JT Note: There is nothing wrong with hedging or taking the opposite view to one's customers. There is nothing wrong with using credit derivatives to accomplish this goal. The underlying RMBSs and CDOs, however, were value-destroying and misrated. I and others said so at the time deals like this were created. GSAMP Trust 2006-3 is just one example. Tranches sold as "AAA," "super-senior," and "investment grade" did not deserve those labels at the outset, and any underwriter or securitization professional worth their salt knew it.


Responding to Goldman Sachs
TSF (also on Huffington Post) – December 25, 2009
By Janet Tavakoli

The New York Times published a Christmas Eve expose of Goldman Sachs’s so-called “Abacus” synthetic collateralized debt obligations (CDOs). They were created with credit derivatives instead of cash securities. Goldman used credit derivatives to create short bets that gain in value when CDOs lose value. Goldman did this for both protection and profit and marketed the idea to hedge funds.

Goldman responded to the New York Times saying many of these deals were the result of demand from investing clients seeking long exposure. In an earlier Huffington Post article, I wrote about Goldman’s key role in the AIG crisis; it traded or originated $33 billion of AIG’s $80 billion CDOs. AIG was long the majority of six of Goldman’s Abacus deals. These value-destroying CDOs were stuffed with BBB-rated (the lowest “investment grade” rating) portions of other deals. These BBB-rated portions were overrated from the start. Many of them eventually exploded like firecrackers.

Goldman said it suffered losses due to the deterioration of the housing market and disclosed $1.7 billion in residential mortgage exposure write-downs in 2008. These losses would have been substantially higher had it not hedged. Goldman describes its activities as prudent risk management. Many Wall Street firms wound up taking losses. The question is, however, how did they manage to get through a couple of bonus cycles without taking accounting losses while showing “profits?”

The answer is that they sold a lot of “hot air” disguised as valuable securities. Goldman claims this was prudent risk management. In reality, Goldman created products that it knew or should have known were overrated and overpriced.

If Wall Street had not manufactured value-destroying securities and related credit derivatives, the money supply for bad loans would have been choked off years earlier. Instead, Wall Street was chiefly responsible for the “financial innovation” that did massive damage to the U.S. economy.

Earlier, Goldman denied it could have known this was a problem, yet acknowledged I had warned about the grave risks at the time. If Goldman wants to stick to its story that it didn’t know the gun was loaded, then it is not in the public interest to rely on Goldman’s opinion about the greater risk it now poses to the global markets.

Goldman excuses its participation by saying its counterparties were sophisticated and had the resources to do their own research. This is a fair point if Goldman were defending itself in a lawsuit with a sophisticated investor trying to recover damages. It is not a valid point when discussing public funds that were used to bail out AIG, Goldman, and Goldman’s “customers.”

Goldman claims the portfolios were fully disclosed to its customers. Yet at the time of the AIG bailout, Goldman did not disclose the nature of its trades with AIG, and Goldman did not disclose these portfolios to the U.S. public. If it had, the public might have balked at the bailout.

The public is an unwilling majority owner in AIG, and public money was funneled directly to Goldman Sachs as a result of suspect activity. The circumstances of AIG’s crisis were extraordinary and without precedent. I maintain that the public is owed reparations, and it would be fair to make all of AIG’s counterparties buy back the CDOs at full price, and they can keep the discounted value themselves.

Some similar CDOs currently trade for less than a dime on the dollar in the secondary market. Goldman’s trades amounted to more than $20 billion (albeit Goldman traded or originated $33 billion of AIG’s $80 billion of this ilk). If Goldman wants to claim it was “only following orders” for customers, that is between Goldman and the hedge funds or other “customers” involved. Goldman can fight it out with them if it wants its money back.

Goldman’s synthetic deals that are still on AIG’s books can be settled at ten cents on the dollar. This is the value at which other bond insurers have settled similar deals. The excess money already paid to Goldman can used to pay down AIG’s public debt.


Janet Tavakoli is the president of Tavakoli Structured Finance, a Chicago-based firm that provides consulting to financial institutions and institutional investors. Ms. Tavakoli has more than 20 years of experience in senior investment banking positions, trading, structuring and marketing structured financial products. She is a former adjunct professor of derivatives at the University of Chicago's Graduate School of Business. She is the author of: Credit Derivatives & Synthetic Structures (John Wiley & Sons, 1998, 2001), Structured Finance & Collateralized Debt Obligations (John Wiley & Sons, 2008).

Janet Tavakoli's book on the global financial meltdown is Dear Mr. Buffett: What An Investor Learns 1,269 Miles From Wall Street (Wiley 2009)


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