Weekend Update April 17 2010

Baltic Dry Index. 3009 +08
LIR Gold Target by 2019: $3,000.

"Why do the Goldmanites, whose wealth today is greater than the wealth of the richest Crassus, build the basilicas of Greenwich Connecticut with the money of poor believers rather than with their own money?"

With Apologies to Martin Luther.

We open for this delightful Icelandic ash quietened weekend with the sound of THUNDER from distant New York. God’s favourite great vampire squid has been charged with a billion dollar fraud in peddling structured mortgage securities to its brain dead marks aka clients. “God’s work,” says America’s up till now toothless and useless watchdog the SEC, included defrauding some of the flock by selling them CDO packages deliberately designed to fail. Charity, according to the SEC, began, stayed and never left home. To become a member of Lloyd Blankfein’s select flock, you had to have above average wealth, market sophistication, and intelligence. Charm, common sense, and an ability to read the prospectus, wasn’t required. Defrauding any old mark was for the lower orders Lehman or Bear Stearns.

Of course Goldman and the Goldmanites haven’t actually been convicted of anything (yet,) and presumably not many sophisticated clients will want to step up in the glare of public ridicule and ignominy and say to the world “we were idiots and rich mugs, with more cash than sense, and we didn’t bother to read the propectus.” Especially so, I expect, if these sophisticated marks were paid professional money managers offering their “expertise” to lower orders of wealthy mugs. However, I suspect that this is Wall Street’s Wittenberg Church moment, with the SEC nailing its “95 Theses” on Goldman’s front door. A reformation of sorts is about to visit Wall Street as America’s Witchfinders General, aka the tort bar, will follow this case with intense interest and then ride out all over the street. It’s not exactly as if Goldman and the Goldmanites don’t have very deep pockets.

For the record, Goldman and the Goldmanites, deny that they did anything wrong, and as we know from their defence in the AIG scandal where they were accused of benefiting by some 12 to 13 billion from the Fed’s bailout of AIG, which they said that their exposure to AIG was trivial. With 12 to 13 billion mere petty cash, it’s unlikely that they would cross the street to scoop up a mere billion.

“Overheard at Goldman Sachs”:
“We assume that you know what you’re doing,
In this ill-advised trade you’re pursuing,
But the opposite bet
That we place on your debt
May eventually hasten your ruin.”
http://blogs.wsj.com/economics/2010/03/17/celebrate-st-patricks-day-with-some-economic-limericks/?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+wsj%2Feconomics%2Ffeed+%28WSJ.com%3A+Real+Time+Economics+Blog%29

SEC accuses Goldman Sachs of fraud

Goldman Sachs has been accused of actively misleading its own clients over the sale of a complex $1bn (£650m) parcel of toxic derivatives tied to the downfall of the US housing market.
By James Quinn, US Business Editor in New York Published: 10:24PM BST 16 Apr 2010
The Wall Street bank, which has previously denied working against its own clients, was yesterday rocked by allegations that it hood-winked investors by selling them a toxic package of mortgages in the interests of another client, the hedge fund Paulson & Co.

Paulson was allegedly betting against the package and paid Goldman $15m for “structuring and marketing” it to unwary investors.

In the first legal case of its kind since the financial crisis, the US Securities and Exchange Commission (SEC) accused the Wall Street investment bank of propagating “deception and conflicts [which were]....old and simple.”

In an astonishing court filing, the regulator charged the bank and 31-year-old bond trader Fabrice Tourre on two counts of securities fraud.

In New York, Goldman shares were down 21.97 to $162.30 by early afternoon, having earlier fallen as low as $155.55 pushing the Dow Jones Industrial Average down 106.56 to 11,038.01. In London, the FTSE100 index closed down 81.05 at 5,743.96, as Lord Oakeshott, a Liberal Democrats Treasury spokesman, wrote to Lord Turner, chairman of the Financial Services Authority, asking for a UK-led probe into the deal.

The SEC, which has been investigating fraud in the mortgage market for more than two years, alleged that Mr Tourre - then a vice-president on Goldman’s structured product desk in New York – worked with Paulson to create a product that was tied to the performance of sub-prime mortgages. It became known as Abacus 2007.

Abacus was a synthetic collateralised debt obligation (CDO) and Paulson played a “significant role” in picking the sub-prime mortgages which were placed within it. But investors in Abacus were told that the mortgages were selected by ACA, an experienced third-party specialist.
Investors were also not told, the SEC claims, that Paulson was actively shorting – or betting against – the sub-prime mortgages in Abacus, as part of a strategy predicting a property market crash.

Instead, Mr Tourre, who now works for Goldman in London, is alleged to have told investors that Paulson had invested $200m in Abacus, when it had not done so.

He did so while secretly believing the sub-prime mortgage market was doomed, writing to a friend that “the whole building is about to collapse anytime now .”

Within nine months of the fundraising for Abacus closing in April 2007, 99pc of the portfolio had been downgraded. Investors lost in excess of $1bn, while Paulson made approximately $1bn.
Goldman said: “The SEC’s charges are completely unfounded in law and fact, and we will vigorously contest them and defend the firm and its reputation.”
http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/7599510/SEC-accuses-Goldman-Sachs-of-fraud.html

Below, Bloomberg covers more of Europe joining Greece in the derivatives minefield from Wall Street’s version of hell. Well, perhaps blaming Wall Street is a little unfair, much of the derivatives financial weapons of mass destruction, were peddled by the London end of Wall Street and European financial houses, for the very good reason that there was little or no regulation or oversight in London. Long term LIR readers know that this is what we predicted long ago.

A bank is a confidence trick. If you put up the right signs, the wizards of finance themselves will come in and ask you to take their money.

Jules Bertillon. A House of All Nations. 1938. Christina Stead.

Saint-Etienne Swaps Explode as Financial Weapons Ambush Europe
By Alan Katz
April 15 (Bloomberg) -- The worst global financial crisis in 70 years arrived in Saint-Etienne this month, as embedded financial obligations began to blow up.

A bill came due for 1.18 million euros ($1.61 million) owed to Deutsche Bank AG under a contract that initially saved the French city money. The 800-year-old town refused to pay, dodging for now one of 10 derivatives so speculative no bank will buy them back, said Cedric Grail, the municipal finance director. They would cost about 100 million euros to cancel today, he said.

“It’s a joke that we’re in markets like this,” said Grail, 38, from the 19th-century city hall fronted by an arched facade and the words Liberte, Egalite, Fraternite. “We’re playing the dollar against the Swiss franc until 2042.”

Saint-Etienne is one of thousands of public authorities across Europe that tried to shave borrowing expenses by accepting derivatives deals whose risks they couldn’t measure. They may be liable for billions of euros, according to the Bank of Italy and consulting and law firms in France and Germany. As global economies climb out of recession, the crisis is hitting Saint-Etienne in central France, Pforzheim in western Germany and Apulia, an Italian regional government on the Adriatic. They may pay for their bets into the next generation.

Alabama’s Jefferson County

From the Mediterranean Sea to the Pacific coast of the U.S., governments, public agencies and nonprofit institutions have lost billions of dollars because of transactions officials didn’t grasp. Harvard University in Cambridge, Massachusetts, agreed last year to pay more than $900 million to terminate swaps that assumed interest rates would rise.

For Jefferson County, Alabama, the day of reckoning came earlier than in Saint-Etienne, but the common denominator was the use of complex, unregulated financial instruments known as derivatives that are typically linked to changes in market interest rates, currencies, stocks or bonds. Billionaire investor Warren Buffett, chairman of Berkshire Hathaway Inc., in 2003 called derivatives “financial weapons of mass destruction.”

They pushed Jefferson County close to bankruptcy two years ago. It had refinanced $3 billion of debt with variable-rate bonds and purchased interest-rate swaps to guard against borrowing costs rising. Its interest rates soared when insurers guaranteeing the bonds lost their top credit grades, and the rate the county received under the swap deals fell.

Under the interest-rate swap deals popular with European municipalities, a bank would agree to cover a locality’s fixed debt payment and the government or agency would pay a variable rate gambling its costs would be lower -- and taking on the risk that they could be many times higher.

‘Hopes of Gain’

The deals were often based on differences between short- and long-term rates or currency movements.

“This is speculating in the hopes of gain,” said Peter Shapiro, managing director at Swap Financial Group LLC, in South Orange, New Jersey, an adviser to companies and governments. “The investor is taking a chance in hopes of a high return. It has nothing to do with hedging.”

Use of swaps in Europe soared in the late 1990s and early 2000s because banks pitched them as the easiest way to reduce costs on fixed-rate loans, according to Patrice Chatard, general manager of Finance Active, which helps more than 1,000 localities across Western Europe manage their debt.

The financial institutions that sold the derivatives were many of the same ones that received government bailouts to weather the worst global credit crisis since the 1930s.

----“These municipal swaps are the same thing as Greece,” said Fruchard, a former banker at Credit Lyonnais, now a unit of Credit Agricole SA, who designed swaps in the early 1990s. “It’s all trying to dress up your accounts.”

----Germany, Italy, Poland and Belgium also used derivatives to manage fiscal deficits, Walter Radermacher, the head of Eurostat told EU lawmakers in Brussels yesterday without being specific.

Municipalities are having to rewrite their budgets. Saint- Etienne raised taxes twice, slashed by three-fourths a plan to renovate a museum commemorating the region’s extinct coal mining industry and sparked the cancellation of a tram line. Pforzheim, on the edge of the Black Forest in Germany, is scrimping on roads, schools and building renovations.

Known as Gold City for its historic jewelry and watch- making industry, Pforzheim was ordered by the Baden-Wuerttemberg regional government office in Karlsruhe to cut its budget by 240 million euros, or about 12 percent annually, over the next four years because of a 55 million-euro loss on derivatives and a projected 50 million-euro annual shortfall from a decline in tax revenue and rising social costs.

The town followed the advice of Deutsche Bank in taking out bets on interest rates in 2004 and 2005, according to Susanne Weishaar, Pforzheim’s budget director until March.

-----In 2005 and 2006, the difference between long- and short- term rates collapsed. As potential losses soared in 2006, Weishaar bought more swaps from JPMorgan Chase & Co. in a vain attempt to protect the town budget. Today Pforzheim owes 55 million euros to New York-based JPMorgan, she said. That’s 11 percent of this year’s spending.

The Deutsche Bank swaps have a positive value for the city of about 9 million euros, Weishaar said, offset by the negative value of JPMorgan swaps set up to protect the city.

“It’s like Easter eggs,” said Weishaar, 45, who holds a degree in math and economics from the University of Ulm. “You want to buy one and somebody sells you a painted hand grenade instead.”

If the grenades explode -- or when local officials decide to cut their losses and get out of long-term contracts when the market is against them -- taxpayers foot the bill.

Risks Versus Savings

More than 1,000 municipalities in France had 11 billion euros in “risky” contracts at the end of 2009, according to Paris-based Finance Active. In Italy, about 467 public borrowers faced losses of 2.5 billion euros on derivatives as of the end of September, according to the Bank of Italy.
http://www.bloomberg.com/apps/news?pid=20601109&sid=a30KHZKX1WJo&pos=15

"I am a bear of Very Little Brain, and big words Bother me."

Winnie the Pooh. Money Manager, Goldman client, European derivatives buyer.

See "Intra-Day" for access to SocGen's report on why we're all Greeks now, plus more on Goldie and the Gang.

UK General Election polls. The hung Parliament Approaches.
http://www.ukpollingreport.co.uk/blog/

Odds Checker. UK General Election Betting Odds.
http://www.oddschecker.com/specials/politics-and-election/next-uk-general-election/most-seats

More on Monday. Have a great spring weekend.

GI.