Editorializing From The Financial Capital Of The World

Although headquartered in the financial capital of the world, the NY Times editors apparently do not believe they need to understand the first thing about finance.  Here they go again, bleating about the civil suit against Goldman Sachs and comparing derivatives to casino gambling:

What all those proposals don’t address is whether the type of derivative Goldman was selling should even be allowed to exist. The Goldman deal was nothing more than a bet on the mortgage market, in which one side was destined to win and the other to lose, without “investing” anything in the real economy. The C.D.O. did not hold actual mortgage-related bonds, but rather allowed the participants to stake a position on whether bonds owned by others would perform well, or tank. And that helped to further inflate the housing bubble.

That is not investing. It is gambling, and it is abusive. It has no place in banks that can bring down the system if they fail.

Hmm - empowering sellers by creating synthetic mortgages that let sellers absorb the demand created by buyers inflated the housing market?  Would it really be a better world if the German money manager on the losing side of the controversial Goldman deal had used his money to fund more construction of new homes?

I will say this - it appears, after the fact, that the overall effect of making housing-related financing more liquid was not helpful.  Had it been harder for people to finance and re-finance their homes the housing bubble would surely have been smaller.  There are lots of ways the government could intervene to make the mortgage market grind more slowly.  They could start with reining in Fannie Mae and Freddie Mac, move on the imposing more stringent mortgage origination criteria (that would have a disparate impact on minorities, women, and immigrants), limit mortgage securitization by requiring originators to retain a portion of their product, and eventually work up the food chain to derivatives.

But even though derivatives are so unfashionable that a NY Times columnist can boast about her ignorance, the Times really needs to crack open a basic economic textbook to help them distinguish between gambling and speculation.

Gambling can be thought of as the creation and transfer of risk for entertainment's sake; the resulting prices and risk transfers don't guide any useful economic activity.  A bet on whether my next toss of the dice will result in a seven does not guide any real economic activity, other than baby getting a new pair of shoes.  Or not.

Speculation, by way of contrast, can provide socially useful prices and the opportunity for risk transfers.  For example, speculators routinely buy and sell futures contracts on corn, even though they have no interest whatsoever in growing, storing, milling, or selling corn.  Why is that not just gambling?  Because the speculators, through their participation in the market, help guide the behavior of people who do have to make a living growing and handling corn.

Kelloggs will be making a lot of corn flakes next December - should they fill their corn silos now to assure their supply of corn, or wait until the next harvest?  A "bet" with a speculator may simplify their planning.

A farmer has to decide whether to plant more corn, leave a field fallow, or plant something else.  What will corn be worth come harvest time?  The existence of speculative derivative contracts on corn helps provide an answer to that question and an opportunity for a farmer to assure his price today.

The Goldman deal looks like socially useful speculation.  Should mortgage originators push even more money out the door to create more supply for the securitization chain?  There were a lot of buyers lined up saying "Yes!"  However, the use of synthetic CDOs allowed sellers to show up shouting "No."  That price discovery can be socially useful, as the Times editors ought to understand.

I QUIBBLE WITH MYSELF:  What about betting on which teams will go the the World Series next fall - is that socially useful?  I would not dismiss the question out of hand - the mayors and police chiefs of Atlanta, Philadelphia, and St Louis (not to mention New York and Boston) might like to know what October will bring; event planners and convention organizers might like to know whether there will be plenty of hotel rooms, or whether their event will be over-run by a baseball crowd.  That is a thin thread, but it takes us to the gray line between gambling and prediction markets.

Comments

[couptrappingismorefun]

Fitz is all Plame and that privileged crap for informants. Boring.

IMF is falling apart over cap and trade and global tax for corps. It's O's global GDP/GNP tax gone through is pals in London again. Soon, they have they're meeting and spies are all over the place. It's going to fall and then O can help us like he knows how. Like he didn't crash the banks and then screw them over schools. IMF is not that big. He's mad at them too and was before he ran...........

[anduril]

From the WSJ article:

Wall Street has become largely a giant casino creating bets whose only purpose is to create fees for itself—with the difference that taxpayers are expected not only to bail out the casino's biggest losers but also to endure misery in the form of lost homes, lost jobs and lost savings if the casino inadvertently triggers a depression. The charges brought against Goldman Sachs by the Securities and Exchange Commission confirm this view.

Whether or not there is any basis for the SEC's claim that it misled investors, the key point is that the synthetic collateralized debt obligation (CDO) at issue was nothing more than an elaborate wager on the future price of some mortgage-backed securities—a wager with as much economic utility as a gigantic bet on a roulette wheel or a horse race. Facilitating such bets has become a huge part of the business of the world's biggest banks.

[Clarice]

AP reporting an investigation revealed the SEC staff spent an inordinate amount of time during the melt down period watching porno on govt computers in their offices.

Great timing on that report's release.

[Ignatz]

--A coin flip needn't result in heads or tails. It can land on its edge.--

I understand there are a significant number of two headed coins in use on Wall Street as well.

[anduril]

I wonder whether this is typical of securities lawyers in the private sector, too? I've heard about the "freewheeling" work environment on Wall St. Perhaps ACA's smart as hell lawyers were otherwise than legally occupied when Paulson was picking assets for inclusion--or maybe it would explain that some of ACA's picks were worse than Paulson's!

_ A senior attorney at the SEC's Washington headquarters spent up to eight hours a day looking at and downloading pornography. When he ran out of hard drive space, he burned the files to CDs or DVDs, which he kept in boxes around his office. He agreed to resign, an earlier watchdog report said.

_ An accountant was blocked more than 16,000 times in a month from visiting websites classified as "Sex" or "Pornography." Yet, he still managed to amass a collection of "very graphic" material on his hard drive by using Google images to bypass the SEC's internal filter, according to an earlier report from the inspector general. The accountant refused to testify in his defense and received a 14-day suspension.

_ Seventeen of the employees were "at a senior level," earning salaries of up to $222,418.

_ The number of cases jumped from two in 2007 to 16 in 2008. The cracks in the financial system emerged in mid-2007 and spread into full-blown panic by the fall of 2008.

[bunkberbuster]

egads. meant to say investors can shout "NO" all day long by buying the "short" side of a CDS on the debt....

[Pofarmer]

Does anybody really think that a system that got as convoluted as the "mortgage banking system" , and, yes, the scare quotes are intentional, had become, wasn't, at some point, going to blow up? It was inevitable. The bets were multiple multiples of the underlying mortgages.

[anduril]

Does anybody really think that a system that got as convoluted as the "mortgage banking system" , and, yes, the scare quotes are intentional, had become, wasn't, at some point, going to blow up? It was inevitable.

Also from the WSJ article:

Third, the crisis of 2007-2009 originated in one of the most highly regulated sectors of the financial system: the U.S. residential mortgage market. The mortgage originators, the government-sponsored enterprises that dominate the securitization process, the commercial banks—these were scarcely institutions ignored by Congress over the years. On the contrary, Washington constantly tinkered with the system in a misguided campaign to increase home ownership. That campaign ended in tears.

[Jim]

Thanks for the legal update. In the GS case though, Paulson's role in both shorting the deal and choosing the securities must remain a fundamental issue. No boilerplate or 'sophisticated trader' argument can deny that. In my book, that is fraud plain and simple, fronted by a bank that has lost its way.

Free markets depend on information and fiduciary duty, regardless of the amount of legal precedent. And getting back to the original post, there is where the NYT (I'm going to puke a little as I write this) is kind of saying something worthwhile despite horribly mangling it; there are over $650 trillion of derivatives in organizations, even with the proposed legislation, backed by the American taxpayer.

No one can say what that exposure really is. No one can say that it is all good price discovery, when the global economy is only $55 trillion. They also render Balance Sheets unreadable as legislated.

Free markets work best when the rules are simple and information is generally available. Neither in the GS case, or the derivative market in general, can this be said to be true, IMO. At the least, no taxpayer should ever be held accountable if these balance sheets unravel again. And one thing we know for sure; they will.

[anduril]

NOT coincidentally:

Health Care Law Will Increase Costs, Experts Conclude in New Report
Fox News ^ | 22 April 2010 | Associated Press

WASHINGTON -- President Obama's health care overhaul law will increase the nation's health care tab instead of bringing costs down, government economic forecasters concluded Thursday in a sobering assessment of the sweeping legislation.

A report by economic experts at the Health and Human Services Department...

[Damen]

You get fined if you don't buy it. Why can't we trade health care if it's mandatory and fineable.

[anduril]

there are over $650 trillion of derivatives in organizations, even with the proposed legislation, backed by the American taxpayer.

No one can say what that exposure really is. No one can say that it is all good price discovery, when the global economy is only $55 trillion.

Hey, TM says so--isn't that good enough for you? And presumably TM also thinks that the fact that

taxpayers are expected not only to bail out the casino's [i.e., Wall St.'s] biggest losers but also to endure misery in the form of lost homes, lost jobs and lost savings if the casino inadvertently triggers a depression

is just, well, collateral damage. Sad, but it's not happening in Connecticut where so many of the Wall Streeters live.

[anduril]

Jim, you musta written that WSJ article.

[PaulV]

How mcuh of the trash in the CDOs orginated with Fannie or Freddie? When will they be held accountable for passing bad paper? Does anyone think that Paulson knew how bad the loans were?

[PaulV]

how "much"

[nathan hale]

That is the $ 100,000.00 question. They designed this product exactly to be shorted, so they knew it was worthless, at least Drexel
was more honest when they peddled their wares
as junk

[Ann says Obama Sucks!]

Charlie:

I thought of you today listening to Mark Levin. Here is an oldie but goody you should post on Pjtv (h/tp Mark Levin):

http://www.washingtonexaminer.com/opinion/blogs/beltway-confidential/An-Earth-Day-tradition-George-Carlin-on-the-intellectual-bankruptcy-of-saving-the-planet-91819469.html#ixzz0lqsf922j ">An Earth Day tradition: George Carlin on the intellectual bankruptcy of "saving the planet"

Too funny!

p.s. daddy would love this!

[Patrick R. Sullivan]

So, anduril, you've quoted Steve Waldman (whoever he is) saying:

Synthetic CDOs are constructed, in part, from derivatives. (They are built by mixing ultrasafe “collateral securities” like Treasury bonds with credit default swap positions, and credit default swaps are derivatives.) But investments in synthetic CDOs are not derivatives, they are securities.

And, now a WSJ article saying:

the synthetic collateralized debt obligation (CDO) at issue was nothing more than an elaborate wager on the future price of some mortgage-backed securities...

Which of these two contradictory claims do you believe...and why?

[Pofarmer]

No one can say that it is all good price discovery,

So, riddle me this.

You've got banks and mortgage companies writing loans and selling them to Fannie and Freddie. You've got F and F packaging them into MBS and selling them to the investment market. You've got the investment market rechopping and reselling those as CDO's, and you've got everybody buying CDS against everything. That's not including the market for seconds and HELOC's.

What is this supposed to be setting the price of?

[bunkberbuster]

I think "keep it simple" is a pretty good mantra as regards regulation.
The linchpin seems to be systemic risk and too-big-to-fail. Let companies that want to play roulette play, as long as working people and/or taxpayers don't get splattered with guts when they fail.
Why isn't that a win-win answer?

[glasater]

Cathyf had a great little "stick figure" explanation she posted over a year ago that told quite a story.

Can't find it and don't remember the title to do a search. But what I do remember was when these brilliant guys were chopping up the MBS's into tranches--they kept the "stinky" ones for themselves.

Wish I could find that clever article.

[Max Regor]

Tom, I think you are missing the point. You say the value is in pricing assets, providing liquidity, I am being generous. Brooksley Born was right. Paulson should have been able to go to to an options exchange to place his bets. Everyone would have seen his bid on the decrease in value and could have accepted or rejected. Instead, we have this carefully crafted vehicle he paid for that in the end was designed to deceive the other side of the deal.

[AL]

In times when American way of enterprise is wobbling, would it be wise to look around? I mean no further than to your Canadian neighbors?

Interest for mortgages in Canada is not tax-deductible, so there is no insensitive to keep mortgage dept as high as possible, and finance everyday expenses from mortgage-issued low-interest credit card.

Result? In current recession mortgage default rate in Canada is one tenth of US.

[AL]

“excessive speculation in a market is conducive to excessive volatility”

Pofarmer, you slowly moving to understand the root of the problem.

Things to think over:

If you hedge 100% of risk, you will get 0% profit.

There is no such thing as gambling insurance. If you do manage to get such insurance, it is fake. Like CDS for US T-bills from AIG.

[peter]

OT, today is the 25th Anniversary of the introduction of New Coke.

[hrtshpdbox]

"If you hedge 100% of risk, you will get 0% profit."

Precisely the goal of commercial hedgers in the futures markets, i.e. to lock in a price and reduce upside potential and downside risk to zero. Someone who hedges 100% of a mortgage portfolio knows that he doesn't need to liquidate the actual holdings while being protected by his put; when he's confident that the risk has subsided and the assets will appreciate, he can take off the put.

[bunkerbuster]

Way too easy to say Goldman created Abacus to fail. The notes had to get a AAA credit rating, and unless they bribed Moody's -- and there's been not even an allegation that they did -- they couldn't have just picked risky bonds to throw into the pool. Secondly, they had to sell the notes to someone, so if they were obviously stinkers or low-rated, they couldn't have done that.
Doesn't it make a lot more sense that Goldman was merely looking for maximal hedging. It wanted a deal that allowed it to collect as many deal fees as possible without being overexposed on either side.
Maybe the result of that effort was that they were more short than long, or maybe it wasn't. But it doesn't fit what few facts we do have to suggest that Goldman's best-case scenario was for Abacus to go down like the Titanic...

[jimmyk]

Wish I could find that clever article.

I think you mean this.

[Pofarmer]

when he's confident that the risk has subsided and the assets will appreciate, he can take off the put.

Which is normally when you get your ass handed too you.

[jimmyk]

Let companies that want to play roulette play, as long as working people and/or taxpayers don't get splattered with guts when they fail. Why isn't that a win-win answer?

Bunkerbuster, I think you have stumbled on to the truth.

[jimmyk]

What is this supposed to be setting the price of?

I think your post answers itself:

You've got banks and mortgage companies writing loans and selling them to Fannie and Freddie. You've got F and F packaging them into MBS and selling them to the investment market....

Fannie and Freddie distorted the prices by overpaying. Being a large government entity with effectively infinitely deep pockets, it could affect the price in a way that no bank could. It's not that different from the way the government distorts dairy and sugar prices. Absent F&F, prices had a chance of being set by rational players with the incentive to get it right. F/F set off a scramble for easy money by making the price artificially high.

The answer is not to focus on the opportunists on Wall Street, but on who is responsible for setting them up: Barney Frank, Chris Dodd, and all the other protectors of Fannie, Freddie, the CRA, and all other scoundrels now expressing feigned righteous indignation.

[Pofarmer]

"Let companies that want to play roulette play, as long as working people and/or taxpayers don't get splattered with guts when they fail. Why isn't that a win-win answer?

Bunkerbuster, I think you have stumbled on to the truth.

Unfortunately, the companies the were playing, were the same companies that we were expecting to be doing the heavy lifting, as well.

[Ranger]

More Blago stuff this morning. Kass in the Sun Times:

http://www.chicagotribune.com/news/columnists/ct-met-kass-friday-20100423,0,1271799,full.column>Blagojevich sends not-so-subtle message to Obama

Obama's former patron and real estate fairy, the convicted influence peddler Tony Rezko, is a key player in the government's case. Blagojevich's aim is to undercut what Rezko has told investigators.

And now Blago wants the president to do the undercutting from the witness stand, with the nation riveted to his every recollection of his days in Chicago politics, hanging with Tony and the guys, with the midterm November elections approaching.

"President Obama has pertinent information as to the character of Mr. Rezko," the Blagojevich filing states. "President Obama can testify to Mr. Rezko's reputation for truthfulness, as well as his own opinion of Mr. Rezko's character. Based on the relationship that President Obama and Mr. Rezko had, President Obama can provide important information as to Mr. Rezko's plan, intent, opportunity, habit and modus operandi."

[anduril]

Bunkerbuster, I think you have stumbled on to the truth.

with all due credit to bunkerbuster--who has provided many lucid comments--people have been saying this for a long time. maybe someone with a direct line to TM can clue him in.

Patrick, your reading problem from yesterday has carried over to today. That's your problem, not mine.

[anduril]

As Long As We're Investigating Goldman Sachs Directors For Insider Trading.... This longish blog is getting at the pervasive corruption throughout much of our financial system, including the corrupt symbiosis between the Fed and the big banks and investment houses. Hey, simultaneously chair of the New York Fed and a board member of Goldman Sachs--so where's the conflict?

Now that Goldman Sachs director Rajat Gupta is under investigation for passing inside information to Galleon's Raj Rajaratnam, we might as well get to the bottom of what happened with Goldman board member Stephen Friedman during his tenure on the board of the New York Fed.

Basically what happened is that Friedman suddenly more than doubled his personal stake in Goldman in the middle of the financial crisis.

As chair of the New York Fed, Friedman wasn't supposed to sit on Goldman's board OR own Goldman stock, but Tim Geithner gave him a waiver to do both.

And now the question is... Did Friedman have some special inside information about the Buffett deal or Goldman Sachs' financial strength that wasn't in the public realm?

Given that he was a director of the firm, this seems at least plausible.

So perhaps the folks at the Justice Department looking into Gupta's behavior might want to take a peak at Friedman's, too.

Following that is a long summary, but fraught with interest. What kind of banana republic are we living in?

[anduril]

So I've been wondering--not for the first time--where are the usual A-holes who should be complaining about "thread hijackers"? Well, here's a bone to you--it's me, so you can complain to your hearts' content:

Blagojevich sends not-so-subtle message to Obama

[anduril]

TV says it all in one short paragraph, re "reform":

Ultimately, what emerged most clearly from Obama’s speech was his faith in the efficacy of regulation, and, by implication, his belief in the intelligence and objectivity of regulators. In this, he revealed—and not for the first time—his predilection for political control of the economy. This, alas, is where a great danger lurks for a genuine free market: Do we really want Big Government to save us from Big Business?

[glasater]

jimmyk--you are just the best!

Thank you

[hit and run]

anduril:
So I've been wondering--not for the first time--where are the usual A-holes who should be complaining about "thread hijackers"?

OT,but you know what I've heard from a very reliable source?

GS uses a MS-based OS!

::grin::

Hope the roses are coming in nicely.

[Daharass]

O won't change and they're needed: peasants seizing land, youth groups demanding other countries apologize, voting schedules and corruption. New leaders and new countries needing help.

Maybe it was planned that way. Anyway, it's okay we said screw they're citizens.

O will have to testify about his Chicago corruption and even CNN, paid by Os, is saying he's guilty. Horrible for this world leader to go down like a banana republic dictator we didn't like. 60 days if he doesn't come back.

[matt]

speaking of health care costs, we are truly screwed. LUN

[anduril]

Martin Wolf has a thought provoking article: The challenge of halting the financial doomsday machine. He starts out with the common sense observation:

Can we afford our financial system? The answer is no. Understanding why this is so is a necessary condition for evaluating ideas for reform. The more aware of the risks one is, the more obvious it becomes that radicalism is the safer option.

and proceeds to discuss those risks, using the work of Andrew Haldane of the Bank of England. I won't favor you with the whole analysis, but these two paragraphs providethe flavor of it:

The combination of state insurance (which protects creditors) with limited liability (which protects shareholders) creates a financial doomsday machine. What happens is best thought of as "rational carelessness". Its most dangerous effect comes via the extremes of the credit cycle. Most perilous of all is the compulsion upon the authorities to blow another set of credit bubbles, to forestall the devastating impact of the implosion of the last ones. In the end, what happens to finance is not what matters most but what finance does to the wider economy.

Does today's engorged financial system produce gains that justify these costs? In a recent speech, Adair Turner, chairman of the UK's Financial Services Authority, argues it does not.* Financial systems are important servants of the economy, but poor masters. A large part of the activity of the financial sector seems to be a machine to transfer income and wealth from outsiders to insiders, while increasing the fragility of the economy as a whole. Given the extent of the government-induced distortions in the system, even the fiercest free marketeer should accept this. It is hard to see any substantial benefit from the massive leveraging up of the economy and, above all, the real estate sector, that we saw recently. This just created illusory gains on the way up and real pain on the way down.

Wolf then reviews the most popular "solutions":

One idea, popular in US Republican circles, is: "just say no" to bail-outs.

Another idea, popular among US liberals, is that the chief issue is "too big to fail".

A third notion is that the big issue is regulatory completeness. It is argued that if only oversight had been effectively imposed, the pattern of overleveraging and default could have been halted.

Haldane judges that all three solution models are illusory, for reasons given in the article.

What is Wolf's solution? Unfortunately, we have to wait till next week:

In the end, halting the financial doomsday machine is going to involve fundamental changes in policy towards - and the structure of - the financial system. There are two broad approaches now under discussion. The official one is to make something roughly like the present system far safer, by raising capital and liquidity requirements, moving derivatives on to exchanges and enforcing prudential regulation. The alternative is structural reform. Which is the least bad option? I plan to address that issue next week.

I'm guessing he'll come out for structural reform of some sort.

[Ranger]

Well, how else are the politicians supposed to extort money from business unless the politicians have the sword of new regulations constantly dangling over the heads of business. And its not really political control when former GS people get to write the regs. It is the Big Business/Big Government nexus, which is designed to preserve the confortable positions of both. Big Business gets protected from challenges posed by more innovative and dynamic upstarts. Big Government gets protected by creating an ever larger number of regulators and staff to fill.

[Old Lurker]

You are a bad bad boy and a trouble maker, Hit.

[anduril]

hit, you've--I hope inadvertently--almost caused a crisis of conscience for me. I did a quick google of "goldman sachs linux" and came up with interesting refs like: Goldman Sachs: "Linux will dominate the enterprise".

This crazy extremely early spring following a fairly severe winter has things a good two weeks ahead of schedule. I'm debating today whether to start the fertilizing routine, but I'm concerned about encouraging rapid growth while nighttime temps are still in the low 40s or even the 30s. Still, the plants are taking off on their own. I do have a few I'm a bit worried for: Chicago Peace, Abraham Darby, Pristine among them.

[anduril]

I'll resist the temptation to paste in this entire, excellent article: Financial reform fails to tackle real issues. The author espouses the "keep it simple" approach (Albert Einstein is famously quoted as saying everything should be made as simple as possible, but not simpler.), which doesn't stand a chance in the current Congress. However, he's very thorough.

[Rob Crawford]

So I've been wondering--not for the first time--where are the usual A-holes who should be complaining about "thread hijackers"?

OK -- the biggest problem is you.

Happy now?

[bunkerbuster]

``Fannie and Freddie distorted the prices by overpaying.''

Wrong. Frannie paid market prices. Period.

More importantly, Frannie had been securitizing mortgages for decades and while it is painfully obvious that the organization had some baked-in conflicts of interest -- though not much more than a typical investment bank -- it is also clear that it never had a motive to inflate housing prices, nor, certainly, to deceive investors in any systematic way.

Inasmuch as Frannie's government quasi-guarantee resulted in conflicts of interest with regulators and their overseers (politicians), it also meant that Frannie needn't worry much about defending its place in the market. It simply had no motive to rip investors' faces off...and in the absence of that, anyone who wants to believe they were anywhere near the cause of the collapse had better be able to come up with a reason they were the linchpin...

[Pagar]

Once again, as Don Surber explains---------
She has put the whole answer on Facebook.

[Pofarmer]

Financial reform fails to tackle real issues.

ditto health care reform, yadda, yadda, yadda.

[Pofarmer]

it is also clear that it never had a motive to inflate housing prices,

If that were true, I don't think you would have had them buying the crap they were buying. They may have had no motive to inflate housing prices, however, they were LEGISLATED into making the max number of loans possible. As you make more and more loans, and the market is saturated, you are naturally going to get into riskier and riskier territory.

[anduril]

Elizabeth MacDonald has a long but excellent article, Goldman's Embarrassing Emails, that provides, IMO, just about the best summary of the SEC case as well as the Goldman defense. In particular, she hits on the aspect that I cited to Jim Rhoads as a factor that gave me pause to wonder whether the case is entirely political: the tenor of the Goldman emails. Here's a sample of those emails (not the whole string cited in the article), focusing on the role of Paulson and ACA's state of mind in that regard:

On January 10,2007, Tourre sent an email to ACA with the subject line "Transaction Summary."

Tourre's email began: "We wanted to summarize ACA's proposed role as 'Portfolio Selection Agent' for the transaction that would be sponsored by Paulson (the 'Transaction Sponsor')."

The SEC says on January 22, 2007, ACA sent an email to Tourre and others at Goldman with the subject line, "Paulson Portfolio 1-22-10.xls,” later noting that it picked 55 out of the 123 securities Paulson’s fund selected.

On February 2, 2007, Paulson, Tourre and ACA met at ACA's offices in New York City to discuss the portfolio. The SEC contends that unbeknownst to ACA at the time, “Paulson intended to effectively short the RMBS portfolio” it helped select by entering into negative bets on the deal via Goldman.

Given those conflicts, the SEC says, during the meeting, Tourre zoomed an email to another Goldman employee stating: "I am at this aca paulson meeting, this is surreal."

Paulson's economic interest was unclear to ACA, the SEC says, and it later sought clarification from Goldman.

ACA later sent a Goldman sales representative an email with the subject line "Paulson meeting" that the SEC says shows ACA was kept in the dark: "I think it didn't help that we didn't know exactly how they [Paulson] want to participate in the space. Can you get us some feedback?"

The SEC says on January 10, 2007, Tourre emailed ACA a "Transaction Summary" that included a description of Paulson as the "Transaction Sponsor" and referenced a "Contemplated Capital Structure" with a "[0]% - [9]%: pre-committed first loss," purportedly showing that the Paulson fund intended to invest in the deal's equity.

The SEC says on January 14, 2007, ACA sent an email to Goldman raising questions: " I can understand Paulson's equity perspective but for us to put our name on something, we have to be sure it enhances our reputation."

The SEC says Tourre knew, or was reckless in not knowing, that ACA had been misled into believing Paulson intended to invest in the equity of the deal, when his fund was actually shorting it.

The SEC says an ACA memo dated February 12, 2007 described Paulson's role as follows: "the hedge fund equity investor wanted to invest in the 09% tranche of a static mezzanine ABS CDO backed 100% by subprime residential mortgage securities."

The SEC says a March 6, 2007 email to the Goldman sales representative for IKB, a commercial bank headquartered in Dusseldorf, Germany and a potential investor in the CDO, said: "This is a portfolio selected by ACA ..."

Tourre subsequently described the portfolio in an internal Goldman email as having been "selected by ACA/Paulson."

What jumps out is that Goldman consistently represented to ACA that Paulson was a Transaction Sponsor investing in the equity, whereas internal Goldman emails make it clear that Goldman regarded Paulson as a de facto Selection Agent. This remained the case even when ACA sought clarification of Paulson's role. Further, Goldman represented to a major customer that the portfolio was selected by ACA, although it knew that Paulson had had a major hand in the selection--Paulson had been, in effect, a co-Selection Agent.

This should be troubling. There doesn't seem to be a word in the emails about input from super bright securities lawyers.

MacDonald then goes on to evaluate Goldman's defense, including Paulson's reputation at the time, etc.

[anduril]

Pofarmer, I think you're right on that. The notion of a government--or quasi-governmental--agency operating efficiently in evaluating values is...implausible to me.

[hit and run]

anduril:
hit, you've--I hope inadvertently--almost caused a crisis of conscience for me.

Quite inadvertently,I assure you.

I am as surprised as anyone to find you have one.

(really,I'm just kidding,as I hope you know)

[Pofarmer]

The notion of a government--or quasi-governmental--agency operating efficiently in evaluating values is...implausible to me.

Especially when their stated purpose is normally to influence a market.

[Ranger]

Wrong. Frannie paid market prices. Period.

Those market prices were inflated by the artificial increase in demand that FM/FM also helped create. And they did very much help create the artificial increase in damand with many, many "inovations" in mortgage lending that they introduced. FM/FM was a key part of the "lake woebegone" syndrom in housing of the last decade, where every borrower was qualified (just like all the children in Lake Woebegone are above average), regaldless of their actual circumstance.

We got the housing buble becaues a huge artificial increase in demand created an artificial shortage in supply, thus driving prices well above what the market could sustain in the long term. FM/FM played a huge role in that.

[anduril]

OK, this next one fits right in with MacDonald. MacDonald was looking at the nitty gritty merits of the SEC case (and Goldman's defense). But this isn't a black and white situation, as Jim Jubak demonstrates in this lengthy piece: Why US really went after Goldman. Core to Jubak's thesis is this:

Now what does all this have to do with the SEC fraud charge against Goldman and the financial-reform bill in Congress?

First, notice that while the banks and regulators may be adversaries in the SEC-Goldman suit, they're more like co-conspirators when it comes to Basel III.

What he then lays out is a complex game of give and take--in which the SEC/Goldman suit is part of a bigger picture--which boils down to:

So regulators and legislators want to increase their territory by increasing regulation of derivatives and by forcing trading in some derivatives to exchanges. That will cost banks by increasing collateral requirements and by lowering fees. Banks may not want to pay all that legislators and regulators want here, but they're certainly willing to pay something in exchange for support on Basel III. So we have the current argument over how much of the derivative market will be exempt from regulation.

This is one reason that I'm just about certain that some financial-reform bill will pass -- something with enough teeth in it so that regulators and legislators can brag but not so many that it's too painful for banks.

[bgates]

it is also clear that it never had a motive to inflate housing prices, nor, certainly, to deceive investors in any systematic way.

Ranger and Po are right about FNFM's effect on housing prices. Are you seriously contending that FM's pervasive distortion of its earnings, which resulted in hundreds of millions of dollars of bonuses for management and later hundreds of millions of dollars in fines, was not "deceptive" and "systematic", or does the period 1998-2004 fall into your definition of "never"?

[Rick Ballard]

It might be wise to check the available data prior to hanging one's hat on the GSEs and CRA as a "primary cause".

The GSE's loans are in much better shape than "prime" loans and approximately half as likely to be in default or foreclosure status as jumbos. There is no doubt about CRA being a contributing factor or the FMs being run as political fiefs but relaxation of mortgage underwriting standards in order to maintain the Wall Street sporting houses and casinos in the manner to which they had become accustomed coupled with credit rating agency willful blindness ranks significantly higher on the causation ladder than do the FMs and CRA.

[Clarice]

More on the giveaway to Soros in Indymac
http://www.lendingonrealestate.com/Content.aspx?URL=www.thinkbigworksmall.com/mypage/archive/1/29027&LinkProp=4&FileName=HomePage.x>The Devil

[jimmyk]

The GSE's loans are in much better shape than "prime" loans and approximately half as likely to be in default or foreclosure status as jumbos.

Rick, I'm not seeing that in the link. It looks to me like F/F are worse than jumbo. But in any case, F/F got into it later in the game, though it was pretty common knowledge that they had implicit government guarantees. I'm not completely absolving Wall St., but I just see them as opportunists who were happy to rake in money until the music stopped.

[jimmyk]

Wrong. Frannie paid market prices. Period.

When an entity as large as Frannie or Freddie enter the market, they affect prices.

[Melinda Romanoff]

jimmyk-

Rick has it right. The Fannie/Freddie cover took the higher (ahem) grade mtges off the books of the originators, freeing up cash at the bank level for more loans. The CRA carved up the amount of free lending cash that had to be directed towards the NINJA loans which with we are now too familiar. The GSE's only bought certain "qualified" loans. What the banks did to qualify those loans was some of the really creative garbage that they tried to get securitized into CLO's and CDO's.

There is a qualifying level to the GSE stuff, just that banks lent the downpayments as well.

Combine that with a falling interest rate environment, the pension demand, alone, for higher yielding securities made PBGC targets reachable, with less cash. Hence the extra demand for garbage debt products.

It became self-feeding.

More later.

[bgates]

Rick, the causes have to be ordered temporally, not by magnitude. Otherwise you end up arguing that the pebble on the top of the mountain is just too darned small to cause an avalanche.

Besides which - and I can't get your link to load properly, so maybe the Fed data addresses this - I'm not surprised that in Q2 2010 the GSE's remaining loans are in better shape. People with jumbo loans are the only ones who had the resources to bleed for this long. I'd think FNFM's problem loans would have ended with a visit from the sheriff a year ago. Of course, if the Fed data shows cumulative defaults over the whole crisis, I'm off base.

[Rick Ballard]

jimmyk,

91.6% of the FM mortgages are current versus 86.6% of the prime and 82.2% of the jumbos. The FHA/VA number is 84.3% - is that what you were looking at?

[Pofarmer]

Ouch. That FHA number is pretty horrible.

[Ignatz]

--The Fannie/Freddie cover took the higher (ahem) grade mtges off the books of the originators, freeing up cash at the bank level for more loans.--

That mechanism coupled with the Fed's easy money seem to me to be what facilitated the bubble.
Both removed market discipline on the entrance to the bubble.
TARP removed it on the exit.

Removing market discipline coupled with helicopter Ben, Dodd's dumb ass bill and Barry's spending sounds like we're creating a Federal version of Lawrence Welk's bubble machine.

[Pofarmer]

That mechanism coupled with the Fed's easy money seem to me to be what facilitated the bubble.

I think you need to factor in the Harvard grad focus on short term vs long term profits. It seems to me, they are basically "churning" the loan portfolio's to generate the maximum amount of fees and "services", consequences be damned.(somebody else was going to own it, anyway).

[Farticle]

Fannie and Freddie was all foreign. Did China get its cash? What about student loans? O is taking over these, so sweetheart deals for who? It's harder to get out of those unless you want to do some federal government service.

[Melinda Romanoff]

Ig-

Aside from the Fed "easy money" comment( to which I will vehemently decry as a canard to the true easy money from the Japan carry trade. Not enough time, nor wine to bring that dead mule back into the light), that's exactly how I see it developed.

[Rick Ballard]

bgates,

I have data saved from the New York Fed's initial starting point in doing those maps but it would not address your point concerning the temporal aspect. The "hot spots" on the map have not changed since December of 2008 and they are not areas where one might anticipate heavy CRA reverse red line lending.

This article provides some quantification of the FMs exposure at the time they were taken over. I'd note that the subsequent credit event auction came in at 92% to 99% versus WaMu at 57%.

[Melinda Romanoff]

Rick-

Didn't ML dump something at 7%? Sticks in my mind, Oct. '08, I think.

[anduril]

Let me feed this in and solicit comments, from the WSJ:

There is a widespread but erroneous belief that the financial crisis has its origins in deregulation dating all the way back to the late 1970s. Therefore any steps to restore the pre-Reagan regulatory system are to be welcomed. This is really bad financial history.

First, in the more controlled capital markets of the 1970s, borrowers generally paid more for their loans because there was less competition. Lousy managements were protected from corporate raiders. Savers earned negative real interest rates because of high inflation. Deregulation—such as lifting restrictions on the interest rates banks could pay and charge—and financial innovation delivered real benefits for the U.S. economy in the 1980s and '90s.

Second, it is not at all clear that our crisis was exclusively caused by a failure of regulation as opposed to a failure of monetary policy. A very large part of the responsibility for the housing bubble and bust lies with the Federal Reserve, which underestimated the extent to which inflationary pressures had relocated themselves from consumer prices to asset prices. This was a near-term error of the period 2002-2004. It has nothing whatever to do with deregulation and everything to do with defective monetary theory.

Third, the crisis of 2007-2009 originated in one of the most highly regulated sectors of the financial system: the U.S. residential mortgage market. The mortgage originators, the government-sponsored enterprises that dominate the securitization process, the commercial banks—these were scarcely institutions ignored by Congress over the years. On the contrary, Washington constantly tinkered with the system in a misguided campaign to increase home ownership. That campaign ended in tears.

Still, it took extraordinary forces to turn a subprime bust into a global financial crisis. The key forces were excessive leverage on and off bank balance sheets, and derivatives that allowed massive but opaque side bets on the future value of U.S. homes. And it was these two factors that magnified (and exported) the losses in the mortgage market; legislators should focus on them. Instead, both the House and Senate bills are packed full of scatter-gun regulations that owe more to the prejudices of legislators than to a rational assessment of what actually went wrong.

[Rick Ballard]

Mel,

Lehman went at around 7% but it included a ton of non-mortgage related junk. I'm off for a bit.

[Ignatz]

--I think you need to factor in the Harvard grad focus on short term vs long term profits.--

Po,
Even Harvard grads are reluctant to create a giant bubble with their own money.
OTOH even Harvard grads can burn the house down when Uncle Sam starts handing out free matches and cans of gasoline.

--Ig-

Aside from the Fed "easy money" comment( to which I will vehemently decry as a canard to the true easy money from the Japan carry trade.--

Mel,
Just because the Nipponese have been easy in a "hello sailor, I'll show you a good time for a trillion yen" sort of way doesn't mean Alan and Ben weren't easy in a slightly less slutty "sure I'd like to come up and have a look at your etchings" manner, does it?

[Charlie (Colorado)]

Hey folks, I'm really looking for technically strong business/finance writers who want to write about the IndyMac/Shumer connection and/or Goldman.

Write me at charliem AT pajamasmedia.com

(Melinda, Cathyf, I'm looking at you.)

[anduril]

Are copy & paste skills technical enough for you?

[Charlie (Colorado)]

Are copy & paste skills technical enough for you?

Er, no. If you wanted to write original content I'd look at it. But it needs to be news/explanation, not rants.

[JM Hanes]

I suspect linking skilz would probably be a plus too. Here's anduril's article in the Wall St. Journal.

[Melinda Romanoff]

Chaco-

You've got mail.

[Melinda Romanoff]

jmh-

That might be construed as being "demanding".

[anduril]

Some people are so f**king stupid:

earlier this thread

@ 10:50

Just tapping in.

Isn't Chicago entertaining?

More tomorrow.

And anduril, define "unregistered security".

Posted by: Melinda Romanoff | April 22, 2010 at 10:50 PM

@ 10:51

Really good article in tomorrow's WSJ: Back to Basics on Financial Reform.

Covers lots of ground.

Posted by: anduril | April 22, 2010 at 10:51 PM

BTW, I did respond as requested but, as has become usual with this freaking human jack-in-the-box, my good natured response was not even acknowledged. Never again.

[glasater]

Anduril--

For the most part I appreciate your posts. I may scroll through them fairly rapidly at times but for the most I take the time to read through them.

I don't want you to take this too badly but--I posted a link on a previous thread on the GS topic 'way before you did.
You didn't acknowledge I had posted the link one iota--in fact you rather claimed it for yourself by inference.

Now it is rather rude of me to point this out to you but you have blatantly done this in the past with me and others who comment here.
So I don't know what else to do but hit you over the head with this behavior on your part.

[Melinda Romanoff]

anduril-

I said ""define", which is not the same as "guess".

I was trying to save you some embarassment on a subject you obviously are trying to learn about. There are way more layers to the onion than what meets the eye.

I don't have the time during market hours for the level of involvement required to teach you the distinctions and nuances of OTC trading. It would take years to explain 30 years of financial engineering research to satisfy me that you understand the concepts.

So, lighten up.

[Mahon]

Someone may have said this already, but sports betting can serve an actual economic purpose beyond generating information (as for mayors and police chiefs.) Say you're a small businessman in Minneapolis who stands to make a lot of money if and only if the Twins are in the World Series. You may wish to lock in some of that profit by "shorting" the Twins in Vegas. Then if they win you make money on your business and if they lose you make money on your bet. The cost is the amount of your bet. The existence of an active and liquid sports book makes this both possible and fair.

[anduril]

Fair enough, glasater, you deserve a response and I don't take your comments badly--at all. I did notice your post on the earlier thread and thought it was intelligent. In fact I thought of referencing your comments but decided not to. Why not? Because in the past you, like others, have posted comments that gave me the distinct impression that you would not welcome interaction with me. I'm sorry, I can't provide examples--I just make a mental note of these things and move on. Apparently I was wrong.

Now, of course I'm glad you like and read my posts. Positive feedback--and, if you don't mind my saying so, my impression is that this is a first coming from you--is in fact appreciated, if for no other reason than that I do go to a fair amount of trouble over most of my posts. As I've said in the past, I've been made aware that there are those who appreciate my posts but are shy about acknowledging it, probably due to the amount of invective that's directed my way. To those people I feel a certain sense of responsibility, if I may put it like that.

Back to your comments. You say that I routinely "borrow" other people's ideas without acknowledgment. I really don't believe that I do that very often and if it does happen at all it's almost always unintentional--sometimes I'm rushed for time, but I think I try to be generous in that regard. For example, on these GS threads I have acknowledged a number of others, including Ignatz, one of my harsher critics. As I said, I made a deliberate decision not to specifically acknowledge you, and it appears I was mistaken in my assumptions. You'll get full credit in the future.

I'm guessing that you decided to direct these comments to me because of my response to Melinda. Perhaps it would be well to explain myself in that regard. In the past Melinda has made a habit of asking me questions, even soliciting comments, and then not acknowledging my response. I have in mind in particular a time when she asked--demanded might not be too strong a word--that I read and respond to a somewhat lengthy document; it was much longer than an average article and dealt with the French counter insurgency effort in Algeria. I read it and responded at considerable length, comparing French policies with US policies, and got zero acknowledgment. When I confronted her for an explanation she said she didn't have time. Now, to me, that is very rude. She has since taken to stalking me and asking silly questions, thus my response today to her very childish behavior.

If my response here has been long in coming it's because I decided to get out and fertilize my roses before the promised rain.

[Ignatz]

Here is the formidable Bill Isaac's take on FinReg and Dodd's current monstrosity.
He always gets to the nub.

[Clarice]

In deciding whether one has been snubbed or one's contributions here overlooked, I ask that we all remember that sometimes in reloading things get lost. Sometimes I do not even see posts unless I start over several threads from the current position.

Often people are very busy and do not have time to read thru all the threads before posting--Sara has said she doesn't and it seems obvious--others have slow loading computers or are posting from handheld devises which really makes it impossible to see everything.

In a word--give everyone a bit of space on that kind of stuff--it's a bug we all have to learn to live with.

[Clarice]

**deviCes***

[glasater]

Anduril--thank you for your very thoughtful response:-)

[anduril]

You're welcome. I was glad to get some constructive feedback.

[Melinda Romanoff]

Fair response to me, anduril, and I apologize for the short shrift on the distinctions within the Battle of Algiers, specifically on site versus the "courtesan" battle in Paris.

I honestly meant to get back to it.

And forgot.

I have no excuse other than that.

As far as the "demand", which you perfectly, and deservedly, mocked me for, I might add, I ruefully chided myself in the same thread, in my way of noting it to myself, albeit in a public fashion.

Please consider this MY personal apology for intruding on your time.

I have big feet. I step on toes from time to time and not realize. until later, that I've "done it again".

I lectured once.

I won't do it again to you.

Unless you ask.

[Melinda Romanoff]

I have a specific example of a slice of unregistered, unregulated, and unlisted security that would house itself within a synthetic CDO (or CLO, mind you).

The mechanics at Zero Hedge lay the metal to the wood in displaying the simplicity of it all.

(It still makes me sweat, reading those numbers. I had to play with this carp every morning.)

[anduril]

Forget it, Melinda. I've stuck my foot in it occasionally, most recently re a combat video. However, I hope I made it clear on that occasion--as well as discussing GS with Jim Rhoads and others--that I'm 1) willing to learn and acknowledge when I'm wrong and 2) have a somewhat thick skin. If you want to save me embarrassment, feel free to do so--but spell out the particulars. I can take it.

[Melinda Romanoff]

anduril-

More tomorrow, and lots to cover.

And my skin is really, really thick, you have no idea.

You have opened a can of economics that you're not going to be able to get the lid back on.

And I don't forget apologies. Especially the ones' (yeah, that's plural) I've made.

Nobody here does. It keeps us civilized.

G'night, anduril.

[anduril]

You have opened a can of economics that you're not going to be able to get the lid back on.

Well, I said I was soliciting comments and I meant it. I'm interested.

[JM Hanes]

Sorry anduril, missed the link on page 1.

[anduril]

The mechanics at Zero Hedge lay the metal to the wood in displaying the simplicity of it all.

I hardly understood a word of it, but it looks EVIL. And I don't for a moment believe that most "sophisticated investors" would understand it, either. To my proposal to let Bernie Madoff out on work release to serve as arbiter of "sophisticated investor" status, I add a slight modification of an old saw (erroneously credited to P. T. Barnum): There's a sophisticated investor born every day. People buying into the Goldman disinfo re "sophisticated investors" need to read up on Long-Term Capital Management.

[Melinda Romanoff]

anduril-

most of the piece was done in "Street" shorthand, and, if translated to plain english versus StreetSpeak (done for speed) you would have no problem with any of the language.

Just keep in mind Each paragraph was an instruction set for what I had to face each and every morning. It's what I got paid to do, build the hedge, or "rate lock" for each scenario, every day.

I won't go into the surprise phone calls from the Japan desk, telling me "I had a problem", when the scenario shifted due to something the BOJ did.

And GS is not running a "disinfo" campaign, they are, to me, getting railroaded by the administration betting on the public not "getting it".

The hearings on the Hill Monday will tell you all you need to know. Dodd can not let any of the witnesses answer simple questions, they must be obstruse, if allowed to answer at all. I'm betting on the latter.

As far as the swaps paper, I will break each scenario down and we will go through it. But I can't right now.

Deal?

[anduril]

No deal. I'm not really interested in the abstruse technical details of the deal. I'm interested in the legal implications of Goldman's representations leading up to the deal. From that standpoint, the email trail should give any observer pause for careful thought.

As for my statement re "Goldman disinfo," what I was referring to was the nonsense about "sophisticated investors." The people who ran Long-Term Capital Management were, by most ordinary measures, as sophisticated as any group of investors could reasonably be expected to be. They also landed themselves and us in one helluva mess, with implications for the present, if I'm to believe some of the commentary. In retrospect they can be seen to have made some very basic reasoning mistakes, so you can call me a confirmed sophisticated-investor-skeptic.

Is Goldman getting railroaded? No. They'll get their day in court--a day they will have no trouble affording--if they really want it. If they don't, then they can try settling. That said, I'm certainly not foolish enough to predict the outcome of the case based on my current knowledge of it, and I'm perfectly open to the possibility of a political motivation to this case in a wider context, which I outlined earlier (a confluence of Basel III, financial reform, etc.). Certainly, if I were a betting man--which I'm not--I'd be betting that Goldman will come out OK in the long run. Partly through their input into this bogus "reform" bill. I'll be keeping my eye on what happens re Cap 'n' Trade, which seems to be rearing its ugly head again.