All the Devils Are Here [169]
The point is, investors were hardly buying an existing security from a neutral market maker. They were buying a security that had been constructed to enable someone to accomplish a specific goal. Quite often, that “someone” was the market maker itself. As Goldman’s Tourre wrote in a June 2006 e-mail, “ABACUS enables us to create a levered short in significant size.” (It was levered because Goldman didn’t have to put up cash.)
And there were times when it appears Goldman wasn’t a market maker at all, but rather a principal. Consider this exchange between David Lehman and Josh Birnbaum: “[We] need to decide if we want to do 1-3bb of these trades for our book or engage customers,” wrote Lehman. Replied Birnbaum, “On baa3 [the lowest rung of investment grade], I’d say we definitely keep for ourselves. On baa2 [the second lowest rung], I’m open to some sharing to the extent that it keeps these customers engaged with us.”
It is also clear from internal e-mails that by 2006 there were Goldman traders—not all of them, but some—who viewed some of their subprime holdings as junk. One trader described a Goldman mortgage-backed security this way: “It stinks.... I don’t want it in our book.” Swenson later wrote in a self-review that “during the early summer of 2006, it was clear that the market fundamentals in subprime and the highly levered nature of CDOs was going to have a very unhappy ending.”
The year 2006 was when Dan Sparks became the head of the mortgage desk. Sparks, an intense Texan who had joined Goldman as an analyst in 1989 after graduating from Texas A&M, spent his early years at the firm helping the Resolution Trust Corporation dispose of assets from the S&L crisis. He made partner in 2002. Sparks was a classic trader: he didn’t let a lot of hope, fear, or sympathy creep into the equation. The price was what the market said it was, and if you were willing to buy securities at that price, whatever happened after the sale was your responsibility. It wasn’t Goldman’s job to protect clients from their own mistakes, he believed; they were all big boys. Whatever the firm’s purpose was in constructing a particular synthetic CDO—market maker, principal, whatever—was irrelevant. In protecting Goldman’s interests, that would prove to be a useful attitude.
Consider, for instance, a November 2006 deal called Hudson Mezzanine, a synthetic CDO that referenced triple-B subprime securities. In terms of serving Goldman’s interests—in a way that wouldn’t be obvious to investors—it was a classic.
The CDO had been constructed, Goldman executives later told the Senate Permanent Subcommittee, while the company was trying to remove triple-B assets from its books. Among those assets was a long position in the ABX index that Goldman had gotten “stuck” with while putting together deals for hedge fund clients that wanted to go short. Unable to find counterparties to take the long position off its hands, Goldman used Hudson as a means by which it hedged its long position.
Goldman selected all the securities that Hudson would reference. These included $1.2 billion in ABX index contracts, offsetting the long ABX position Goldman wanted to hedge, and another $800 million in single-name CDS, or credit default swaps that referenced specific mortgage-backed securities issued in 2005 and 2006.
None of which was clear from the Hudson prospectus. Instead, the disclosure merely said that the CDO’s contents were “assets sourced from the Street,” making it sound as though Goldman randomly selected the securities, instead of specifically creating a hedge for its own book. Page four of the pitch book also said, “Goldman Sachs has aligned incentives with the Hudson program by investing in a portion of the equity.” Only on page thirteen does the pitch book make the standard disclosure that Goldman was providing the initial short position. But according to the Senate Permanent Subcommittee, Goldman didn’t then sell that short position to a client, as a true market maker would. Instead, “Goldman was the