Saturday, April 17, 2010

Goldman as Bookie: Inspector Renault Assesses Synthetic CDOs

Posted by Jeff Lipshaw

I really think this should have been the epigram on the SEC's complaint against Goldman Sachs:  "I'm shocked, shocked to find gambling is going on in here!"  I've spent a little time in the last couple days digging past the allegations to the structure of the deal, and conclude that blaming Goldman Sachs for this is about as sensible as blaming the Race & Sports Book at Caesars Palace for taking bets on both sides of the game.

Seriously.  Bookies don't gamble.  They facilitate gambling.  They set odds to equalize the betting on both sides.  When the game or the race is over, they gather up what the losing side lost, pay what the winning side won, and skim a little bit for themselves.  You know when you place a bet with a bookie that it's the nature of the system that the bookie HAS to have a counter-bet to offset your own.  Now imagine that you'd like to bet against the Pakistani badminton team in its upcoming match against Indonesia because you think there are a lot of crazed Pakistani badminton fans who will bet the farm on their team.  There aren't any bookies who take badminton action.  So here is what you do.  You find a reputable bookie and ask him to set odds on the match for no other reason than you see those Pakistanis as suckers just waiting to be taken. You'll even pay the overhead to set up the line.  Caesars posts a line on the match; you bet Indonesia; the Pakistanis bet Pakistan; Indonesia creams Pakistan; Caesars collects the Pakistani bets, pays you off, and makes a little money in the process.

Then, horror of horrors!  The bettors on the Pakistani team sue Caesars because it didn't disclose that it set the badminton line and took the action because somebody wanted to bet on Indonesia!  Ludicrous, you'd say.

But as far as I can tell that's exactly what Goldman did here.  What made the deal work for Goldman was that it was the purchaser from ABACUS of credit default swap bets on the reference portfolio and the seller of matching credit swap bets to Paulson on the same portfolio.  I'm afraid that what's going on is that the deal is indeed so complex in its structure and terminology that even the sophisticated public is flummoxed.  SYNTHETIC CDOS WERE NOTHING BUT GAMBLES ON THE DIRECTION OF THE HOUSING AND SUBPRIME MARKET.  Like all derivatives, they might well have served as a conservative strategy if one had an underlying business that was exposed, and wanted to hedge away losses at the cost of additional speculative gains, either going long or short on the market.  If ABN Amro and IDK Deutsche Bank wanted to bet on the subprime market, they had to have a bookie with counter action to create an opportunity for the bet!

At first I thought this case was odd for its secondary actor liability issues.  Now I think it's just as interesting on issues of materiality, reliance, and causation.

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Why don't synthetic CDOs violate the anti-gaming statutes? If the buyer of protection doesn't own the security or something like it, it cannot be insurance. So why isn't it just illegal gambling?

Posted by: Howard Yaruss | Apr 19, 2010 4:05:18 PM