The Audacity Of Synthetics
by ilene - February 9th, 2010 9:24 pm
Karl Denninger discusses an article posted here several weeks ago, John Paulson and the Greatest Pump and Short Fraud Ever, by Mark Mitchell at Deep Capture. - Ilene
The Audacity Of Synthetics
Courtesy of Karl Denninger, The Market Ticker
DeepCapture has picked up something I’ve written about before, but none of these folks seem to put together the "big picture", as I outlined yesterday on my Blogtalk show.
As Fiderer explains, Paulson asked the banks to create those CDOs “so that they could be sold to some suckers at close to par. That way, Paulson’s hedge fund could approach some other sucker who would sell an insurance policy, or credit default swap, on the newly minted CDOs. Bear, Deutsche and Goldman knew perfectly well what Paulson’s motivation was. He made no secret of his belief that the CDOs subordinate claims on the mortgage collateral were close to worthless. By the time others have figured out the fatal flaws in these securities which had been ignored by the rating agencies, Paulson could collect up to $5 billion.
Let’s step back a second.
A "CDO", or "Collateralized Debt Obligation", is in theory a very simple instrument. It is, at it’s core, a collection of income-producing "assets" that have a cash flow that can be diced up paid to people who have purchased components of the CDO.
The usual thought process when someone says "CDO" is that some bank bought a bunch of bonds, compiled them into a CDO and then sold off the tranches.
The CDO itself is typically held off-balance sheet in a SIV/SPV, lest the bank be forced to recognize it as part of it’s "assets." This is permissible because the bank doesn’t own the assets, the legal entity does, and it got the money to buy them from the people who bought the tranches that were issued. The banks do this because they get a nice fee for filing the papers to establish the entity along with a management fee to act as the servicer – that is, the "guy in the middle" who takes the money that comes in from the debt instruments and slices it up, paying out those funds to the buyers of the CDO’s tranches.
So you can think of a CDO, in it’s simplest form, as a way of taking a
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John Paulson and the Greatest Pump and Short Fraud Ever
by ilene - February 3rd, 2010 11:39 am
John Paulson and the Greatest Pump and Short Fraud Ever
Courtesy of Mark Mitchell at Deep Capture
By now, everybody knows that the market for collateralized debt obligations was riddled with fraud in the lead-up to the financial crisis. What is less known is the fact that hedge fund managers helped create and inflate the market for these toxic securities specifically so that they could bet against them and profit from the inevitable collapse.
An example of a particularly sordid scheme, orchestrated by hedge fund billionaire John Paulson, was discovered some time ago by David Fiderer, a blogger for the Huffington Post. The information in Fiderer’s blog is rather incriminating, and, of course, the mainstream media is not on the case, so I think it bears repeating.
In a close reading of Wall Street Journal Gregory Zuckerman’s book, “The Greatest Trade Ever”, an otherwise starry-eyed account of Paulson’s bets against the mortgage market, Fiderer discovered this nugget:
Paulson and [partner Paolo Pellegrini] were eager to find ways to expand their wager against risky mortgages. Accumulating it in the market sometimes proved to be a slow process. So they made appointments with bankers at Bear Stearns, Deutsche Bank (NYSE:DB), Goldman Sachs (NYSE:GS), and other banks to ask if they would create CDOs that Paulson & Co. could essentially bet against.
As Fiderer explains, Paulson asked the banks to create those CDOs “so that they could be sold to some suckers at close to par. That way, Paulson’s hedge fund could approach some other sucker who would sell an insurance policy, or credit default swap, on the newly minted CDOs. Bear, Deutsche and Goldman knew perfectly well what Paulson’s motivation was. He made no secret of his belief that the CDOs subordinate claims on the mortgage collateral were close to worthless. By the time others have figured out the fatal flaws in these securities which had been ignored by the rating agencies, Paulson could collect up to $5 billion.
“Paulson not only initiated these transactions, he also specified the terms he wanted, identifying which mortgages would be stuffed into the CDOs, and how the CDOs should be structured. Within the overall framework set by Paulson’s team, banks and investors were allowed to do some minor tweaking.”
It is not clear which banks ultimately participated in Paulson’s scam, but Fiderer quotes…
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Philip R. Davis is a founder Phil's Stock World, a stock and options trading site that teaches the art of options trading to newcomers and devises advanced strategies for expert traders...
Ilene is editor and affiliate program
coordinator for PSW. She manages the site