Betting On Double Zero

The other big story breaking this weekend is McClatchy's Greg Gordon revealing just how Goldman Sachs became this big winner in the financial meltdown by betting everything would go sour. The article's a must read, but highlights include this (emphasis mine):

"The Securities and Exchange Commission should be very interested in any financial company that secretly decides a financial product is a loser and then goes out and actively markets that product or very similar products to unsuspecting customers without disclosing its true opinion," said Laurence Kotlikoff, a Boston University economics professor who's proposed a massive overhaul of the nation's banks. "This is fraud and should be prosecuted."

John Coffee, a Columbia University law professor who served on an advisory committee to the New York Stock Exchange, said that investment banks have wide latitude to manage their assets, and so the legality of Goldman's maneuvers depends on what its executives knew at the time.

"It would look much more damaging," Coffee said, "if it appeared that the firm was dumping these investments because it saw them as toxic waste and virtually worthless."

Lloyd Blankfein, Goldman's chairman and chief executive, declined to be interviewed for this article.

A Goldman spokesman, Michael DuVally, said that the firm decided in December 2006 to reduce its mortgage risks and did so by selling off subprime-related securities and making myriad insurance-like bets, called credit-default swaps, to "hedge" against a housing downturn.

DuVally told McClatchy that Goldman "had no obligation to disclose how it was managing its risk, nor would investors have expected us to do so ... other market participants had access to the same information we did."

For the past year, Goldman has been on the defensive over its Washington connections and the billions in federal bailout funds it received. Scant attention has been paid, however, to how it became the only major Wall Street player to extricate itself from the subprime securities market before the housing bubble burst.

In other words, there's a very, very good chance that Goldman Sachs knew it was selling toxic waste to investors while the company itself arranged its own finances to bet that the very financial products it was selling would collapse completely.

It is very much fraud, on a massive, economy destroying scale, and Goldman made billions from it. If it can be proven that Goldman Sachs knowingly sold products that it was convinced would collapse in value, then it's over for them.

Any financial reform must start with the prosecution of those responsible for creating, packaging, and selling these financial products to serve as a warning that it will never be allowed to happen again.

But what are the odds of that happening? Obama's financial team is compromised to the hilt by connections to financial companies, especially Goldman Sachs. Do you think Timmy, Helicopter Ben, or Larry Summers are going to allow anything to happen to Goldman or any of the Too Big To Fail Banks? Do you think Congress, taking millions in lobbyist dollars, will allow any of that to happen?

Perhaps when the next bubble bursts and throws us into a real depression, people will pay attention. But it won't happen otherwise.

Yves Smith at nakedcap surmises that Goldman Sachs's escape tunnel went through AIG:

Goldman used another route….and the road, not surprisingly, was through AIG. From an e-mail over the summer:

This also points out a *VERY* good nugget re: banks who used CDOs/AIG offensively as opposed to as a hedge. This is likely what bothered me most about the AIG debacle. The trades GS had on with AIG were generally *not* super senior CDOs GS was long simply because they had
underwritten CDOs and were “stuck” with the AAA risk as a result. Rather, GS had a whole program of issuance — something they called “Abacus” — which were deals they put together with the sole purpose
of getting short subprime/CDO risk. Their sole purpose in doing the deals was to get long protection/short risk on the underlying collateral. AIG was simply the vehicle they chose to moneitze that PnL. Call me crazy, but I put the AIG counterparties in two different camps: guys like SocGen, who bought bonds in good faith and then hedged the credit risk by buying CDS from AIG, and guys like GS, who used AIG as their lottery ticket for offensively constructed trades to capitalize on mispriced subprime risk. The former, to me, seem much more deserving of a bailout than the latter…

DeutscheBank had a broadly similar program called Start.

This of course makes complete sense. There simply was not enough insurance capacity (the monolines plus the volume on the Markit indexes) to account for the big names that went short (Paulson, Goldman, one other large but secretive player we are aware of). That road had to go through AIG as well.

The evidence is starting to build up. In 2006 the smart financial firms were making money off the Bush Boom. The really smart financial firms were planning to make even more money off the Bush collapse.

And they left us holding the check. The roulette wheel came up 00 just as Goldman Sachs put everything down on it. Everyone else on the board was wiped out.

But not Goldman Sachs.