Abacus Allowed Goldman Sachs to Shuffle Debt Risk Like Beads
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By Jody Shenn and Bob Ivry
April 16 (Bloomberg) -- From July 2004 through April 2007, as credit markets boomed, Goldman Sachs Group Inc. created 23 financial transactions called Abacus, the word for a relatively crude counting tool involving the shuffling of beads.
Today, the Securities and Exchange Commission sued the bank for securities fraud in what would be the penultimate offering in the series, according to Bloomberg data.
The bank used the deals to off-load the risk of mostly subprime home loans and commercial mortgages to investors, either as hedges for similar positions or to bet against securities itself. While the data show New York-based Goldman Sachs issued at least $7.8 billion of Abacus notes, the risk passed to investors was multiples higher.
The Abacus transactions are so-called synthetic collateralized debt obligations, which marry two financial innovations that contributed to the worst collapse in financial markets since the Great Depression.
The financial tools, often called technologies, are credit- default swaps, used to transfer the risk of losses on debt, and securitization, used to slice the risk in a pool of assets into various new securities.
Abacus deals were filled with default swaps that offered payouts to Goldman Sachs if certain mortgage bonds didn’t pay as promised, in return for regular premiums from the bank.
Upfront Cash
Some of the cash needed for the potential payouts to Goldman Sachs would be raised upfront, and essentially placed in escrow, by selling Abacus CDO notes with varying ratings. The grades were tied to how many of the underlying securities needed to default before the CDO classes would.
Such securitization enabled debt with the lowest investment-grade ratings to be transformed, in part, into AAA securities that turned out to not be as safe as that ranking suggested. At least $5 billion now carries junk ratings, below BBB-, from Standard & Poor’s, or has defaulted, Bloomberg data show.
The SEC said today that Goldman Sachs created and sold Abacus 2007-AC1 without disclosing that hedge fund Paulson & Co. helped pick the underlying securities and also bet the CDO would default. Paulson was proved correct, and his hedge fund eventually turned a $1 billion profit and CDO investors lost a similar amount, according to the SEC.
The deal was different from most Abacus CDOs in that Goldman Sachs said that a third-party, ACA Management LLC, was choosing the underlying debt instead of the bank itself, according to prospectuses.
At least $192 million of the debt was granted top grades by credit-rating companies, and an additional $1.1 billion was supposedly even safer, according to Bloomberg data.
“This would never have been possible if the ratings had been correct,” said Gene Phillips, director of PF2 Securities Evaluations, a New York-based advisory firm. “For these trades to come out so well for Paulson, the ratings agencies would not have been able to identify as well as Paulson did that these were crappy assets.”
To contact the reporters on this story: Jody Shenn in New York at [email protected]Bob Ivry in New York at [email protected].
Last Updated: April 16, 2010 16:08 EDT
Share Business ExchangeTwitterFacebook| Email | Print | A A A
By Jody Shenn and Bob Ivry
April 16 (Bloomberg) -- From July 2004 through April 2007, as credit markets boomed, Goldman Sachs Group Inc. created 23 financial transactions called Abacus, the word for a relatively crude counting tool involving the shuffling of beads.
Today, the Securities and Exchange Commission sued the bank for securities fraud in what would be the penultimate offering in the series, according to Bloomberg data.
The bank used the deals to off-load the risk of mostly subprime home loans and commercial mortgages to investors, either as hedges for similar positions or to bet against securities itself. While the data show New York-based Goldman Sachs issued at least $7.8 billion of Abacus notes, the risk passed to investors was multiples higher.
The Abacus transactions are so-called synthetic collateralized debt obligations, which marry two financial innovations that contributed to the worst collapse in financial markets since the Great Depression.
The financial tools, often called technologies, are credit- default swaps, used to transfer the risk of losses on debt, and securitization, used to slice the risk in a pool of assets into various new securities.
Abacus deals were filled with default swaps that offered payouts to Goldman Sachs if certain mortgage bonds didn’t pay as promised, in return for regular premiums from the bank.
Upfront Cash
Some of the cash needed for the potential payouts to Goldman Sachs would be raised upfront, and essentially placed in escrow, by selling Abacus CDO notes with varying ratings. The grades were tied to how many of the underlying securities needed to default before the CDO classes would.
Such securitization enabled debt with the lowest investment-grade ratings to be transformed, in part, into AAA securities that turned out to not be as safe as that ranking suggested. At least $5 billion now carries junk ratings, below BBB-, from Standard & Poor’s, or has defaulted, Bloomberg data show.
The SEC said today that Goldman Sachs created and sold Abacus 2007-AC1 without disclosing that hedge fund Paulson & Co. helped pick the underlying securities and also bet the CDO would default. Paulson was proved correct, and his hedge fund eventually turned a $1 billion profit and CDO investors lost a similar amount, according to the SEC.
The deal was different from most Abacus CDOs in that Goldman Sachs said that a third-party, ACA Management LLC, was choosing the underlying debt instead of the bank itself, according to prospectuses.
At least $192 million of the debt was granted top grades by credit-rating companies, and an additional $1.1 billion was supposedly even safer, according to Bloomberg data.
“This would never have been possible if the ratings had been correct,” said Gene Phillips, director of PF2 Securities Evaluations, a New York-based advisory firm. “For these trades to come out so well for Paulson, the ratings agencies would not have been able to identify as well as Paulson did that these were crappy assets.”
To contact the reporters on this story: Jody Shenn in New York at [email protected]Bob Ivry in New York at [email protected].
Last Updated: April 16, 2010 16:08 EDT
