Question about John Paulson / M-securities

[asphaltgambler]

Can someone here explain in layman's terms how one Guy could "invent " mortgage backed securities and then get the entire world onboard? ? I understand greed and short term profits but how do you sell that bag of ***** to the people that are supposed to be regulating these guys??

[jyl]

I'm not an expert on this stuff but here's the short version.

Neither Paulson nor Goldman invented mortgage backed securities. There were lots of MBS before the Abacus deal.

Paulson wanted to short the US housing market. He got Goldman to put together a MBS backed by pools of mortgages that he, Paulson, helped select. He chose those pools that he felt were most likely to decline in value.

Goldman packaged these as the so-called Abacus deal and sold them to large, supposedly sophisticated, institutional investors. Just another of the many MBS deals that were being done at the time.

Paulson took a short position on some part of the Abacus MBS, presumably with credit default swaps (CDS) though I haven't read exactly what tool he used.

The housing market blew up and Paulson made a lot of money, the investors who bought the Abacus MBS lost a lot of money. Goldman got their fee.

As it turns out, Paulson could probably have shorted any MBS and made the same profit, because the whole market blew up. Presumably the collapse was much greater than he expected at the time, otherwise he wouldn't have bothered to get Goldman to put together this specific MBS.

The investors who bought Abacus were big banks and other large institutions. They lost lots of money, on all sorts of assets of which Abacus was a small part.

Paulson's investors, who were probably a mix of wealthy individuals and other institutional investors, made a lot of money on shorting Abacus. So did Paulson.

Separately, by the way, Goldman held MBS as part of their own assets. At some point they became concerned about the housing market too, and shorted the market with CDS. This hedged their portfolio so that their direct losses from the MBS collapse were largely offset by profits on the short postion, and their net loss on MBS was much smaller than suffered by other banks. They lost plenty of money even so, though, because all assets fell hard in value, not just MBS. I don't know if they invested directly in Abacus.

Basically, in the micro view, this was a deal done between big boys, all of whom knew they were taking risks, could win or lose big, and were being well-paid to make the correct bet.

In the macro view, the losses inflicted by Abacus on the investing banks were one more thing among many that drove some of them to near insolvency, which was one more thing among many that drove the global financial system to near collapse in 2008, which was the main thing that forced governments around the world to take desperate and dramatic measures to stave off a second Great Depression. Those measures succeeded - the financial system did not collapse and we had a "Great Recession" which is at least better than a Great Depression.

The people doing the deal probably had no idea how dramatic events would be or that they would be helping to drive the financial system to the brink. I'd say it wasn't their job to care. The point of capitalism is that individuals act purely in their own financial self-interest, while appropriate laws and regulations constrain the behaviour that would be most harmful to the country as a whole.

The MBS market was not heavily regulated at the time. The trend for the past few decades had been to de-regulate the financial system and let market forces work. So I doubt that the structure of the Abacus deal was illegal in any manner. Whether Goldman committed any fraud in selling the Abacus deal, I don't know. I don't think a salesman has to actually believe in the product that he sells, but I suppose he can't factually misrepresent, and whether they crossed that line is unknown (to me).

[asphaltgambler]

thanks for the detailed response. ...........UFB..............I think I need an education in these financial matters.....My understanding when reading the news often falls short

[jyl]

Get a subscription to Economist and read it weekly - its the most neutral, thorough and thoughtful periodical on global economics, politics, and some general-interest news too (science, culture, etc). Not completely neutral, but their bias is pretty obvious, they even refer to it, so you can filter it out.

TV news, most newsweeklies, and almost all daily papers are for crap on anything complex. CNN is no good. FOX is also worthless, they seem to hire people for their breasts not their brains. CNBC is entertainment not analysis.

New York Times is good but rather costly for home delivery, and they tend to have multiple articles over several days or weeks on a subject, rather than a single weekly piece. Wall St Journal is good but maybe a bit "in the weeds". NYT and WSJ both have evident editorial biases, I don't bother to read anything on either's editorial page.

Internet financial blogs are a seriously sketchy information source on this stuff - they are often very knowledgeable, but they almost always are trying to push a particular view and don't seem to have any concept of presenting both sides of the issue, often this crosses over into being downright misleading. Plus, 90% of bloggers seem to have a permanent negative/bearish bias - some events actually are positive/bullish, and they can't seem to comprehend that.

There are some blogs by actual economists that can be very good, but kind of dry.

[Porsche-O-Phile]

Great summary John - that's exactly my understanding of this too.

The issue is one of full disclosure to clients, rather than simply hedging ones position. Everyone knew the housing market was going to implode sooner or later, it was perfectly logical to be taking straddle positions - but these absolutely should have been disclosed as a matter of ethics and proper protocol.

And +1 to the comments re: CNN, MSNBC, Faux News, etc. Pure entertainment to sell Viagra ads. Little or no content.

[asphaltgambler]

Thanks! !

[Rich76_911s]

I see it like this.

Paulson and Goldman got together and put a 911 together. They went out and found the worst chassis they could find. Rust, accident damage, etc. Then they went and found a motor miester rebuilt engine and transmission that had been sitting in a barn for a decade to drop into it. Once they slapped a pile of bondo on it, spray some paint, and did some sneaky tricks to clean up the engine and transmission they put it on ebay with a PPI that says everything is awesome. The PPI was done by an independant shop. It sold and a week later the car broke and is worthless.

If a used car salesman pulled this kind of stunt and got caught he'd be fined and put out of business. But if you do it for a billion dollars and use mortgage backed securities somehow it falls under a completely different set of rules, and the hurdle for prosecution is set so high it is near impossible to be charged let alone attain a guilty verdict.

I believe investors come to the United States as a place to invest because they believe we regulate our markets and avoid fruad. Transactions like this simply devalue the United States as a place to invest.

[jyl]

Would he (the used car salesman?). If he didn't say anything specifically false about the car, let the independent shop's PPI do the talking ("how is the engine? well, look at the PPI"), and the buyer was a car dealer with a staff of mechanics and body/paint guys who was himself in the business of buying and selling used 911s? I doubt the buyer would have any recourse. This isn't about selling a used car to grandma.

[Rich76_911s]

I honestly don't know the law well enough to say with certainty that a used car salesman who intentionally withholds information could be prosecuted or not. Honestly the law should be independent as to whether the car is being sold to grandma or victory motorsports. The intent to deceive was in motion from step one of the process.

Goldman can hide behind curtains (S&P, Moody's) and escape conviction, which I am certain will be the case, but at the end of the day the answer will be the same. They designed a product they knew with a high degree of certainty would fail, sold it to customers knowing it would fail, and reaped huge rewards for their actions.

Maybe I am naive to think that intentionally screwing a customer shouldn't be normal practice, and our allowing it to happen (routinely now out of Goldman) is devaluing the integrity of our markets.

[jyl]

I agree it is unsavory, and that the banks/investors should take it out on Goldman by withholding future business. I don't know if they did/are. I haven't heard that they ever sued Goldman, which is interesting. It is an extremely competitive and avaricious business, and everyone is used to making profits off the losses of others and vice-versa.

[Mo_Gearhead]

The Senate hearings for G/S are just another attempt to make 'Wall Street' out to be the big-bad-boogie-man in the eyes of the general public. They make it sound as if Goldman was selling these 'bundled securities' to Maw and Pa Kettle in Podunk, Arkansas - and thus 'tricking' some poor innocent investors.

I don't know how much money we are talking about (in these individual bundled groups of mortgages) - tens of thousand ...hundreds of thousands ...millions? But I suspect the latter. These were not bought by some rube trying to up his portfolio
from penny stocks. When securities of this magnitude ($$) swap hands, we are talking about individuals/firms that are taking risks. Every share traded on the Exchanges daily has a buyer and a seller, each one thinking they are doing the right thing. Some (including several on this BB ) predicted that housing was a bubble - while MANY thought it was a free ticket to riches. We found out who was correct.

As I stated on another thread; If I place several types of dog shyte in a paper bag and price it - and you present yourself as an expert on dog shyte and purchase it from me - who's the larger fool?

[asphaltgambler]

............to me. ...........this is fascinating


..

[Zeke]

Originally Posted by Rich76_911s

I see it like this.

Paulson and Goldman got together and put a 911 together. They went out and found the worst chassis they could find. Rust, accident damage, etc. Then they went and found a motor miester rebuilt engine and transmission that had been sitting in a barn for a decade to drop into it. Once they slapped a pile of bondo on it, spray some paint, and did some sneaky tricks to clean up the engine and transmission they put it on ebay with a PPI that says everything is awesome. The PPI was done by an independant shop. It sold and a week later the car broke and is worthless.

If a used car salesman pulled this kind of stunt and got caught he'd be fined and put out of business. But if you do it for a billion dollars and use mortgage backed securities somehow it falls under a completely different set of rules, and the hurdle for prosecution is set so high it is near impossible to be charged let alone attain a guilty verdict.

I believe investors come to the United States as a place to invest because they believe we regulate our markets and avoid fruad. Transactions like this simply devalue the United States as a place to invest.

I think you missed the part where the 911 became the object of a new entity in which there were investors. Then, the 911 constructors sold short and made way many times more money than simply selling a junk car for a high price.

[Rich76_911s]

Ha yeah Milt I try to keep things simple so I can understand them. GOOD to see you back by the way.

Looks like the SEC and Goldman are going to settle out of court.

Reuters

Goldman set to settle SEC fraud case soon: report

05:51 AM EDT LONDON (Reuters) - Goldman Sachs may soon settle its fraud case with the U.S. regulator, the New York Post reported on Thursday, opting to end a legal fight rather than endure a repeat of the public flogging it received this week. The Post report, citing sources familiar with the matter, said Wall Street's top investment bank was mulling closing the fraud case with the U.S. Securities and Exchange Commission (SEC) to limit damage to its reputation. "It's almost a certainty that there will be a settlement," the paper quoted a source as saying. Goldman could not immediately be reached for comment in London. Goldman Chief Executive Lloyd Blankfein and other executives faced a blistering cross-examination from U.S. lawmakers about the company's ethics and behavior toward its clients on Tuesday. The SEC has filed a civil fraud suit against Goldman, charging that it hid vital information from investors about a mortgage-related security. Goldman has denied the charges. (Reporting by Steve Slater and Douwe Miemema, Editing by Sitaraman Shankar)

Doesn't really come as a surprise. This whole parade seems like it was a walk in the park between two old friends. Not to make this political but it is also being settled the day after Republicans happened to block the bank reform bill.

[Rich76_911s]

Originally Posted by jyl

I agree it is unsavory, and that the banks/investors should take it out on Goldman by withholding future business. I don't know if they did/are. I haven't heard that they ever sued Goldman, which is interesting. It is an extremely competitive and avaricious business, and everyone is used to making profits off the losses of others and vice-versa.

The "free market" response of less business to Goldman is an integral part of regulation. My opinion is that for the US to continue it's dominance as a safe harbor to invest, we need to take things a step beyond the free market response at times. No doubt that is just my opinion and I hold myself to very high ethical standards, maybe too high for Wall Street.

You are right business is business and trading is one where money goes from one person to another without value being exchanged (both parties in a transaction can never come away satisfied). I honestly don't mind when people outwork someone else and win in trading, but this time it looked more like taking money than making money. At least from this outsiders perspective.

It is also interesting that business flow to Goldman does not ever seem to slow, so maybe this is a smaller problem than I perceive.

[chocolatelab]

I thought the dog and pony shoiw in congress was some of the most interesting TV I've watched

I watched almost the entire telecast of the goldman folks getting grilled in congress.

I thought the discusion about when or what makes something crap was interesting.

At any point a particular security can go from crap to worth buying when it strikes the right price.

That 76 rusty 911 is crap at 18k is crap but looks very good at 2.4k

Maybe for you and me that transision from crap to gem never happens but for large financial institutions it occurs regularly.

If you think about it every seller see's the product they are unlaoding as having diminishing returns and every buyer feels the opposite.

Does that mean I would have ripped you off if I sold you that 76 911 for 2.4k.

I guess its a mater of opinion.

I understand this situation is slightly different but it is really interesting to consider........