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When banks sell "bad debt" they are acting as principals - this means that they explicitly state to their client that they have no obligation to look out for th

by EugeneG 16y ago

When banks sell "bad debt" they are acting as principals - this means that they explicitly state to their client that they have no obligation to look out for their interests. Every security has a price, "bad" securities are just cheaper than "good" securities. Participants in the markets always have different views. A bank (or any other principal) is not obligated to make sure that you're aware of their view. By definition, the person selling a security thinks they are better off selling it, and the person buying it thinks they are better off buying it.

kjhgfhjkhgfv 16y ago
If you know they are bad and are intending to make money out of destroying your client and the client is relying on a rating agency that is prepared to give it a AAA in order to get more business from you - then I think someone is being a bit naughty somewhere.
- EugeneG 16y ago
  There's no such thing as "knowing" they are bad. Everyone has an opinion, and the price people are willing to pay reflects that. For example, Lehman stock trades now. It has a price. I can sell it to you and feel perfectly fine about it, even if I think it's the biggest piece of crap in the world and I can't wait to sell it. I may end up wrong, because my opinion is just one of many, many. Lots of money is made by others by disagreeing with people who absolutely "know" something.
  - jrockway 16y ago
    Going to have to agree with you here. Why does a share of Google cost more than a share of Illegal Online Pharmacy, Inc? Because the market has decided that Google is going to work out better than Illegal Online Pharmacy. The market could be wrong; that's not a crime, that's just losing at poker.
  - Natsu 16y ago
    > There's no such thing as "knowing" they are bad. So they put billions of dollars on that bet after doing a lot of research and yet they didn't really know anything? Or are you trying to convince me that the stock market is legalized gambling? I'm confused here.
    - ZachPruckowski 16y ago
      >the stock market is legalized gambling It is. Buying a non-dividend-yielding stock is a bet that the price of that stock will go up, while selling a share is a bet that the price will go down. (yes, that's simplified) Doing all that research is like counting cards - you have a lot better information than the average investor, but you can't know for certain whether you should hit or stand on that 16, just what the best play is. So the GP's argument is that banks didn't actually know the securities would go south, but they knew it was more likely than the buyers thought. The information that the originating banks had that many investors didn't was that the loans were lower quality than mortgage loans had been in the past. So the investors were making their pricing calculations based on historical default data, which would obviously underestimate the default risk, causing them to think that the securities were worth a higher price than they would be if priced with a more realistic default rate in mind. And it wasn't a small difference. It was like a 10x difference in the default rate, which would have made lower tranches nearly worthless and really cut into the value of higher tranches. Let's use a car analogy. I want to sell my (hypothetical) 2005 Prius, and you're interested. You take a look at the car and it appears to be in good shape, so you're willing to pay roughly the Blue Book value for it. However, I know that the car is actually in need of serious maintenance costing thousands of dollars, and will probably break down on you before it's gone 10 miles. Obviously, I just withheld crucial information and sold you a lemon, with major penalties. Now, had you known it was in need of maintenance and offered a lower price knowing that (because you're a mechanic or something), then that's a different story.
deleted 16y ago
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kls 16y ago
But they are required by law to provide full disclosure. Something they where negligent to do with the mortgage backed securities.
- yummyfajitas 16y ago
  What did they fail to disclose?
  - kls 16y ago
    http://www.mcclatchydc.com/2010/04/30/93252/goldman-sought-to-shed-risky-mortgage.html http://www.mcclatchydc.com/2010/04/30/93252/goldman-sought-t... Viniar made no mention of Goldman's short bets or the $266 million gain. Instead, he said the market had seen "a little bit of nervousness" but the housing weakness had been "so far largely contained. The did not disclose material analysis that they where using to hedge the company against mortgage backed securities and explaining to analyst and clients that the losses where "so far largely contained". That is cut and dry fraud. They knew it was not contained and that is why the where bailing as fast as possible.
    - yummyfajitas 16y ago
      You are confusing Goldman's prop desk and their sales desk. The prop desk is not required to inform clients of their positions. The sales desk is required to disclose information on the composition of the security they are selling. I.e.: "Bond X is comprised of 523 loans from Florida, 247 loans from Texas, etc, all rated AAA". Your link does not suggest they failed to do this. In much the same way, if I think AAPL will tank, I am legally permitted to sell my shares.
      - kls 16y ago
        I am not confused about anything they where fined for civil fraud. They should have been charged with criminal fraud because they where culpable in allowing the racket to be structured. http://www.sec.gov/news/press/2010/2010-59.htm http://www.sec.gov/news/press/2010/2010-59.htm from the article: Tourre structured the transaction, prepared the marketing materials, and communicated directly with investors. Tourre allegedly knew of Paulson & Co.'s undisclosed short interest and role in the collateral selection process. Goldman Sachs did not disclose Paulson & Co.'s short position or its role in the collateral selection process in the term sheet, flip book, offering memorandum, or other marketing materials provided to investors.

by EugeneG 16y ago

kjhgfhjkhgfv 16y ago

If you know they are bad and are intending to make money out of destroying your client and the client is relying on a rating agency that is prepared to give it a AAA in order to get more business from you - then I think someone is being a bit naughty somewhere.

EugeneG 16y ago
There's no such thing as "knowing" they are bad. Everyone has an opinion, and the price people are willing to pay reflects that. For example, Lehman stock trades now. It has a price. I can sell it to you and feel perfectly fine about it, even if I think it's the biggest piece of crap in the world and I can't wait to sell it. I may end up wrong, because my opinion is just one of many, many. Lots of money is made by others by disagreeing with people who absolutely "know" something.
- jrockway 16y ago
  Going to have to agree with you here. Why does a share of Google cost more than a share of Illegal Online Pharmacy, Inc? Because the market has decided that Google is going to work out better than Illegal Online Pharmacy. The market could be wrong; that's not a crime, that's just losing at poker.
- Natsu 16y ago
  > There's no such thing as "knowing" they are bad. So they put billions of dollars on that bet after doing a lot of research and yet they didn't really know anything? Or are you trying to convince me that the stock market is legalized gambling? I'm confused here.
  - ZachPruckowski 16y ago
    >the stock market is legalized gambling It is. Buying a non-dividend-yielding stock is a bet that the price of that stock will go up, while selling a share is a bet that the price will go down. (yes, that's simplified) Doing all that research is like counting cards - you have a lot better information than the average investor, but you can't know for certain whether you should hit or stand on that 16, just what the best play is. So the GP's argument is that banks didn't actually know the securities would go south, but they knew it was more likely than the buyers thought. The information that the originating banks had that many investors didn't was that the loans were lower quality than mortgage loans had been in the past. So the investors were making their pricing calculations based on historical default data, which would obviously underestimate the default risk, causing them to think that the securities were worth a higher price than they would be if priced with a more realistic default rate in mind. And it wasn't a small difference. It was like a 10x difference in the default rate, which would have made lower tranches nearly worthless and really cut into the value of higher tranches. Let's use a car analogy. I want to sell my (hypothetical) 2005 Prius, and you're interested. You take a look at the car and it appears to be in good shape, so you're willing to pay roughly the Blue Book value for it. However, I know that the car is actually in need of serious maintenance costing thousands of dollars, and will probably break down on you before it's gone 10 miles. Obviously, I just withheld crucial information and sold you a lemon, with major penalties. Now, had you known it was in need of maintenance and offered a lower price knowing that (because you're a mechanic or something), then that's a different story.

deleted 16y ago

[deleted]

kls 16y ago

But they are required by law to provide full disclosure. Something they where negligent to do with the mortgage backed securities.

yummyfajitas 16y ago
What did they fail to disclose?
- kls 16y ago
  http://www.mcclatchydc.com/2010/04/30/93252/goldman-sought-to-shed-risky-mortgage.html http://www.mcclatchydc.com/2010/04/30/93252/goldman-sought-t... Viniar made no mention of Goldman's short bets or the $266 million gain. Instead, he said the market had seen "a little bit of nervousness" but the housing weakness had been "so far largely contained. The did not disclose material analysis that they where using to hedge the company against mortgage backed securities and explaining to analyst and clients that the losses where "so far largely contained". That is cut and dry fraud. They knew it was not contained and that is why the where bailing as fast as possible.
  - yummyfajitas 16y ago
    You are confusing Goldman's prop desk and their sales desk. The prop desk is not required to inform clients of their positions. The sales desk is required to disclose information on the composition of the security they are selling. I.e.: "Bond X is comprised of 523 loans from Florida, 247 loans from Texas, etc, all rated AAA". Your link does not suggest they failed to do this. In much the same way, if I think AAPL will tank, I am legally permitted to sell my shares.
    - kls 16y ago
      I am not confused about anything they where fined for civil fraud. They should have been charged with criminal fraud because they where culpable in allowing the racket to be structured. http://www.sec.gov/news/press/2010/2010-59.htm http://www.sec.gov/news/press/2010/2010-59.htm from the article: Tourre structured the transaction, prepared the marketing materials, and communicated directly with investors. Tourre allegedly knew of Paulson & Co.'s undisclosed short interest and role in the collateral selection process. Goldman Sachs did not disclose Paulson & Co.'s short position or its role in the collateral selection process in the term sheet, flip book, offering memorandum, or other marketing materials provided to investors.