All the Devils Are Here [167]
The Goldman Sachs mortgage department, which at its peak had some four hundred people, was, by its nature, conflict central. It underwrote mortgage-backed securities, which it sold to clients. It built CDOs that included its own mortgage-backed securities and those of others. It created synthetic CDOs, allowing clients to take either the long or short side of the bet. Sometimes Goldman itself was on the other side of a client bet. Most of the time, the client had no knowledge of Goldman’s position. It also actively traded all those instruments for its clients—and itself. Sometimes it bought or shorted mortgage-related securities because it couldn’t get the deal done without committing its own capital. Other times, it did so because it had its own “view” about which way the securities were headed and it was trading for its own account. In any case, the line between client-related trading and proprietary trading was very blurry: if Goldman hedged a position that was a result of facilitating a client trade, did that count as a client trade or a proprietary trade?
Goldman’s chief risk officer, Craig Broderick, would later say that “our client base is extremely aware and clear about what function we are performing.” But contemporaneous e-mails—and complaints after the fact—would paint a messier picture.
The structured product group, which was part of the mortgage desk and which put together many of Goldman’s most complex trades, was co-headed by Michael Swenson, a former Williams College hockey player in his late thirties, and David Lehman, a young star hired from Deutsche Bank around 2004, when he was just thirty. They made a decision early on that synthetic business could be big, so they staffed up accordingly. Or, as Swenson put it in his 2007 self-evaluation, “I can take credit for recognizing the enormous opportunity for the ABS synthetics business two years ago. I recognized the need to assemble an outstanding team of traders and was able to lead that group to build a number one franchise.” And that he did. Among those he recruited was Josh Birnbaum, a star trader who traded the new ABX index.
Until synthetics came along, Goldman had been a middling player in both the mortgage-backed securities and the CDO markets. But it quickly became a force in this new market, which consisted of both synthetic CDOs and hybrid CDOs. (These contain both real mortgage-backed securities and credit default swaps.) Quickly, Goldman began to climb up the rankings; in both 2006 and 2007, it was the fourth largest underwriter of CDOs. Wrote Birnbaum in his 2007 self-review: “♯1 market share in ABS CDS [ABX and single name] est 30-40%.” Although mortgages were a relatively small piece of Goldman’s overall business—the department’s 2006 revenue barely topped $1 billion, compared to nearly $38 billion for the firm itself—almost half of the mortgage desk’s 2006 revenue came from “structured products trading and CDOs.”
One of the earliest Goldman synthetic CDOs, put together in 2004, was called Abacus. It came about when IKB, a German bank that had become an aggressive CDO investor, came to Goldman seeking exposure to a specific set of mortgage-backed securities. Goldman was happy to oblige, and built a synthetic CDO based on the securities IKB wanted to reference. The dollars IKB received would come from the customers who took the short side of the transaction. Over the next few years, Abacus became a kind of Goldman franchise, with about sixteen deals and $10 billion worth of securities sold, according to the Senate Permanent Subcommittee on Investigations.
Later, Goldman would insist that the synthetic CDO deals the firm put together were “often initiated by clients,” to quote Goldman’s 2010 letter to shareholders. In that original Abacus CDO, this was clearly true. “IKB craved this product,” says a person familiar with the deal. He adds that, in the early years, the hard part was finding someone to take the short side of the trade, because no one wanted that risk.
But the firm’s later insistence that it was