Goldman Sachs and their economic downturn

So I was watching C-span for 6 hours yesterday and I figured I'd summarize wtf is going on in the investment banking world for you. That'll save you the agony of watching c-span, though some of our nation's senators are pretty feisty! So here's the dilly-o as I understand it...

Apparently Goldman Sachs sold tons of product. The product was an assembly of lots of individual components (a portfolio), but all those components were pretty much at the same level of crappiness that had a huge risk of failure (Like loans that people take out on "stated income" not "proven income"). But they made it look good by adding in a few golden eggs, which ups the average of the whole portfolio. Lay people didn't get to see what's inside but saw the average/rating thinking it was o.k.; insiders that knew couldn't get a straight answer from Goldman Sachs as to why they were selling it! But they continued to sell it.. and they continued to give the impression that the products (CDOs) were an investment that would grow, not fail. All the while, they never told anyone that they were putting money on the products FAILING (short selling) and continued to aggressively sell it to investment firms even after they had sealed their position on it. And then when everything failed, they cashed in (because they had done such a good job of exposing everyone to the risk) and laughed all the way to the bank... errr banks closed down. Maybe they just laughed in their office.

So where did they get their product from? Well no one just willy nilly creates portfolios. A company like ACA compiles a list of components that gets put into the product which middlemen like Goldman Sachs can sell to their clients (which are investors who want to buy products that will make them money) One of the products they sold was known as Abacus, and it was the idea of one of Goldman Sachs' former employees, John Paulson who runs his own investment company now. He sat in on several meetings between ACA and Goldman Sachs when they were crafting the portfolio and supplied a list of at most (but over half) 55 of the 90 components in that portfolio. (see reference at bottom) Then Paulson organized through Goldman Sachs an arrangement to short sell that product... as in plan to make money when the product loses value. So THIS is the motive for why Goldman would want to sell so much of the bad product... to benefit one client over another.

But this didn't just happen once with one product. It happened again... and again.. with so many different product names and portfolios, but they all had one common thread. They were all solely dependent on risky loans that should never have been given out in the first place. So why were the loans made? It's because CDO's like these takes the risk off the bank and shifts it to the people who buy the CDOs. The banks were happy to make loans because the money keeps pouring in from one end to give to the other. But when the money never appeared to send the money the other way (people didn't pay their loans/mortgages), that's when all the products lost value, the banks crashed because there was no money, and EVERYBODY that was betting for the CDOs to increase in value lost their money.

I think the real damning evidence in the case would come from whether or not we can prove this:
Did Goldman's aggressive sales of the poor product drive riskier and riskier behavior from the banks, causing the whole system to feedback on itself and explode? It's interesting to think of this in Mechanical terms.

Hope you enjoyed,
Alvin



http://www.businessinsider.com/aca-didnt-exactly-select-most-of-those-mortgage-bonds-paulson-did-2010-4