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Home Publications Blogs Beat the Press Steven Davidoff Whitewashes the Investment Banks in the NYT

Steven Davidoff Whitewashes the Investment Banks in the NYT

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Sunday, 04 November 2012 11:21

Steven Davidoff used a Dealbook column to defend the investment banks behavior in selling collaterized debt obligations (CDOs) filled with bad mortgages. While he does make an important point, he glides over some clearly improper and possibly illegal behavior on the part of the banks.

Davidoff notes that the CDOs in question were sold to people who certainly should have been sophisticated investors and who were clearly warned that Goldman Sachs and other banks were not acting as investment advisers in the deal. In other words, the buyers were people managing hundreds of millions or even billions of dollars in assets, who were given explicit warnings that the sellers were not recommending the assets as a good investment.

Given that these people were paid six or even seven figure salaries, it was reasonable to expect that they would do their homework and independently seek to evaluate the quality of the assets they were buying. If they did not independently assess the quality of the assets then they are the ones most immediately to blame, not the sellers.

However, Davidoff does glide over a key misrepresentation in at least one case. The synthetic CDO Abacus, that Goldman Sachs sold to its clients, was put together by John Paulson who was shorting the CDO. In this case, Goldman presented itself to its clients as a neutral party not, as was actually the case, an agent for the person shorting the CDO. This was a fundamental misrepresentation.

If there were similar misrepresentations in the other cases Davidoff notes, then the banks deserve to be held at least partially responsible for the losses incurred. Sophisticated buyers should do the homework for which they are being paid very generous salaries. However this failure does not excuse misrepresentations that border on fraud by the sellers.

There is one other important point in this story worth noting. All the bad news from the housing bubble was already baked in at the point where these deals were made. The bubble peaked in the summer of 2006 and was headed down by the start of 2007. The economic collapse would have occurred regardless of whether or not these CDO deals took place. These deals simply affected the distribution of the losses among the big players. They did not cause the losses to occur.

Comments (2)Add Comment
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written by andrew clearfield, November 04, 2012 1:24
ACA Management had a reputation for putting only quality mortgages in their CDOs, and this is why investors were willing to buy from them. But Goldman tricked ACA into putting crap mortgages into their CDOs. Goldman told ACA that the genius John Paulson had picked out some really good mortgages that he wanted to go long on, when actually Paulson deliberately picked out bad mortgages to go short on. So ACA put Paulson's bad mortgages into CDOs and sold them to clients who trusted ACA's track record for only selling good products. In other words, these buyers of the ACA CDOs should have done their research, but in a sense they did; they knew ACA was a trustworthy company that would only sell good products - what they didn't know is that ACA was tricked into selling crap by Goldman telling ACA that Paulson wanted to go long on housing CDOs and had picked out the best mortgages for doing so.
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written by Mark Herlihy, November 05, 2012 2:38
While it is likely true that the bubble had peaked before many of these deals were cut, I don't think one can conclude that the deals had no causal connection to the ultimate losses. The existence of this type of deal contributed mightly to the overheating of the market, and to the sharp erosion of underwriting standards for the underlying mortgages and the securities themselves. These specific deals could be likened to the final hollowing-out of the base of the pyramid that brought the entire, inherently unstable structure down.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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