1. Goldman Sachs' Senior Bond in Trust Certificates: I mentioned in my Friday post that I bought just 50 shares of a trust certificate containing a senior GS bond: Bought 50 PJI at 20.8
There are six fixed coupon Trust Certificates that contain the Goldman Sachs' senior bond maturing in 2033. This is the link to the FINRA information about this bond. Finra shows that Fitch rates the bond A+. Moody's is at A1 and S & P rates the bond at A.
These six fixed coupon trust certificates are:
The market prices are as of the close on 4/16/2010. My purchase of PJI was made with a limit order at $20.85. I lifted the yield information from Marketwatch without attempting to verify it.
So, this is close. I went with the slight current yield advantage of PJI. I could eliminate HJG on the current yield disparity, and DKP on both current yield and YTM. I figured JZS, PYB and PJI would be close on YTM without checking it. While preparing this post, I checked the YTM using the Morningstar Bond Calculator. I found JZS had a YTM of 7.58%; PYV was at 7.57%; and PJI was slightly better at 7.64%. This is not material to me. I would just go with the current yield advantage on this one, assuming the same ease in purchase.
There is also a synthetic floater, GJS, which I have bought and sought many times, linked to the same bond.
Sold 100 GJS /Bought 100 GJS AT $13/ /GJS VS. PYT NOW Bought 100 GJS at 12.25 Bought 100 GJS at $10.5 (April 2009).
2. GOLDMAN'S DEFENSES OR ARGUMENTS-POTENTIAL EXPOSURE: After reading more about the Abacus investment deal doomed to fail from its inception, I thought that it would be worthwhile to summarize what I perceive to be arguments in Goldman's defense.
To borrow from the noted legal beagle W. C. Fields, never give a doofus an even break. (Never Give a Sucker an Even Break) The Abacus 2007-AC1 deal was a private placement with European banks acting as the primary patsy. Theoretically, these banking institutions were sophisticated participants and had access to the same information as Paulson. If those banks believed that subprime mortgages from borrowers with low credit scores who purchased over priced homes in California, Nevada and Arizona were good investments, then they have no one to blame but themselves. The flip book states that Abacus is only being offered to "sophisticated" institutional investors. (page 3 Disclaimer: Abacus 2007-Ac1 Flipbook 20070226) There is also a statement in the Disclaimer about the risks of this security and investors in it "should be prepared to suffer a loss of their entire investment".
The flip book also contains the following material statements:
"Goldman Sachs may, by virtue of its status as an underwriter, advisor or otherwise, possess or have access to non-publicly available information relating to the Reference Obligations, the Reference Entities and/or other obligations of the Reference Entities and has not undertaken, and does not intend, to disclose, such status or non-public information in connection with the Transaction. Accordingly, this presentation may not contain all information that would be material to the evaluation of the merits and risks of purchasing the Notes.
Goldman Sachs does not make any representation, recommendation or warranty, express or implied, regarding the accuracy, adequacy, reasonableness or completeness of the information contained herein or in any further information, notice or other document which may at any time be supplied in connection with the Transaction and accepts no responsibility or liability therefore. Goldman Sachs is currently and may be from time to time in the future an active participant on both sides of the market and have long or short positions in, or buy and sell, securities, commodities, futures, options or other derivatives identical or related to those mentioned herein. Goldman Sachs may have potential conflicts of interest due to present or future relationships between Goldman Sachs and any Collateral, the issuer thereof, any Reference Entity or any obligation of any Reference Entity. " (page 8)
In his Barrons column, Andrew Bary adds an important fact about ACA Mangement that is neglected in most news stories, and it is also material to Goldman's defense. ACA had every incentive to act in the interests of investors in Abacus because it issued a 900 million dollar guarantee on the deal. And this is just unbelievable, these "experts" at ACA in mortgage back securities received 4.5 million for guaranteeing 909 million of the securities in this pool. The government does mention this guarantee starting at paragraph 61 of the complaint against GS: online.wsj.com .pdf
ABN Amro, which owned ACA, backstopped ACA for just 2 million and ended up losing 841 million when this CDO collapsed, which is what Paulson's firm expected it to do. I thought that was a joke when I first read it. So ABN AMRO was doing its best to imitate the financial wizards in AIG's Financial Products Unit, picking up those pennies and nickels in front of a steam roller. Paulson's firm asserts that ACA had the sole legal authority to choose the securities in the Abacus CDO, which I suspect to be a true statement.
Then there is a question of whether Paulson's role in helping ACA to select the securities to be included in Abacus was even material under these circumstances. Paulson would not have been well known at the time. The ratings from Moody's and S & P, slavishly followed by the lazy, would be more important than the selection process for the securities in the Abacus CDO. The ratings of the tranches of this CDO can be found at page 14 of the Flip Book. And it may have been generally known that the "sponsor" of the CDO would play a role in the selection process. The very nature of this synthetic CDO would reveal that some participants would be betting on a decline in the underlying securities. I would add that it would be in the interest of ACA's employees to claim that they were duped rather than to blame themselves for being stupid.
Another factor weighing in favor of Goldman would be that the firm purportedly lost over 90 million of its own money investing in the deal. While this does not excuse the alleged failure to make material disclosures, it is evidence that GS did not consider Paulson's role as material.
The timing of the Complaint is also suspicious as the financial reform bill is nearing its showdown phase, as the GOP senators line up in united opposition to the Democrats' proposal. The war of words heated up as Obama characterized Senator McConnell's assertions in opposition as "cynical and deceptive". CSMonitor.com While I regard that as an accurate description of what the GOP is doing now, that is beside the point. For purposes of this discussion, the point is simply that the Complaint filed against GS has occurred in the context of this charged political atmosphere. Once that simmers down, the Feds may be willing to compromise with GS, allowing GS to pay a small fine without admitting or denying anything, which is important in the event that civil suits are filed against GS.
A professor of securities law wrote a column in the NYT claiming that the maximum penalty in the SEC's action "may" be the 15 million that Goldman was paid to put the deal together, plus the $500,000 penalty for civil fraud. The real danger to GS would be in refusing to settle the case for a slap on the wrist, and force the SEC to try the case before a jury. If GS then loses, the professor points to a 1979 Supreme Court decision, that would allow the institutions who lost money to use that fraud verdict to estop GS from relitigating the fruad issue in a subsequent civil case for damages. PARKLANE HOSIERY CO., INC. V. SHORE, 439 U. S. 322 :: Volume 439 :: 1979 :: It would behoove GS then to settle this matter in a few months, when the hyperventilating from the press dies down, rather than risk an adverse verdict in the SEC's case. A settlement, where nothing is admitted, could not be used in subsequent civil proceedings for damages.
ProPublica recently published an article about how another hedge fund called Magnetar helped to create CDOs of the riskiest parts of CDOs and then bet against its own creation. An independent analysis by ProPublica found that 96% of the Magnetar deals were in default by the end of 2008. The German Bank, IKB Deutsche Industriebank, mentioned in the SEC Complaint against Goldman (WSJ) as one of the duped buyers of the Abacus trash, was also a buyer in at least four of the Magnetar deals. IKB had to be bailed out by the German government. ProPublica Maybe the Europeans have at least learned a valuable lesson about dealing with American financial wizards. (Magnetar claims that the press does not comprehend what it was actually trying to do: see SEC Is Looking at Other Mortgage Deals - WSJ.com)
A photograph of the Fabulous Fab can be found in this article from the Telegraph. All of the events in question occurred before the Fabulous Fab reached his 30th birthday.
Taking into account all of the above, the Fabulous LB would not characterize the government's case as strong or good, and that is after giving the government the benefit of the doubt on the allegations made against Goldman in the recently filed Complaint. This will not stop politicians from pushing government regulators to file suit against GS here and abroad, however. The U.K. P.M., Gordon Brown, who is in a tight race for re-election in just 3 weeks, publicly requested the U.K.'s Financial Services Authority to investigate Goldman Sachs: MarketWatch Brown said he was shocked about the "moral bankruptcy" indicated by the events summarized in the SEC's Complaint: Bloomberg
Of course, I would never believe the statement made in the GS annual report that they put their clients interest first.
The masters of disaster have only one interest, making the maximum amount of money for themselves, and sometimes that requires throwing their clients under a train. And, the comment from Gordon Brown about moral bankruptcy, well, that goes without question.
Since the market is obsessing about this complaint against Goldman, and contemplating all kinds of worst case scenarios as if every imaginable plague was about to be visited on GS, I thought that it would be helpful to offer a preliminary assessment of the government's case which does not look that air tight and is leaky in several respects.
Thanks for your views on the SEC case against GS. It will be interesting to watch it play out. The timing is certainly suspect. Maybe Goldman bought compound put options on GS stock to profit from their own fall! (Just kidding. Or am I?)
ReplyDeleteThe market was due for a pullback anyway. Soon this will all blow over, like the ash from that volcano in Iceland.
The name of the volcano is Eyjafjallajökull, Now that sounds like trouble to me.
ReplyDeleteI thought your summary of the GS defense and penalties to be good and I know it wasn't meant to be a overarching view of the industry, but I thought I'd put in a couple pennies.
ReplyDeleteI'm not claiming to understand the intricacies of these financial instruments but my layman's take is the bigger picture with these lawsuits, civil or otherwise, is to enact regulation to reign in this disclosure fraud as well as the ratings failings.
Whether the case is "strong or good" Goldman is high profile and is the poster child for the unethical and morally bankrupt levering of the synthetic CDO's which had no actual loans in them but were insuring re-processed triple B minus rated loans re-engineered to look like triple A rated debt instruments. Goldman and their ilk took advantage of the apparent ineffecient ratings guidelines or regulations.
If this was the car industry, there would be outrage. But because Goldman and others have used the terms of their clients and buyers as "sophisticated" I guess that's supposed to let the sellers and engineers of disaster off the hook? I'm sick of hearing about how this industry should get a pass because of their Ivy league credentials, their high IQ's and the "sophisitication" of their industry.
Morally and ethically, many of them are used-car salesman trying to get your money at any cost and that may be giving used-car salesman a bad name. But we call their engineers and mathematicians "financial wizards." They are morally bankrupt and need to be reigned in with regulation. If you were the one before the car industry was regulated who bought a 'lemon' handpicked buy a guy who specialized in identifying cars that would implode within a short period of time but represented to you as a the best quality you could purchase, would you only blame yourself if you took it to your mechanic and he told you it passed the certification process?
I think you'd want the certification process beefed up as well as the laws for brokering cars.
I'm not saying the likes of AIG FP are not culpable. In fact, in many ways, there were WORSE in their morally bankrupt pursuit of greed. Enter AIG FP's Cassano, who is another great example of why we need more regulation (can you say "Master of Disaster"). However, at least initially, I don't think they knew the true proportion of subprime loans they were insuring by purchasing these CDO's and I believe that was based on the rating agency failings in combination with the engineered manipulation of those agencies by Goldman and company.
To say "they should have known" misses the a critical point in my view as now we're assuming individuals are privy to all the disclosure/information they need to make an informed decision as well as acting in a way responsible enough to not endanger the whole financial system and ultimately have their sins and risk paid for by responsible tax payers (e.g. bailouts). In this case the levered/systemic risk being taken on didn't proportionately match the due diligence it should have required to evaluate.
At any rate, the apologists for Goldman like Cramer need to focus on the real motivation behind the SEC bringing these cases, that is, overdue regulation on how these (levered) structured products are rated, disclosed, and collateralized.
A major problem for the government's case is that ACA was in the business of evaluating mortgage risk, and supposedly in a better position than a hedge fund manager to evaluate and assess the risk of these securities. This topic is discussed in this article: http://online.wsj.com/article/
ReplyDeleteSB10001424052748703594404575192483794335778.html
The ratings agencies were a major source of the problem and nothing has really been done yet to remove their conflicted state.
I would agree with you that this transaction served no economic purpose. Those securities were just being recycled. The entire purpose was to create a vehicle for Paulson to buy a CDS on the securities, which would pay his firm a great deal if he was correctly bearish but cost him a great deal of money if the other sophisticated parties in the transaction were right. This is nothing more than casino gambling.