Profiting from Investments Designed to Implode

Late last year, the NYT detailed Goldman’s role in the collapse of various GS constructed CDOs (Banks Bundled Bad Debt, Bet against It and Won). The article looked a numerous CDOs, including the Abacus 2007 that was the subject of the SEC complaint.

If you missed it during the last minute holiday shopping, I suggest you take a close look now.


“Mr. Egol and Fabrice Tourre, a French trader at Goldman, were aggressive from the start in trying to make the assets in Abacus deals look better than they were, according to notes taken by a Wall Street investor during a phone call with Mr. Tourre and another Goldman employee in May 2005.

On the call, the two traders noted that they were trying to persuade analysts at Moody’s Investors Service, a credit rating agency, to assign a higher rating to one part of an Abacus C.D.O. but were having trouble, according to the investor’s notes, which were provided by a colleague who asked for anonymity because he was not authorized to release them. Goldman declined to discuss the selection of the assets in the C.D.O.’s, but a spokesman said investors could have rejected the C.D.O. if they did not like the assets.

Goldman’s bets against the performances of the Abacus C.D.O.’s were not worth much in 2005 and 2006, but they soared in value in 2007 and 2008 when the mortgage market collapsed. The trades gave Mr. Egol a higher profile at the bank, and he was among a group promoted to managing director on Oct. 24, 2007.

“Egol and Fabrice were way ahead of their time,” said one of the former Goldman workers. “They saw the writing on the wall in this market as early as 2005.” By creating the Abacus C.D.O.’s, they helped protect Goldman against losses that others would suffer.

As early as the summer of 2006, Goldman’s sales desk began marketing short bets using the ABX index to hedge funds like Paulson & Company, Magnetar and Soros Fund Management, which invests for the billionaire George Soros. John Paulson, the founder of Paulson & Company, also would later take some of the shorts from the Abacus deals, helping him profit when mortgage bonds collapsed. He declined to comment.”

To me, there is a line that separates what is acceptable behavior on Wall Street and what is not. Shorting stocks, betting against housing and mortgages is one thing. I have no issue with a directional bet, up or down.

Creating synthetic products that are designed to implode, sandbagging clients to invest in them, and then betting against them — that is highly problematic.

click for larger graphic

Graphic courtesy of NYT


Banks Bundled Bad Debt, Bet against It and Won
NYT, December 23, 2009

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