Goldman and CDO's-a Match made in Heaven.

Although no one active in investment banking will admit it the CDO was inherently designed for the investor to take the hit if there were a problem. But that shouldn't surprise anyone. Investment firms by definition like to buy things they think are cheap, and sell things they think are expensive.

There are reports tracking individual firms and the IPO's they bring to market to show whose offerings performed better in the secondary market. These reports clearly delineate those houses that are aggressive in their pricing to the advantage of the issuer, and those that are more buyer focused.

Not surprisingly as often as not Goldman's issues are not the best performers in the secondary market, but then again the culture of Goldman was as an investment banker as regards clients, and as a trader as regards itself. Its' salespeople were propelled on the back of powerful equity and debt capital markets capabilities and crushingly powerful trading desks who understood the finesse of managing proprietary and clients trading functions.

Now back to CDO's for a moment. As I explained in my pieces on CDO's Part IV on 17.3.10 the trick in CDO's was to find those names that fit into the guidelines as prescribed by the rating agencies and yet yielded more than their official rating would have presumed. They provided the kicker in yield which made the CDO structure work.

Back in the early noughties I pushed to create CDO's where the investor had the ability to choose the issues in the portfolio, or to actively trade out of those issues they didn't like. The trading desks didn't like the idea, and to be fair it didn't work.

Letting the investor choose essentially resulted in the CDO being too expensive for them to purchase. Trading out of names worked in theory, but the cost of doing so was prohibitive because it was almost always the case that the first names chosen by the investor to trade out of were the names that provided the extra yield. Another problem was that as the market conditions for a specific issuer had deteriorated to the point that the investor wanted to trade out of them the damage in the market price had already been done thus making the transaction redundant.

Add to this that few investors really understood the dynamics of CDO's, nor did they feel competent to manage the credit portfolio. If they did (feel competent) they would offer to manage the credit pools for CDO's essentially becoming either third party managers or independent advisers-like Paulson; but also like any number of Hedge Funds and quite a few traditional Asset Managers that are household names in the US and Europe.

Now we are nearing the perfect storm in which Goldman decided to complete "god's work". You take some clever people-inside Goldman and out-who have a strong opinion that the credit boom was getting way overheated. It wasn't just Goldman. A major European bank at its' seminar for Hedge Funds and Proprietary traders were advising their clients as early as April '07 that they were actively hedging their mortgage exposure and suggested to this rarefied group of accounts that they to should do the same.

So, allegedly, Paulson and Goldman get together and work out the perfect storm. Paulson picks names he wants to short, Goldman slams them into their CDO, and in an action which is an incredibly clear indication that the storm is nearing it's apex, they find another "third party" ACS Management to manage the portfolio, who not only agrees to manage the portfolio, but also invests in it. It appears that ACS Management understood that Paulson was acting as an investor in this CDO. The funny thing was is that he was, but from the short side. I think this is called a lie of omission. I think the SEC calls it fraud.

When I first started on Wall Street I had a boss who told me "I will never lie to you, but you must listen very closely to what I say".

I believe a lot of people will be scrutinising every word out of the mouth of Goldman for a very long time.