Goldman Sachs’ arrogant public response to the Securities & Exchange Commission accusation of fraud is another example of self-righteous overconfidence on Wall Street. Not that the SEC suit will be won by the government. In fact, that’s partly what’s given Goldman its chutzpah. Odds are pretty high the investment bank will prevail in court. Whether it told investors that the hedge fund manager John Paulson shorted the portfolio of mortgage bonds in which they invested—or synthetically invested, so to speak — may be beside the point legally.
What is not defensible ethically or economically were the ratings on the collateralized debt obligation (CDO) itself — the structured investments that Goldman repeatedly sold, and the likes of which Merrill Lynch and Citigroup sold more of.
The fundamental deceit at the heart of the CDO requires more public understanding. The CDO turned triple-B mortgage-backed securities into triple-A. On that simple alchemy, world finance almost collapsed. Merrill and Citigroup in particular rushed to issue CDOs from 2004 on, rapidly becoming the biggest in the field. But the esteemed Goldman also participated. Did Goldman really believe these securities deserved a triple-A rating from Standard & Poor’s and Moody’s? You can bet that they did not.
It is worth spending a moment to understand what was done. It is not as simple as some journalistic accounts make it out to be.
Mortgages themselves—as distinct from mortgage-backed securities or mortgage bonds, for short —have been “tranched” since the early 1980s. They are put into a vehicle and investors buy bonds against them—the mortgages are the collateral and the mortgage interest is passed through to the investors. Eighty percent or so of the investors buy bonds in the senior tranche—and are entitled to receive interest first, so defaults have to be very high to jeopardize their income. These mortgages bonds are rated triple-A and are paid the least interest—though still significantly more than triple-A corporate bonds.
The next ten percent get paid off next, and may be rated single-A, and so on, until we reach the mezzanine, maybe 2 to 5 percent of the bonds, which gets paid (almost) last, and are usually rated triple-B. Thus if defaults rise only moderately, there is a good chance these triple-B bonds will lose value because interest payments will be reduced or cease altogether, and may even fall to zero.
But a collateralized debt obligation or CDO is not composed of mortgages. And increasingly they were composed largely, and even only, of these triple-B tranches. Wall Street argued that these could also be made into a hierarchy—that is, tranched. But because all the triple-Bs are susceptible to even a modest rise in default rates, you can’t truly shield the senior 80 percent of the CDO bond holders from rising defaults. It’s not like a package of mortgages themselves.
Wall Street got the ratings agencies to assume that if these tranches are sufficiently diversified geographically, a hierarchy can be made. Default rates will rise in only one part of the country and not at all in others. It was a mind-boggling assumption. In truth, the triple-A part of the CDO, supposedly the top of the barrel, was almost as vulnerable as those at the bottom.
Did anyone see through this? Yes, the now famous “big shorts.” Why did Goldman and others do it? Because the triple-Bs paid higher rates, and they could therefore create supposed triple-A investments with high rates. And they took 1 to 2 percent of every deal off the top. Why did the supposed independent CDO managers go along? Because they made a fortune if the investments were sold. Why did sophisticated financial managers buy them? Because it improved their bottom line and, after all, Goldman agreed they were triple-A even if the financial manager had some doubts.
There was one more step. Wall Street ran out of mortgages and therefore tranches to throw into a CDO. So they created them out of thin air by selling credit default swaps to people like John Paulson. Paulson paid maybe 2 percent a year for the right to get the full amount of the loan back, should it collapse. That annual payment served as interest on a synthetic CDO. Debt was being created without additional collateral. And Paulson picked especially fragile mortgage bonds on which to buy insurance.
Market rigging? You tell me.
Goldman Sachs by the technique of cross border M & As in vertical motivation had enmassed large profits with either thresold or majority acquisitions of major resources all over the world controlling Global Village. Their budgets are larger than the budgets of many countries and it is my belief that their budget could be larger than the budget of US being the biggest economy with complex legal structures penetrated into the world. History indicates that either former or the current employee was head of the US treasury working in their favour against the interest of not only US but also against the interests of the world at large. There is a necessity to regulated such large group abusing their oligopolistic stature involved with insider trading difficult to the proved against the concerns and interests of indefensible.
Goldman Sachs by the technique of cross border M & As in vertical motivation had enmassed large profits with either thresold or majority acquisitions of major resources all over the world controlling Global Village. Their budgets are larger than the budgets of many countries and it is my belief that their budget could be larger than the budget of US being the biggest economy with complex legal structures penetrated into the world. History indicates that either former or the current employee was head of the US treasury working in their favour against the interest of not only US but also against the interests of the world at large. There is a necessity to regulate such large group abusing their oligopolistic structure involved with insider trading difficult to be proved against the concerns and interests of indefensible.
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