Thursday, April 22, 2010

Comment I Posted To "Did Goldman deceive...?" On The Conglomerate Blog

Comment I posted on the Conglomerate Blog, "Did Goldman deceive the collateral manager? Why it matters" by Erik Gerding.
I think the case is more complicated. The CDO is synthetic and, by definition, will include various derivatives (CDSs and other forms of derivatives). All derivatives are zero sum and have counter parties. The derivatives in use here are bespoke or not standardized, exchange traded derivatives. All the parties understood these facts.

The long investors, IKB, ACA and any other investor understood that there was a counter party to the derivatives with economic interests adverse to their interest. If there was not, the derivatives could not exist.

In non-standard, non-exchange traded derivatives, both sides to the derivative have input and negotiate the terms.

All the long investors understood that there was a short party(ies) to the transaction negotiating pricing and terms including the mortgages to be included. While it is not in the complaint, it is safe to assume that ACA (and the other investors) understood a party economically adverse to the long side of the transaction was suggesting mortgages. ACA is an experienced party to this type of transaction.

Since ACA understood there was an adverse party suggesting mortgages, is it relevant or material if it is Paulson? I think not unless you believe Paulson used fraud, undue influence or coercion to get ACA to accept a mortgage. The facts in the complaint do not support this since, ACA rejected some of the mortgages suggested by Paulson and ACA suggested mortgages not on Paulson's list that Paulson and the other parties accepted.

1 comment :

  1. While it is not in the complaint, it is safe to assume that ACA (and the other investors) understood a party economically adverse to the long side of the transaction was suggesting mortgages.

    If it were in the complaint, there would be no complaint. According to the complaint, ACA thought that Paulson was a long, taking a first-loss position on the CDO.

    I think this whole long-short thing is overblown in the case of an AAA-rated security. Any time I buy insurance, I am "short" the thing I insure, but that does not mean that I am betting against it. The "short" side of the $1b CDO could have been a long trying to hedge a bet against $2b of bonds he owned and liked. IKB wanted a portfolio selected by an independent selection agent, not the table scraps of a bet between a long and a short.

    I think it very unlikely that ACA knew Paulson was in the room with them trying to pick trash. Which raises the question of why they let him in the room if he was not presented to them as a fellow long.

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