It's important to understand what was at the center of the whole global financial meltdown. Synthetic CDOs created from cash-settled CDS. Anytime someone tries to tell you that poor people who all of a sudden found banks willing to loan them money for housing caused the crisis, simply laugh in their face. The value of the worthless, synthetic bullshit that ML, UBS, GS and the rest of them created far dwarfed anything that the FHA was involved in.
READ THIS ARTICLE.
thanks for this!
Don't forget the demand side of the coin. People were scrambling to get the CDOs, and that's why they became so popular.
Only because they were rated AAA. Think they would have been quite as popular with a C rating?
You just distilled the cause of the entire crisis.
Bingo. Wall Street would sell me a bag of my own shit. They sell what is popular at the time.
Thanks for the article and link! Indeed, there are so many useful for nowadays elements, that people are looking even to make their lives better. I prefer to take such complicated items from the reliable place and manufacturers, as the mentioned one. And to protect scrren of my devices from mud, for instance.
Thanks - great article
I don't think Senator Levin had any idea how a Synthetic CDO worked when he kept asking Blankfein "why would you sell them and bet against them?!"
Blankfein is bamboozling like the sack of shit that he is. Yes, market makers stay neutral and hedge exposure, but that's not what GS was doing. They were selling the CDOs, and then shorting them. This is a speculative position. Market makers do not speculate.
Are you positive, and is it known, that it was the market makers at GS that took the short positions? I have to ask for a source if you answer yes. I'm not as read as some on this.
I ask this, because if it was a prop desk that went short, that has nothing to do with the market-making transactions.
[quote=jhoratio]It's important to understand what was at the center of the whole global financial meltdown. Synthetic CDOs created from cash-settled CDS. Anytime someone tries to tell you that poor people who all of a sudden found banks willing to loan them money for housing caused the crisis, simply laugh in their face. The value of the worthless, synthetic bullshit that ML, UBS, GS and the rest of them created far dwarfed anything that the FHA was involved in.
READ THIS ARTICLE.
http://www.marketwatch.com/story/out-of-thin-air-synthetic-cdos-pumped-…]
agree 100%
i would give you a silver banana for the article, but ran out. here's a virtual hug, instead.
VIRTUAL HUG
dont forget about the credit rating agencies for incompetently rating the risk for these things, AND the fuckers got a way with it.
CDOs are not rated AAA. They are tranched according to attachment and detachment points and each tranche is rated based on its seniority in the CDOs capital structure and the various credit enhancements. Not that it really mattered in the case of mortgage backed deals considering they were so highly levered and backed with complete shit.
However, corporate loans and bonds have been securitized into CDOs for two decades and are generally sound in terms of their viability.
As a caveat, I see no reason that Goldman should not be able to underwrite the structure and then subsequently short it. There is no need to disclose their positions. However, if goldman marketed the deals to investors and stated that they were long or provided contradictory advice to investors then there was fraud. In the absence of this scenario i dont see an issue.
You shouldn't be able to short it for the same reason you can't short your company's own stock. It's a conflict of interest - a moral hazard. Firms have an incentive to disguise the shittiness of their products if they're allowed to short them. And since it's a lot easier to put lipstick on a pig than structure a decent investment, that's just what they did! Plus, there are a limited amount of actually good deals. There is an unlimited supply of shit. Hey! Another bonus! Easy, unlimited supply, and the ratings agencies say it's AAA!
Obviously, there is nothing wrond with sound cash streams structured into tranches. That is also something entirely different from what we are talking about. We're not wondering whether structuring solid fixed income products into CDOs is a good idea in general. We're trying to figure out how to stop people from structuring pure shit.
Isn't that (supposed) to be the purpose of an independent portfolio selection agent? Not saying you're wrong, I'm just saying that's what I'd expect the counterpoint would be.
I'm not a mortgage expert, but from my (elementary) understanding of synthetic CDOs, someone would have had to be short in order for the product to exist in the first place. As I understand the fraud allegations, it is not about GS shorting the deal, it is about failing to disclose that Paulson was short - my question is, how could ACA possibly have thought they WEREN'T short? Someone had to be, and if ACA didn't incorporate Paulson's recommendations into the reference security selection, Paulson would walk away and they'd have no CDO to buy. Someone please tell me if I'm wrong.
No you are absolutely right... that is the point of Synthetic CDOs, to replicate the payment of an existing CDO. If they didn't have someone on the short side, Goldman would have had to do it themselves.
And please... what do you mean a market maker shouldn't be positioned? Your purpose is to make them a market, show them a bid/ask, you are not an investment advisor with fiduciary responsibility. Not to mention, that if the desk is positioned, it can benefit clients because they will be a better buyer or seller.
Also if the client doesn't like the price or advice, it can go to a competitor... and in fact they will. Don't act like these firms like ACA and what have you are poor saps who were swindled, they are sophisticated investors who knew what they wanted and they got it... it just so happened their view was wrong, really wrong. It happens. Life goes on.
of course it was the prop desk that went short. there is no conflict of interest because goldman had no effect on how the CDO eventually turned out. they make a big deal about goldman being instrumental in selecting the underlying mortgages, but it wouldnt have mattered. all mortgage deals blew up no matter what they held if they were structured in 2006 and 2007. goldman had a material interest in seeing the deal turn to shit, but it is only a conflict of interest if they actually manage the deal, which they did not.
Yeah, then jhoratio, I have to call bullshit. The prop desk guy and the market-maker have no interaction here. They weren't even aware of each other's actions. That being the case, where's the true conflict?
You make it sound like ONE group created something, and then sold it while shorting it too. The market-maker wasn't speculating. The firm he happens to work for had another department that was speculating, and appropriately at that, because it was unaware of the market-making transaction going on.
what a fucking cluster fuck.
so basically the best tranches of a CDO were investment grade rated, and that made the rest of the CDO seem investment grade. thats kind of stupid.
I do see the argument for the accusations of conflict of interest in the Goldman case. However, I fail to sympathize as they weren't selling Abacus to Joe Schmo down the street, they securitized the collateral and marketed to sophisticated institutional investors. From an accountability standpoint, the investors who bought these mortgages failed miserably in performing their own due diligence (as did the rest of the market) and thus should take appropriate responsibility. You think infomercial salesman purchase their own products that they know are garbage? Buyer Beware . . .
I am against banning synth cdos. They are a good way to take a position in the market. They do have value,as they an be an easy hedge to cdos you have in your portfolio,they have a social value. Like blanfien said yesterday,they are not much different from cash settled commodity futures. The senators were acting like goldman, through it's actions in this case, hurt the average joe. ACA and IKB are not the average joe,should have known what they were doing,and probably don't want extra regulation to result from this. The senators are not protecting anyone that wants to be protected IMO.
Synthetic CDOs amount to nothing more than Monopoly Money. The garbage should be banned. All it did was make a big problem 1,000 times worse.
Jhoratio, your argument doesn't make sense. No one would make the argument that an institution which makes a market for IBM stock cannot hold IBM stock themselves, and I don't think anyone would make the argument they have to disclose that they are long on IBM to someone they buy the stock off. I understand this issue is emotive because (a) it involves (very indirectly) people's homes and (b) many people have an irrational bias against anyone shorting a particular market, but it is completely immaterial to a client's best execution whether the institution providing the market is bullish or bearish on that particular asset class. The senate and SEC are completely barking up the wrong tree.
As far as synthetic CDOs go, the banks were middlemen between investors who wanted exposure to the US housing market, and investors who were either bearish on the housing market or looking to hedge other positions. They facilitated the trades, but these trades could only happen with demand on both sides or where the bank was willing to take the risk onto its own balance sheet (witness the enormous writedowns in 2008).
Where Goldman (and to a much greater extent MS, ML, Lehman and Bear) DID bend the rules of ethics was in chopping up dicey BBB or sub-investment grade bonds and persuading goons at ratings agencies to assign triple A ratings to some tranches of the resultant CDOs. However to state that a market maker somehow should favour the 'good' long investors against the 'evil' shorts by giving added disclosure of their own views on a security is ridiculous, particularly in a derivatives marketplace.
A basic point which many people (including the entire sub-committee) fail to understand is that EVERY transaction in ANY area of the market or indeed the wider economy has a buyer and a seller, or in other words a long and a short. There is nothing inherently wrong with being short, just as there is nothing inherently wrong with selling something.
Right, but when talking about Synthetic CDOs, "wanting exposure" amounts to making bets. Not investing on the actual underlying assets. Just because there was a demand and buyers and sellers for every transaction does not mean such a security should exist, nor does it mean that it's a sound investment and NOT a simple bet.
Synthetic CDOs have destructive consequences and have no actual, tangible economic benefit. They are bets, plain and simple.
This characterisation could be used to describe any derivative, including plain vanilla stock options which are also reference securities. As another poster commented, the alternative would be for the excess appetite for MBS exposure to be funnelled into even more dodgy home loans, which would have been even more catastrophic. A synthetic CDO is merely a vehicle for the writing and buying of insurance (in a financial sense a la options rather than the common usage of the word). Yes it is gambling in the same sense that involvement in any financial marketplace can be classed as gambling.
In my opinion it isn't the derivatives themselves which need improved regulation but the institutions which used them so ineptly. Theoretically (i.e. if markets actually were perfectly efficient) they would allocate risk to those best able to manage them. Unfortunately it turns out many of these 'sophisticated' institutions are, in fact, populated by brain dead morons. And (this isn't aimed at you btw) if I read one more person quoting Warren Buffett, a guy who owns an insurance empire, talking about derivatives as a "weapon of mass financial destruction" I am going to explode. Buffett LOVES derivatives.
By the same token you should be against any cash settled security, including certain futures. Synthetic CDOs were created because investors wanted long exposure to the housing market but there were not enough assets. To be honest, I'd rather have Synthetic CDOs than government/mortgage brokers/etc pushing home loans to unqualified people simply because liquidity is cheap and people want exposure.
OP, maybe I'm way out to lunch here, but if the underlying MBS hadn't been such crap wouldn't synthetic CDOs, as ridiculous as they are, still be worth something? So what created the problem? Irresponsible lending. What greatly exacerbated the problem? Synthetic CDOs. Am I wrong?
^^^ Nice visual.
Buffett didn't say "derivatives" are financial WMDs, he said CDS are. And he's right.
Irresponsible lending only happened because banks knew they could off-load the loan, any loan, to a securitizer. At that point the only thing that mattered was volume. More loans, more money. The only reason the securitizers wanted every last crappy loan was because they knew that the ratings agencies would call the top tranche AAA no matter what was in there. The only reason investors wanted them was because they were AAA rated assets paying materially more than what you could get elsewhere in the AAA universe. The only reason the investors could buy the AAA rated tranches is because Magnetar (who in my opinion did absolutely nothing wrong) bought all the equity tranches. And the only reason Magnetar could buy the equity tranches is because they were able to hedge them with cash settled CDS on the mezz tranche. Take cash settled CDS away and literally the entire chain of events ceases to exist.
You can't buy cash settled fire insurance on your neighbors house because there is an incentive for you to burn it down. You can only own the protection if you also own the risk. Not so with CDS. There is no need to also own the bond. Thus, there is an incentive to cause the default, or set up for failure, the bonds that underlie a CDS that you own. And for some reason, that is perfectly legal today. This is what it means to "short" synthetic CDOs. You buy CDS on the the shit that's in the CDO (itself just a bunch of CDS). Of course you know your CDS will hit because the entire thing was engineered to fail. This is why AIG went under. They were the counterparty on a lot of these CDS and when they all went under, they couldn't pay. Good thing the government swooped in with our tax money and made sure Goldman got their payout.
This is everything I could have said and more. Nicely done.
I look at the whole thing as almost a circular reference. The Synthetic CDOs were so destructive because of the shitty lending going on, and so much shitty lending was going on because the banks could securitize the shit into shitty CDOs. Chicken and Egg madness!!!!! Though, seriously, I do think that is a HUGE difference between Synthetic CDOs and other derivatives. Along with what JHoratio said, is why I consider them to essentially be gambling and monopoly money garbage.
I already explained to you why cash settled CDS are essential but I see you chose to ignore my reply in that other thread mainly because you sounded like an ignorant jackass in that thread, like now. I'd expect your rhetoric from some of the students on this board but I assume the gold star next to your name means you're in the industry which makes your ignorance totally unacceptable and embarrasing.
The flaw in your argument is that you're assuming the only way to have material exposure to a firm is to own one of its bonds. There are many different ways of getting exposure to a firm and CDS offer a way of hedging that risk. I already used an example of someone hedging non-marketable securities using CDS in the other thread so I won't repeat it here again. That's what CDS were invented for. Anyone who owned a bond could just sell it if they were bearish. People with non-marketable exposure don't have that luxury and the only way for them to hedge economic risk associated with the entity, would be through CDS.
One quick example is in Q4 08 after Lehman collapsed. Are you suggesting that only people who owned the bonds of financial firms should have been allowed to buy the CDS, even if they were exposed in other ways but did not own the bonds? So all those other instituions exposed should've sat on their risks and done nothing about it? What if I'm currently exposed to some no-name bank in Greece which doesn't have a liquid CDS market. Are you suggesting I shouldn't be allowed to hedge this risk by purchasing CDS on Greek sovereign debt even though I don't own a Greek bond? So what would you suggest I do instead? Sit on the risk and get Euro-fucked?
Frankly I don't think anyone is suggesting that CDS dont have a useful purpose or companies shouldnt be allowed to hedge/speculate using CDS just like any other financial instrument. The real issue in my mind is how do regulate the amount of exposure that any one company can acheive using these type of deriatives. I could really care less about any one particular company making poor investment decisions and being completely wiped out as a result of those decisions. However, when one company is able to obtain exposure and lever itself to the hilt with these instruments, there is a serious systemic risk factor involved. And now one company's decisions are affecting an entire economy.
You can't say after the fact that what you know now about a security was a definitive fact years ago. This stuff was ranked AAA. Someone thought that it was not bound to fail, otherwise it wouldn't have been rated that highly. You can't say "of course you know your cds will hit". There was a chance that it wouldn't.
jhoratio - you are a moron. Buffett collected over $3B in premiums writing CDS.
Nice to see some sensible posts in this thread.
jhoratio,
You never responded to my and Washedup's response to your selling+shorting conflict of interest argument. I think you have something confused in that argument, and it's one that the Senators seemed to have confused yesterday, as well. I get your distaste for CDOs, but I'd like to flesh out the other argument a bit more, particularly because it seemed to be a popular topic yesterday. Re-read what we wrote above.
If anyone tells you that the decision to extend/accept credit to purchase something is a unilateral decision, laugh in their face.
Bump on the still unanswered question as to whether it is unlawful for Goldman's market makers to bring to market the Abacus product and then have their prop desk short it. From someone on the street, honestly, how stove-piped are these two divisions at firms?
Even if it is not illegal, I have to agree with McCain and say that is is highly suspect and clearly more prone to shadiness.
You're falling into the same trap as the senators - the belief that longs are "investors" whilst shorts are "speculators". Abacus was a derivative product - it necessarily had equal and opposite short and long positions. As market maker, BOTH sides were clients for the bank. If anything the shorts were at a disadvantage, as the portfolio selection agent, who nobody disputes had final say over the securities included, was long on the deal. I don't think anyone would be complaining if Goldman remained long on the deal (which they actually did, although this is probably just because they couldn't sell all of the long positions) even though that is effectively, in Levin's words, 'betting against' their clients on the short side. Clearly the senators struggled with the concept of a market maker (witness all the nonsense about being a fiduciary - how exactly can you have fiduciary responsibilities to both sides of a trade you nitwit!!!).
The flip side is if Goldman actually DID tell porkies in which case that would clearly be fraud and they should be nailed.
Btw Goldman and they are borderline obsessive about their Chinese walls. For example someone in corporate finance even attempting to speak to a research analyst will immediately trigger a meeting with compliance. Obviously it is difficult to prevent the respective parties from having a chat over a beer but they do make a decent fist of trying to manage the conflicts.
^^^^^ good info. Having no experience in these kinds of deals, I did not understand the chinese wall concept. I don't care who is long and who is short... as long as it is an honest bet.
Absolutely, I know at my firm anytime anyone speaks to another person where there could be even the slightest argument for a conflict, a lawyer has to be present on the line. Not to mention every conversation and email is recorded anyway.
Not cell phone calls; surprised that wasn't mentioned at the hearing (or if it was, I missed it).
Anyway, the point is, GS would have had to have exactly zero exposure to this deal (ie, long/short positions net to zero) in order to fulfill its fiduciary duty, and that would have clearly meant it would have been unable to make an effective market in the security, which likely would have been a violation of the contract
Reprehenderit temporibus iure assumenda harum. Neque earum voluptatem inventore aliquid tenetur repellat. Ut iusto qui atque molestiae necessitatibus repellat veritatis. Rerum aliquid eum in totam rerum est.
Necessitatibus voluptatem enim velit labore. Vel et veritatis distinctio hic ea provident ea. Totam illum est quia veniam recusandae sit.
Similique mollitia eos et dicta non autem. Sit omnis vitae corrupti provident occaecati.
Veniam laboriosam maxime ea aut. Ut qui sunt excepturi in et molestiae aliquid. Odio quasi non quo in.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...
Quibusdam sed unde dolores voluptas maxime est. Et ut voluptatum temporibus est. Fuga at quia ut qui consequatur voluptatem. Numquam neque provident minima aut reiciendis. Nihil placeat dolorum vel qui sunt. Aut incidunt sed sit odit.
Quam nulla voluptatibus reiciendis et est et repellendus. Omnis debitis in vel hic beatae et provident aliquam.
Repellendus quisquam eos magnam nesciunt. Eum nam pariatur non ipsam deleniti. Amet nobis assumenda autem praesentium.
Id dolor voluptatem iusto odio vel in saepe. Dolores explicabo vel accusantium ducimus. Qui et eligendi alias sunt qui ut. Praesentium voluptates magnam est aliquid nisi et. Inventore possimus repellat est maxime eaque nemo est magni.
Rerum eligendi vel omnis libero consequatur itaque. Magni sequi necessitatibus et consequuntur eum. Amet voluptates libero eum molestiae repudiandae reiciendis ratione. Esse atque quis vitae aliquam aspernatur amet vel.