Tuesday, April 20, 2010

Are Paulson's Views in Early 2007 Relevant?

In early 2007, as the subprime lending market was crumbling, Paulson's views, to the extent they were known, were extremely bearish. It is reasonable to assume that IKB, RBS, and ACA were familiar with Paulson's views. If not, how could Paulson's views matter to them?

Whenever you purchase a "synthetic CDO" from a broker dealer, you know that someone, somewhere is the "other side" of the trade. Someone has to be the seller of the insurance contracts (the CDSs) that are contained in the "synthetic CDO." How could it possibly have mattered if IKB and RBS had known that Paulson was much of the other side? They had to know for certain that someone, possibly even Goldman, was taking the other side of their trade.

This brings us to ACA, the so-called independent advisor, who picked the CDSs contained in ABACUS, the CDO purchased by IKB and RBS. ACA, apparently did not know that Paulson intended to short sell the CDOs in the ABACUS package. So what? Would they have weighted Paulson's views more strongly than their own? ACA had a full research team poring over the CDSs to select for ABACUS. Some came from Paulson, many of Paulson's were rejected, and most that were selected were not on Paulson's list.
So, just how did Paulson matter?

More to the point, a broker-dealer is not obligated to inform buyers of a security, the identity of the seller. Such a requirement would destroy much of the current securities market. Imagine if every time Warren Buffett sold a security, the executing broker announced to the market place that the seller was Buffett!

The SEC is way off base in this complaint and, hopefully, Goldman will prevail in the court of law, if not in the court of public opinion.