Those hoping for a measure of justice for the Wall Street executives who brought us the financial crisis won’t be finding it anytime soon in the downtown Manhattan federal courtroom of Judge Barbara S. Jones.
What you’ll find there instead is the continuation of the Securities and Exchange Commission’s ridiculous civil lawsuit against Fabrice Tourre, the Goldman Sachs Group Inc. executive director who, at 28, shepherded to market in April 2007 Goldman’s infamous Abacus 2007-AC1 synthetic collateralized debt obligation. The deal was done at the behest of hedge fund manager John Paulson (who made a bundle) and a pair of foolish European banks (who lost one).
Jones should have thrown out the case against “Fabulous Fab” when she had the chance last week, because it is beyond absurd to single out for punishment one member of the Goldman team for putting together a deal for several highly sophisticated investors on the grounds that they weren’t sufficiently informed that some of them would make money while others would lose money. In every trade, there is a winner and a loser. That is the very nature of a market.
What’s more, by 2007, synthetic CDOs similar to Abacus had been packaged hundreds of times across Wall Street by nearly every major firm. Although it is fair to wonder why such outright gambling in the form of synthetic CDOs was permitted at all on Wall Street -- Hello, SEC, are you there? -- it is unfair for Tourre to be singled out by the regulators for doing his job.
Largest SEC Penalty
Goldman, a party to the original lawsuit filed by the SEC in April 2010, settled with the agency nearly a year ago for $550 million -- the largest penalty paid by a Wall Street firm to the SEC -- but admitted only that its marketing materials for the Abacus deal “contained incomplete information.”
At the time Goldman settled, Tourre rightly refused to go along -- after all, Goldman’s lawyers had vetted and approved the marketing materials, and he was just one member of a larger team. He decided to fight to clear his name, which had been badly tarnished by being included in the SEC lawsuit in the first place and by the hours he spent testifying before Senator Carl Levin’s Permanent Subcommittee on Investigations.
E-Mails to Girlfriends
Tourre was further embarrassed by Goldman’s decision to release his personal e-mails to his two girlfriends, one in New York and the other in London. Goldman was thoughtful enough to translate Tourre’s e-mails into English from French. Asked at the Senate hearing why Goldman would choose to release Tourre’s personal e-mails, Lloyd Blankfein, Goldman’s chief executive officer, essentially claimed ignorance.
Senator Tom Coburn, an Oklahoma Republican, was not impressed by Blankfein’s answer. “If I worked for Goldman Sachs,” Coburn responded, “I’d be real worried that somebody has made a decision he’s going to be a whipping boy, he’s the guy that’s getting hung out to dry, because nobody else had their personal e-mails released.” Coburn was right: Tourre has been made the scapegoat.
Judge Jones, however, doesn’t seem to agree. Instead of tossing the case entirely last week -- as Tourre’s lawyers at Allen & Overy suggested she do on the narrow grounds that the U.S. does not have jurisdiction because the investors who bought the Abacus deal were foreign banks -- she allowed the case to proceed, while limiting the charges against him. The two sides’ lawyers are set to meet with a magistrate on June 27 to discuss next steps.
Betting Against Housing
How did we get to this point? As usual, the story starts with an idea. Throughout 2006, Paulson had been looking for ways to increase aggressively his macro bet that the housing market would collapse. Repeatedly, and in many different forms, Goldman helped Paulson do so. (In December 2006, Goldman ended up mimicking Paulson’s short against the mortgage market, eventually making billions.)
The Abacus deal allowed Paulson to bet $1 billion that securities tied to the mortgage market would collapse. The CDO Goldman created was not composed of actual home mortgages but rather of a series of bets on how home mortgages would perform.
A Simple Idea
Although the architecture of the deal was highly complex, the idea behind it was simple: If the people who took out the mortgages continued to pay them, the security would keep its value. If, on the other hand, homeowners started defaulting on their mortgages, the security would lose value because investors would not get their contracted cash payments on the securities they bought. That is what happened, of course, just as Paulson thought it would.
As was the custom with synthetic CDOs, an independent entity, ACA Management LLC, helped Goldman put together the deal and was ostensibly responsible for choosing the securities to be referenced in it.
Of course, the deal would only happen if Tourre and Goldman could find investors willing to take the opposite bet from Paulson. Tourre found two eager European banks: the Dusseldorf-based IKB Deutsche Industriebank AG, which ended up losing $150 million, and ABN Amro NV, a large Dutch bank that later that year was purchased by a consortium of banks led by the Royal Bank of Scotland. RBS, of course, hit trouble and is now 84 percent owned by the British government.
Banks Go Bust
ABN Amro got involved in the deal when it agreed -- for a fee of about $1.5 million a year -- to insure 96 percent of the risk ACA Capital Holdings Inc., an affiliate of ACA Management, assumed by investing $951 million on the long side of the deal. When ACA Capital went bust in early 2008, ABN Amro had to cover most of ACA’s obligation regarding Abacus, losing close to $1 billion in the process.
The SEC’s case against Goldman -- and now Tourre alone -- was no slam-dunk. One of the SEC’s beefs against them was that they had not properly disclosed Paulson’s role in the deal to ACA and the two European banks. But that’s a bunch of bunk. For instance, ACA was no innocent victim, but had transformed itself in 2004 from an insurer of municipal bonds to a big investor in risky CDOs after getting a $115 million equity infusion from a Bear Stearns private-equity fund, which became ACA’s largest investor.
Furthermore, documents show that Paolo Pellegrini, John Paulson’s partner, and Laura Schwartz, a managing director at ACA, had meetings together -- including on Jan. 27, 2007, at the bar at a ski resort in Jackson Hole, Wyoming -- where the main topic of conversation was the composition of the portfolio that went into Abacus. According to CNBC, in his deposition with the SEC, Pellegrini said explicitly that he told ACA of Paulson’s intention to short the Abacus deal. (Pellegrini has not responded to my requests for a comment, and his deposition is not available to the public.)
Other documents show Paulson and ACA agreeing on which securities to include in Abacus and seem to call into question the SEC’s contention that ACA was misled. (What’s left of ACA is suing Goldman separately.)
Vetting the Portfolio
IKB was no babe in the woods either. Another e-mail, sent on March 12, 2007, by Joerg Zimmerman, a vice president at the bank, to a Goldman banker in London who was working with Tourre on the deal, revealed that IKB, too, had some say in what securities Abacus referenced. “Did you hear something on my request to remove Fremont and New Cen serviced bonds?” Zimmerman asked, referring to two mortgage-origination companies that were having severe financial difficulties and that Zimmerman wanted removed from the Abacus portfolio. The final Abacus deal did not contain any mortgages originated by Fremont or New Century. (Zimmerman did not respond to an e-mail request for comment.)
A former IKB credit officer, James Fairrie, told the Financial Times that the pressure from higher-ups to buy CDOs from Wall Street was intense. “If I delayed things more than 24 hours, someone else would have bought the deal,” he said.
Another CDO investor told the newspaper that IKB was known to be a patsy. “IKB had an army of Ph.D. types to look at CDO deals and analyse them,” he said. “But Wall Street knew that they didn’t get it. When you saw them turn up at conferences there was always a pack of bankers following them.”
Enough is enough. The SEC should drop what’s left of the Abacus lawsuit, free Fab and use its scarce resources to pursue the real criminals of the financial crisis: The top Wall Street executives who greedily led their firms to ruin, taking the economy with them.
(William D. Cohan is a Bloomberg View columnist. The opinions expressed are his own.)
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