All the Devils Are Here [173]
It was an astonishingly brazen idea—like “a bettor asking a football owner to bench a star quarterback to improve the odds of his wager against the team.” That was the description Scott Eichel, a Bear Stearns trader, gave to Gregory Zuckerman, the Wall Street Journal reporter whose book The Greatest Trade Ever documented Paulson’s audacious short. Eichel explained to Zuckerman that when Paulson broached his idea with Bear Stearns, it said no. “[I]t didn’t pass the ethics standards,” said Eichel. It didn’t pass Bear Stearns ethics standards? The same Bear Stearns that had created some truly terrible subprime securities without batting an eyelash? Yet Goldman Sachs had no such qualms.
Paulson knocked on Goldman’s door at a fortuitous moment. The firm had begun thinking about “ABACUS-rental strategies,” as Tourre described it in an e-mail. By that, he meant that Goldman would “rent”—for a hefty fee—the Abacus brand to a hedge fund that wanted to make a massive short bet. Paulson’s idea fit perfectly.
Paulson paid Goldman $15 million to rent the Abacus name. The buyers of the CDO—the longs on the other side of the Paulson short—assumed it was a deal instigated by Goldman, since Abacus was a Goldman platform. They had no idea that Paulson was helping to select the securities that would make up the deal. Indeed, as the deal was nearing completion, the Paulson team decided to throw out mortgages originated by Wells Fargo. Wells Fargo mortgages, after all, might actually perform. Goldman’s failure to disclose Paulson’s involvement in selecting the securities in its marketing material for the transaction became the heart of the SEC’s case against the firm.
(According to one person familiar with the deal, Goldman even contemplated keeping the short position for itself instead of giving it to Paulson, who was not considered an important client. The irony is rich: had Goldman kept the short position for itself, it would have double-crossed Paulson, but the SEC would have had no case.)
There were no clean hands here. In renting the Abacus platform and helping to select the referenced securities, Paulson was doing something that may have been perfectly legal, but was awfully sleazy. He wound up shorting most of the $909 million super-senior tranche. The rating agencies were cooperative, as always, even though the Abacus deal was specifically stocked with securities that had been chosen in the expectation that they would fail. Eric Kolchinsky, the Moody’s analyst who oversaw the rating process, later testified that he hadn’t known about Paulson’s involvement and that it was “something that I personally would have wanted to know.” He added, “It just changes the whole dynamic of the structure, where the person who’s putting it together, choosing it, wants it to blow up.” But this was a lame excuse. If there was one party with a duty to do its own due diligence on the securities Abacus referenced, surely it was the rating agencies.
The CDO manager that was supposed to be choosing the securities, a firm called ACA Management, took its fees and appeared to look the other way—exactly what Goldman hoped it would do. E-mails show that one CDO manager had even turned the deal down “given their negative views on most of the credits that Paulson had selected,” as Tourre wrote. (The SEC claimed that ACA didn’t understand that Paulson was going to short the deal, which is a little hard to believe.) ACA also invested $42 million in the securities, and its insurance arm took the other side of the Paulson bet by guaranteeing the $909 million in super-senior tranches.
The final counterparty was an Abacus veteran: IKB. IKB was no lamb being led to slaughter. It had bragged incessantly about its expertise in the CDO market and, according to a lawsuit later filed against