The New Robber Barons Read online

  Goldman's other big role in the CDO business that few of its competitors appreciated at the time was as an originator of CDOs that other banks invested in and that ended up being insured by AIG, a role recently highlighted by Chicago credit consultant Janet Tavakoli. Ms. Tavakoli reviewed an internal AIG document written in late 2007 listing the CDOs that AIG had insured, a document obtained earlier this year by CBS News. [CBS did not have the data to make the connection between the CDOs and Goldman's large role as underwriter of CDOs backing its own trades and the trades of other banks.] "Goldman Fueled AIG's Gambles," by Serena Ng and Carrick Mollenkamp, Wall Street Journal, December 12, 2009.

  Goldman was unsuccessful in misleading me, but what chance would non-financial professionals have against Goldman's hokum? Goldman misled many members of the press, Congress, and even "investigators" (unless investigators were going along for the ride) for a very long time.

  Why did Goldman Sachs try to pass itself off as merely an "intermediary?" In my opinion, it was trying to make its role sound innocuous when it was not. In its role as a structurer and underwriter of CDOs, Goldman was responsible for a high standard of thorough due diligence.

  Investigating a Criminal Cover-Up

  On November 17, 2009 (a week after my report), SIGTARP released its report. Despite discussing AIG and its problematic protection on CDOs, the report did not mention Goldman's key role as underwriter (creator) of many of the CDOs, including CDOs for which foreign banks were paid billions in the AIG settlement. It appears that either the well-staffed TARP investigators knew less than I did, or they didn't understand the implication of information they had (if they had it), or there was a cover-up. In other words, the SIGTARP report contained information that was less damaging to Goldman's fairy tales than what I had already put in the public domain on November 10, 2009.

  That begs the question. When Goldman called me (before my November 10 report), did Goldman already know that the SIGTARP report would not contradict its story? In other words, did it know the SIGTARP report would fail to reveal its role as creator (underwriter) of many of the value destroying CDOs? Was SIGTARP part of a cover-up?

  Documents filed with the SEC had been redacted so that the names of the CDOs backing credit default swaps, the size of individual deals, the fallen prices of the CDOs, and the names of the banks tied to each deal were not revealed. Was the SEC also part of a cover-up?

  I sent my concerns to staffers on the Senate Banking Committee, the Financial Crisis Inquiry Commission, and other Congressional offices that had previously contacted me for information.

  SIGTARP is now partly blaming Fed secrecy, yet why has SIGTARP been so slow to connect the dots? SIGTARP is now investigating a potential criminal cover-up. ["AIG Probe May Lead to Criminal Cover-up Charges, Barofsky Says," by Richard Teitlebaum, Bloomberg News, April 28, 2010.]

  Perhaps it's also time to investigate SIGTARP's process, since it reeks like three day old fish.

  Dodd-Frank Reform Failure: "Customer Transactions" Were Behind the Meltdown

  Goldman was responsible for huge systemic risk, even though it characterized its AIG trades as "customer transactions." It's one thing to provide emergency relief for "troubled assets," and its quite another for Congress to delay so long in asking how these assets came to be so troubled in the first place. Congress has neither uncovered the truth nor mitigated the risk of even greater future devastation. The Dodd-Frank Bill does not provide necessary financial reform, because Wall Street lobbyists successfully tailored the language to suit bankers.

  Senator Carl Levin (D. Mich.), Chairman of a senate investigative panel, issued a memo stating that Goldman "magnified the impact of toxic mortgages." In other words, it kept repackaging, reselling or protecting (buying credit default protection on) losers. It took the wrong kind of nerve for Goldman's CEO to say he was doing "God's work,"* when the reality includes this brand of malicious mischief.

  In one case, a $38 million subprime-mortgage bond created in June 2006 ended up in more than 30 debt pools and ultimately caused roughly $280 million in losses to investors by the time the bond's principal was wiped out in 2008, according to data reviewed by The Wall Street Journal. "Senate's Goldman Probe Shows Toxic Magnification," by Carrick Mollenkamp and Serena Ng, Wall Street Journal, May 2, 2010.

  All of the large Wall Street banks generate huge risk in foreign exchange, commodities trading, interest rate derivatives, credit derivatives and more. The Dodd-Frank Bill's so-called financial reform leaves the entire financial system at great risk from "customer transactions."

  In Third World America, Arianna Huffington explains how Wall Street bought off Congress. America's middle class is caught in the middle of a bi-partisan betrayal. Righting these wrongs will not be easy. Among other things, it may require an amendment to our Constitution to prevent money cartels from buying off our elected officials.

  * Endnote: Goldman CEO Lloyd Blankfein's quip that he is doing "God's work," is put in its proper perspective by this apt quote at Jesse's Cafe Americain :

  "There will be hard times in the last days. People will love only themselves and money. They will brag and be proud, tearing others down. They will be without love, gratitude, respect, or forgiveness. They will tell lies and be out of control. They will despise what is good and betray friends. They will believe they are better than others, and will love only what pleases them. They will say they are serving God, but their actions will show they are not." 2 Timothy 3:1-5

  Goldman Sachs Sued by German Bank Over Davis Square VI, an AIG CDO Bailed Out by Taxpayers

  October 5, 2010

  Landesbank Baden-Wuerttemberg, a German state-owned bank, is suing Goldman Sachs over a $37 million loss on its investment in its share (a tranche) of a CDO called Davis Square VI. TCW, the manager for all of Goldman Sach's Davis Square deals, is also being sued:

  "Goldman knew at the highest levels of its organization that its representations to LBBW Luxemburg that the notes merited triple-A ratings and were high grade were blatantly false," the Stuttgart-based bank said. "Goldman committed fraud and, or, was negligent in marketing and selling the notes to LBBW Luxemburg." ("Goldman Sachs Sued Over German Bank's $37 Million Loss on CDO," by Edvard Petterson and Patricia Hurtado, Bloomberg News, October 4, 2010.)

  Separately, French Bank Societe Generale bought protection from AIG on two tranches of the Davis Square VI CDO, which Goldman Sachs created (structured) and underwrote. On November 10, 2009, I uncovered that information, and it was the first time this information was in the public domain. ("Goldman's Undisclosed Role in AIG's Distress," TSF, November 10, 2009)

  The German bank makes an excellent point. The portfolio backing Davis Square VI before the September 2008 initial taxpayer bailout of AIG, can be found on my web site via this link: Davis Square VI.

  In an earlier commentary, I discussed Davis Square IV, another one of the AIG deals: "Congress Exposes Potential Profiteering in AIG's Deals: Delay Enabled Further Cover Up," January 28, 2010.

  Taxpayers might again ask why the Federal Reserve was so eager to bail out all of AIG's deals (credit default swaps) linked to problematic CDOs at 100 cents on the dollar. The largest beneficiary of that largesse was Goldman Sachs, whose former officers rose to influential positions in the U.S. Treasury and Federal Reserve Bank and were at Goldman's helm when these deals were created.

  The taxpayer funded bailout of AIG very likely helped Goldman Sachs to avoid potential lawsuits, among other lucrative benefits. (See "Goldman Sachs: Bullies on the Block," September 13, 2010.)

  The complaint is Landesbank Baden Wuerttemberg v. Goldman, Sachs & Co. and TCW Asset Management Company,10-7549, U.S. District Court, Southern District of New York.

  CHAPTER 3

  Caveat Emptor

  Bank of America Says Merrill's Huge Hit was in December (Not November)?

  January 26, 2009

  James Mahoney, a Bank of America spokesman said: “Beginning in the second week of December, and progressi
vely over the remainder of the month, market conditions deteriorated substantially relative to market conditions prior to the Dec. 5 shareholder meetings. So Merrill wound up making adjustments for the quarter that were far greater than anticipated at the beginning of the month [December].

  These losses were driven by mark-to-market adjustments which were necessitated by changes in the credit markets, and those conditions change on a daily basis.” (“BofA’s Latest Hit” – WSJ January 26, 2009).

  Maybe. But BofA and Merrill will have to explain that in some detail, because shareholders will want to know why the November roiling of the markets did not cause huge mark-downs. How about some disclosure to reassure everyone? Especially since at least one investment bank already explained how November was such a horrific month that they had a surprise loss due to the credit markets. Yet, BofA says Merrill’s surprise loss was in December, so let’s recap November.

  This did not get enough press, but in early November, Chinese banks (top tier banks like Bank of China and Industrial and Commercial Bank of China) refused to fork over billions in collateral on dollar/yen FX trades which were out of the money after the yen’s October appreciation. The headlines should have read (but didn’t): “Chinese Banks say: STUFF IT.”

  The Chinese banks won a game of drag race “chicken” with foreign banks. Most credit support annex agreements would say that closing out these trades would be an event of default, and then the cross default on all the trades would kick in with the same counterparty. But the credit of the Chinese banks was better than many of their counterparties, and they renegotiated contracts with the Chinese banks.

  What inspired Chinese banks to play and win this game of brinkmanship? The motive may be entirely unrelated to the bath that highly-placed “retail client” Chinese have taken with investments in mini-bombs, er, I mean mini-bonds, sold to them with “AAA” ratings by U.S. investment banks. The latter is just icing on the rice cake.

  Hedges on exotic equity trades failed (delta “hedging”) in October when Volkswagen rose, and French banks took losses, and around $50 billion of these trades would roll in December. That was obvious in November. Correlation books took huge hits. Also in November in Asia, I believe, correlation trades blew up and Merrill Asia’s correlation book may have taken huge losses, and it was partly linked to structured (equity) products. “Correlation” trades unwound like crazy and there were large losses. Yet, Merrill says it did not take huge losses in November?

  In the last three weeks (primarily last two weeks) of November, corporate leveraged loans, private equity (and related loans) and commercial real estate hit the skids.

  Some of November’s events triggered Goldman’s surprise loss of more than $2 billion, most of which (for Goldman) occurred in the last two weeks of November reportedly from corporate leveraged loans, correlation trades, private equity and related loans and commercial real estate. But according to Merrill, its losses were in December, not November. Maybe. But as a U.S. taxpayer, I say: Prove it.

  I would like to see a detailed explanation of how Merrill’s rubber gripped the road round Dead Man’s Curve during a horrific November (Goldman could take a lesson from Merrill—who knew?), and I’d like to see the breakdown of its surprise losses in December.

  Merrill's Murder/Suicide

  February 7, 2009

  Yesterday, Tom Patrick of Vernon Capital and former executive vice Chairman of Merrill Lynch (ousted from Merrill in 2003), told CNBC that Merrill Lynch committed suicide. He said that from June 2006 to March 2007 Merrill’s super senior CDO positions rose from $4 billion to $60 billion and it never sold a bond. (Click here - may require subscription).

  Tom Patrick and CNBC just woke up to the problems at Patrick’s former stomping grounds. Sort of.

  As appalling as Tom Patrick’s and CNBC’s late-to-the-party revelations sound, it wasn’t that simple and it wasn’t that innocent.

  As I told CNBC on October 24, 2007 (Click here - requires subscription), Merrill suppressed key facts, hadn’t hedged properly quarters earlier, failed to report losses, and had an Enronesque problem. ( In January of 2007, I wrote an article for GARP saying risk professionals should bail out and short the positions.)

  Tom Patrick confirmed what I had told CNBC (and many others) long ago. Merrill’s risk would boomerang back on its balance sheet. There were few actual sales, just temporary transfers of risk. But that was just a part of the problem.

  It is a shame that Merrill couldn’t quietly commit suicide. In trying to delay its own death, it dragged others down with it.

  As I explain in my new book Dear Mr. Buffett: What An Investor Learns 1,269 Miles From Wall Street (Warren Buffett will feature the book prominently at the Berkshire Hathaway Annual Meeting in May 2009) Any investment banker worth their salt knew that “super senior” and “AAA” tranches and other “investment grade” tranches did not deserve those ratings, yet bond insurers, special purpose investment vehicles, and hedge funds participated in the madness adding risk and leverage to the financial community.

  Investments in pension funds, mutual funds and retail investments soured. For some of these "sophisticated investors” it seemed like a suicide pact with Merrill and other culpable investment banks. But for many naïve retail investors and for prudent financiers who are watching the effects on the global financial community, Murder/Suicide seems a more apt description. Moreover, Merrill was not the only investment bank that participated in this madness.

  [See also my February 5, 2009 Financial Times commentary “The China Syndrome: It’s Our Fault They Don’t Trust Us”

  Ken Lewis Must Go

  April 24, 2009 (Ken Lewis resigned at the end of September 2009)

  The key issue is whether Ken Lewis disclosed losses to shareholders in the early December meeting. He did not. Furthermore, if you look at the linked article in my analysis below, it seems James Mahoney, BofA’s spokesman, was (intentionally or otherwise) part of a cover-up (see January 26 WSJ article embedded in the link below).

  In my opinion, the bottom line is—and was—that Ken Lewis must go.

  Hank Paulson was hyped as one of the best and brightest, because he was a former Goldman CEO. But I would argue that he must believe his own hype if he thought that people would not immediately question the timing of the Merrill losses and Lewis’s disclosure. It was extremely inappropriate for him to even opine on whether Ken Lewis should disclose the losses, much less reportedly pressure Lewis not to disclose. That aside, Lewis is an adult and a highly paid CEO responsible for his decisions.

  Around the end of January, I publicly challenged BofA’s representation of the timing of the Merrill losses. There were large losses in Oct/November, but it seemed primarily November, and Lewis should have known this going into the December shareholder meeting. Obviously I was only working with publicly available information and experience that Ken Lewis should probably have as well. This is my analysis. You may wish to compare this with Merrill’s fourth quarter release and subsequent admissions. :

  BofA Says Merrill's Hit was in December (not November)? - January 26, 2009

  Bank of America’s Shareholders Should Reject Bonus Plans

  January 12, 2010

  In July 2009, New York Attorney General Andrew Cuomo reported that, among other things, the compensation structures at most banks were "a major impetus for the subprime fiasco."*

  Shareholders fed up with the fact that key contributors to the global credit crisis plan to pay billions of dollars’ worth of cash and stock in bonuses to employees might consider following Goldman's suit. Goldman Sachs's shareholders brought separate actions against the Board of Directors for alleged breach of fiduciary duties in approving billions of dollars in bonuses.

  Bank of America and its acquisitions, Countrywide and Merrill Lynch, were neck-deep in the subprime crisis. In July 2008, Bank of America acquired Countrywide, which made $97 billion in subprime or high interest loans during the peak years of 2005 through 2007.** On October 6,
2008 (three days after TARP was approved), Bank of America agreed to settle a multi-state predatory lending lawsuit against Countrywide for $8.7 billion. Bank of America received its first $25 billion TARP injection around three weeks later.

  Bank of America proposes to pay billions of dollars’ worth of cash and stock bonuses to its Merrill Lynch employees. Merrill Lynch claims that the fact that it lost tens of billions of dollars on so-called super senior 'investments" during the crisis is proof it innocently sold risky investments to others. Don't believe it.

  Here's what happened. Merrill was involved with a lot of subprime lending and packaging and knew or should have known exactly what it was doing. What is more, Merrill had other pockets of risk unrelated to subprime.

  For example, in December 2006, Ownit, a California-based mortgage lender partly owned by Merrill, declared bankruptcy. Its CEO, William Dallas, stated he was paid more to originate no-income-verification loans than for loans with full documentation.