4 ms·

I think the other side can claim that what they should have been sold was a diversified portfolio to insure whereas what they were given was a concentrated port

I think the other side can claim that what they should have been sold was a diversified portfolio to insure whereas what they were given was a concentrated portfolio. If you ordered a box of bananas from a grocer and what they delivered was a box of all their rotten bananas that they hand selected, I think you would have a claim that they acted improperly. That GS brought in an outside agent, ACA, to me suggests that the portfolio construction was supposed to have some oversight to prevent the box of bad bananas scenario. If not, then why was there a third party agent? GS becomes culpable since they made the representation to the sellers of the insurance that there was an independent third party monitoring the construction, when in fact they knew it was really Paulson driving the portfolio construction.

yummyfajitas 16y ago
The short side of a banana sale is a guy with a comparative advantage in the production of bananas. The short side of a bet is a guy who thinks you are going to lose. A synthetic CDO is a package of bets, not a package of bananas. If you bet that the Yankees would win, you can be sure that someone else believed the Yankees would lose. Similarly, if you received a synthetic sports bet, with a payoff of 100 x Yankee win + 100 x Red Sox win + 100 x Blue Jays win, you can be sure that someone else thinks that at least 2 of the 3 teams will lose. If you lose this bet, you've got no cause for complaint since you were trying to do the same thing to the other guy. Paulson picked (in their opinion) the worst securities out there. ACA picked (in their opinion) the best of the worst. Everyone on the long side of this bet (which includes Goldman) believed Paulson was wrong and were fully prepared to take their money.
- mattmaroon 16y ago
  Humorously even Paulson and most of the other people who made a fortune had no idea just how right they were. They were all buying the mezzanine tranches (confusing lingo for next to worst) of the CDOs, when in reality even the best tranches (called senior) hit 0. They could have made many times more money (and a few people did, though not more than you could count on your fingers) since the credit default swaps were much cheaper on the highly-rated tranches but the risk was effectively the same since the correlation between subprime defaults considered to be about .3 was actually 1. Hindsight is 20/20 though.
mattmaroon 16y ago
Your analogy falls apart because a CDO is, by definition, a collection of rotten bananas. They all were, and anyone who was betting on them should have known that. It's the worst-performing (in hindsight too) tranches of bonds backed by mortgages that get into a CDO. Nobody needed to repackage the higher tranches because they were assumed to be risk-free and given the same rating as US Treasuries so they were just sold as bonds. Synthetic CDOs were all built to effectively wager against credit default swaps, which were all hand-selected by investors (mostly hedge fund managers). If you purchased synthetic CDOs then of course they were hand-selected rotten bananas, but you were wagering (incorrectly) that the rating models used by S&P and Moodys were correct in assuming that if you got enough rotten bananas together, you were left with 80% good bananas and 20% really rotten ones.

yummyfajitas 16y ago

The short side of a banana sale is a guy with a comparative advantage in the production of bananas. The short side of a bet is a guy who thinks you are going to lose. A synthetic CDO is a package of bets, not a package of bananas. If you bet that the Yankees would win, you can be sure that someone else believed the Yankees would lose. Similarly, if you received a synthetic sports bet, with a payoff of 100 x Yankee win + 100 x Red Sox win + 100 x Blue Jays win, you can be sure that someone else thinks that at least 2 of the 3 teams will lose. If you lose this bet, you've got no cause for complaint since you were trying to do the same thing to the other guy. Paulson picked (in their opinion) the worst securities out there. ACA picked (in their opinion) the best of the worst. Everyone on the long side of this bet (which includes Goldman) believed Paulson was wrong and were fully prepared to take their money.

mattmaroon 16y ago
Humorously even Paulson and most of the other people who made a fortune had no idea just how right they were. They were all buying the mezzanine tranches (confusing lingo for next to worst) of the CDOs, when in reality even the best tranches (called senior) hit 0. They could have made many times more money (and a few people did, though not more than you could count on your fingers) since the credit default swaps were much cheaper on the highly-rated tranches but the risk was effectively the same since the correlation between subprime defaults considered to be about .3 was actually 1. Hindsight is 20/20 though.

mattmaroon 16y ago

Your analogy falls apart because a CDO is, by definition, a collection of rotten bananas. They all were, and anyone who was betting on them should have known that. It's the worst-performing (in hindsight too) tranches of bonds backed by mortgages that get into a CDO. Nobody needed to repackage the higher tranches because they were assumed to be risk-free and given the same rating as US Treasuries so they were just sold as bonds. Synthetic CDOs were all built to effectively wager against credit default swaps, which were all hand-selected by investors (mostly hedge fund managers). If you purchased synthetic CDOs then of course they were hand-selected rotten bananas, but you were wagering (incorrectly) that the rating models used by S&P and Moodys were correct in assuming that if you got enough rotten bananas together, you were left with 80% good bananas and 20% really rotten ones.