Tag - Aig

I’m sure by now you’ve heard that Goldman Sachs (NYSE:GS) has been indicted for fraud. Goldman is accused of creating securities that were designed to fail, so it and its hedge fund cronies could make billions in profits. 

Case in point: Abacus 2007-AC1. “Abacus” was a 23-part series of “synthetic collateralized debt obligations” that Goldman Sachs constructed and sold to supposedly sophisticated investors. 

According to Bloomberg, a “synthetic collateralized debt obligations” was a mixture of “…credit- default swaps (CDO), used to transfer the risk of losses on debt, and securitization, used to slice the risk in a pool of assets into various new securities.”   

(We’ve discussed how the securitization process allowed good (prime) and bad (subprime) mortgages to be combined to create new securities that inevitably received undeserved AAA ratings from rating companies.) 

Abacus 2007-AC1 was one such synthetic collateralized debt obligation. When Goldman went to sell this security to investors, it didn’t reveal the fact that hedge fund Paulson & Co. (no relation to former Goldman CEO and Treasury Secretary Henry Paulson) had helped choose the securities that would be included. Also not revealed was the fact that Paulson & Co. bet that Abacus 2007-AC1 would default.    

Paulson & Co. made $1 billion when the Abacus 2007-AC1 CDO inevitably defaulted. It was designed to fail.   

It seems a stretch to think that Goldman Sachs didn’t know that Abacus 2007-AC1 was designed to fail. And there were 22 other Abacus transactions between 2004 and 2007.   

Now, it is well known that some mortgage loans are more risky than others. Risky loans carry higher interest rates, to offset the risk. This has always been true.   

But the securitization process made it possible to hide risky loans alongside low-risk loans. And it’s clear that rating agencies like Moody’s or Standard & Poor’s did not do enough due diligence on these CDOs to find out exactly what was in them.   

In my opinion, the ratings agencies deserve some of the blame. But that doesn’t change the fact that the securitization process was a deliberate attempt to “put one over” on the ratings agencies.  

At this point, I keep coming back to all the people who continue to say there was no way to see the financial crisis coming. It’s a long list, full of bank CEOs, current and former Fed officials, Treasury officials, and Congressmen.   

Well, how about this: I’d say that not only was it possible to see the financial crisis coming, the financial crisis was a direct and inevitable result of the types of transactions Goldman Sachs was conducting.   

In other words, it wasn’t the housing bubble and the sub-prime loans that created the financial crisis, it was the deliberate concealment of risk through securitization that caused the financial crisis.   

If investors know they are buying risky assets, then they have to hedge that risk. For instance: if you buy Greek bonds, you know there’s a chance you might not get paid back. And you certainly won’t be able to use those bonds as collateral for other investments.   

But what if you buy a Treasury bond that, through the process of securitization, is really just a Greek bond with a better sounding name? And since Treasury bonds are generally considered to be as good as cash, you use it as collateral for other investments?    

Well, when that bond defaults, not only do you lose the money you spent on the bond, you also suddenly do not have the collateral needed to support your other investments. And the whole thing comes crashing down, like a big margin call.   

So who’s at fault? Clearly, investors didn’t know what they were buying. And ratings agencies didn’t know what they were rating. But still, the SEC is charging Goldman Sachs with fraud, for deliberately misleading both investors and the ratings agencies about the risk of CDOs like Abacus.   

If these charges are proven, then investors and ratings agencies may be guilty of being gullible. But Goldman is guilty of lying.   

And it may not be just Goldman Sachs. JP Morgan (NYSE:JPM), UBS (NYSE:UBS), Deutsche Bank (NYSE:DB), and others created and sold synthetic mortgage-backed CDOs.   

According to Bloomberg, UBS has already been sued by Hamburg-based HSH Nordbank AG for “deliberately selecting inferior quality” assets for a synthetic CDO called

Senate Banking Chairman Christopher Dodd is all set to put his latest banking regulation bill up for a vote. The bill would put an end to proprietary trading, lend transparency to hedge fund trading and derivatives, and give the Federal Reserve the power break up companies if they pose a “grave threat” to the economy.   

Dodd’s proposal would also create a nine-member “Financial Stability Oversight Council” of regulators, led by the Treasury Secretary. According to Bloomberg, “…the council can make recommendations to the Fed to impose “strict” rules for capital, leverage, liquidity and risk management to make it difficult for firms to grow so big and complex that they endanger the financial system. It could require the Fed to regulate non-bank financial firms that threaten financial stability, ensuring that “the next AIG would be regulated” by the Fed…”   

It’s clear what Dodd is trying to accomplish here. He’s trying to make it so that financial firms can’t engage in trading activities that could ultimately destabilize the entire economy. I’m not sure these proposals, as I understand them, accomplish the objective.   

It seems to me that, once again, it was fraud and outright lying that led to the financial crisis. The ability of investment banks to create mortgage-backed securities that were created using both prime and sub-prime mortgages, and then sold as AAA rated investments was deliberately deceitful.   

It seems to me that the dollar amount of credit default swaps that AIG wrote was deliberately concealed. After all, if you guarantee more than you can possibly pay, there’s something wrong.   

It seems to me that the accounting rules that allowed Lehman Brothers to simply remove $50 billion in impaired assets from its balance sheet encouraged fraud. And statements by former Lehman CEO Richard Fuld that everything was A-OK at the company were lies.   

In civil law, there are laws that try and address ethical behavior, like reckless endangerment, depraved indifference and even manslaughter. It seems to me that we need some ethics rules for Wall Street, too. And this is where all of the financial regulation proposals I’ve seen fall short.   

I know, you’re probably thinking we’ll sooner see pigs fly than ethics rules for Wall Street. But in my opinion, some serious consequences for behavior that’s deemed unethical would help. Or it might help.   

As I told you last week, TradeMaster Daily Stock Alerts’ Jason Cimpl is out in California, attending the Roth Capital Growth Conference. Jason sent me the following this morning:   

The Roth conference is in full swing and thus far I have been impressed with the positive outlook for business spending and the benefits from cost management during the slowdown. Everyone in the media barks about consumer spending trends because that is a large part of GDP. While the consumer is important so are businesses.    

Spending among businesses is a strong sign of economic stability. If business spending is increasing, which is what I am hearing a lot of from CFOs, that means economic growth is more likely to persist.   

Yesterday I focused on business software providers. This group is slaughtered during recessions as businesses protect capital. We know business spending in this industry has picked up, just look at revenue growth, but is it going to remain? All signs point to yes.   

That’s a great insight from Jason. Because it helps explain the seeming disconnect between the stock market and consumer spending/unemployment. Consumer spending is a headline number. But the consumer is also fickle, as we’ve seen in consumer confidence numbers.   

Businesses are far more reliable. And if businesses are spending money, then the economy is on more solid footing than it might appear from consumer numbers.  

Jason also reports that he’s seen at least one company presentation that “made his jaw drop.” That’s Jason-speak for he’s found what should be a big winner for his TradeMaster Daily Stock Alerts readers.

I still think $2.80 looks like a good target for Maguire Properties (NYSE:MPG) before earnings next Tuesday. I will keep you posted in the coming days.  

An influential German business confidence survey showed a surprise drop in the country, the first in 10 months. A cold winter has apparently hurt retail sales in Germany.

That's pressuring the euro, and providing strength for the U.S. dollar. It's been pretty well documented that the euro does not tend to rally alongside the dollar. And that's what we saw yesterday.

One positive note from yesterday - Maguire Properties rallied off of support at $1.50. Volume was strong and the stock broke above its 50-day moving average. You may recall yesterday, I said the stock needed to rally, and soon. Now, it needs to keep rising.

Another Winner for TradeMaster Readers

Also yesterday, TradeMaster Daily Stock Alerts' Jason Cimpl told us he expects consolidation for the stock market this week. (Consolidation occurs when prices don't move much as investors adjust to a new price level.)

Yesterday, the S&P 500 traded in a tight 7-point range. And it won't be surprising if it holds to a similar tight range today. We might anticipate the negative news from Germany to be offset by an improved reading of the Case-Shiller home price index.

TradeMaster Daily Stock Alerts' readers closed out of two more positions yesterday - one for a 7% gain and one for a 1% loss. So far in February, they've gone 9 out of 11. Outstanding.

The Twists Keep Coming

Bloomberg is breaking a very interesting story concerning investment banks, toxic mortgage debt, and AIG. I know I've discussed these issues ad nauseum. But the twists keep coming...

Now, we know that investment banks like Goldman Sachs and Morgan Stanley bought "insurance" for mortgage-backed securities in the form of credit-default obligations (CDOs). It was these CDOs that eventually crushed AIG.

But what has escaped scrutiny is that the banks that bought the most CDOs to insure mortgage-backed securities are also the banks that bought the most credit default swaps from AIG. In other words, it's as if these investment banks knew the mortgage-backed securities they held were garbage, knew that the CDOs would crush AIG, and found a way to profit from that.

Yes, AIG made dumb bets. And it's fundamental to capitalism that poorly-invested money will be "redistributed" to the wise. But in this case, we're looking at a possible insider trading case. That's because some of these investment banks also owned mortgage lenders.

A former swaps trader said, "If these banks had insight into the underlying loans (mortgage-backed securities) because they had relationships with banks, originators, or servicers, [this] is at the least, unethical."

It also may be illegal. And the worst part? It is exactly this information that the New York Fed tried to keep hidden in November 2008.

I plan to be unavailable for a few hours, starting around 10 a.m. this morning. I want to hear the members of the New York Fed try and defend their actions regarding the AIG (NYSE: AIG) bailouts in front of Congress.

The New York Tines published some of the prepared testimony of the principal players. I try to keep a level head, but I'm reaching for my pitchfork and torch right now.

*****Recall that the New York Fed orchestrated what ultimately became an $85 billion bailout. A good portion of that cash was paid directly to other companies with which AIG had entered into the now famous credit default swaps. These were essentially insurance contracts on mortgage backed securities held by banks and underwritten by AIG.

A full $25 billion in AIG bailout money went to pay off Goldman Sachs (NYSE: GS). Here's a section from the New York Times (Mr. Baxter s the general counsel for the NY Fed):  

Mr. Baxter explained that the New York Fed felt compelled to pay out A.I.G.'s counterparties in full to unwind tens of billions of dollars in derivative contracts because "there was little time, and substantial execution risk and attendant harm of not getting the deal done by the deadline of Nov. 10." That was the date when A.I.G. was scheduled to report its earnings and could face downgrades from credit ratings agencies. A downgrade would have led to more collateral calls and even greater liquidity problems for A.I.G., Mr. Baxter said.

He added, "Even in a best-case scenario, we did not expect that the counterparties would offer anything more than a modest discount to par." Under the circumstances, he said, "the Federal Reserve had little or no bargaining power."

That statement was reinforced by Mr. Habayeb, the former A.I.G. chief financial officer, who said in his prepared remarks that prior to the bailout, "The counterparties were unwilling to accept less than par value."

Mr. Baxter said it would have been "an abuse of our authority" for the Fed to have threatened A.I.G.'s counterparties with its regulatory power to get discounts.

I almost don't know where to begin. No bargaining power? How about telling AIG's counterparties that the Fed didn't have to pay bailout money in the first place?

And since when is paying off a failed company's debt not an abuse of Fed authority, but negotiating with the recipients (like Goldman) about the amounts they'll get clandestinely funneled into their coffers is?

There's no doubt that Congress is going to try to score some big hits on these guys. I hope we get to see them squirm.

*****For the record, I have no problem with derivatives like credit default swaps. But they should be regulated. No company should be able take on more liability than they can cover. But that's exactly what AIG did.

*****The Energy Information Agency releases the latest oil and gas inventory numbers today. Analysts are expecting a 2 million barrel build for oil and 1.7 million barrel build for gasoline. However, in a report released yesterday afternoon, the American Petroleum Institute said that oil supplies actually fell by 2 million barrels and gasoline supplies rose only 916,000 barrels.

Of course, that would be good news. Investors are desperate for signs that more than just corporate profitability is improving. And a draw on oil supplies would help. Oil prices are one of the best proxies for economic growth.

*****I just recommended a $3 U.S. based company that makes amorphous alloy core transformers for the Chinese market. The Chinese government has mandated that old silicon steel core transformers be replaced by more efficient transformers, like the amorphous alloy core product that this company produces.