Taking Megan McArdle Apart - Part II

Here is another excerpt that I think is off-base from Megan McArdle's Matt Taibbi Gets His Sarah Palin On

"First of all, of course banks sell people positions they aren't themselves taking.  Sometimes the bank is right, and sometimes the customers are; differences of opinion are what make marriages and horse races.  Second of all, the banks that went down, the ones that arguably caused the financial crisis, were long their own toxic waste (and that of others).  Third of all, Goldman itself might argue that its mortgages were not as toxic as others, and for all I or Matt Taibbi know, they might be telling the truth.  Fourth of all, the disconnect between the underwriting and the customer side of the investment houses was not only legal, but in some cases, mandatory.  Excessive entanglement between the two is why Henry Blodget, whom Taibbi references elsewhere, has been banned from the securities industry for life.  That Taibbi could even ask how this was not securities fraud is really troubling."

1. "First of all, of course banks sell people positions they aren't themselves taking.  Sometimes the bank is right, and sometimes the customers are; differences of opinion are what make marriages and horse races."  That's fine, I don't think anyone is arguing this point.
2. "All the banks that went down were long their own toxic waste"  Yeah, except GS, (who had AIG write CDS on SPECIFIC securities for GS) who got bailed out while others were left to die.  This is where the outrage is.  Remember The Fed took  CDO's at a price that equated to par from "banks" into Maiden Lane III.  Here was the statement from the New York Fed.  Pursuant to the agreement, the NY Fed, has made available a term loan in an aggregate amount up to approximately $30.0B. AIG has contributed $5.0B for an equity interest in ML III. AIGFP, ML III and the NY Fed have entered into agreements with AIGFP’s CDS counterparties to terminate approximately $53.5B notional amount of CDS and purchase the related Multi-Sector CDOs.

   Of these, CDOs with a principal amount of approximately $46.1B settled on November 25 and a corresponding notional amount of CDS were terminated. Settlement on the remaining $7.4B notional amount of CDS is contingent upon the ability of the related counterparty to obtain the related Multi-Sector CDOs and thereby settle with ML III and terminate such CDS with AIG. Pending such settlement, which AIG expects to occur by year-end, the collateral posting provisions relating to these CDS have been suspended such that additional collateral will not be required of AIG nor will posted collateral be returned to AIG.

   With respect to the approximately $11.2B of exposure to Multi-Sector CDOs AIG and the NY Fed are working to structure the termination of the related CDS and/or the purchase by ML III of the related Multi-Sector CDOs. Unless this exposure is terminated, AIG will continue to bear market risk and the risk of adverse changes in collateral posting requirements relating to these CDS and could incur additional unrealized market valuation losses with respect to these CDS. On November 25, ML III bought approximately $46.1B in par amount of Multi-Sector CDOs through a net payment to CDS counterparties of approximately $20.1B, and AIGFP terminated the related CDS with the same notional amount. The aggregate cost of the purchases and terminations was funded through approximately $15.1B of borrowings under the Senior Loan, the surrender by AIGFP of approximately $25.9B of collateral previously posted by AIGFP to CDS counterparties in respect of the terminated CDS and AIG’s equity investment in ML III of $5.0B. I bet Goldman owned quite a few of those bonds.  I don't think the Fed has ever told us the actual banks that delivered the bonds to them and got taken out whole.  However, I do not think anyone disputes that Goldman was one of the sellers.  Additionally, GS had plenty of toxic waste.  What does Megan think it meant when Goldman led or was near the top of all street firms in "Level3 assets" for 2007-2008??  Level 3 assets were a nice way of saying "toxic waste". 
3. Maybe Goldman's mortgages weren't as toxic as others?  I believe Taibbi cited as an example, GSAMP 06-S3, a fabulous second lien deal.  As Taibbi said in his article, 18% of the mortgages were in default within the first 18 months!  I'm sure that number is a hell of a lot higher now. 
4. The separation of the underwriting and the "customer side" of the investment houses.  That's pretty funny.  In most shops, the new issue (underwriting) desk was on the same trading floor as the secondary trading desk.  Most of the time they were in the same row!  Everything was coordinated. There was no disconnect in my opinion.  Goldman saw the whole house of cards coming down in the residential mortgage credit market, and just like a lot of shops, they were moving as many bonds as they could out the door to customers and buying credit protection and selling the ABX.  One hand knew what the other was doing.  This isn't just Goldman, but it is how things work.  The only argument you can make against Taibbi is "everyone else was doing it too."  That's not much of an argument against his overall piece.

Comments

[supra for boy]

Beautiful!!! You truly have an eye for colour.

[eric]

Great points Fletch. Especially about the warehouse operation. Everybody got paid out of the same pot. Sales guys used to get nice credits for bringing in "mandates" from CDO managers and the carry and fees they produced all went into the same pot. Meanwhile, the secondary desk made liquidity at a loss to get guys into the next deal.

[fletch]

gs also one of the largest counterparties in the mkt to the biggest and baddest hedge fund players during this period (aka "the smart money"). their traders were proud of discussing the info advantage that came from these relationships. they facilitated liquidity but were definitely going the same way in their own books. as you've pounded away for a yr and a half, risk was laid off on the "dumb money".

let's also not forget that the guy that approved purchases of bonds or synthetic exposure for cdo warehouses (in virtually every shop across the street) was the same primary/secondary trader that handled all the custy flows/information. the system was almost perfectly centralized on 1 desk w/very little oversight or restraint