All the Devils Are Here [172]
• In the spring of 2007, as the clock was ticking on the mortgage market, Goldman created a $1 billion CDO squared that was a mixture of cash and synthetic collateral called Timberwolf. Part of the collateral for that CDO included credit default swaps that referenced securities backed by Washington Mutual pay option ARMs. Timberwolf also included Abacus CDO securities in its collateral.
Once again, Goldman had to push hard to sell the deal. Finally, though, Goldman was able to sell about $300 million of Timberwolf securities to Bear Stearns Asset Management. The firm sold another $78 million—at a sizable discount—to an Australian fund called the Basis Yield Alpha Fund, which at the time had only $500 million under management. According to a $1 billion lawsuit Basis later filed—a suit whose central claim is that the Timberwolf purchase forced Basis into insolvency—Goldman told Basis that the market was stabilizing. And while the Timberwolf prospectus states that Goldman owned equity in Timberwolf, the Senate Permanent Subcommittee would later highlight that Goldman also had a substantial short position. “Goldman was pressuring investors to take the risk of toxic securities off its books with knowingly false sales pitches,” said Basis’s lawyer. Goldman called the lawsuit “a misguided attempt by Basis, a hedge fund that was one of the world’s most experienced CDO investors, to shift its investment losses to Goldman Sachs.” One fund manager who knows Basis has a different take: “Dumb money,” he says.
Within a year, Timberwolf’s triple-A securities had been downgraded to junk, as the WaMu option ARMs defaulted. The Goldman trader responsible for managing the deal later characterized the issuance of Timberwolf as “a day that will live in infamy.” Tom Montag put it more bluntly. “Boy that timeberwof [sic] was one shi**y deal,” he wrote on June 22, 2007. Once again, Goldman insists that it lost hundreds of millions of dollars on the Timberwolf deal, but to the extent that the deal provided a way for Goldman to exit or hedge existing positions, the firm lost less than it would have otherwise.15
• And then there was Abacus 2007-ACI, the most infamous of all the Goldman synthetic CDO deals. Nearly three years after the deal was completed, the SEC would charge Goldman with fraud, alleging that the firm made “materially misleading statements and omissions” in connection with the deal. Goldman heatedly disputed the SEC’s charges at first, but ended up settling the case for the record sum of $550 million and conceding that the marketing materials were “incomplete.” But in truth, the legal issues were far from the most disturbing thing about Abacus 2007-ACI.
It began with John Paulson, then a little-known hedge fund manager, who along with Andrew Redleaf, Michael Burry, and a handful of others, had been painstakingly buying credit default swaps on subprime mortgage-backed securities. Paulson and his staff were convinced that the entire mortgage market was poised to collapse. Their analysis, in retrospect, was prescient. As a Paulson employee wrote in January 2007, “[T]he market is not pricing the subprime RMBS wipeout scenario. In my opinion this situation is due to the fact that rating agencies, CDO managers and underwriters have all the incentives to keep the game going, while ‘real money’ investors have neither the analytical tools nor the institutional framework.” Anticipating that “wipeout scenario,” Paulson was seeking to do something that would have a big potential payoff. He wanted to make an industrial-sized short by betting against all the triple-A