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USA Vs. GS - Pot Calls Kettle Black?
The SEC has charged Goldman Sachs with a 10b-5 violation. The accusation
is that GS:
“Made untrue statements of material facts or omissions of material
facts.”
So there are essentially two accusations. A) They flat out lied and B)
there were things about the Abacus transaction that probably should have
been disclosed but were not.
For me, (A) is a matter of law and contracts. Lawyers will battle that
question out. (B), on the other hand, is a much more subjective issue.
From the facts that are out there today it would appear that there were
Omissions made. Those Omissions were potentially material. There was
clearly a large group of individuals involved with the transaction that
basically knew, or had strong reason to believe that the Abacus
transaction was deeply flawed and the probability of success for a buy
side investor was very low. There is evidence that the highest levels of
management at Goldman Sachs held these views on Sub Prime synthetic
transactions.
I want to focus on B (material omission) and compare the Abacus deal to
what I consider to be the worst transaction in the history of finance.
That transaction was the $4.6 billion of the Fannie Mae Preferred Stock
issued on May 7, 2008. This very large piece of crap went into the
garbage can four months after it was issued. It paid one lousy quarterly
dividend of 2% and then poof it was all gone. The original investors
saw a 95+% loss of their principal. It was a wipe out that was four
times the size of the Abacus deal.
When comparing the Fannie pref deal to the Abacus deal it is very
important to make the distinction of who got bilked. In the case of
Abacus some sophisticated investors took a big risk with other people’s
money and lost. In the case of Fannie the deal was sold retail. It went
to unsuspecting investors. It was peddled to Community banks across the
country. It went to public bond funds and into thousands of IRA’s. It
went to widows and orphans. There can be no question that the standards
of disclosure must be higher on a public deal sold retail than a private
deal sold to sophisticated investors.
The underwriters are the ones closest to the transaction. Here’s where
the conflicts of interest and real material omissions can occur. Check
out the names on the bottom of these two slides. There are some things
to observe here.
The first slide is a Fannie Pref deal from December 2007. Note that
Lehman and Merrill are on the top of the list as co leads and Goldman
Sachs and JP Morgan were ranked second. There are others who are in
still smaller type. In ‘street talk’ this ranking means: who was
responsible, who did the most, who got paid the most, who has the
biggest dick and who should you first call if there is, heaven forbid, a
problem.
Now consider the May 08 slide. Goldman is now on the center bottom (the
lowest rank according to custom) and good old JPM is nowhere to be
found. Functionally these two opted out of this deal.
Also compare the commission paid to the underwriters. 1% in 07 and
fourteen months later it’s up to 3.5%. That is big money. The difference
in commission income was $125mm. The riskier the deal the more the
Street makes. So the underwriters got fat. But Goldie and JP said no. If
they wanted to be on the top of the list they could have been. They
chose not to because of the risk that the pref deal would blow up in
their and their client’s faces.
GPM and GS walked away pretty clean from the mortgage meltdown. They
dodged the bullet because they saw it coming. Likewise, they saw the
wave coming for Fannie. Wall Street knew this deal was doomed. But they
sailed it off into the coming storm and kept the fees.
Former Treasury Secretary Hank Paulson understands the need for a higher
standard of disclosure for public deals than anyone I can think of. He
ran GS for years; he understands securities law as well, if not better,
than most Wall Street lawyers. He knew that Fannie Mae was headed into a
crisis.
From Hank’s book “On the Brink”:
In June of 2006 he met with Emil Henry Treasury AT and was briefed on
the GSE’s, his thoughts of this meeting:
“It didn’t take a genius to see that something had to be done”
Also from the book:
“Fannie and Freddie were disasters waiting to happen”.
Throughout the crazy markets of 2008 Paulson had near daily contact with
the captains of the big banks and Walls Street firms. His call log is
littered with conversations with Blankfein. I don’t believe for one
second that in May of 2008 he was not acutely aware of the perilous
state of the entire mortgage market and thereby the likely implosion of
the Agencies. He not only let $4.6b of bad paper go to weak hands, he
encouraged it to happen. He and the rest of his staff were pushing OFHEO
(Fannies regulator) to get the Pref deals done. Other than behind the
scene pressure Paulson had no direct involvement with the Fannie deal.
So technically there is no material omission of facts. On the other hand
he helped get something done that he must have know was going to blow
up.
James Lockhart, the head of Fannie’s regulator OFHEO (now FHFA)
understood the state of Fannie in May 08. I’m no fan of Mr. Lockhart,
but I am quick to admit that he is very bright, well educated and a
seasoned pro. This guy was looking at what was coming on a daily basis.
He had to understand that a crisis was brewing. He was desperate to get a
Fannie recap done in May of 2008. He knew he would be gone soon,
regardless of who won the coming presidential election (he now works
for Wilbur Ross doing distressed debt transactions. Fitting.). His
interest was to kick the can down the road so his childhood friend,
George Bush could get out of D.C. before the lights went out. He pushed
Fannie hard to get the deal done. He traded a release from a two-year
old consent order against Fannie in exchange for the completion of the
equity recap. As a result Fannie was allowed to increase its leverage
ratios. Keep in mind that this was just four months before Fannie went
into receivership. The OFHEO notice:
Another fellow in the story who is on my list of material omissions is
the CEO, Dan Mudd. Dan was ex GE Capital, President and CEO. Let’s be
clear on this one. You do not achieve the Big Kahuna status at GE unless
you know your stuff cold. You have to live and breathe corporate
finance, debt and credit to get that seat. So here again I have to
assume that someone this connected had to have know in May of 2008 that
the end was nigh. He should not have let the deal get done. He had
enough insight to see the lines crossing, yet he let the deal go
through. He was conflicted. Half of Washington was breathing down his
neck. He gambled other people’s money and he lost it. If he had stiffed
the likes of IKB or other pro investors I would have no problem. But he
paid $150mm in fees so he could rip off smaller investors.
The rating Agencies had a single A on the Pref. If you looks at all of
the qualifying language in the rating you would see that there were a
dozen caveats as to what might go wrong. But retail brokers and retail
investors and regional community banks don’t read that language. An A
rating was supposed to mean something. This could have read: “We
are rating this A. We are assuming that it will not rain in the next six
months.” It was pouring outside when they made the call.
So rating agencies, regulators, corporate executives, senior government
officials and a sizable chunk of Wall Street omitted material
information on the Fannie deal. The investors were wiped out less than
six months after the transaction closed. Doesn’t that sound like Abacus
with different players? In many ways the Fannie deal was more heinous.
I doubt the SEC will look into this one. No sense in one branch of the
government suing another. It would just look silly. So to hell with
those small investors. The SEC will focus its attention where there is
something to gain. Possibly to the benefit of some big shot investors
and politicos.
I am no fan of GS, and believe they should get taken down a few pegs.
But in 07 and 08 everyone was selling crappy deals. Even government
agencies.
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Excellent Article Bruce, Thanks.
I am wondering if the media/congress will get this info or not, there is a lot of ammo here to burn.
Thanks for putting together this very big deal of reporting. I cannot see how this can be ignored.
I happened to have printed out the cover sheet for posting for my employees back in 2009. I did not know just how much more there was in the story.
removed
I guess the lesson in all this is:
When a sell-side person calls you up and asks, "do you want to do this trade?", you need to ask him/her "how are you going to fuck me?". I would think you'll hear nervous laughter and a sheepish, "who, us?". The key is to not give in. They are trying to fuck you, so you might as well find out how. They are not your friend, they don't give a shit about your family, and they don't like you. The sooner we all accept this, the better off everyone will be.
Oh and thats a B&W of fat boy slim isnt it?
Insightful as usual. The issue for me turns on whether there is any duty of care when selling a product that it will at least perform according to expectations. After all we are dealing with "assets" that are carded to produce "income" and get "repaid". If someone sells a car knowing its wheels will drop off as soon as it exits the yard, what are the warranties worth? In finance you have the opposite of warranties, you have disclaimers and disclosures. The crucial assumption is that a bond with a coupon and a rating will perform. If the prefs or the ACA securities were known in advance to contain an IED which was triggered remotely or was known to be on a timer, then caveat emptor does not apply. The trick is whether the prefs or CDO's contained an IED planted or known to exist by the seller of the prefs or CDO's. You don't expect an asset to have an IED, it is supposed to pay income and if the seller of the security knows there is an IED, it also knows that it is not a normal security. QED, IMO and its Fraudie and Funny, not Freddie and Fannie :)
Well put. In my view there was IED. It was one of those special one with the copper that goes molten. I think a lot of folks knew it was there.
Fine article, thank you.
Incidentally FNMA $25 Preferred Series T is my favorite hyper inflation play, up from a low of 53c to $1.49 ask. Twenty to one payoff if housing prices pay off plus the possibility of a government bone thrown to failing banks.
Bruce: Have you made a false dichotomy at the beginning of your post with A) and B)? Don't they both turn on the word "material"?
Furthermore, B) might actually be clearer than A) from a legal standpoint. If something is omitted, there it is (not). It's not always so clear as to what is "false", though. SEE: Wm Jefferson Clinton and the meaning of "is" etc.
Well done Bruce.
Your best article IMO. Exposing the hypocrisy and no accountability era.
hmmm not sure.. isn't he that dick smoker.. what's his name ?
And just think, the privately owned USA central bank Federal Reserve has a lot of exposure to Fred/Fann.
Got physical gold/silver?
Fabulous post. Thank you. Who do you complain to when the law keeper and the law breaker are one and the same?
Tks. On your question; your on your own.
If you think the banks are doing this country in watch what the food corporations are doing to us -
http://www.pbs.org/pov/foodinc/photo_gallery_watch.php
http://www.pbs.org/pov/foodinc/trailer.php
The ripoff on the preferred sale was done in order to keep Barney and Chris happy boys. They have run the monster for twenty years or more. Where else could they get jobs for the special people they wanted to love and reward and also get a political contribution slush fund?
There had been an agreement reached somewhere in the time line to start cutting the GSE down to size and reduce the loan volumes. the housing meltdown begins. I can still see Chuckie "Mr. New York" Schumer with that doofus smile describing how raising the FNM and FRE loan limits to $750K from $400K was going to be the solution. This just after they were given orders to wind down. Idiots all.
The next big scam was the sale of shares in Wachovia to TPG and the TU in only a few months. Were they sophisticated investors?
No doubt that the STD originated with FNM and FRE, inflamed by the CRA enabeling liar without a home.
Great post Bruce thx. Thx also for mentioning Mr. Fwank..
Excellent post AND analysis, Bruce
Nothing like using actual facts to support one's position. Nice work digging all this up.
"His interest was to kick the can down the road so his childhood friend, George Bush could get out of D.C."
When Lehman collapsed... this is exactly what I thought. Henry "I Worked for the Nixon Admin" Paulson was trying to hold the entire fraudulent charade together with chewing gum and crazy glue until the Bush-whackers got out of town on Jan. 20th 2009...
If the economy blew up after midnight 1/20/2009... Bush et al knew they could blame the new guy regardless of whether it was McCain or Obama.
Paulson is Up to His Neck in it and Deserves SOME "Credit"
You are right.... there are plenty of investigations and prosecutions to go around. But the FBI and DOJ are looking every place BUT Wall Street and DC running around Amerika from Florida to San Diego looking for $1 million mortgage fraud cases... you know the BIG fish...
A plague on both houses. GS and the Admin were cheek by jowl.
Good work.
Great article, Bruce. Thanks!