The SEC requires that broker-dealers like Goldman disclose "material adverse facts," which among other things includes "adverse interests." Former prosecutors and regulators point to these areas as potential avenues for prosecution. Why? Because a $2 billion bet against clients you lied to, qualifies as an "adverse interest" that should have been disclosed.
But these "adverse interests" weren't even the worst part of Hudson. Goldman also used a complex pricing method to turn the deal into an impressive triple screwing. Essentially, Goldman bought some of the mortgage assets in the Hudson deal at a discount, resold them to clients at a higher price and pocketed the difference. This is like getting an invoice from an interior decorator who, in addition to his outrageous and unwarranted fee for services, charges you $170 a roll for brand-name wallpaper he's actually buying off the back of a truck for $63.
In summary
To get $1.2 billion in crap off its books, Goldman dumps a huge lot of deadly mortgages on its clients, lies about where that crap came from and claims it 'believes' in the product even as it's betting $2 billion on its failure. When its victims try to run out of the burning house, Goldman stands in the doorway, blasts them all with gasoline before they can escape, and then has the gall to send a bill overcharging its victims for the privilege of getting fried.
Timberwolf, the most notorious of Goldman's scams, was another car whose engine exploded right out of the lot. As with Hudson, Goldman clients who bought into the deal had no idea they were being sold the "cats and dogs" that Goldman was desperately trying to get off its books. An Australian hedge fund called Basis Capital sank $100 million into the deal on June 18th, 2007, and almost immediately found itself in a full-blown death spiral. Within a month, Basis Capital lost $37.5 million, and was forced to file for bankruptcy.
In many ways, Timberwolf was a perfect symbol of the insane, faith-based mathematics and darkly corrupt marketing that defined the mortgage bubble. The deal was built on a satanic derivative structure called the CDO-squared. A normal CDO is a giant pool of loans that are chopped up and layered into different "tranches": the prime or AAA level, the BBB or "mezzanine" level, and finally the equity or "toxic waste" level. Banks had no trouble finding investors for the AAA pieces, which involve betting on the safest mortgage borrowers in the pool. And there were usually investors willing to make much higher-odds bets on the crack addicts and no-documentation immigrants at the potentially very lucrative bottom of the pool. But the unsexy BBB parts of the pool were hard to sell, and the banks didn't want to be stuck holding all of these risky pieces. So what did they do? They took all the extra unsold pieces, threw them in a big box, and repeated the original "tranching" process all over again. What originally were all BBB pieces were diced up and divided anew -- and, presto, you suddenly (and fraudulently) had new "AAA' securities and new toxic-waste securities.
A CDO, to begin with, is already a highly dubious tool for magically (and fraudulently) converting risky subprime mortgages into AAA investment vehicles. A "CDO-squared' doubles down on that fraudulence, taking the waste products of the original process and converting them, fraudulently, into "AAA investments.' This is like taking all the kids who were picked last to play volleyball in every gym class of every public school in the state, throwing them in a new gym, and pretending that the first 10 kids picked are varsity-level players. Then you take all the unpicked kids left over from that process, throw them in a gym with similar kids from all 50 states, and call the first 10 kids picked All-Americans. In short, it's fraud. On a grand scale.
Those "All-Americans" were the 'assets' in the Timberwolf deal. In reality they were the recycled nightmare dregs of the mortgage craze. To quote Beavis and Butt-Head, they were "the ass of the ass."
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