Page 171 - untitled
P. 171
F FINANCIAL CRISIS INQUIRY COMMISSION REPORTINANCIAL CRISIS INQUIRY COMMISSION REPORT
CDOs in . The company wouldn’t make the decision to stop writing these con-
tracts until .
GOLDMAN SACHS: “MULTIPLIED THE EFFECTS
OF THE COLLAPSE IN SUBPRIME”
Henry Paulson, the CEO of Goldman Sachs from until he became secretary of
the Treasury in , testified to the FCIC that by the time he became secretary many
bad loans already had been issued—“most of the toothpaste was out of the tube”—
and that “there really wasn’t the proper regulatory apparatus to deal with it.” Paul-
son provided examples: “Subprime mortgages went from accounting for percent of
total mortgages in to percent by . . . . Securitization separated origina-
tors from the risk of the products they originated.” The result, Paulson observed,
“was a housing bubble that eventually burst in far more spectacular fashion than
most previous bubbles.”
Under Paulson’s leadership, Goldman Sachs had played a central role in the cre-
ation and sale of mortgage securities. From through , the company pro-
vided billions of dollars in loans to mortgage lenders; most went to the subprime
lenders Ameriquest, Long Beach, Fremont, New Century, and Countrywide through
warehouse lines of credit, often in the form of repos. During the same period, Gold-
man acquired billion of loans from these and other subprime loan originators,
which it securitized and sold to investors. From to , Goldman issued
mortgage securitizations totaling billion (about a quarter were subprime), and
CDOs totaling billion; Goldman also issued synthetic or hybrid CDOs
with a face value of billion between and June .
Synthetic CDOs were complex paper transactions involving credit default swaps.
Unlike the traditional cash CDO, synthetic CDOs contained no actual tranches of
mortgage-backed securities, or even tranches of other CDOs. Instead, they simply
referenced these mortgage securities and thus were bets on whether borrowers would
pay their mortgages. In the place of real mortgage assets, these CDOs contained
credit default swaps and did not finance a single home purchase. Investors in these
CDOs included “funded” long investors, who paid cash to purchase actual securities
issued by the CDO; “unfunded” long investors, who entered into swaps with the
CDO, making money if the reference securities performed; and “short” investors,
who bought credit default swaps on the reference securities, making money if the se-
curities failed. While funded investors received interest if the reference securities per-
formed, they could lose all of their investment if the reference securities defaulted.
Unfunded investors, which were highest in the payment waterfall, received pre-
mium-like payments from the CDO as long as the reference securities performed but
would have to pay if the reference securities deteriorated beyond a certain point and
if the CDO did not have sufficient funds to pay the short investors. Short investors,
often hedge funds, bought the credit default swaps from the CDOs and paid those
premiums. Hybrid CDOs were a combination of traditional and synthetic CDOs.
Firms like Goldman found synthetic CDOs cheaper and easier to create than tra-
