Abaucs, Internet Boom, The Great Depression

1. Goldman Sachs – A Bubble
Making Machine
Date :- 25th November 2012
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2. Roadmap
Goldman Sachs History
Bubble 1 – Great Depression
Bubble 2 – Internet Age
Bubble 3 – Abacus – Housing Boom
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3. Goldman Sachs - History
 World’s most powerful Investment bank
 Founded in 1869, and headquartered in the Lower
Manhattan area of New York City
 Founded by German immigrant named Marcus
Goldman, with his son-in-law Samuel Sachs.
 Its everywhere across Globe
 Firm Provides M&A advice, Underwriting services,
Asset Management and Prime Brokerage to its Clients
1869 2012
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4. The Great Depression
 Started in late 1920’s
 Goldman Sachs were pioneer in using the Commercial
paper, made money lending out of short term IOUs to
small time vendors in downtown Manhattan
 Main Financial tool used to attract investors was
“Investment Trust”
 Made an Endless Investment Pyramid.; Goldman hiding
behind Goldman.
 First Effort was “Goldman Sachs Trading Corporation”
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1928 - 1929 4

5. Goldman Sachs 1928-29
Goldman
They bought it all with its Sachs
own money
Issued 1 Million Shares
@ $ 100 per share
July 1929 Goldman
Sachs
Trading
Co. 1928
7.2 Million Shares – 6.2
Shenandoah Blue Ridge Million Shares owned by
Corp. Shenandoah mostly
owned by GSTC.
Public
Sold common & Preferred
Share to Public The sold 90% to Public at $ 104.
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6. The Great Depression – Contd..
 Simple technique was a daisy chain of borrowed money.
 E.g.: You have a $1, and you borrow $9 against it.. Then you
take that $10 fund to borrow $90, then again take your
$100, so long as public is still lending, Borrow and invest
$900.
 If last fund in the line starts to lose value, you no longer have
money to pay back and every one gets into losses.
 Bank suffered a totaled losses of $475 Billions.
 Economist John Galbraith held up the Blue Ridge and
Shenandoah trusts as classic examples of madness of leverage
based investment.
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1928 - 1929 6

7. Internet Age – Technology
Boom
 After the depression, strict underwriting guidelines
were followed that Wall Street adhered to taking a
company Public.
 After 1995, technology outperformed all other sectors,
and .com service companies started performing better.
 After around 65 years, Goldman Sachs created a
reputation for attracting the smartest talent on the
street.
 It trained its executives to firms Mantra = “LONG
TERM GREEDY”
1869 2012
1999 – 2001 7

8. Internet Age – Contd..
 Robert Rubin, Goldman’s Co-chairman became the
treasury Secretary of America.
 He was prototypical Goldman banker.
 Just as it did with “Investment Trust” in the 1920’s,
Goldman started slow in this era and finished crazy in
the Internet Years.
 Major problem was Nobody told Investors that the
rules had changed. “Everyone on the inside knew”.
 Goldman has denied that it changed its underwriting
standards during the Internet Years.
1869 2012
1999 – 2001 8

9. Internet Age – Contd..
 Goldman helped Yahoo, a little known company with
weak financials to go public in 1996.
 Technology boom had begun.
 Goldman quickly became the IPO king of the Internet
Era.
 In 1999, Goldman at the height of boom, took 47
companies public including etoys.com, and webvan.com
 As leading Underwriter of internet stocks, goldman
provided profits far more volatile than those of its
competitors,.
1869 2012
1999 – 2001 9

10. Internet Age – Contd..
Laddering Spinning
Manipulating the share prices of the new offerings Process of bribery
Artificially jack up the new company's price which Offering the executives of newly public company
is of course was to bank's benefit - 6% fee of $500 shares at extra-low prices, in exchange of future
million IPO is a very serious money underwriting business.
Goldman was repeatedly sued by shareholders for Banks engaged in spinning would then undervalue
engaging in laddering in IPO's. the IPO, ensuring that hot openings price shares it
had handed out to insiders would be more likely
to rise quickly, supplying bigger first day rewards
for chosen few.
Maier, a leading hedge fund manager termed Spinning of hot IPO shares was not a harmless
Goldman as worst Perpetrator, as goldman totally corporate perk, instead it was an integral part of
fueled the bubble. fraudulent scheme to win new investment banking
business.
This led to the market crash, As they built these
stocks upon an illegal foundation, manipulated up.
Goldman paid $40 million for its laddering
violations
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11. Internet Age – Contd..
 Some $5 Trillion of wealth was wiped out on NASDAQ alone.
 Major problem wasn’t money that was lost by shareholders, it was
money gained by investment bankers who received hefty bonuses.
 Goldman paid $28.5 billions in compensation and benefits from
1999 to 2002.
 Market was no longer a rationally managed place to grow real and
profitable businesses. It was ocean of someone else’s money
 Goldman paid $7 billion a year into salaries and $110 million fines.
 After Internet Tech bubble, Goldman was ready with its new profit
driven strategy, just for another bubble to inflate.
1869 2012
1999 – 2001 11

12. Abacus – The Housing Boom
 A legal entity registered in the “Cayman Islands” in 2005
 Series of SCDO structured & marketed by Goldman Sachs
 Managed by the “Correlation Trading Desk” of Goldman Sachs
What is “ABACUS 2007 – AC1”?
 SCDO structured & marketed by Goldman Sachs in 2007
 Consisted reference portfolio of 90 RMBS amounting to $2B
(mostly sub-prime mortgages)
Who is Fabrice Tourre?
1. 31 year old, Executive Director in Goldman Sachs
2. Part of the Correlation Trading Desk
3. Responsible for structuring & marketing of ABACUS
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12
2007

13. Abacus – Players Involved
• Goldman Sachs & Co:
 A global investment banking & securities firm founded in 1869
 Known for advisory service & proprietary trading
• Paulson & Co:
 Well known Hedge fund founded in 1994 by John A. Paulson
 Known for advisory service & proprietary trading
• ACA Management:
 Well known manager of Collateralized Debt Obligations
 Experience in analyzing Credit Risk in RMBS
• ACA Capital:
 Parent company of ACA Management
 Experience in under writing protection
• IKB Deutsche Industriebank AG:
 Bank based in Dusseldorf, Germany
 Specializes in lending to small & medium sized companies
• ABN Amro:
 Major European bank
• Security & Exchange Commission (SEC):
 Agency that acts as the primary enforcer of federal securities laws
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13
2007

14. Abacus - Residential Mortgage Backed
Securities
1. Group of residential mortgages that banks package together
2. A type of security whose cash flows come from residential
mortgages
3. Holders of an RMBS receive interest and principal payments from
the residential debt
Bank:
Bank:
Packages securities into RMBS
Packages securities into RMBS
Loan
Loan
Homeowner Homeowner
Homeowner Homeowner
Homeowner
Mortgage payment
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2007 14

15. Abacus – Collateralized Debt
Obligations Features of CDO–
1. A kind of bond / assets (RMBS)
2. One bank borrows money from
RMBS: another bank by selling it’s asset
portfolio
Packages securities
into tranches rated 3. Exchange of interest payment &
by risk the principle amount due on
maturity
1 1
3 4 4. Value derived from underlying
portfolio
2
Seller Bank 5. CDO rely upon the cash flow
Buyer Bank
5 generated from RMBS to pay the
interest payments
1. Holder Bank divides RMBS into tranches & sells to another party
2. Buyer pays initial principal to seller, accordingly to tranches
3. Buyer receives interest from cash flows
4. Seller receives principal from cash flows
5. Seller pays back principal to Buyer on maturity 15

16.  Works exactly similar to normal CDO
 Except that buyer doesn’t have to own any underlying
assets
 Mirror image / Replica of normal CDO
 Operates through financial contract called “Credit Default
Swaps”
 Risk of loss on SCDO is divided into tranches just like
normal CDOs
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2007 16

17. Abacus – Credit Default Swaps
• OTC traded “Derivative contract” (Kind of insurance policy)
• There are 2 sides, protection buyer & protection seller
• Each have a different perspectives on the reference CDO’s future performance
• Buyer of protection pays monthly premiums
Reference CDO,
• Performance is evaluated based on the underlying assets based on portfolio of
RMBS
SCDO:
Debt security packaged
in a Special Purpose
Vehicle In credit event, the
Initial
1 3 protection buyer
investment receives All sellers
Money
Protection Seller
Shorting the CDS in
2 Protection Buyer
Long CDS in order to
order to Premiums short SCDO
Long SCDO
* Goldman Sachs Paulson & Co.
* ACA / ABN Amro
* IKB
* ACA
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18. Abacus - Structure
CDS protection CDS protection
Buyer Seller
100%
ACA/
ABN Amro
Super Senior notes
Paulson
50%
Goldman Sachs
45%
IKB
Class - A notes
ACA
21%
Lower-rated Notes
9%
Equity Tranche
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0%

19. Abacus – Ethical Issues
 Serving two clients on the opposite sides of the same deal
 Goldman withheld the information from IKB about Paulson’s significant
involvement in selecting the securities in the ABACUS CDO.
 GS provided wrong information to ACA that Paulson had long equity in
CDO & represented that ACA was the sole “Portfolio Selection
Agent” to investors.
 Truth Telling & Transparency
 Goldman withholds a material fact in its marketing brochure & does not
inform its client verbally of the same fact.
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2007 19

20. Abacus - Conclusion
 CDO failed due to Subprime market meltdown.
 Johan Paulson earn approx $ 1billion due to short sale.
 IKB lost approx $ 150 million.
 ACA Capital lost approx $ 900million
 GS lost approx 100million which was partially offset by $15million fees
which he received from Paulson.
 GS also charged by SEC worth $550 million for marketing materials for
the ABACUS transaction with incomplete information.
 ABN AMRO has filed a case in SEC against Goldman Sachs
 Bottom line, based on the information in this case study of the Goldman
Sachs ABACUS case, Goldman Sachs acted unethically because:
1. The institution failed in its fiduciary duty to act in the best interest of its
client. It failed in this duty because it chose to be in a position where it
was subject to conflicts of interest.
2. The institution was not honest. It failed to disclose material information
to its client, IBK and to its service provider, ACA.
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2007 20

21. We welcome Questions?
Thank You
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