The widely distributed - nay viral - picture of a young woman carrying a sign referring to Abacus - the much litigated Goldman Sachs/Paulson/IKB deal got me thinking.
Here is the sign for the small number of you that have not seen the picture:
It says that "It's wrong to create a mortgage-backed security filled with loans that you know are going to fail so that you can sell it to a client who isn't aware that you sabotaged it by intentionally picking the misleadingly rated loans most likely to be defaulted on".
I can't help but agree except this is not what happened in the Abacus case. The Abacus security was an entirely synthetic security. It was not filled with loans that were intentionally picked, it was loaded with derivatives that someone thought were most likely to be defaulted on.
That is an important distinction. If Goldman had created a security filled with bad loans and sold them there is no way that the client would be able to work out that someone was betting against the loans.
But that is not what happened. It was filled with derivatives where it was obvious that a financially sophisticated counter-party was taking the other side. Indeed what the security was was the reverse side of a bundle of bets against mortgage securities bound up by Goldman Sachs and the simplest understanding of it revealed that fact. Sure the buyer did not know it was Paulson taking the other side of the bet. (Indeed, given Paulson's latest run the fact that was Paulson neither adds nor subtracts from the case for buying or not buying the Abacus bundle.)
I think Goldman Sachs was done here unfairly (although it is hard to imagine it happening to more deserving people). Anyone who was financially sophisticated (and IKB certainly portrayed themselves as sophisticated) should have realized there was an opposite side to that bet and that someone had deliberately taken the opposite side with respect to every derivative in the bundle.
Now contrast this with what happens when I make a short sale. I borrow a security from a broker which is identical to any other security with the same cusip number. I sell it in the market. The person on the other side purchased a security and they have no idea whether they purchased it from a long or a short.
People who buy securities from me in the regular securities market are at a disadvantage to IKB. IKB knew there was someone making the opposite bet. When we make money short selling (and we have made plenty) the people who lose have no way of knowing that Bronte/John Hempton was on the other side of the bet.
I am (in part) a short-seller. I regularly try to stuff the market with securities that are "intentionally picked" as "most likely to be defaulted on".
Where is my sign?
The content contained in this blog represents the opinions of Mr. Hempton. Mr. Hempton may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Hempton's recommendations. The commentary in this blog in no way constitutes a solicitation of business or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author. In particular this blog is not directed for investment purposes at US Persons.