Banks Issued Obligations, Paid by Investors; Then Took Default Insurance, ...

   ... Paid Again as Policyholders.

   At the beginning of this post, Happy Holidays to All, and to All a Happy New Year!  This is the joyous season of the year.

   Do not be angry.  But ask questions.

   It is reported on this Christmas Eve Day by two indisputably knowledgeable and experienced financial reporters in this country, that Goldman Sachs and other Banks sold synthetic Collateralized Obligations of their own making to their clients.  Mortgages were not actually contained in the CDO's, but these securities were "linked to" mortgages.  Gretchen Morgenson and Louise Story, "Banks Bundled Debt, Bet Against It and Won" p. A1, col. 2 (New York Times Nat'l ed., Thursday, December 24, 2009).  The CDO's did contain a form of Credit Insurance known to readers of this space:  Credit Default Swaps, which were originally intended to pay off "when a borrower defaults.  These swaps made it much easier to place large bets on mortgage failures."  Id.

   The CDS's or Credit Default Swaps were always written to pay out if there was a "credit event," much as a Commercial General Liability Insurance Policy is written to pay out if there is a "covered Occurrence".  The rules governing a "credit event" changed, however.  The Banks were reportedly responsible for the change in rules.  Id.  A "credit event" which would cause a payout under the CDS's was expanded to include more "triggers," including a very lucrative trigger for the Banks "like a ratings downgrade on a bond."  Id.

   A spokesperson for Goldman Sachs is cited in the linked newspaper report as saying "that clients knew Goldman might be betting against mortgages linked to the securities," although it is also reported in the linked article that worries about a housing bubble led "top Goldman executives" in December, 2006 "to change the firm's overall stance on the mortgage market, from positive to negative, though it did not disclose that publicly."  Id.

   It bears repeating perhaps that "[o]ther Wall Street firms also created risky mortgage-related securities that they bet against."  Id.

   Questions arise for all such Wall Street firms based on this information.  Was there a Fiduciary Duty in operation here, flowing from the "Wall Street firms" to their investor-clients?  One of the first duties of a Fiduciary is loyalty.  The duty of loyalty includes the duty of disclosure, notice, keeping the other party informed.

   What evidence is there that this was done?

   What exactly did these "Wall Street firms" report to their clients, such that "clients knew" the firms were betting against mortgages linked to the securities which were issued by the very firms betting against them?

   Aside from the question of what information was provided to their clients, was there a waivable conflict in favor of the very firms which made a lot of money by issuing both the securities and the CDS's in which the firms bet against the mortgages linked to those securities?  Were conflict waivers ever requested by the "Wall Street firms" in question?

   Was full disclosure made by these firms to their clients, first?

   Questions abound as a result of the linked newspaper report.  To say again, this is not a time for anger.  It is in fact the joyous season of the year by common consent, as Dickens observed.  

   But ask questions. 

Please Read The Disclaimer.

Comments

[scoremore]

very nice aritcle..i've learned a lot from this article..especially about the bank's policy regarding mortgages...