Saturday, April 17, 2010

Goldman Sachs and Early 2007

What was going on in early 2007? New Century Financial collapsed in early 2007. Most sub prime lenders had gone belly up in 2006. The entire subprime lending market was going down the tubes. Everyone knew that, except, apparently, the Royal Bank of Scotland and IKB Germany.

If you were alive and breathing in early 2007 and did not know that the subprime market was collapsing, then you must have been an idiot.

In this environment, enter John Paulson and Goldman Sachs. With the disaster of subprime lending making front page headlines daily in early 2007, Goldman and Paulson created a package of subprime CDOs with a Triple B rating and IKB Germany and Royal Bank of Scotland, two very sophisticated investors, bought them.

What was happening? Knowing full well that the subprime lending market had been blown to pieces in 2006 and early 2007, IKB and Royal Bank of Scotland decided to buy the CDO package and bet that the worst was over. They bet wrong. The worst was not over. Paulson bet right. The worst was yet to come.

So, where is the fraud? There was no one in the financial world that did not know that John Paulson thought subprime lending was going to come a cropper. It was the daily stuff of business news. Certainly, the honchos at IKB and Royal Bank of Scotland were fully aware of Paulson's views and that Paulson's views applied specifically to the package of CDOs that they were buying. They thought Paulson was wrong and bet accordingly.

Just exactly what did Goldman fail to disclose -- that Paulson helped select the CDOs in the package that the big bank investors bought? Was that the crime? Besides violating a customer confidence, the information would have been completely irrelevant to IDB and RBS, both of whom were aware of Paulson's views on exactly the kind of CDOs that they were buying. The knew that Paulson thought they were crazy; they thought Paulson was crazy.

Goldman did not "underwrite" the CDO package. They did sell the package, acting as a placement agent. There is no way that they were required, under the law, to disclose the role of John Paulson. (It would not have mattered to IKB or RBS, in any event, since they were well aware, along with anyone else breathing, that subprime CDOs were a huge risk in early 2007).

It is easy to use Goldman as a whipping boy here, but the truth is that the buyers knew what they were buying. They had bought a lot of this stuff both before and after they bought the Goldman package. They just made a wrong bet. Paulson bet right.

There is no crime here. Goldman did nothing wrong.

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