Goldman Dealmaking and Politics Election 2010 at Issue in SEC Lawsuit

* Goldman Sachs redux - I received a lot of email from folks yesterday, mostly telling me that the SEC lawsuit is a bad thing for Goldman, and not something to be easily dismissed. Let me also weigh in on some additional information which has come out over the last 24 hours, and in response to various reader’s feedback. Please note that since this story has received so much coverage from so many sources, that I was trying to avoid it altogether. But the feedback from yesterday’s blog forces me to expand the conversation:


1>    It is entirely possible that what Goldman Sachs did, as it pertains to the Abacus CDO’s origination, by not disclosing the involvement of various market players, was illegal by the letter of the law. For this there is no excuse.


2>    On the side of the SEC, they have put their most competent investigator on the Goldman Sach hunt. This is the same guy who chased the family behind the Crazy Eddie’s electronic scandal 20 years ago. This guy haunted the family, who had been skimming money for years from the business, and was hiding the cash in strange places. This investigator persisted for a better part of a decade and many years later, was able to recover skimmed cash in the ceiling of a family member’s residence. This guy earned the nickname, “Pit-Bull”, and it is the belief of many, that he will exact some measure of victory against Goldman Sachs.


3>    I will however say that it was common practice to line up both the short and the long sides of synthetic CDO’s during this time period, prior to a deal getting done. This is because a synthetic CDO comes into being because one party is willing to bet that the underlying assets in a structure will default, and make the interest payments on those securities while they are waiting for the underlying assets to default. On the other side of the ledger, you have the investors in the CDO betting on the success of the underlying assets, for which they receive an interest payment, and take on the risk of loss of principal if the underlying assets default. In other words, it takes both sides, the long and the short side to participate to create a synthetic structure, such as the Abacus CDO in question. And let me say that it was common practice to line up both sides of the trade before creating these types of bonds, by the billions. While I am not trying to dismiss Goldman, or any other Investment Bank (IB) for omissions of disclosure, as someone who was involved in this business on a real time basis, let me suggest that the guy betting against the synthetic trade typically did have some input as to what went into these structured investments; if not the exact portfolio, then usually by requesting the IB follow some sort of parameters in the creation of these portfolios.


4>    There has been some chatter about the SEC’s law suit was timed to over-shadow a very critical, 160 page report, effectively damming the SEC for failing to shut down Alan Stanford’s $8 billion scam. There was a very sharp, anti-SEC editorial in yesterday’s WSJ. Here are a few points from that editorial. In the IG’s report, they cited the fact that the SEC knew about the Stanford scam before he took in the bulk of the $8 billion which was lost. In addition, an SEC investigator who was on the Stanford case, eventually left the SEC and went to work for Stanford. On a real time basis the WSJ editorial suggests that the SEC failed miserably by not pursuing Stanford when it could have saved investors almost $8 billion, and that the Goldman lawsuit is a smokescreen for their collective incompetence.


5>     The fact that the SEC was split along political lines, with the 3 democrats voting for pursuing this case is also notable, and many commentators think there is a political agenda here. Especially since this is timed to coincide with the Democratic initiative to pass financial reform. The thinking being with the SEC pursuing a big case against the biggest IB out there, that Republicans would be discredited if they did not go along with financial reform. I think it is disgusting that the Democrats would pursue such an agenda, but as I get older, less and less seems to surprise me.


6>    News reports up until yesterday, made it seem as if Goldman was given a chance to settle with the SEC. It came out yesterday, that was not the case. So let me correct that piece of mis-information from yesterday’s blog. If Goldman was NOT given a chance to settle with the SEC ahead of the suit becoming public, then it means that the SEC has a different agenda in mind, than just justice. This timing and lack of forewarning to Goldman leads me back to thinking that the timing had political motives or to act as a smoke screen for the IG’s report on the SEC’s bungling of the Stanford case.


7>    Today, Paolo Pellegrini, the Paulson employee at the time, who was at the meeting with ACA, said he did not pick out what securities to put in the deal, just that they preferred securities which had low FICOs and high LTV loans. And according to Pellegrini, it was obvious that Paulson was taking the short side of the trade, contrary to conflicting news reports that Paulson was disguising their involvement as being on the long side of the trade. This is a blow against the SEC case. It still does not speak to whether there should have been some sort of disclosure about the involvement of derivative players behind the scenes.


In short, there are many plots and sub-plots here. Read yesterday’s WSJ’s editorial. It is short, and quite a read. In my opinion, GS and other IB’s might have been violating SEC disclosure rules all along. It is how the business was getting done at the time. As for specifically singling out Goldman, I think it is wrong, and there seems to be other objectives which the SEC, the Democrats, or both, are pursuing with this case, and its unique timing last Friday.


* Greece - yields on Greek bonds (3 to 10 year maturities) are now above 8%, the highest level seen in the current crisis. Of course, it did not help matters much this week, that a German official has said that Greece will need 80 billion euros, up from the 40 to 50 billion euro estimate from earlier statements. On this news, Greek yields have been pressing higher, as the 80 billion euro requirements is greater than the 50 billion euro package from the EU and the IMF. Over the near term, the higher yields will insure that Greece tap the EU/IMF package over the next month, as they have to roll-over maturing debts. Stay tuned for more.