FORECLOSUREGATE 3.0   Jan 30 2011

Quelle Surprise! Goldman Profited From AIG Bailout Via Abacus Trades (You Read It Here First) Jan 2011 12:05 AM PST Shahien Narisipour at Huffington Post revealed that the FCIC report, due to be released officially tomorrow, shows that contrary to its pious assertions to the contrary, Goldman received funds for its own account from the AIG bailout, to the tune of $2.9 billion. Why is this significant? Because Goldman maintained that the monies it received from the rescue were for customer trades, not for its own account. And while this may seem to be news, it isn’t, except for putting a firm dollar value on what Goldman received for its own account. We posted on Goldman’s AIG exposures both as principal and agent on February 7, 2010, and specifically flagged that the Abacus trades that Goldman insured with AIG were principal positions, not client trades. We caught some flack for it by the time from various commentators who seemed more persuaded by Goldman’s PR that the extensive work done by Tom Adams, which we presented in a series of posts in early 2010 (see here, here and here for some examples). From the February 2010 post: Possible Productive Lines of Inquiry That Get Short Shrift The focus on Goldman’s marks with AIG largely bypasses what we think is a more serious issue: the role of all synthetic or heavily synthetic CDOs, which allowed Goldman to go net short. The usual vehicle for that was a “mezz” CDO, because the CDS would be on BBB subprime trances, the layer that would go “boom” first. The bulk of Goldman’s AIG-related CDOs were older vintage “high grade” CDOs, meaning the synthetic component was not large (on the deals we looked at, a maximum of 20%) and they would be on AA bonds, which were not the slice you’d be eager to use if your strategy was to go net short. So the fixation on the marks has the unfortunate effect of diverting attention away from what we think was the much more troubling activity: the use of heavily/all synthetic CDOs to establish a short position. Even though the deal documents allowed for the possibility that Goldman would keep the short interest created by these deals, anyone who invested in them or acted as a guarantor would have thought very differently, and probably have asked for much higher returns if it had understood Goldman was acting as a principal rather than as a middleman (and how Goldman influenced the deal parameters to assure that its short position worked out). The story indicates that $5.5 billion of Abacus trades (a Goldman synthetic short program of 26 deals in total) were insured by AIG. Using the AIG Abacus trades as an entry point into the entire Abacus program would be a very useful exercise. Note that the disclosure on the Abacus trades guaranteed by AIG continued to be sparse. The Abacus trades were pure synthetic CDOs, and pure synthetics were excluded from the Maiden Lane III portfolio (the special purpose entity established by the Fed to hold the non-synthetic CDOs that the Fed purchased from various dealers). From Huffington Post: Goldman Sachs collected $2.9 billion from the American International Group as payout on a speculative trade it placed for the benefit of its own account, receiving the bulk of those funds after AIG received an enormous taxpayer rescue… At a hearing on July 1, 2010–two weeks before Goldman sent the e-mail acknowledging how $2.9 billion in AIG funds wound up in its own account–the crisis panel questioned Goldman’s chief financial officer, David A. Viniar and managing director David Lehman. Both said they knew nothing about AIG funds landing in the bank’s private coffers, according to a transcript of the hearing… According to the crisis commission report, Goldman bought credit default swaps from AIG as a form of insurance on investments known as Abacus, which were pools of mortgage-linked securities. It is separately a sign of the times that the Goldman CFO and a managing director in the CDO business could deny in sworn testimony that Goldman had received funds from its own account from the AIG rescue. As we stressed in our series of posts on the AIG exposures, the information we worked with was already in the public domain, even though few took the effort to piece together what it meant.

US Bankruptcy Trustee Takes Interest in “Ta Dah” Documents Mysteriously Appearing in Foreclosures (aka Probable Fabrications) One of the sorry reminders of the decline of the rule of law in the United States is the frequency with which incidents of what look like document forgeries take place in foreclosure cases. The fact that a now-shuttered subsidiary of Lender Processing Services, a vendor to the servicing industry, had a price list for creating mortgage-related documents out of whole cloth attests to the long-standing demand for this sort of product. The reason for this activity is simple. As we’ve stressed in various posts, in so-called private label securitizations (the non-Fannie/Freddie type), a great deal of evidence indicates that the originators and packagers of these deals did not bother complying with the contracts they created to govern these transactions on a widespread, perhaps pervasive basis sometime after 2003. And their shortcomings only come to light in foreclosures, and then (possibly) if the foreclosure is contested. Given how low foreclosure rates were historically, this was a risk the securitization industry seemed willing to take, and it is now reaping the fruit of this short-sighted bet. The big problem for servicers and trustees (the parties that are responsible for the trust that holds the assets of the securitization) is that the pooling and servicing agreement which governs the securitization required that the note (the borrower’s IOU) be transferred though a specific set of parties by a specified time not all that long after the deal closed. Increasingly savvy anti-foreclosure lawyers recognize that the party attempting to foreclose may not have the legal standing to do so. A new development is that the US Bankruptcy Trustee, which is part of the Department of Justice, has started poking around the nether world of slipshod and possible made-up documents, and is asking banks to explain what they are up to. These inquiries may be paving the ground for broader-based action. The case in question is a Connecticut Chapter 13 filing (hat tip April Charney). US Trustee Motion in CT for 2004 Examination DeutscheBank purports to be the trustee for a particular 2005 mortgage securitization which contains the mortgage at issue. This is a partial list of the documentation problems; the motion itself makes for instructive reading: In the first filing, Deutsche provides a copy of an undated promissory note which is not made out to the trust but the originator. A few days later, Deutshce filed an objection to the debtor’s plan of reorganization, and in it said the mortgage (the lien, not the note) had been recorded as transferred from the originator to Sand Canyon (a unit of Option One) in 2005 and then transferred to Deutsche less than two weeks before the bankruptcy filing. Note that a 2010 transfer is well outside the time parameters stipulated in the pooling and servicing agreement. The borrower’s side asks what happened to the note, since there is no evidence it was transferred. Several months later, Deutsche shows up in court with the usual fix for this sort of problem, an allonge (an attachment to a note that is so firmly secured that it is supposed to be inseparable to allow extra room for signatures. Query if the allonge were properly attached, how would it be possible to make a copy of the original note and not see at least part of the allonge?) The truly creative part is these documents include an assignment of mortgage dated June 11, 2010, but effective as of May 1, 2005. I never knew law offices had time machines as part of their standard equipment. The trustee separately questions the 2010 assignment, since it was signed by an employee of Sand Canyon, when Sand Canyon did not own any mortgages or mortgage servicing rights at that point in time. Even though the bankruptcy trustee is merely requesting a Rule 2004 examination (which means it wants someone from Deutsche to appear and answer questions about the case under oath), it is clear that he does not like what he sees so far: The United States Trustee has reviewed the documents filed by Deutsche in this case and has concerns about the integrity of those documents and the process utilized by Deutsche….Bankruptcy Courts have discussed the need for secured lenders to provide accurate information in filings before the Court… Consequently, “cause” exists authorizing the issuance of a subpoena to compel document production under Bankruptcy Rules 2004(c) and 9016… The US Trustee has asked for a pretty extensive list of documents related to this bankruptcy. I’d love to be a fly on the wall and see the Deutsche employee try to explain his way out of this one.

FCIC Insiders Say Report Gives Wall Street a Free Pass, Simply Sought to Validate Conventional Wisdom About Crisis Posted: 26 Jan 2011 12:53 PM PST From the very outset, the Financial Crisis Inquiry Commission was set up to fail. Its leadership, particularly its chairman, Phil Angelides, was seen as insufficiently experienced in sophisticated finance. The timetable was unrealistic for a thorough investigation of a crisis this complex, let alone one international in scope. Its budget and staffing were too small. The investigations were further hampered by the requirement that subpoenas have bi-partisan approval along with Its decision to hold hearings with high profile individuals, including top Wall Street executives, before much in the way of lower-level investigation had been completed. The usual way to get meaningful disclosure from a top executive is to confront him with hard-to-defend material or actions; interrogations under bright lights, while a fun bit of theater, generally yield little in the absence of adequate prep. So with expectations for the FCIC low, recent reports that the panel urged various prosecutors to launch criminal probes were a hopeful sign that the commission might nevertheless come out with some important findings. But correspondence from insiders in the last few days suggests otherwise. One, for instance, wrote, “I’m still in the process of getting the stink out of my clothes.” These ideologically-neutral sources close to the investigation depict the commissioners as having pre-conceived narratives and of fitting various tidbits unearthed during the investigation into these frameworks, with the majority focusing more on the problems caused by deregulation and the failure of the authorities to use even the powers they had, while the minority assigns blame to government meddling, particularly housing-friendly policies. These insiders see both sides as wrong, and want to encourage investigative reporters to challenge both the majority and dissenting accounts. They contend that both versions help perpetuate the myth that Wall Street was as much a victim of the crisis as anyone else. One of these sources sent this document in an effort to question the notion that any of the reports coming out of the FCIC were the result of a fact-based investigative process, meaning operating in an objective manner, scouring information to see which theories or storylines seemed most consistent with what had been unearthed. As you will see, he makes clear that he regards all of the FCIC narratives as falling well short in explaining the crisis. Now if we could only get Kurosawa to enter stage left and tell us what really happened….. From a source close to the investigation: Recently, I got started talking with a neighbor about ideologues in and around government. He had just read a book called Emerald City. He said it was about how we screwed up in Iraq by letting the ideologues run the post war show. The problem was that they had no “on the street” Iraqi experience. For them it was all theory and little practical experience. They were sure they were right and nothing could be said to change them. When things didn’t go according to plan, they just pretended it did or asserted events would turn their way shortly. It occurred to me that we should be on the alert for this phenomenon when it comes to the three reports (one report and two dissents) to be released the Financial Crisis Inquiry Commission later this week. True to form, the reports start out with how many documents were reviewed and how many people interviewed. This sets us up to believe that the Commissioners relied on facts garnered from the documents and interviews in coming to their conclusions. It would do Americans a lot of good to put this to the test. Did the Commissioners really use the facts to arrive at their conclusions or did they arrive at the conclusions first and are simply citing a selection of the facts to support their previously arrived at positions? In fact, the majority will provide a history of financial crisis anecdotes and then try to fit the facts into its theory that the crisis was avoidable if only the financial sector took fewer risks and government was more competent. The dissents will do the same to support their theory that it was all government’s fault. The problem is that the financial crisis was a real event. It didn’t happen in a theoretical model. It happened in real life and ruined the retirement savings of millions of Americans. Not only should we be skeptical of both the majority and the dissents, we should put them to the test to explain exactly how their theory explains the losses of hundreds of billions of dollars in the securities markets and trillions more in residential real estate. The question we should always keep in mind is for them to explain how abrupt catastrophic financial systemic failure happened. (Remember Secretary Paulson going to Congress kneeling before Nancy Pelosi and begging for three quarters of a billion [sic] dollars over the weekend.) In a systemic failure there are always things that people do which in hindsight look imprudent: take on too much leverage, speculate instead of hedge, chase short term goals at the expense of long term security, panic, etc. If these things are offered up by the majority who says the crisis was avoidable, put them to the test. Which of the multitude of anecdotes were critical? If they can’t identify one or two critical factors, ask them specifically (anecdote by anecdote) whether the crisis would have occurred even if the anecdote in question didn’t occur. If they can’t tell you either, then really what they are saying is the crisis was a “perfect storm” of just the right mix of private sector greed and public sector incompetence coming together at the same time. In other words, what happened could not have been predicted and the crisis was not avoidable. The ideologues in dissent have already started to sell a different theory. Some will try to say that the crisis was all due to affordable housing goals at the GSEs and the Community Reinvestment Act. This theory doesn’t hold true anywhere but in some right wing economist’s model. We should be able to assume that the GSEs did their best to pursue profits for their shareholders. That is, they didn’t intend to underwrite loans they knew would not be paid back. Nothing in the AHGs or CRA required them to underwrite bad mortgages. Indeed, those goals specifically were hedged so that they could be ignored if loans to satisfy them could not be made under terms which were economic. The ideologues may say that underwriting bad mortgages by the GSEs resulted in an unsustainable increase in housing prices that all of a sudden collapsed (causing the financial crisis). But this would not (could not) have happened so widely and so quickly without other factors intervening. For example, how did the AHGs and CRA cause the rapid collapse of AIG, various monoline insurers, various investment banks, numerous money market funds or billions of dollars of losses in a huge number of mutual funds and pension funds none of which were subject either to the goals or CRA? Catastrophic financial system collapse is not the result of largely unrelated anecdotes. There are too many firewalls in the system to allow it to happen. It has to be the result of one or more firewalls failing or something really big in the system going bad. What was there about the system that was big enough to cause systemic failure so quickly? What connects the two: the failure of the housing and securities markets? Based on further discussions with individuals familiar with how the report was developed, the following shortcomings are evident: The Commission was able to do comparatively little in the way of forensic work; the bulk of its effort was devoted to the hearings, which delivered relatively little in the way of new insight As indicated above, the FCIC report is guilty of “drunk under the streetlight” behavior, of trying to fit its story to already known or easily found information. Even though the report makes extensive use of salacious extracts from e-mails, the insiders content that none of these information in these e-mails illuminates information critical to the crisis trajectory. As a result, the report underplays or completely misses the real drivers of the crisis. Specifically, it gives short shrift to the obvious epicenters: – How a previously benign securitization process allowed for the creation and sale of bad mortgages on a widespread basis – How inadequate disclosure as alleged in a number of recently filed big lawsuits allowed mortgage backed bonds that contained many loans that fell below the underwriters’ promised standards to be sold to investors – How a shadow banking system ballooned with products increasingly based on dubious financial instruments – How CDOs that were devised by subprime shorts, most importantly the hedge fund Magnetar, drove the demand for the worst sort of subprime loans, extended the toxic phase of the subprime bubble well past its sell-by date – How the dealer banks knowingly created toxic products, and via flawed risk management processes, allowed traders to retain significant portions of them via strategies that amounted to gaming of the banks’ bonus systems Merely reading news releases of the last few weeks will show the shortcomings of the FCIC report. For instance, it skips over the role of the failure of the securitization industry to adhere to its own agreements, even though the FCIC was presented with this information last summer. It also is silent on the sort of abuses coming to light, such as the fact that Bear Stearns was allegedly double-dipping on its own deals, demanding that originators make extra cash payments on bad mortgages they had sold into pools that Bear was selling to investors, while failing to pass those payments on to investors (knowing that they instead would seek to have the bond insurers be the ones who would make investors whole). Similarly, on the eve of the release of the FCIC report, the SEC, which astonishingly had declared disclosure on mortgage-backed securities to be “robust”, has done a quiet about face and has issued a new rule requiring issuers of asset backed securities to conduct a quality review and disclose to investors what that review consisted of. Note that this closing of a gaping loophole in disclosure has gone largely unnoticed. The sad thing isn’t that the FCIC did not do its job. As we indicated earlier, that failure was by design. No one in the officialdom wants the mechanisms of the crisis to be exposed in full. It would compromise too many influential people and restoke well warranted public ire about the bailout of a miscreant financial services industry and its ongoing extractive behavior. Ironically, this core element of the dissent’s criticism is spot on, even if their own narrative suffers from precisely the same flaws. As FCIC commissioner Peter Walliston observes: Like Congress and the Obama administration, the Commission’s majority erred in assuming that it knew the causes of the financial crisis…The Commission did not seriously investigate any other cause and did not effectively connect the factors it investigated to the financial crisis. The majority’s report covers in detail many elements of the economy before the financial crisis that the authors did not like, but generally fails to show how practices that had gone on for many years suddenly caused a worldwide financial crisis. In the end, the majority’s report turned out to be a just-so story about the financial crisis, rather than a report on what caused the financial crisis….. From the beginning, the Commission’s investigation was limited to validating the standard narrative about the financial crisis—that it was caused by deregulation or lack of regulation, weak risk management, predatory lending, unregulated derivatives, and greed on Wall Street. Other hypotheses were either never considered or were treated only superficially. In criticizing the Commission, this statement is not intended to criticize the staff, who worked diligently and effectively under difficult circumstances and did extraordinarily fine work in the limited areas they were directed to cover. The Commission’s failures were failures of management. By having the FCIC validate widely accepted, superficial, and ultimately inadequate explanations of the crisis, the Obama administration continues in its policy of looking forward rather than back, when looking back is the foundation of any serious scientific, investigative, or prosecutorial process. The odds are high that the media and the public at large will mistake the extensive use of anecdote in the FCIC report for accuracy and completeness. As with so many accounts of the crisis, the artful use of detail will yet again have the effect of diverting attention from the true drivers of the crisis and thus leave Wall Street free to devise new ways to wreck the economy for fun and profit.