Saturday, January 19, 2008
How Goldman Sachs Beat The Subprime Crash
Michael Lewis, Bloomberg, has an intriguing article on how Goldman Sachs beat the subprime market crash inspite of being one of the giant firms of Wall Street, all of whom followed the herd. What's odd about the subprime crash is Goldman Sachs Group Inc. A single firm took a position contrary to the rest of Wall Street. Giant Wall Street firms are designed for many things, but not, typically, to express highly idiosyncratic views in the market. Even more surprising is how little Wall Street seems to have dwelled on how and why Goldman Sachs made its killing. By the end of 2006, the people creating and selling subprime mortgages and other so-called CDOs (collateralized debt obligations), had put Goldman Sachs in exactly the same position as every other Wall Street firm. Enter two smart guys who trade Goldman's proprietary books to argue to the CEO and chief financial officer that the subprime market feels soft and that Goldman should short it. This they do, in such massive quantities that they more than offset the long positions in subprime held throughout the rest of the firm, leaving Goldman short the subprime market and in a position to make billions when it crashes. End of story.
In the article, Michael Lewis cites Kate Kelly as providing this information in her Wall Street Journal article on December 14th 2007 titled 'How Goldman Won Big on Mortgage Meltdown'. The group's big bet that securities backed by risky home loans would fall in value generated nearly $4bn of profits during the year ended November 30, according to people familiar with the firm's finances. Those gains erased $1.5bn to $2bn of mortgage-related losses elsewhere in the firm.
And then she goes on to name the two traders responsible for selling the huge short positions to their overlords. Goldman's trading home run was blasted from an obscure corner of the firm's mortgage department -- the structured-products trading group, which now numbers about 16 traders. Two of them, Michael Swenson, 40 years old, and Josh Birnbaum, 35, pushed Goldman to wager that the sub-prime market was heading for trouble.
You can read the full article here. As Bloomberg's Michael Lewis says, it is highly unusual for a big Wall Street firm to counter it's own CDO holdings with short positions, without in any way intimating their own mortgage department about this, or even their reasons for doing so. True that they were saved from being wiped out, but if they had shared this knowledge with their mortgage department, their clients too would have been protected from the crash.
More importantly though, this kind of insurance being set up by Goldman to cover their own holdings might serve as a model for all of Wall Street, instead of just being limited to nimble and savvy hedge funds. I'm guessing that chances of Wall Street committing mass suicide, as in 2001 with internet stocks and now with mortgage backed securities, is going to go significantly down in the near future.
In the article, Michael Lewis cites Kate Kelly as providing this information in her Wall Street Journal article on December 14th 2007 titled 'How Goldman Won Big on Mortgage Meltdown'. The group's big bet that securities backed by risky home loans would fall in value generated nearly $4bn of profits during the year ended November 30, according to people familiar with the firm's finances. Those gains erased $1.5bn to $2bn of mortgage-related losses elsewhere in the firm.
And then she goes on to name the two traders responsible for selling the huge short positions to their overlords. Goldman's trading home run was blasted from an obscure corner of the firm's mortgage department -- the structured-products trading group, which now numbers about 16 traders. Two of them, Michael Swenson, 40 years old, and Josh Birnbaum, 35, pushed Goldman to wager that the sub-prime market was heading for trouble.
You can read the full article here. As Bloomberg's Michael Lewis says, it is highly unusual for a big Wall Street firm to counter it's own CDO holdings with short positions, without in any way intimating their own mortgage department about this, or even their reasons for doing so. True that they were saved from being wiped out, but if they had shared this knowledge with their mortgage department, their clients too would have been protected from the crash.
More importantly though, this kind of insurance being set up by Goldman to cover their own holdings might serve as a model for all of Wall Street, instead of just being limited to nimble and savvy hedge funds. I'm guessing that chances of Wall Street committing mass suicide, as in 2001 with internet stocks and now with mortgage backed securities, is going to go significantly down in the near future.
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