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THE MADNESS 

Ira Wagner, the head of Bear Stearns’s CDO Group in , told the FCIC that he
rejected the deal when approached by Paulson representatives. When asked about
Goldman’s contention that Paulson’s picking the collateral was immaterial because the
collateral was disclosed and because Paulson was not well-known at that time, Wagner
called the argument “ridiculous.” He said that the structure encouraged Paulson to
pick the worst assets. While acknowledging the point that every synthetic deal neces-
sarily had long and short investors, Wagner saw having the short investors select the
referenced collateral as a serious conflict and for that reason declined to participate. 
ACA executives told the FCIC they were not initially aware that the short investor
was involved in choosing the collateral. CEO Alan Roseman said that he first heard of
Paulson’s role when he reviewed the SEC’s complaint. Laura Schwartz, who was re-

sponsible for the deal at ACA, said she believed that Paulson’s firm was the investor
taking the equity tranche and would therefore have an interest in the deal performing
well. She said she would not have been surprised that Paulson would also have had a
short position, because the correlation trade was common in the market, but added,
“To be honest, [at that time,] until the SEC testimony I did not even know that Paul-

son was only short.” Paulson told the FCIC that any synthetic CDO would have to
invest in “a pool that both a buyer and seller of protection could agree on.” He didn’t
understand the objections: “Every [synthetic] CDO has a buyer and seller of protec-
tion. So for anyone to say that they didn’t want to structure a CDO because someone
was buying protection in that CDO, then you wouldn’t do any CDOs.” 
In July , Goldman Sachs settled the case, paying a record  million fine.
Goldman “acknowledge[d] that the marketing materials for the ABACUS -AC
transaction contained incomplete information. In particular, it was a mistake for the
Goldman marketing materials to state that the reference portfolio was ‘selected by’
ACA Management LLC without disclosing the role of Paulson & Co. Inc. in the port-
folio selection process and that Paulson’s economic interests were adverse to CDO
investors.” 
The new derivatives provided a golden opportunity for bearish investors to bet
against the housing boom. Home prices in the hottest markets in California and
Florida had blasted into the stratosphere; it was hard for skeptics to believe that their
upward trajectory could continue. And if it did not, the landing would not be a soft
one. Some spoke out publicly. Others bet the bubble would burst. Betting against
CDOs was also, in some cases, a bet against the rating agencies and their models.
Jamie Mai and Ben Hockett, principals at the small investment firm Cornwall Capi-
tal, told the FCIC that they had warned the SEC in  that the agencies were dan-
gerously overoptimistic in their assessment of mortgage-backed CDOs. Mai and
Hockett saw the rating agencies as “the root of the mess,” because their ratings re-
moved the need for buyers to study prices and perform due diligence, even as “there
was a massive amount of gaming going on.” 
Shorting CDOs was “pretty attractive” because the rating agencies had given too
much credit for diversification, Sihan Shu of Paulson & Co. told the FCIC. Paulson
established a fund in June  that initially focused only on shorting BBB-rated
tranches. By the end of , Paulson & Co.’s Credit Opportunities fund, set up less