Tag Archives: RMBS

How To Create A 3 Trillion Dollar Bubble And Burst It

The U.S. Financial Crisis Inquiry Commission have released a preliminary report on its findings after investigating the rating agencies role in the financial crisis.  Inflated initial ratings, and later rapid downgrades, on mortgage‐related securities by the agencies have contributed to the financial crisis through a number of channels, the commission concludes.

“In total, $2.5 trillion worth of RMBS and $564 billion worth of CDOs have been downgraded since January 2007.”

Financial Crisis Inquiry Commission

In other words; the rating agencies have erased more than 3 trillion dollars from investors accounts by correcting their own initial mistakes, triggering the biggest financial crisis since the 1930’s. The preliminary report explains what happened and how, but leaves the questions on why open to more speculations.

April 20, 2007:

Moody’s issue a report stating:

“Barring cumulative losses well in excess of current expectations, we do not expect a material number of downgrades to bonds rated A or higher.”

July 10, 2007:

S&P announce that they are placing 612 subprime RMBS tranches issued in late 2005 through 2006 on watch for possible downgrade.

Moody’s followed by downgrading 399 tranches of 2006 vintage subprime RMBS and placing an additional 32 tranches on watch for possible downgrade.

The downgraded securities totaled $5.3 billion in value and constituted 1.3% of 2006 vintage first lien RMBS.

July 11, 2007:

Moody’s placed 184 tranches of CDOs backed primarily by RMBS, with original face value of approximately $5 billion, on watch for possible downgrade.

July 12, 2007:

S&P downgraded 498 of the 612 tranches it had placed on watch two days earlier. The majority of the tranches were rated BBB or lower, but 8 AAA rated tranches were included.

By the middle of 2008 over 90% of Baa tranches had been downgraded.

Downgrades of Aaa tranches of RMBS did not begin in earnest until the middle of 2008 and continued steadily until the middle of 2009, when they leveled off with about 80% of tranches downgraded.

“In total, $2.5 trillion worth of RMBS and $564 billion worth of CDOs have been downgraded since January 2007,” the Financial Crisis Inquiry Commission writes in their preliminary report.

Stupidity Or Manipulation?

There are only two possible explanations for the rating agencies handling of the credit derivatives:

1. They had no clue what so ever about what they were doing.

Or

2. They purposely tried to manipulate the market.

The commission don’t make any conclusive statements at this point, but the last word have definitely not been said in this matter.

But its beyond doubt that the rating mess was one of the main triggers behind today’s the financial crisis.

This is the report’s introduction:

The purpose of this preliminary staff report is to present background on the role that credit rating agencies (RAs) may have played in the financial crisis. Most subprime and Alt‐A mortgages were held in residential mortgage‐backed securities (RMBS), most of which were rated investment grade by one or more RA. Furthermore, collateralized debt obligations (CDOs), many of which held RMBS, were also rated by the RAs. Between 2000 and 2007, Moody’s rated $4.7 trillion in RMBS and $736 billion in CDOs. The sharp rise in mortgage defaults that began in 2006 ultimately led to the mass downgrading of RMBS and CDOs, many of which suffered principal impairments. Losses to investors and writedowns on these securities played a key role in the resulting financial crisis.

Inflated initial ratings on mortgage‐related securities by the RAs may have contributed to the financial crisis through a number of channels. First, inflated ratings may have enabled the issuance of more subprime mortgages and mortgage‐related securities by increasing investor demand for RMBS and CDOs. If fewer of these securities had been rated AAA, there may have been less demand for risky mortgages in the financial sector and consequently a smaller amount originated. Second, because regulatory capital requirements are based in part on the ratings of financial institutions’ assets, these inflated ratings may have led to greater risk‐adjusted leverage in the financial system. Had the ratings of mortgage‐related securities not been inflated, financial institutions would have had to hold more capital against them. On a related point, the ratings of mortgage‐related securities influenced which institutions held them. For example, had less subprime RMB been rated AAA, pension funds and depository institutions may have held less of them. Finally, the rapid downgrading of RMBS and CDOs beginning in July 2007 may have resulted in a shock to financial institutions that led to solvency and liquidity problems.

In addition, downgrades of monoline bond insurers such as Ambac and MBIA and other providers of credit protection such as AIG triggered collateral calls built into insurance and derivative contracts, exacerbating liquidity pressures at these already troubled firms. This led to ratings downgrades of the securities these firms insured, prompting increased capital requirements at the firms which held these securities and – in the case of money market mutual funds only permitted to hold highly rated assets – sales of assets into an already unstable market.

Here’s a copy of the report.

Enjoy!

Related by the Econotwist:

Spain Loses AAA Rating – Here’s The Full Report

European Banks: “Leman Times Ten”

Proposal For New Single European Bond

Fitch: Credit Markets Still Deteriorating

You Sue Me, I Sue You, Oh Peggy, Peggy Sue

Banks Face Multi-Hundred-Million Dollar Settlements

Killing My CDS Softly

E.U. Prepared To Set Up Own Rating Agency

SEC To Take Action Against Moody’s

ECB Makes Rating Agencies Irrelevant

Goldman’s Collateralized, Securitized And Synthesized Fraud

Fitch Expects More European Sovereign Downgrades

Moody’s Downgrade Ambac Debt, Deals will be Affected

AIG: What Did FED Bail Out and Why?

The Arab World – Downgraded

Michael Milken Warns Against Sovereign Debt

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Conquering The Devil

Goldman Sachs has been described almost as the major force behind all evil in the world. The Goldman-boss Lloyd Blankfein has been seen as a symbol of all bank’s infectious greed and predatory lending practice – a monster with tentacles spread all over the world – with no other goal than make themselves filthy rich on ordinary tax payers expense. Well, I’m sorry – it’s just not that simple.

“Anyone who has ever worked on Wall Street knows that the first thing anyone thinks about is how much money they can make off of deals. That’s the goal, the motive, the driving force. And it’s not new.”

Jeff Harding


“Since most of our legislators, bureaucrats, and White House residents have no idea what caused the Great Recession, they are itching to blame it on someone, and that someone is Goldman Sachs, the arch-capitalist of our time. As if fraud was the cause of all of our problems. It’s like blaming greed,” Jeff Harding at The Daily Capitalist writes.

“Let me first get it on the table: I am not defending Goldman Sachs. The point of this article is to defend free market capitalism which has been incorrectly branded as the villain in our economic crisis. If Goldman defrauded their clients, they should pay the price,” Mr. Harding adds.

(Read: The Law of Unintended Consequences)

“The information on this case is too new to evaluate, and without further analysis of the complaint and the facts, I will withhold judgment. I would like to review the Abacus 2007-AC1 prospectus or PPM and the allegations of misrepresentation and fraud before I condemn Goldman. I have analyzed similar deals in the past and I would like to compare this one to what I believe was the norm for disclosure.”

(Read: Peeling Back the Onion)

“It sounds bad for Goldman now, and while it may very well be all true, the government loves to trot out the juicy bits for press conferences which the press loves, such as Mr. Tourre’s email. As you all know, you can’t always trust what prosecutors say and there’s always more to the story.”

“I also have a healthy suspicion of economic crimes. These are crimes not based on ethics, traditional crimes, or a violation of someones rights by the perpetrator, but are crimes against the people as defined by legislators or some economic czar.”

“Not to stir up a debate here, but insider trading is one example of the government trying to create a level playing field. The distinguished economist Henry Manne has spent a lifetime showing why that is incorrect and irrelevant.”

“Yet today many pro-capitalism economic writers were quick to criticize Goldman. Mish Shedlock came out with an article today that blasted Wall Street ethics:”

Sadly, this business screws the client for a fee time and time again because there is no ethics, no sense of fiduciary responsibility, and no walls on separation of duty to prevent fraud. …

(You might wish to read his piece since it’s very critical; Complete Ethics Overhaul Needed)

“I don’t mean to be blasé about this or be overly critical of Mish because I think he’s one of the best economics writers, but anyone who has ever worked on Wall Street knows that the first thing anyone thinks about is how much money they can make off of deals. That’s the goal, the motive, the driving force. And it’s not new. Of course that doesn’t excuse civil or criminal wrongs. But what it does mean is that you’ve got to look out for your own position and your due dil better be more than good. Caveat emptor. That’s just the way it is and everyone knows it. I am sure you are all shocked by this revelation.”

“Yes, there are many fine people in the business who do put their clients’ interests before their own. But so what. Do I wish that ethics were better? Of course. But don’t be surprised when in a world where people lie awake at night thinking about how to make more money, some very big players lose money in a deal.”

Here is the gist of the complaint as reported in the SEC press release:

According to the SEC’s complaint, filed in U.S. District Court for the Southern District of New York, the marketing materials for the CDO known as ABACUS 2007-AC1 (ABACUS) all represented that the RMBS portfolio underlying the CDO was selected by ACA Management LLC (ACA), a third party with expertise in analyzing credit risk in RMBS. The SEC alleges that undisclosed in the marketing materials and unbeknownst to investors, the Paulson & Co. hedge fund, which was poised to benefit if the RMBS defaulted, played a significant role in selecting which RMBS should make up the portfolio.

The SEC’s complaint alleges that after participating in the portfolio selection, Paulson & Co. effectively shorted the RMBS portfolio it helped select by entering into credit default swaps (CDS) with Goldman Sachs to buy protection on specific layers of the ABACUS capital structure. Given that financial short interest, Paulson & Co. had an economic incentive to select RMBS that it expected to experience credit events in the near future. Goldman Sachs did not disclose Paulson & Co.’s short position or its role in the collateral selection process in the term sheet, flip book, offering memorandum, or other marketing materials provided to investors.

The SEC alleges that Goldman Sachs Vice President Fabrice Tourre was principally responsible for ABACUS 2007-AC1. Tourre structured the transaction, prepared the marketing materials, and communicated directly with investors. Tourre allegedly knew of Paulson & Co.’s undisclosed short interest and role in the collateral selection process. In addition, he misled ACA into believing that Paulson & Co. invested approximately $200 million in the equity of ABACUS, indicating that Paulson & Co.’s interests in the collateral selection process were closely aligned with ACA’s interests. In reality, however, their interests were sharply conflicting.

According to the SEC’s complaint, the deal closed on April 26, 2007, and Paulson & Co. paid Goldman Sachs approximately $15 million for structuring and marketing ABACUS. By Oct. 24, 2007, 83 percent of the RMBS in the ABACUS portfolio had been downgraded and 17 percent were on negative watch. By Jan. 29, 2008, 99 percent of the portfolio had been downgraded.

Investors in the liabilities of ABACUS are alleged to have lost more than $1 billion.

Today Goldman sent this email out to their clients explaining their version of the case:

NEW YORK, April 16, 2010 — The Goldman Sachs Group, Inc. (NYSE: GS) :

Lloyd Blankfein - CEO - Goldman Sachs

We are disappointed that the SEC would bring this action related to a single transaction in the face of an extensive record which establishes that the accusations are unfounded in law and fact.

We want to emphasize the following four critical points which were missing from the SEC’s complaint.

* Goldman Sachs Lost Money On The Transaction. Goldman Sachs, itself, lost more than $90 million. Our fee was $15 million. We were subject to losses and we did not structure a portfolio that was designed to lose money.

* Extensive Disclosure Was Provided. IKB, a large German Bank and sophisticated CDO market participant and ACA Capital Management, the two investors, were provided extensive information about the underlying mortgage securities. The risk associated with the securities was known to these investors, who were among the most sophisticated mortgage investors in the world. These investors also understood that a synthetic CDO transaction necessarily included both a long and short side.

* ACA, the Largest Investor, Selected The Portfolio. The portfolio of mortgage backed securities in this investment was selected by an independent and experienced portfolio selection agent after a series of discussions, including with Paulson & Co., which were entirely typical of these types of transactions. ACA had the largest exposure to the transaction, investing $951 million. It had an obligation and every incentive to select appropriate securities.

* Goldman Sachs Never Represented to ACA That Paulson Was Going To Be A Long Investor. The SEC’s complaint accuses the firm of fraud because it didn’t disclose to one party of the transaction who was on the other side of that transaction. As normal business practice, market makers do not disclose the identities of a buyer to a seller and vice versa. Goldman Sachs never represented to ACA that Paulson was going to be a long investor.

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“Goldman isn’t going to role over on this one so the SEC has a huge fight on its hands,” Jeff Harding concludes.

Read the full post at The Daily Capitalist.

Related by the Econotwist:

Goldman’s Collateralized, Securitized And Synthesized Fraud

Obama: “It Is Time”

Goldman Sachs Charged With Fraud – Here’s The SEC filing

Teaching Pigs How To Fly

Goldman Sachs: “Damn American Bastards!”

AIG: What Did FED Bail Out and Why?

EU Wants Answers From Wall St. On Greek Debt

Ordnung muss sein

The Bailout Package Under The Christmas Tree

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