Goldman Fraud Is Not Goldman’s Alone

My good Mr. Ericson, you seem to be delusional. So kindly allow me to point out a few uncomfortable facts you seem to have failed to point out.

1) ProPublica’s report on what should have occured in 2005 didn’t come out until after the bubble popped. Pointing out catastrophe after it occurs is completely useless to anyone, and I doubt that anyone you sited would have had the perceptiveness to see the housing bubble for what it was.

2) You seem to have no understanding of CDO’s or how they function. Paulson in no way hindered the underlying securities he was betting against. He offered to pay people to insure what were considered highly rated debt instruments. If he had been wrong, he would have paid a substantial sum of money to those that offered to take his wager. However, when the debt of these institutions began to default, he made a great sum of money. No one was fooled; there was no deception. Everyone new exactly what he wanted to bet against and they rushed in to claim the other side, which they thought was a sure thing. To liken this as “..stuffing turds into casings…” is just incompetent.

3) And finally, your claim that Paulson gave no service of any kind here is, to your standard, a poor observation. Thank God, your riot making doesn’t appear to be all that effective, since what Paulson was engaged in is effectively insurance. By your decree, any man who doesn’t make a product with his own hands is useless to society. Overlooking the value of having people like Paulson running around is a grave error, since his bets ultimately helped correct a huge discrepency in the marketplace. You may not like the idea of CDO’s or short selling or derivatives. However, they are necessary, particularly when exuberance creates the sort of nonsense productivity we’ve witnessed in real estate in the last decade.

In closing, you seem to be looking for a scapegoat to your problems. This has led you to attack a man; a man who, consequentially, is considerably more intelligent than yourself. And, you are attacking him solely because he was right about something very few people had the forsight to see. The advantage now is that Paulson, with the money that he earned (and he did earn it, make no mistake), is now in a position to invest in ways that do create wealth for society (as you were so offended that he hadn’t). And, given his track record, I’d say he will make an excellent manager; far better than the people he took the money from, anyway.

I’d recommend, before attempting to have him lynched, that you at least take an hour and attempt to learn what you’re talking about, since, based on the general lack of prevelant facts in this travesty you call an article, you have no idea.

Thank you for your thoughts. Mr. Thaler. I suppose I should have been more specific about Paulson. Goldman, Magnetar et. al.’s offenses. They go to the difference between collateralized debt obligations and so-called synthetic CDOs. The former I have no fundamental problem with. The latter I do.

Before I push this point further I should explain: I did, in fact, predict that the proliferation of over the counter derivatives would lead to crisis, in 1999: ( http://www.alternet.org/story/658/one_bank_under_god/ ), and I thought the housing bubble was overripe as of mid 2005: (http://www.citypaper.com/news/story.asp?id=10358 ). I should not have written above that as of 2006 “everyone knew” housing was going down, but rather that everyone should have known, and at any rate, every serious person who was paying attention knew.

What I failed to recognize in 2005 was how unregulated derivatives could be combined with ballooning CDOs to extend the bubble for two more years, creating a massive financial crash where only a minor one would have been. That was Paulson’s genius. He found suckers to insure those CDOs-bonds he had no financial interest in-so he could collect the payoff when they defaulted. This had the effect of extending the mortgage party for such productive citizens as these: (http://www.citypaper.com/news/story.asp?id=16788 ), and they dominated the housing market from 2006-2008.

A functioning market would have countered the fraud. The synthetic CDOs Paulson and his ilk used magnified the market while facilitating fraud. If every mortgage in the U.S. that could have gone bad, did, the losses would have been in the $200 billion range (http://www.citypaper.com/digest.asp?id=16754 ). But through the magic of synthetic CDOs, the bets to be placed against those dodgy bonds were unlimited, and the cost (mainly to future taxpayers) will probably exceed $2 trillion.

So financial innovation worked at cross purposes to a functioning capitalist system. This is why capital markets require adult supervision.

Your contention to the contrary notwithstanding, the SEC’s complaint does allege that Goldman misled investors by stating that a third party called ACA-not Paulson-had chosen the bonds it was selling ( http://www.sec.gov/litigation/complaints/2010/comp-pr2010-59.pdf ). It’s right there on page 2. Tourre did this cynically, according to the complaint, sending an email stating:

“One thing that we need to make sure ACA understands is that we want their name on this transaction. This is a transaction for which they are acting as portfolio selection agent, this will be important that we can use ACA’s branding to help distribute the bonds.”

And Goldman led ACA to believe that Paulson was buying into the bonds-not betting against them.

You overstate your case, claiming I’d like to see Paulson “lynched.” On the contrary, I would like to see him taxed, for everyone’s own good. Some people can’t see the difference.

Mr. Thaler, you present yourself as a member of that rare breed, the successful day trader. If you are indeed prospering this way, I tip my hat. Thank you for taking the time to comment on my modest blog, and I wish you success in your chosen endeavor.

Thank then for a very intelligent response. I apologize for my initial temperament, but, as I said elsewhere, I am inundated by conspiracy theorists and, based on your initial article and not being familiar with your work, I mistook you.

However, I don’t agree with you. Here’s why:

Ultimately, responsibility rests upon the heads of the parties that entered into the CDO contracts. Although Paulson did not want his identity released, this act in and of itself is not condemning. I doubt very many people would have cared about Paulson being for or against these CDOs since, frankly, no one knew who he was.

Moreover, Paulson and Goldman should not be held responsible for the excessive leverage taken on by other entities. To say that he intended to make money from the downfall of those bonds does not somehow excuse the counterparties from blame. It should have been trivial that someone was betting against them; that much was obvious, since someone was paying them for the insurance.

I actually agree with your distaste for synthetic financial instruments, and not just CDO’s. I’m seeing concerning behavior coming from many funds that specialize in exposure to materials, like SLV or GLD, which makes me believe they’re nothing more that options fancily packaged. And, I acknowledge that these synthetic instruments have the capability to vastly overleverage the system.

But I think contempt would be better reserved for the individuals who took the risk. They could have easily figured out how much net exposure they had. Even though Paulson enabled far more insurance to be covered than there existed actual bonds to be purchased, no one forced these funds and banks to sit across form the table. Though the defaults exacerbated the situation, I can’t in good faith accept that the blame belongs at the feet of Paulson or Goldman.

Regardless, after reading your comment, I expect we can both agree that the derivatives market needs some sort of regulation, and I would suggest the best form is to force banks to include a section on their SEC filings that details their exposure and best/worst case situations, with an accompanying explanation of their expectations.

And again, let me apologize for coming out of the shadows swinging punches. It was rude of me.

Well, nobody has to agree with me. But you overlook one huge risk that, I think, may have paid off for people like Paulson even though it shouldn’t have. Paulson reportedly cleared $2 billion on his trades in 2008, as the crisis deepened and the bailout began. The people who took the other side in Paulson’s bets were the companies that issued the credit default swaps. As we now know, one of the biggest of those insurers was AIG, which received something like $180 billion in U.S. government backing, because it could not pay out on all its losing bets.

Nowhere in the coverage of this matter so far have I seen an accounting of who paid Paulson his $2 billion “winnings” in 2008. But I don’t think it’s crazy to speculate that at least some of that money came courtesy of the Treasury and the Federal Reserve.

If that’s true, then Paulson’s bet hurt all of us twice-first during the unsustainable home price runup and concomitant fraudulent lending against same; then in the bailout after the inevitable crash.

In a real capitalist system, counterparty risk is the ultimate trump card. It’s built into the boilerplate of all credit default swaps, and indeed, in all corporate bonds issued: if the issuing company goes bankrupt, you don’t get paid. The bailout overturned that law of business-at least for the lucky few. If Paulson was among them, then I suggest that taxing him is the least we should do.

How about we not bailout anyone else, instead? I find the idea of giving money to banks so that they can meet their obligations only to take back the money from the people they were obliged to leaves a very nasty taste in my mouth. This is precisely why the U.S. government shouldn’t get involved in this sort of thing. I hardly think it’s right to screw over Paulson or other managers who had an astute view of the marketplace after the fact. Maybe, take back the U.S. citizens money and then turn the carcasses of the banks over to these men, since they were the major debt holders at the end?

Realistically, there’s no fix now, we’ve come too far and cheap money from the Fed has permeated the environment too deeply to make proper sense of anything. The best we can hope for is to take steps to prevent the government from ever being able to intervene on the behalf of a major corporation again. And, looking at the landscape, that’s one hell of a reclaimation project…