Did Goldman Sachs Really Lose $90 Million from the CDO It Constructed for Paulson?

Goldman Sachs claims it lost $90 million from holding a piece of the synthetic CDO that it constructed for John Paulson & Co., a transaction now famous as the subject of the SEC's recent enforcement action against Goldman. Can we take this claim of a $90 million loss at face value? Goldman has persistently asserted it was well-hedged against AIG risk, and didn't need the billions it garnered when the U.S. Treasury bailed out AIG's creditors for 100 cents on the dollar. One wonders why Goldman, if it were a good corporate citizen dedicated to doing God's work, didn't decline the money it didn't need, especially when so many middle class taxpayers are badly stretched. But on Wall Street, money talks and good deeds walk. It's fine if John F. Kennedy declined his presidential salary because of his family's wealth, but Wall Street isn't in Camelot.

Considering how well Goldman supposedly was hedged against AIG risk, it's hard to imagine it wasn't hedged against the decline in the mortgage markets. After all, e-mails quoted in the SEC's charges make clear that Goldman expected that decline. And Goldman evidently greatly reduced its overall exposure to real estate and mortgages even before and while it put together ABACUS 2007-AC1. From a risk management standpoint, one would expect that when Goldman unexpectedly got saddled with a piece of the ABACUS deal, it would have hedged itself. Certainly, it wouldn't have knowingly carved out a piece of its risk profile and left its interest in ABACUS 2007-AC1 naked long. So did Goldman really lose $90 million? Its accounting and risk management records might make for interesting reading in this regard.

If Goldman was in fact hedged against its ABACUS exposure, or was able to take advantage of general hedging in the mortgage and real estate sector to offset its ABACUS losses, then its claim of a $90 million loss could be false or misleading. Ordinarily, $90 million, more than lunch money to most people, ain't squat sit to Goldman Sachs. But Goldman's vaunted reputation is on the line. Claiming this $90 million loss as an indication of its innocence, if there really isn't such a loss, just might step over the line. The SEC has sanctioned a public company for making a misstatement in connection with its defense of an investigation. See SEC Press Release No. 2004-67 (May 17, 2004)(captioned, "Lucent Settles SEC Enforcement Action Charging the Company with $1.1 Billion Accounting Fraud"). Given how Goldman's stock has gyrated with the back and forth among news stories about the case, a misstatement by Goldman about the strength of its defenses could conceivably step over the line and itself be potential grist for the SEC's enforcement mill.

Back to hedging. A fun question might be to ask what Goldman, as a market maker, did with the RMBSs that related to ABACUS 2007-AC1. Goldman, like other large banks active in the mortgage business, might have made markets in those RMBSs. The SEC complaint alleges (and essentially all news sources agree) that the RMBSs underlying ABACUS 2007-AC1 dropped in value very quickly after the deal was done, hammering the long side of the deal. If Goldman was a market maker in some or all of these RMBSs and dropped its quotes muy pronto, one would have to wonder why it was so unafraid of imposing losses on its own holdings in the ABACUS deal. The answer could well be that it was well-hedged on ABACUS and dropped its bids because it didn't want to buy doggy RMBSs from someone else trying to hit its bids.

Although the derivatives markets were, and still are, murky on the best of days, records of Goldman's quotes may exist in documentation maintained by institutional investors who were seeking market valuations for accounting purposes. Big compilers of market data like Bloomberg and Reuters may also have relevant information. Of course, Goldman should have records of its own quotes. But independent verification would be de rigueur, now that the parties are dancing in federal court. The discovery process (i.e., the process in litigation of collecting and exchanging evidence) in SEC v. Goldman is likely to begin presently. Perhaps the SEC's litigation team will find some interesting stuff.