itself with fraudulent mortgage lending and securitization:
"Lehman, Goldman Top Barron’s 500 List
May 15, 2006, 9:50 am

Two big-name investment firms — Lehman Brothers and Goldman Sachs — sit atop the Barron’s 500 survey of corporate performance. The annual list ranks the largest United States and Canadian companies by a collection of factors including stock price, cash flow and sales growth.

Both companies, of course, have benefited from hot capital markets around the world. Barron’s depicts Lehman, which ranked No. 1, as having successfully transformed itself from a stodgy old bond house into a hot-shot player in both investment banking and asset management. It recorded record profits this year, and its stock price has doubled.

“If we lie stagnant in the growth curve, the stock will mirror that,” Lehman chief executive Richard Fuld tells Barron’s. “I have no intention of letting us be stagnant.”

Rudy said...

Linda wrote...

@ Stoneleigh--Printing presses will not be deployed while the bond market retains the power to punish, and that will be the case for some time. After a deleveraging great enough to break the power of the bond market it wold be a different story, but that is then and this is now.

I'm not good at bonds. I do not understand this paragraph. What is the power to punish of the bond market? Why will the great deleveraging break the power?

I will attempt an answer (speaking for myself of course, not for Stoneleigh)

The power to punish are the higher returns that the bond market would seek for rolling over old debt and/or granting new debt to the US economy, and should the USA really start printing with abandon to completely withhold any funding. It is the official position of TAE that if the bond market turns its back on the dollar the consequences for the US economy will be so devastating that the printing presses aren´t a viable option at this time.

A great enough deleveraging should significantly reduce the amounts of debt (to the point of sustainability even) through default/liquidation and probably completely overhaul and transform the economy (globalisation reversed, virtually no credit available) thus reducing the need for external or any kind of funding making the bond market less powerfull.


Starcade, now from Siren said...


And Charles is right on the mark with it.

el gallinazo said...


Don't be concerned by M's self-deleted comment. By his own admission, he had become possessed by a diabolical raccoon which had taken over his verbal communications by a process known to the occult as automatic writing. When control was finally released to the conventional personality, he was quite apologetic. Them raccoons is the devil's spawn.

Greenpa and the BBC link:

Iranian cleric blames quakes on promiscuous women

At first I thought you had linked us to The Onion. But now I realized that said Iranian cleric is 100% correct. I hold Carol King responsible with her early 70's hit, "I Fell the Earth Move Under My Feet."

scandia said...

@ Woody and Starcade...The charges against GS has brought me face to face with " hope" that was lurking unseen by me. Alas there is no way to " fix " the financial system is there? No way to " fix " the political system is there?
So-o-o I conclude that TAE still has a role to play, that Stoneleigh's tour is a useful action.
@Zander, interesting developments with Clegg in the UK election campaign. Would appreciate your read of the campaign so far. What are your friends and family saying?

scandia said...

Just reading that an oil platform off Louisiana is on fire, some workers still missing...
Will this influence the supply/price of oil? Or is the production capacity insignificant?

scandia said...

In to-day's Telegraph,
" Alistair Darling resists calls to ban Goldman from Treasury"
He says, " I don't think you can stop doing business with a firm because an individual is accused of doing something."
" DOING SOMETHING "? ! Masterful criminal understatement!

Greenpa said...

The Polka Dot Gallows:

"Chrysler Lost $4 Billion but Sees Signs of Improvement"

Just the headline from a front page NYT article.

The mind boggles. Somewhere in the article, which I have not read, has to be a quote: "We really expect, due to our careful management changes, to only lose $3.7 Billion in the next quarter. Executive bonuses will go up accordingly, of course."

Woody said...


Try not to misunderestimate the tectonic impacts of Fatima's booty shakin' :>)

jal said...

Greenpa said...
Good old-fashioned herding

Here is another phenomena.

Due to the tax structures ... being able to deduct the interest of your mortgage on your income tax, people are doing like the businesses and dumping their losing investments/mortgages.

Due to easy money it was possible to acquire income producing real estate and become part of the affluent society/rich.

This turned into a rogue wave. (Soliton)

An Economy of Liars
Free markets depend on truth telling. Prices must reflect the valuations of consumers; interest rates must be reliable guides to entrepreneurs allocating capital across time; and a firm's accounts must reflect the true value of the business. Rather than truth telling, we are becoming an economy of liars. The cause is straightforward: crony capitalism.

Mr. O'Driscoll fails to provide a convincing story as to how honesty returns to the system once it is rid of regulation (without major restructuring of corporate boundaries).

Martha Stewart, Conrad Black, and B. Madoff were petty thieves.

Look back at what happened to the market when they got caught with their hands in the cookie jar.

Now, look at what the markets are doing after
Statement by William K. Black

before the Committee on Financial Services United States House of Representatives regarding

"Public Policy Issues Raised by the Report of the
Lehman Bankruptcy Examiner"


We are living in an interesting time.

zander said...

@ Scandia.

My family would vote labour if they adopted the goosestep, they're mostly ex-colliery :)
Y'know it's a strange development this, don't think anyone seen this coming, he's actually ahead in some polls, could be reversion to normal if this turns out to be a honeymoon period - so deeply entrenched are the two main parties, he seems to be holding his ground for the moment though and although it can only be good for the overall political landscape of the UK for some new blood to be injected into a diseased system, he's hardly radical, and not that far away from the other two on many policy issues, I thought he came across as a bit naive and giggly myself, but definitely fresh. One really positive element is that it has thrown up a palatable alternative to many who may have been considering BNP, who seem to be ebbing away IMHO.
However I'm convinced that a fairly equal 3-way split, which now seems pretty likely, would be viewed very badly by all markets, who would rightly conclude that Britian is all over the place in deciding on the next best foot forward, a FTSE 100 steep decline at that point may trigger a domino effect collapse in markets worldwide, again IMO only.

On another issue, I was in the borders last night at my usual getaway, and it lies under route 1 to Glasgow airport airspace, it was simply magical to experience the clear, starry, inky black night totally aircraft free until 3am-ish. I for one will never miss air travel.


Woody said...

Scandia & Starcade,

The full "Gravity" of the I&S message seems a bit illusive to many of us who still have some connection to the happy motoring society. I've been reading TAE for more than a year, and every time I think we're near the bottom, another crevas opens.

scandia said...

@ Zander...thanks for your view...I had forgotten about the BNP. Are they projected to win some seats?
As for Clegg I naively hope he wins so that someone new can have a look at what is going on and fill in the electorate. Or will he side with his class?

@ Woody...bottom? Which bottom? Financial, environmental, political,social order...wobbly systems as far as the eye can see. Let's hope there is a bottom, not an abyss.

@ Rudy...thanks for your post on how the bond market will " punish ".

@ board...something I found significant happened to-day. I bought a sausage from a cart usually set up in front of the local hardware store and , while eating, had a conversation with the Polish vendor who came to Canada in 1984. Very interesting to hear his experience of communism, its good points and how it failed. What had me choking on the sausage was he began to tell me, confidential like, that the banks are really insolvent. This was the first time anyone has warned me. It is usually me giving people a head's up. Perhaps people understand more than I have credited, perhaps they are making arrangements.

I. M. Nobody said...

scandia said...

What had me choking on the sausage was he began to tell me, confidential like, that the banks are really insolvent. This was the first time anyone has warned me. It is usually me giving people a head's up. Perhaps people understand more than I have credited, perhaps they are making arrangements.

Oh yes, many people just don't feel the need to make a lot of noise about it. In my own data gathering, it appears that almost everyone knows that the thing that goes bump in the night, is not just a loose shutter.

Linda said...

@Rudy--Thanks for your bond explanation. I know Stoneleigh's been busy. So the power to punish is higher rates and/or not doing bond auction business. Then...poof...if the bond market turns its back on the dollar the consequences will be so devastating that the printing presses aren't a viable option. Don't get what happens after the poof. What is turning its back on the dollar? The higher rates & no auctions? So then...I'm missing a step. Sorry I'm a cretin. Linda.

Ilargi said...

New post up.

The American people can't afford God's work anymore


Purpose said...

It seems that much of the attribution to Goldman of wrong results from the fact that the common analogies employed to understand the transaction are ill suited to that purpose. Goldman built a something equivalent to "a car designed to blowup" as Ratigan suggested. But that's nothing like what they did, is it?

Better is the analogy that Goldman created a die to be thrown, and sought bettors on which of its faces would land facing up. John Paulson influenced the design of the die, like what values appear on which of its faces. Nonetheless, any prospective party to the bet could inspect this instrument and judge the likelihood of possible outcomes according to their own expectations about the future. The outcome of the throw depended on future market conditions. Is there any reason to believe Goldman could give Paulson any kind of advantage over the large international banks that took positions opposite to his in predicting the possible outcomes or the design of the die? Or that Goldman had a vested interest in pleasing one of their customers (Paulson) over another (big international banks)? Or that the international banks would have taken different positions had they known of Paulson's bet, or role in the instrument's creation?

After all, whatever Paulson's side of the bet, if the banks were making big bets on this instrument, *someone* had to take an equal and opposite position to theirs. As a synthetic derivative, this die represents a zero sum game. *Someone* had to lose a lot of money.

Am I missing something?