Goldman, among others on Wall Street, has said since the collapse that it made big money by using the ABX to bet against the housing market. Worried about a housing bubble, top Goldman executives decided in December 2006 to change the firmâs overall stance on the mortgage market, from positive to negative, though it did not disclose that publicly.
Even before then, however, pockets of the investment bank had also started using C.D.O.âs to place bets against mortgage securities, in some cases to hedge the firmâs mortgage investments, as protection against a fall in housing prices and an increase in defaults.
Mr. Egol was a prime mover behind these securities. Beginning in 2004, with housing prices soaring and the mortgage mania in full swing, Mr. Egol began creating the deals known as Abacus. From 2004 to 2008, Goldman issued 25 Abacus deals, according to Bloomberg, with a total value of $10.9 billion.
Abacus allowed investors to bet for or against the mortgage securities that were linked to the deal. The C.D.O.âs didnât contain actual mortgages. Instead, they consisted of credit-default swaps, a type of insurance that pays out when a borrower defaults. These swaps made it much easier to place large bets on mortgage failures.
Rather than persuading his customers to make negative bets on Abacus, Mr. Egol kept most of these wagers for his firm, said five former Goldman employees who spoke on the condition of anonymity.
On occasion, he allowed some hedge funds to take some of the short trades.
Mr. Egol and Fabrice Tourre, a French trader at Goldman, were aggressive from the start in trying to make the assets in Abacus deals look better than they were, according to notes taken by a Wall Street investor during a phone call with Mr. Tourre and another Goldman employee in May 2005.
On the call, the two traders noted that they were trying to persuade analysts at Moodyâs Investors Service, a credit rating agency, to assign a higher rating to one part of an Abacus C.D.O. but were having trouble, according to the investorâs notes, which were provided by a colleague who asked for anonymity because he was not authorized to release them. Goldman declined to discuss the selection of the assets in the C.D.O.âs, but a spokesman said investors could have rejected the C.D.O. if they did not like the assets.
Goldmanâs bets against the performances of the Abacus C.D.O.âs were not worth much in 2005 and 2006, but they soared in value in 2007 and 2008 when the mortgage market collapsed. The trades gave Mr. Egol a higher profile at the bank, and he was among a group promoted to managing director on Oct. 24, 2007.
âEgol and Fabrice were way ahead of their time,â said one of the former Goldman workers. âThey saw the writing on the wall in this market as early as 2005.â By creating the Abacus C.D.O.âs, they helped protect Goldman against losses that others would suffer.
As early as the summer of 2006, Goldmanâs sales desk began marketing short bets using the ABX index to hedge funds like Paulson & Company, Magnetar and Soros Fund Management, which invests for the billionaire George Soros. John Paulson, the founder of Paulson & Company, also would later take some of the shorts from the Abacus deals, helping him profit when mortgage bonds collapsed. He declined to comment.
The woeful performance of some C.D.O.âs issued by Goldman made them ideal for betting against. As of September 2007, for example, just five months after Goldman had sold a new Abacus C.D.O., the ratings on 84 percent of the mortgages underlying it had been downgraded, indicating growing concerns about borrowersâ ability to repay the loans, according to research from UBS, the big Swiss bank. Of more than 500 C.D.O.âs analyzed by UBS, only two were worse than the Abacus deal.
Goldman created other mortgage-linked C.D.O.âs that performed poorly, too. One, in October 2006, was a $800 million C.D.O. known as Hudson Mezzanine. It included credit insurance on mortgage and subprime mortgage bonds that were in the ABX index; Hudson buyers would make money if the housing market stayed healthy â but lose money if it collapsed. Goldman kept a significant amount of the financial bets against securities in Hudson, so it would profit if they failed, according to three of the former Goldman employees.
A Goldman salesman involved in Hudson said the deal was one of the earliest in which outside investors raised questions about Goldmanâs incentives. âHere we are selling this, but we think the market is going the other way,â he said.
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Tetsuya Ishikawa, a salesman on several Abacus and Hudson deals, left Goldman and later published a novel, âHow I Caused the Credit Crunch.â In it, he wrote that bankers deserted their clients who had bought mortgage bonds when that market collapsed: âWe had moved on to hurting others in our quest for self-preservation.â Mr. Ishikawa, who now works for another financial firm in London, declined to comment on his work at Goldman.
http://www.nytimes.com/2009/12/24/business/24trading.html?pagewanted=2&_r=3
Read the book by Mr. Ishikawa. Interesting reading...
