Investment Banks Should Not Rate Packages They Create

[Guest Tea Party Patriot]

This Goldman Sachs scandal proves that investment banks should not rate investment packages they create. They are no different casinos where you can bet on a player will lose a game. Only an investment bank the deck is stacked more in their favor.

 

How much money do American taxpayers have to lose before these crooks are stopped.

[Guest Ron]

The government will respond by raising our taxes or cutting more services. The rich get richer, the poor get poorer.

 

Send Goldman Sachs a thank you card for helping us lose 8 million jobs here in the U.S., bankrupting Greece, propping up China, and filling their coffers with record profits.

[Guest Steve in DC]

"No, really, these are good investments ... (wink-wink) would the world's largest investment bank, full of greedy people, lie to you??"

[Guest Janet Tavakoli]

Synthetic CDOs should be abolished. They're too complex and provide no real benefit. They only existed to game the system or hide losses.

[Guest Not Worst]

Synthetic CDO's are just another example of how Wall Street accomodates the marketplace. During the dot-com bubble years, investors wanted internet stocks. So if a some tech students had an idea for a internet experiment, they got someone to write-up a business plan and Wall Street issued stocks for their experimental company.

 

In recent years, investors wanted income. So Wall Street created these black box securities where income came out of the black box - for a while anyway.

 

And while the manufacturing part of the economy continues to shrink, Wall Street has filled the economic void by manufacturing securities. It's just that with the products that Wall Street manufactures, there's no warranty, no guarantee, and they make it very difficult to even look inside the box before you buy their product. But the box itself is beautifully wrapped, beautifully presented, what more could a customer want ?

[Guest LAW]

Shorting the Mortgage Market. Commonly, investors purchased RMBS or CDO securities as long-term investments that produced a steady income. They did not seek to sell them, and there was little secondary market in which these securities were bought or sold on a regular basis.

In 2006, the high risk mortgages underlying these securities began to incur record levels

of delinquencies. Some investors, worried about the value of their holdings, sought to sell their RMBS or CDO securities, but had a difficult time doing so due to the lack of an active market.

Some managed to sell their high risk RMBS securities to investment banks assembling cash

CDOs.

 

Instead of selling their RMBS or CDO securities, some investors purchased “insurance”

against a loss by buying a credit default swap (CDS) that would pay off if the specified securities incurred losses or experienced other negative credit events. By 2005, investment banks had standardized CDS contracts for RMBS and CDO securities, making this a practical alternative.

 

Much like insurance, the buyer of a CDS contract paid a periodic premium to the CDS seller, who guaranteed the referenced security against loss. CDS contracts referencing a single security or corporate bond became known as “single name” CDS contracts. If the referenced security later incurred a loss, the CDS seller had to pay an agreed-upon amount to the CDS buyer to cover the loss. Some investors began to purchase single name CDS contracts, not as a hedge to offset losses from RMBS or CDO securities they owned, but as a way to profit from particular RMBS or CDO securities they predicted would lose money. CDS contracts that paid off on securities that were not owned by the CDS buyer were known as “unclothed credit default swaps."

 

Some investors purchased large numbers of these CDS contracts in a concerted strategy to profit

from mortgage backed securities they believed would fail.

 

Investment banks took the CDS approach a step further. In 2006, a consortium of investment banks led by Goldman Sachs among others launched the ABX index, which tracked the performance of 20 subprime RMBS securities. Borrowing from longstanding practice in commodities markets, investors could buy and sell contracts linked to the value of the ABX index. According to a Goldman Sachs employee, the ABX index “introduced a standardized tool that allow[ed] clients to quickly gain exposure to the asset class.” An investor – or investment bank – taking a short position on ABX contracts was, in effect, placing a bet that the basket of RMBS securities would lose value.

[Guest LAW]

Goldman Sachs Shorting the Mortgage Market. Goldman Sachs senior management closely monitored the holdings and the profit and loss performance of its mortgage department.

 

In late 2006, when high risk mortgages began showing record delinquency rates, and the value of

RMBS and CDO securities began falling generally, Goldman Sachs Chief Financial Officer

David Viniar convened a meeting on December 14, 2006, to examine the data and consider how

to respond.

 

Beginning in early 2007, Goldman Sachs initiated an intensive effort to not only reduce

its mortgage risk exposure, but profit from high risk RMBS and CDO securities incurring losses.

A presentation to the Goldman Sachs Board of Directors identified a number of actions taken

during the year, including: “Shorted synthetics” and “Shorted CDOs and RMBS."

 

At times, the net short position accumulated by Goldman Sachs was as large as $13.9 billion. The short positions held by the firm’s mortgage department became so large that according to the Goldman Sachs risk measurements, the positions comprised 53 percent of the firm’s overall risk, according to Goldman Sachs own Value-at-Risk (VaR) measures. Senior management had to repeatedly allow the mortgage department to exceed the VaR limits that had been established by the firm.

 

Beginning in July 2007 and continuing into the next year, credit rating agencies downgraded hundreds of RMBS and CDO securities. On one day in October 2007, they downgraded $32 billion in mortgage related securities, causing substantial losses for investors. A Goldman Sachs manager reacted to the news by noting that Goldman had bet against those securities by purchasing credit default swaps. His colleague responded: “Sounds like we will make some serious money.” The reply: “Yes we are well positioned.”10 In the end, Goldman Sachs profited from the failure of many of the RMBS and CDO securities it had underwrote and sold. As Goldman Sachs CEO Lloyd Blankfein explained in a November 2007 email: “Of course we didn’t dodge the mortgage mess. We lost money, then made more than we lost

because of shorts.”

[Guest wiki]

Forms of credit default swaps had been in existence from at least the early 1990s. J.P. Morgan & Co. is widely credited with creating the modern credit default swap in 1994. In that instance, J.P. Morgan had extended a $4.8 billion credit line to Exxon, which faced the threat of $5 billion in punitive damages for the Exxon Valdez oil spill. A team of J.P. Morgan bankers led by Blythe Masters then sold the credit risk from the credit line to the European Bank of Reconstruction and Development in order to cut the reserves which J.P. Morgan was required to hold against Exxon's default, thus improving its own balance sheet.

 

In 1997, JPMorgan developed a proprietary product called BISTRO (Broad Index Securitized Trust Offering) that used CDS to clean-up a bank's balance sheet. The advantage of BISTRO was that it used securitization to split up the credit risk into little pieces which smaller investors found more digestible, since most investors lacked EBRD's capability to accept $4.8 billion in credit risk all at once. BISTRO was the first example of what later became known as synthetic collateralized debt obligations (CDOs).

 

Credit default swaps became largely exempt from regulation by the U.S. Securities and Exchange Commission (SEC) with the Commodity Futures Modernization Act of 2000, which was also responsible for the Enron loophole.

[JT Allen]

What you folks are missing is that investment banks don't technically rate their own securities. Sure, they say "oh these are great investments" about the information black hole they create when selling garbage, but, (and this might be even worse) they PAY to have their garbage rated by Standard & Poors and Moodys.

These ratings companies used to merely provide statistics on investment banks, then they provided "ratings" and then they started getting paid by the investment banks to provide the ratings, and therein lies you enormous-giganitic-cannot-be-overstated Conflict Of Interest.

Have a nice day.

[Luke_Wilbur]

I am just wondering how much it costs to get a AAA+ rating.

[Guest Tea Party Patriot]

What you folks are missing is that investment banks don't technically rate their own securities. Sure, they say "oh these are great investments" about the information black hole they create when selling garbage, but, (and this might be even worse) they PAY to have their garbage rated by Standard & Poors and Moodys.

These ratings companies used to merely provide statistics on investment banks, then they provided "ratings" and then they started getting paid by the investment banks to provide the ratings, and therein lies you enormous-giganitic-cannot-be-overstated Conflict Of Interest.

Have a nice day.

 

I stick to my premise. The willful neglect of the credit rating agencies to properly score securities reveal that it is the investment banks who are the actual ones that rate the packages they create. These rating agencies just give investors and borrowers a false sense of security. They might as well uses the judges from American Idol for their rating system.

 

Handling our money should not be a game show. There are real people that have real lives trying to pay their ever-growing debt.

[JT Allen]

I stick to my premise. The willful neglect of the credit rating agencies to properly score securities reveal that it is the investment banks who are the actual ones that rate the packages they create. These rating agencies just give investors and borrowers a false sense of security. They might as well uses the judges from American Idol for their rating system.

 

Handling our money should not be a game show. There are real people that have real lives trying to pay their ever-growing debt.

 

I see your point: the investment banks create their own ratings via paid-in-full credit rating agencies. NO ethics, NO fiduciary duty, but heaps and heaps of conflict of interest.

How is none of this illegal?