Creating Toxic Assets to Profit From the Collapse

I am certain that there are some readers out there who still somehow think that our financial crisis was caused by greedy poor people buying houses that they couldn't afford. Then when the economy tipped a little bit, the weight of their snow-balling defaults kept the economy on a downward slide. After all, it is what some cable media people were telling you. That assumption plays well with hard working Americans because the alternative is to believe that those at the top - the respectable people in fancy suits running Our banks were actually doing something wrong. [article]

Guess what? It gets a bit complicated but I'll walk you through it.

[An up-and-coming Goldman Sachs employee created] mortgage-related securities, named Abacus, that were at first intended to protect Goldman from investment losses if the housing market collapsed. As the market soured, Goldman created even more of these securities, enabling it to pocket huge profits. Goldman’s own clients who bought them, however, were less fortunate.

We have all been hearing about these so-called "toxic securities" that the banks were sitting on as things collapsed, but this sounds a bit different. This sounds like the banks created stinky assets, sold them to investors, then bet against them.

Pension funds and insurance companies lost billions of dollars on securities that they believed were solid investments

Goldman was not the only firm that peddled these complex securities — known as synthetic collateralized debt obligations, or C.D.O.’s — and then made financial bets against them, called selling short in Wall Street parlance. Others that created similar securities and then bet they would fail, according to Wall Street traders, include Deutsche Bank and Morgan Stanley, as well as smaller firms like Tricadia Inc., an investment company whose parent firm was overseen by Lewis A. Sachs, who this year became a special counselor to Treasury Secretary Timothy F. Geithner.

Isn't also nice to know that the fox is watching the hen-house for us? We can be fairly certain that next to nothing will change as a result of a Geithner-led investigation. Nevertheless, We The People need to know this so we can force the issue and make real change happen.

One focus of the inquiry is whether the firms creating the securities purposely helped to select especially risky mortgage-linked assets that would be most likely to crater, setting their clients up to lose billions of dollars if the housing market imploded.

Our ignorance is blissful for those in financial power. As long as We keep scrabbling for our dollar, they can fleece Us for their millions. The stink of this practice is overwhelming. It is true that any prudent investment strategy calls for hedges against possible changes in the economy. In the simplest terms, it is like owning both stocks and bonds because each generally performs well when the other is not. But most investors don't create a massive failure so that their hedge can profit extraordinarily.

“The simultaneous selling of securities to customers and shorting them because they believed they were going to default is the most cynical use of credit information that I have ever seen,” said Sylvain R. Raynes, an expert in structured finance at R & R Consulting in New York. “When you buy protection against an event that you have a hand in causing, you are buying fire insurance on someone else’s house and then committing arson.”

It is also important to note that this is not an accident, or some sort of one-off switch-a-roo.

The creation and sale of synthetic C.D.O.’s helped make the financial crisis worse than it might otherwise have been, effectively multiplying losses by providing more securities to bet against. From 2005 through 2007, at least $108 billion in these securities was issued, according to Dealogic, a financial data firm. And the actual volume was much higher because synthetic C.D.O.’s and other customized trades are unregulated and often not reported to any financial exchange or market.

And the assets in question were unregulated. Why do you suppose that was? Who do you suspect profits when financial shenanigans go under the radar?

A handful of investors and Wall Street traders, however, anticipated the crisis. In 2006, Wall Street had introduced a new index, called the ABX, that became a way to invest in the direction of mortgage securities. The index allowed traders to bet on or against pools of mortgages with different risk characteristics, just as stock indexes enable traders to bet on whether the overall stock market, or technology stocks or bank stocks, will go up or down.

Goldman, among others on Wall Street, has said since the collapse that it made big money by using the ABX to bet against the housing market.

Ponder that, dear readers. In 2006 there were people shaping a mortgage crisis, who built an index to monitor that developing crisis, then reveled in the collapse making billions of dollars. If you are in foreclosure right now, or can see the possibility of it from where you are, then you must be pretty angry right about now. You might want to contact your Senator and Representatives and make certain they know just how this makes you feel.

And what happens to the people who play fast and loose with your castle?

Mr. Egol and Fabrice Tourre, a French trader at Goldman, were aggressive from the start in trying to make the assets in Abacus deals look better than they were [snip] Goldman’s bets against the performances of the Abacus C.D.O.’s were not worth much in 2005 and 2006, but they soared in value in 2007 and 2008 when the mortgage market collapsed. The trades gave Mr. Egol a higher profile at the bank, and he was among a group promoted to managing director on Oct. 24, 2007.

“Egol and Fabrice were way ahead of their time,” said one of the former Goldman workers. “They saw the writing on the wall in this market as early as 2005.” By creating the Abacus C.D.O.’s, they helped protect Goldman against losses that others would suffer.

But hey, claims Goldman, we played fair. We said there was risk. It's the investors fault for being greedy!

The Goldman salesman said that C.D.O. buyers were not misled because they were advised that Goldman was placing large bets against the securities. “We were very open with all the risks that we thought we sold. When you’re facing a tidal wave of people who want to invest, it’s hard to stop them,” he said. The salesman added that investors could have placed bets against Abacus and similar C.D.O.’s if they had wanted to.

Funny, earlier in the article it specifically states that Goldman was quietly buying the shorts and rarely selling that option to investors. It's a bit like those lottery ads on the radio that make it all exciting and trumpet how you can win millions, and then the odds of winning are tacked on at the end of the ad at breakneck speed that no one could catch. But hey, we warned you!

The banks themselves met and established the rules that would be in effect. In fact, they created new rules that more quickly fleeced those holding the toxic investments that the banks themselves created.

This is exactly the reason that unfettered business is a Bad Idea. While I am all in favor of capitalism, it has to be on a level playing field. Those at the top simply cannot be allowed to make the rules whereby they profit at Our loss. The entire point of this blog, Pitchforksandtorches, is to function as a wake up call. It is a call to action. In a Democratic Republic such as ours, the simplest thing you can do is holler, frequently and intelligently and preferably in writing, to your elected officials. If you believe they are not acting in your best interest, then WORK to find a better candidate and get that person elected. Heck, that better person might even be you. These are the preferred Pitchforks and Torches in a civilized society, but just like their literal namesakes, they work better in a large group.

Pass along this blog if you believe in what I am trying to do. Tell like-minded friends and family. Tell those who you think disagree and have conversations about it. Read the articles I link to and get your information straight from the source rather than through my filter. Use the knowledge you gain to ask more questions and seek out your own answers from other sources. Our ignorance is Their best tool. Our knowledge becomes Their restraint.

"You can fool some of the people all of the time, and all of the people some of the time, but you can not fool all of the people all of the time. ~ attributed to Abraham Lincoln."

"Don't get fooled again!" ~ The Who