Last Friday's announcement by the SEC that it is bringing fraud charges against Goldman Sachs and one of its traders rocked Wall Street. As the agency continues to examine comparable transactions to the ABACUS 2007-AC1 CDO at the heart of its complaint against Goldman, banks are no doubt legitimately concerned whether they could be next in the SEC's crosshairs. In order to establish a short list of likely candidates, let's take a look at some of the largest underwriters of similar CDOs in 2007:
|
Lead Underwriter |
2007 Volume, CDOs Comparable to Goldman's ABACUS 2007-AC1 (US$millions) |
|---|---|
|
BofA Merrill Lynch (part of Bank of America (NYSE: BAC)) |
$9,972.0 |
|
UBS (NYSE: UBS) |
$8,340.0 |
|
Citigroup (NYSE: C) |
$5,456.0 |
|
Royal Bank of Scotland |
$4,419.2 |
|
Barclays Capital (part of Barclays PLC) |
$2.594.0 |
|
Morgan Stanley (NYSE: MS) |
$2,344.3 |
|
Goldman Sachs (NYSE: GS) |
$2,264.5 |
|
JPMorgan Chase (NYSE: JPM) |
$1,752.1 |
Source: Credit Suisse.
2007: A very good year for fraud
It's logical to look at 2007 -- the year in which the real estate bubble drew on its last reserves of momentum before beginning to come apart. Indeed, the further we advance into "Ponzi finance" territory (to use Hyman Minsky's expression), the greater the incentives to continue "dancing" by resorting to any means -- including fraud. These raised, skewed incentives are present at all levels of the system -- whether it be speculators who need to refinance their home mortgages or credit rating agency executives and derivatives salesmen who need to keep generating revenue in order to guarantee the annual compensation they have become accustomed to.
Goldman's CDO was putrid
According to a report by Wachovia Capital Markets cited by the Wall Street Journal, Goldman's ABACUS 2007-AC1 CDO was one of the worst performers out of hundreds of comparable transactions. Within a year, 100% of the bonds underlying the CDO had been downgraded -- only two other transactions, structured by Deutsche Bank and UBS, achieved that dubious distinction. (Mind you, the performance of the CDO or the size of losses incurred by investors aren't by themselves grounds for a fraud charge.)
It's not just Uncle Sam the banks need to worry about
Finally, the government isn't the only party Goldman (and other banks) should be concerned about. I expect the SEC's action will embolden CDO investors to bring lawsuits of their own. AIG (NYSE: AIG) is already examining whether or not to attempt to recover losses on mortgage-related securities from Goldman. Dutch bank Rabobank is waging a suit against Merrill Lynch for misrepresenting the risks of a CDO named Norma. Expect more -- perhaps many more -- to follow.
Due to three sweeping changes on Wall Street, now's the time to invest in these stocks.
