Ethical Challenges of Complex Products: Case of Goldman Sachs and the Synthetic Collateralized Debt Obligations
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Complaint: Goldman, Sachs & Co. and Fabrice Tourre
UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK SECURITIES AND EXCHANGE COMPLAINT COMMISSION, [Securities Fraud] Plaintiff, 10-CV-___________ ( ) v. ECF CASE GOLDMAN SACHS & CO. and Jury Trial Demanded FABRICE TOURRE, Defendants. Plaintiff, the United States Securities and Exchange Commission ("Commission"), alleges as follows against the defendants named above: OVERVIEW 1. The Commission brings this securities fraud action against Goldman, Sachs & Co. (“GS&Co”) and a GS&Co employee, Fabrice Tourre (“Tourre”), for making materially misleading statements and omissions in connection with a synthetic collateralized debt obligation (“CDO”) GS&Co structured and marketed to investors. This synthetic CDO, ABACUS 2007- AC1, was tied to the performance of subprime residential mortgage-backed securities (“RMBS”) and was structured and marketed by GS&Co in early 2007 when the United States housing market and related securities were beginning to show signs of distress. Synthetic CDOs like ABACUS 2007-AC1 contributed to the recent financial crisis by magnifying losses associated with the downturn in the United States housing market. 2. GS&Co marketing materials for ABACUS 2007-AC1 – including the term sheet, flip book and offering memorandum for the CDO – all represented that the reference portfolio of RMBS underlying the CDO was selected by ACA Management LLC (“ACA”), a third-party with experience analyzing credit risk in RMBS. Undisclosed in the marketing materials and unbeknownst to investors, a large hedge fund, Paulson & Co. Inc. (“Paulson”), with economic interests directly adverse to investors in the ABACUS 2007-AC1 CDO, played a significant role in the portfolio selection process. After participating in the selection of the reference portfolio, Paulson effectively shorted the RMBS portfolio it helped select by entering into credit default swaps (“CDS”) with GS&Co to buy protection on specific layers of the ABACUS 2007-AC1 capital structure. -
2008 U.S. CDO Outlook and 2007 Review: Issuance Down in 2007 Triggered by Subprime Mortgages Meltdown; Lower Overall Issuance Expected in 2008
STRUCTURED FINANCE Special Report 2008 U.S. CDO Outlook and 2007 Review: Issuance Down in 2007 Triggered by Subprime Mortgages Meltdown; Lower Overall Issuance Expected in 2008 AUTHOR: CONTENTS: Jian Hu 1. Summary Senior Vice President (212) 553-7855 2. U.S. CDO Issuance Fell for the First Time since 2002 [email protected] 3. While Slightly Down in Volume, SF CDOs and CLOs Continued to Dominate U.S. CDO Issuance in 2007 CO-AUTHOR:1 4. Strong First and Second Quarters Offset Declines in the Suzanna Sava Assistant Vice President - Third and Fourth Quarters of 2007 Analyst 5. Unprecedented SF CDO Downgrades in 2007 Shatter (212) 553-1621 [email protected] Historical Record 6. Overall U.S. Financial Market Conditions Remain Difficult CONTACTS: 7. Generally Slower Issuance and More Negative Rating Yuri Yoshizawa Activity Are Expected Heading into 2008 Group Managing Director (212) 553-1939 [email protected] 1. SUMMARY Yvonne Fu Team Managing Director (212) 553-7732 2008 OUTLOOK [email protected] To increase transparency on the macroeconomic and financial framework William May that underpins its risk assessments, Moody's has published a baseline Team Managing Director outlook for the global economy, as well as three potential economic risk (212) 553-3868 [email protected] scenarios. These economic scenarios are intended to help Moody's ana- lysts formulate the outlooks for their specific markets using a consistent WEBSITE: set of assumptions that envisage various stressed economic and financial www.moodys.com conditions. The baseline outlook is inspired by major international organizations' eco- nomic outlooks. -
Why Cdos Work
Why CDOs Work Jon Gregory1 Revised version, 3rd March 2014 1. Introduction The growth of the structured credit market gave rise to many complex collateralised debt obligation (CDO) structures. An investment in a CDO can be broadly characterised paying a return as compensation for exposure to a certain range of losses on a static or managed portfolio. Precise quantification of the risks in a CDO is complex since one needs to assess the multidimensional loss distribution for the underlying portfolio. Prior to the beginning of the global financial crisis in 2007, the CDO was a successful financial innovation. Investment banks made large profits from structuring CDOs and hedge fund and real money investors generally made good returns, at least when judged against the credit rating of the underlying investment. Banks also utilised CDOs so as to achieve “regulatory arbitrage” in relation to their capital requirements (a topic not dealt with in this article). Other players in the CDO market gained also, for example rating agencies earned good fees for rating the plethora of CDO structures and monoline insurers collected significant premiums for insuring or “wrapping” senior CDO tranches. However, the global financial crisis was partly catalysed by an implosion of the CDO market. CDOs have been blamed for causing the crisis, pricing models for CDOs have been heavily criticised, litigation has been rife and investor demand has almost disappeared. All players in the CDO market, notably banks, rating agencies as well as investors have suffered as a result. Banks lost billions of dollars due to failed hedging and write-downs due to the counterparty risk in trades with failing monoline insurers. -
Goldman Sachs: Reputation and Regulatory Risk
Reputation resilience Goldman Sachs: reputation and regulatory risk processes that govern ethical behaviour, Goldman Sachs has been clear for innovation, quality, safety sustainability and many years that its reputation is a security. In accounting jargon, these key corporate asset. But recent business processes comprise the intangible assets that speak for 70% of the market events have shown that having such value of the average traded company. awareness is not always enough Reputation drives intangible asset value. Reputation-relevant intangible assets impact By Nir Kossovsky on corporate financials in several ways. By affecting customers, they impact on pricing The probability that a CEO will sit down to power and sales revenue. By affecting breakfast tomorrow morning and suffer employees and vendors, they impact on headline shock involving his or her operating costs. By affecting creditors, they company is significant. The Economist impact on the cost of debt capital. And by magazine reported recently that Oxford affecting equity investors, they impact on Metrica estimates that executives have an earnings multiples and equity value. 82% chance of facing a corporate disaster There’s more. Another group of external within any five-year period, up from 20% stakeholders impacted by reputation, whose two decades ago. More than ever, rather actions can have life-altering consequences than shaping the news, companies are for most companies, are the regulators. This playing catch-up. Companies have reached issue’s case study on risk and reputation the limits of corporate branding and are management looks at what happens when realising the weaknesses in traditional executives at an iconic firm admired for its marketing. -
1 an INTRODUCTION to COLLATERALISED DEBT OBLIGATIONS Moorad Choudhry and Aaron Nematnejad
1 AN INTRODUCTION TO COLLATERALISED DEBT OBLIGATIONS Moorad Choudhry and Aaron Nematnejad Collateralised Debt Obligations (CDOs) A CDO is essentially a securitisation in which a special purpose vehicle or SPV issues bonds or notes against an investment in a diversified pool of assets. These assets can be bonds, loans such as commercial bank loans or a mixture of both bonds and loans. Where assets are bonds, these are usually high-yield bonds that provide a spread of interest over the interest liability of the issued notes; where the assets are loans, the CDO acts as a mechanism by which illiquid loans can be pooled into a marketable security or securities. The third type of CDO is known as a synthetic CDO and refers to a structure in which credit derivatives are used to construct the underlying pool of assets. The investments are funded through the issue of the notes, and interest and principal payments on these notes are linked to the performance of the underlying assets. These underlying assets act as the collateral for the issues notes, hence the name. The key difference between CDOs and ABS and multi-asset repackaged securities is that the collateral pool is more actively managed by a portfolio or collateral manager. Generally CDO feature a multi-tranche structure, with a number of issued securities, most or all of which are rated by a ratings agency. The priority of payment of the issued securities reflects the credit rating for each note, with the most senior note being the highest rated. The term waterfall is used to refer to the order of payments; sufficient underlying cash flows must be generated by the issuing vehicle in order to meet the fees of third-party servicers and all the note issue liabilities. -
Dynamic Hedging of Synthetic CDO Tranches
Theoretical framework Homogeneous Markovian contagion model Comparison of hedging performance Dynamic hedging of synthetic CDO tranches Areski Cousin ISFA, Université Lyon 1 Young Researchers Workshop on Finance 2011 TMU Finance Group Tokyo, March 2011 Areski Cousin Dynamic hedging of synthetic CDO tranches Theoretical framework Homogeneous Markovian contagion model Comparison of hedging performance Introduction In this presentation, we address the hedging issue of CDO tranches in a market model where pricing is connected to the cost of the hedge In credit risk market, models that connect pricing to the cost of the hedge have been studied quite lately Discrepancies with the interest rate or the equity derivative market Model to be presented is not new, require some stringent assumptions, but the hedging can be fully described in a dynamical way Areski Cousin Dynamic hedging of synthetic CDO tranches Theoretical framework Homogeneous Markovian contagion model Comparison of hedging performance Introduction Presentation related to the papers : Hedging default risks of CDOs in Markovian contagion models (2008), Quantitative Finance, with Jean-Paul Laurent and Jean-David Fermanian Delta-hedging correlation risk ? (2010), submitted, with Stéphane Crépey and Yu Hang Kan Areski Cousin Dynamic hedging of synthetic CDO tranches Theoretical framework Homogeneous Markovian contagion model Comparison of hedging performance Contents 1 Theoretical framework 2 Homogeneous Markovian contagion model 3 Comparison of hedging performance Areski Cousin Dynamic -
The CDO Product Overview Collateralized Debt Obligations, Or Cdos, Are Structured Vehicles That Are Similar to Leveraged Closed-End Funds
The CDO Product Overview Collateralized debt obligations, or CDOs, are structured vehicles that are similar to leveraged closed-end funds. As discussed below, the majority are cash flow structures, a fair number are synthetic structures, and some use a market value structure. A majority of all CDOs are actively managed and invested in different asset classes. At the core of the CDO is a bankruptcy-remote, special-purpose entity (SPE) that issues securities to investors in the form of several classes that are tranched into differently rated and some unrated securities. Each class of securities represents a different level of risk and reward associated with the asset pool. The most senior securities have credit ratings higher than the average ratings of the collateral pool, with lower tranches being rated below the seniors. The first-loss tranche is equity (or preferred shares) that is typically not rated. The proceeds from the offering are typically used to purchase a portfolio of assets, or may be held in the SPE. Should some of the assets fall into default or trigger some of the transaction covenants, excess spread is first used to cover any losses. However, there might not be sufficient assets to cover these losses, and the lowest-level, or more junior securities may take a loss. Payments to each of the liability classes are dictated by a stipulated priority of payments that reallocates the risk and rewards associated with the assets. This allows the CDO issuer to tailor the liabilities to meet the risk/return profiles of a broad range of investors and to attract additional groups of investors. -
Document Filed by Ilene Richman
No. 20-222 In the Supreme Court of the United States GOLDMAN SACHS GROUP, INC., ET AL., PETITIONERS v. ARKANSAS TEACHER RETIREMENT SYSTEM, ET AL. ON WRIT OF CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE SECOND CIRCUIT JOINT APPENDIX (VOLUME 1; PAGES 1-400) KANNON K. SHANMUGAM THOMAS C. GOLDSTEIN PAUL, WEISS, RIFKIND, GOLDSTEIN & RUSSELL, P.C. WHARTON & GARRISON LLP 7475 Wisconsin Avenue 2001 K Street, N.W. Suite 850 Washington, DC 20006 Bethesda, MD 20814 (202) 223-7300 (202) 362-0636 [email protected] [email protected] Counsel of Record Counsel of Record for Petitioners for Respondents PETITION FOR A WRIT OF CERTIORARI FILED: AUGUST 21, 2020 CERTIORARI GRANTED: DECEMBER 11, 2020 TABLE OF CONTENTS Page VOLUME 1 Court of appeals docket entries (No. 18-3667) ................... 1 Court of appeals docket entries (No. 16-250) ..................... 5 District court docket entries (No. 10-3461) ........................ 8 Goldman Sachs 2007 Form 10-K: Conflicts Warning (D. Ct. Dkt. No. 78-6) .................................................... 23 Goldman Sachs 2007 Annual Report: Business Principles (D. Ct. Dkt. No. 143-16) ............................. 30 Financial Times, Markets & Investing, “Goldman’s risk control offers right example of governance,” Dec. 5, 2007 (D. Ct. Dkt. No. 193-20) .......................... 34 Dow Jones Business News, “13 Reasons Bush’s Bailout Won’t Stop Recession,” Dec. 11, 2007 (D. Ct. Dkt. No. 170-24) ................................................ 37 The Wall Street Journal, “How Goldman Won Big on Mortgage Meltdown,” Dec. 14, 2007 (front page) (D. Ct. Hearing Ex. T) ....................................... 42 The New York Times, Off the Shelf, “Economy’s Loss Was One Man’s Gain,” Dec. -
Yale ICF Working Paper No. 0706 Collateralized Debt Obligations And
Yale ICF Working Paper No. 0706 Collateralized Debt Obligations and Credit Risk Transfer Douglas J. Lucas, Executive Director, CDO Research, UBS Laurie S. Goodman, CoHead, Global Fixed Income Research, UBS Frank J. Fabozzi, Professor in the Practice of Finance, Yale University, School of Management and International Center for Finance This paper can be downloaded without charge from the Social Science Research Network Electronic Paper Collection: http://ssrn.com/abstract=997276 Collateralized debt obligations and credit risk transfer Douglas J. Lucas, Executive director and head of CDO Research, UBS Laurie S. Goodman, Managing director and CoHead of Global Fixed Income Research, UBS Frank J. Fabozzi, Professor in the Practice of Finance, School of Management, Yale University ABSTRACT Several studies have reported how new credit risk transfer vehicles have made it easier to reallocate large amounts of credit risk from the financial sector to the nonfinancial sector of the capital markets. In this article, we describe one of these new credit risk transfer vehicles, the collateralized debt obligation. Synthetic credit debt obligations utilize credit default swaps, another relatively new credit risk transfer vehicle. Financial institutions face five major risks: credit, interest rate, price, currency, and liquidity. The development of the derivatives markets prior to 1990 provided financial institutions with efficient vehicles for the transfer of interest rate, price, and currency risks, as well as enhancing the liquidity of the underlying assets. However, it is only in recent years that the market for the efficient transfer of credit risk has developed. Credit risk is the risk that a debt instrument will decline in value as a result of the borrower’s inability (real or perceived) to satisfy the contractual terms of its borrowing arrangement. -
Pricing Synthetic CDO Tranche on ABS
Pricing Synthetic CDO Tranche on ABS Yan Li A thesis submitted for the degree of Doctor of Philosophy of the University of London Centre for Quantitative Finance Imperial College London September 2007 Abstract This thesis develops a modeling framework for the pricing of a synthetic Collateralized Debt Obligation on Asset-Backed Securities (CDO on ABS) and other credit derivatives on ABS. A credit derivative with ABS exposure has attracted much attention in recent years. As one of the latest innovations in the financial market, a credit derivative on ABS is different to the traditional credit derivative in that it sources credit risks from the ABS market, for example the Sub-Prime mortgage market, rather than from the market for corporate default risks. The traditional credit risk models are all designed for corporate default risks however they do not cover some of the unique features associated with an ABS. Motivated by this modeling discrepancy, in this thesis we design a credit risk model for the pricing and risk management of credit derivatives on ABS. The thesis starts with an introduction to some related products and markets. The difficulties in the construction of a pricing model for credit derivatives on ABS are outlined and some basic concepts are introduced to simplify the problem. The foundation of the model is based on a reduced fonn approach, where defaults are driven by an explicit intensity. A prepayment intensity is also introduced to drive the dynamics of the future cash flow of an ABS asset. For multiple name products such as a CDO on ABS, we model the default and prepayment dependency between each of the single name assets via a copula approach, where the interdependency of default and prepayment of each single name asset is also dynamically captured in an integrated framework. -
A Brief History of Goldman Sachs
A Brief History of Goldman Sachs Established 1869 In 1869, a German immigrant named Marcus Goldman moved to New York City with his family and opened a one-room basement office next to a coal chute at 30 Pine Street in Lower Manhattan. During a period of tight and expensive bank credit, Goldman offered the local merchants an alternative. He would purchase their promissory notes and then sell the notes to New York’s commercial banks, becoming a pioneer in what became known as the commercial paper business. With the addition of his son-in-law, Samuel Sachs, in 1882, and his son, Henry Goldman, in 1885, Marcus Goldman’s enterprise became a partnership with a new name: Goldman, Sachs & Co. By the time the firm joined the New York Stock Exchange in 1896, Goldman Sachs was a leader in commercial paper sales. As the firm’s clients grew in number, it opened offices in Boston and Chicago (1900), San Francisco (1918), and Philadelphia and St. Louis (1920), becoming a national firm. In 1897, Goldman Sachs established relationships with financial firms in major European capitals, providing an array of services that included foreign exchange, letters of credit, gold shipments and arbitrage. In the early 1900s, as clients increasingly needed larger amounts of long-term capital, the firm began to establish its investment banking business. In two of the firm’s first public transactions— initial stock offerings for General Cigar and Sears Roebuck, both in 1906—Goldman Sachs broke new ground in making equity and debt securities more attractive to investors. -
On the Mechanism of Cdos Behind the Current Financial Crisis and Mathematical Modeling with Lévy Distributions
Intelligent Information Management, 2010, 2, 149-158 doi:10.4236/iim.2010.22018 Published Online February 2010 (http://www.scirp.org/journal/iim) On the Mechanism of CDOs behind the Current Financial Crisis and Mathematical Modeling with Lévy Distributions Hongwen Du1, Jianglun Wu2, Wei Yang3 1School of Finance and Economics, Hangzhou Dianzi University, Hangzhou, China 2Department of Mathematics, Swansea University, Swansea, UK 3Department of Mathematics, Swansea University, Swansea, UK Email: [email protected], {j.l.wu,mawy}@swansea.ac.uk Abstract This paper aims to reveal the mechanism of Collateralized Debt Obligations (CDOs) and how CDOs extend the current global financial crisis. We first introduce the concept of CDOs and give a brief account of the de- velopment of CDOs. We then explicate the mechanism of CDOs within a concrete example with mortgage deals and we outline the evolution of the current financial crisis. Based on our overview of pricing CDOs in various existing random models, we propose an idea of modeling the random phenomenon with the feature of heavy tail dependence for possible implements towards a new random modeling for CDOs. Keywords: Collateralized Debt Obligations (CDOs), Cashflow CDO, Synthetic CDO, Mechanism, Financial Crisis, Pricing Models, Lévy Stable Distributions Collateralized debt obligations (CDOs) were created in lateralized Bond Obligations, or CBO), loans (Co- 1987 by bankers at Drexel Burnham Lambert Inc. Within llateralized Loan Obligations, or CLO), funds (Coll- 10 years, the CDOs had become a major force in the ateralized Fund Obligations, or CFO), mortgages credit derivatives market, in which the value of a deriva- (Collateralized Mortgage Obligations, or CMO) and oth- tive is “derived” from the value of other assets.