John Paulson - A Credible Defense?

Guest Post By David Fiderer

John Paulson Defends His Toxic CDOs By Insulting Everyone's Intelligence

John Paulson, the hedge fund investor behind the toxic CDO
referenced in the S.E.C. complaint, ratcheted up his
nobody-saw-it-coming rhetoric, with a letter nominally addressed to his own investors but clearly intended for a broader audience of ignoramuses and amnesia victims:

"It is easy to forget that before the collapse, the
overwhelming view of investors, ratings agencies and economists was
that the housing market was strong and would continue to get stronger."

The opposite is true. Nobody was saying that the housing
market was strong and would continue to get stronger during the weeks
prior to April 26, 2007, the closing date of Goldman's notorious Abacus 2007-AC1.
There are countless ways to discredit Paulson's statement, just as
there are countless ways to discredit his claim that he operated in "good faith." (As Vanity Fair was kind enough to point out, Paulson's bad faith manipulations were first highlighted here on HuffPo seven months ago.)

Here's a brief sampling of the evidence that reveals Paulson's deliberate intent to deceive:

January 18, 2007: Moody's: "Early Defaults Rise in Mortgage Securitizations"

Mortgages backing securities issued in late 2005 and
early 2006 have had sharply higher rates of foreclosure, real estate
owned (REO) and loss than previously issued securities at similar,
early points in their lives. These "early default" measures have been
primarily visible in the subprime universe, but are not limited to that
sector. Moody's is currently assessing whether this represents an
overall worsening of collateral credit quality or merely a shifting
forward of eventual defaults which may not significantly impact a
pool's overall expected loss.

What Moody's Overlooked And What John Paulson Understood:
That last sentence, above, makes no sense. If the loan write-offs are
front-loaded, the total loss, by definition, is worse, because fewer
well-performing loans provide less interest and principal amortization
in the subsequent years. It's Finance 101. Regular mortgage-backed
securities, as opposed to CDOs, are static portfolios. They are not
like a dynamic loan portfolio managed by a bank, which may suffer a
higher-than-expected loss in one quarter to be offset by a
higher-than-expected profit in a subsequent quarter.

The well-performing loans in a mortgage pool will never pay back
more than 100% of their respective principal and interest. And a
sooner-than-expected credit loss erodes the equity cushion present at
closing. As noted earlier here and here,
these deals were capitalized with $103 worth of mortgages for every
$100 worth of debt. The ratings agencies assumed that the 6% lifetime
credit losses would be somewhat back-loaded, so that the pool would
generate interest income to offset the expected credit defaults.
Moody's assumed that about 80% of the credit losses would be spread out
over years 3 through 6.

By year-end 2006, the rate of foreclosures plus REO for the ABX (2006-1),
a composite of subprime bonds like those in Abacus 2007-AC1, was 5.7%.
One month later, it was 6.3%. This percentage, which had been growing
at double-digit rates for more than a year, foretold that the BBB and
BBB- tranches, in the bottom 5% of capitalization, would get wiped out.

February 22, 2007: Bloomberg: "The BBB- rated portions of ABX contracts are 'going to zero,'''...

The BBB- rated portions of ABX contracts "going to zero,''
said Peter Schiff, president of Euro Pacific Capital, a securities
brokerage in Darien, Connecticut. ``It's a self-perpetuating spiral,
where as subprime companies tighten lending standards they create even
more defaults'' by removing demand from the housing market and hurting
home prices, he said.

Peter Schiff wasn't psychic. He had done the math, and, unlike so
many so-called sophisticated investors, did not piggyback off of
someone else's due diligence.

February 22, 2007: MarketWatch: "Sub-prime gloom picks up after HSBC warning"

Foreclosures jumped 35% in December versus a year earlier,
according to recent data from RealtyTrac. For the fifth straight month,
more than 100,000 properties entered foreclosure because the owner
couldn't keep up with their loan payments.

March 12, 2007: CNNMoney.com: "Subprime: The risk to Wall Street
As subprime woes widen, the money machines at Morgan Stanley, Goldman and other banks may sputter."

March 13, 2007: CNNMoney.com: "Scary math: More homes, fewer buyers"

Subprime lenders are already getting crushed, but the
impact rising mortgage delinquencies will have on home prices overall
is still an open question. At a minimum, it means financing is drying
up for those with less-than-perfect credit and that spells fewer home
buyers.

And foreclosed properties will add supply to a housing market that already has too much.
"It's
going to be a really big deal," says Dean Baker, co-director of the
Center for Economic and Policy Research. "[National] inventory is 20
percent higher than last year, vacancy rates have soared and prices are
down about 3 percent," he says. "Now, with the tightening of credit, I
don't see how prices don't fall another 5, 6 or 7 percent."

The tightening of credit could take as many as one million buyers
out of the market, says Baker, citing Bear Stearns research. "Even if
you cut that in half, say to 400,000 or 500,000, that's huge."

Mark Zandi, chief economist for Moody's Economy.com, is also
concerned. "I think the subprime problems will take housing activity to
a whole other level," he says. Zandi is projecting a doubling of
subprime defaults this year to 800,000. "Those homes will go on the
market at a discount and will weigh on the market," he says.

March 19, 2007: Forbes: "Subprime: The Next Wave Of Corporate Fraud Probes?"

New Century Financial Corporation, a major subprime
mortgage lender, is a good illustration of the trends roiling the
industry. During the first nine months of 2006, New Century has been
forced to repurchase hundreds of millions of dollars of mortgage loans.
On Feb. 7, 2007, the company announced that it would restate its
earnings for the first three quarters of 2006 due to accounting errors
in connection with repurchases.

Now, New Century has received a grand jury subpoena in a criminal
investigation by the Department of Justice, and also faces a parallel
civil investigation by the SEC. Numerous states have barred New Century
from making new loans, and are now conducting their own investigations.
And the company's shares have been delisted from the New York Stock
Exchange.

Back then, people did not know how bad things would get because,
after all, 40% of subprime mortgages were extended with limited or no
documentation, which is why they were known as "liar loans." But they
knew it would be bad, and they knew, if they did the math, that the
BBB- rated tranches would get wiped out. Paulson wants us to believe
that almost no one else had figured this out. Alan Greenspan
claims, "there's a very small group -- most of whom are my friends --
who got it right for the right reasons...I know four or five people who
are really good. I don't know six, seven, eight or nine." At least
that's what John Paulson pays him to say.

Comments

[BlackBeard]

speaking of lawyering, here's Elliot Spitzer on Government & Markets:

http://fora.tv/2009/11/12/Eliot_Spitzer-Governments_and_Markets-From_Rand_to_Feinberg#fullprogram

[starfish]

Thanks for the link. I watched and learned.

[Cammy Le Flage]

Oh for the love of jesus mary and joseph.  He knew.  He should not even be talking right now as he is digging himself into his own hole (although he can afford it, but I am sure his little ego is busted - he has a HUGE one).  BOA was drained by Countrywide in 2005/2006 and in 2007 Countrywide burned such a hole in BOA that BOA had to just take it over and do some creative accounting etc.  Sheezzzzzz.... I knew in 2005 something was rotten in Denmark and I consider myself an idiot.  Mr. UVA trying to act like he made money honestly.  No one did in the past ten years if you truly think about it unless you are a fisherman selling fish off of your boat everyday.  The game is rigged.  It has always been rigged but lord have mercy, admit it is rigged and admit what you are doing or you just look like a douche.  Rich douches are still douches.  Mr. Paulson - you were in Virginia for a time.  You better start acting like it.  Time for reruns of the Wire to get a grip on reality....

[Sqworl]

DOES ROUBINI RING A BELL????? He called the crash in 2006...But no, the shills and pundits would not allow the bubble to burst!!!

[SDRII]

"Nobody was saying that the housing market was strong and would continue to get stronger during the weeks prior to April 26, 2007"

What? A guy shorts the house and by chance succeeds using the publicly available information put out by the very house he is shorting and he has to defend himself? You play the game that is not the one you want, which is a far cry from endorsing the current complex. Supposedly savvy instituional investors took the other side of these trades, preyed upon or not, and that is exploitation? Blame the rocket scientists who analysed the collateral and thought it a good trade. Blame the isnurance companies for exhuberance and negligence. Blame greenspan for the idiotic notion that credit derivatives lower risk in a closed system. Blame Rubin for rpeal of GS. And if this was such an obvious trade why is it that JP was one of the lone wolfs who actually put client capital at risk?

The weak argument here that he was wrong (or unpatriotic,, not sure) to short the market is mystifying? Does the poster think the same of the current buy buy buy equity markets? Isn't owning a share of apple the latest iteration of everyone deserves to own a piece of the american dream. 

Maybe this banker should focus his energy on the other Paulsen, namely Jim, and the rest of the long only pump monkeys who are perpetually incapable of any form of analysis. At least Paulson had the good sens to prey on the "sophisticated" instituioonal investors. And citing Peter Schiff as representitive of anything more than a voice in a wilderness further detracts from the credibility.

[Budd Fox]

Cannot agree more on this...THIS Paulson has the only merit of having f+@&ed up the big banks thoroughly when they were happy to sell him insurance they tought worthless on something they thought was invincible sure fire money makers. Find another target for politically driven lawsuits...this one would be defeated easily.

[Fraud-Esq]

Shorts are important to the market. But, this isn't a traditional healthy short position. The man CREATED the product to short it and used a bank to pimp it to other investors without disclosing his unique position in creating it to fail as fast as possible. And that is only one facet of many that makes these trades different from traditional, healthy shorting. Don't confuse this with "shorting" the market. That type of conflation is bad for the reputation of much needed market shorts who use logic with existing products.  

[Problem Is]

"The opposite is true. Nobody was saying that the housing market was strong and would continue to get stronger during the weeks prior to April 26, 2007..."

But Tyler: The Opposite is Reported in the Media as Truth

Lie is truth. Truth is... well just a conspiracy theory from a disgruntled blogger...

Steve Lies-man, Cramer the Clown and Larry "CokeHead" Kudlow will back me up on this one...

So will Rahm Baby and Obummer...

The lies and its associated propaganda will only get bigger on the escalator ride down. The Amerikan political class is an abject, corrupt, bought off failure owned by the oligarchy. Bananas all around everyone.

[Ragnar Danneskjöld]

nobody took Schiff and Roubini seriously then and they don't take them seriously now.  It's the boy who cried wolf.

[GoldmanSux]

This article claims to prove intent to deceive, but does no such thing. Poor.

[Shiznit Diggity]

ACA, not Paulson, had final say over the RMBS issues referenced by Abacus 2007-A1. If Paulson was allowed to have undue influence over the selection of those RMBS issues, ACA is at fault and potentially liable for breach of fiduciary duty.

[Fraud-Esq]

I agree. Do you think any conflicts of interest or special relationships between Goldman, Paulson, and ACA should have been disclosed if they existed? Who would be liable for the lack of disclosure? I assume both parties.

[demsco]

I disagree with all who blame Paulson. He made a bet, he was right and made money (that is the real crime I guess). He did not tell ACA he was long, he did not misled ACA and, as it turns out, ACA sucked at what it did. At the very least ACA misunderstood what his position was and that is unlikely as Pelligrene (spelling is wrong I know) said. Everyone seems to be missing the point, GS told IKB that the portfolio was picked by ACA, not Paulson. It was GS who broke the law and not Paulson. If Paulson went to IKB and said I am buying this and you should to when he was going short he would have defrauded them, but he did not. No one listened to Schiff in 2007, that is not a crime as he was a nobody, like Paulson, during that time. We all have the luxury of hindsight and want to believe what we want to believe.

However, I can assure you that in 2007 most people being paraded on TV and at brokerage houses new the market was imploding, privately, but publicly they said housing was great. I am sure I can go back and find positive articles on sub-prime, Alt-A and prime jumbos from that same period which shows the opposite of what was found in this post. Finally, clearly Paulson knew the market was going to implode which is why he went short, so what? The institutions who took the other side decided housing and junk loans would go higher.

Would we be having this conversation if Paulson lost money on this deal? Nope. He did nothing wrong and until all the info comes out uner oath we really know nothing about the case or evidence. Do you really think the SEC would not be charging Paulson if they had even weak evidence against him? Of course they would because he made money betting against America, gasp! I cannot believe I have to defend him, this is ridiculous.

[Cammy Le Flage]

Whose blaming Paulson?  He made money how he made it.  We are laughing at him for trying to explain that he did not do what he actually did.

[Fraud-Esq]

I tend to agree with you. What would you say, however, had ACA learned Paulson was short, confronted him regarding his mortgage selections, and agreed not to disclose his position to the investors? There is no evidence of this that I've seen. I'm just curious what your opinion would be under that circumstance.

[Ned Zeppelin]

Then ACA would be on the 10b-5 liability bus downtown with the Fabulous One and the Squid. 

[BoyChristmas]

Yes, we know the overwhelming view was that the real estate markets were strong going forward. THATS WHY EVERYONE LOST THEIR MONEY TO A FEW RICH A**F****. Go to hell, making money because you are smarter than everyone is one thing, doing it by joining in on a fraudulent scheme is nothing more than cheap tricks. Break up the big boys.  

[Tapeworm]

Why did the "regulators" allow synthetic CDOs to exist? Why did the FED do everything to mess up the rate curve so that the synthetics get a market?

 Perhaps all of this is a smokescreen to keep the heat off of the trillion dullar steaming heap on the FED books.

[GFORCE]

Paulson took huge risk going against an msm/tbtf bubble. The markets of mid 07 were playing as they are now but worse- there was actually volume then. So many couldn't join the dots of credit/expansion.

John is clean- Hank?? hmm, maybe not.

[Privatus]

John Poison.

[RobertShaw]

Crooks all of them.  And this just blew my head off.  Turns out that if Goldman Sachs' board gets sued by their shareholders... AIG has to pay.-

http://www.businessweek.com/news/2010-04-20/aig-said-to-insure-goldman-s...

[Fraud-Esq]

I'm curious about another ZH reader opinion. This has not been proven, however, hypothetically....

Had Paulson or someone else paid Goldman to do everything he said to deceive an investor and this person in fact took part in the planning of such deception, sales pitch (minus the direct representations), the final product, etc., However he preferred to pay someone $15M to take the legal liability for him, fronting him, directly pitching it face to face, making the acts and omissions.... so to speak.....would you feel he is "part" of this fraud? Or would you feel because he has someone fronting the scheme...he is immune?

To me, under these hypothetical facts, to find one immune and the other culpable is simply intellectualizing the same shell games we all accuse banks of playing everyday. Under these specific hypothetical facts, I would suggest the person is guilty of the acts and the omissions, if he knew about them and planned them.

I have not seen these facts regarding Paulson, but we should prepare to hear them about others someday soon, I would think.  

[Rick64]

Why was Paulson suggesting which securities should be included, and why was he consulted on this? Especially if he was intending on betting against it. By his own admission ACA was experienced at this, so why would they need his expertise. ACA chose many of the securities he suggested and then he bet against them. Hmm, looks like collusion to me.

[Grand Supercycle]

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