Larry Summers Unfit to be Fed Chair

Mr. Summers is unfit to be Fed Chairman. His major problem is not that he was spectacularly wrong about deregulation in the pre-crisis era, though he was. Nor is it his burgeoning private sector roles and the conflicts of interests he is accumulating. Prof. Summers main problem is that he is an intellectual bully who will not give a fair hearing to those with whom he disagrees.

His arrogance does not simply extend to women, although he was part of the Clinton era cabal that shouted down the prescient warnings of Elizabeth Warren, Sheila Bair, and Brooksley Born. In the summer of 2005 Raghuran G. Rajan, the chief economist of the International Monetary Fund, delivered a paper at the Jackson Hole, Wyoming conference sponsored by the Federal Reserve Bank of Kansas City in which he presented evidence that the banking system was getting dangerously risky. Mr Summers, then at the Treasury Department, rose to proclaim “the basic, slightly Luddite premise of this paper to be largely misguided.”

Had Mr. Summers been a fair-minded academic and objectively considered Mr. Rajan’s research, the world might have been spared a financial crisis. This is not the kind of judgment and temperament we need at the Federal Reserve Board. Please–let Mr. Summers’ second and third acts remain in academia and the private sector.

SEC v. Tourre: Fabrice’s Team Fights Back

The SEC had Fabrice Tourre on the ropes today, but could not finish him off.  Mr. Tourre’s lawyer, Pamela Chepiga, delivered a skillful cross examination impeaching a key SEC witness, i.e. Dean Atkins of ABN Amro, the Dutch bank that acted as the effective guarantor of ACA’s long position in the super senior tranches of the Abacus deal.

Never Debate the Meaning of Surrealism with A Frenchman Part II (For Part I see my July 19 blog)


In the closing moments of his redirect of Mr. Tourre, The SEC’s Matthew Martens finally got away from debating the meaning of surrealism with the French gentleman and finally got away from the cacophony of misunderstanding about Paulson that was ACA’s distracting role in this trial.  He went back to the only way the SEC will win this case–proving fraud against a non-ACA party.  In the last ten minutes of his re-direct, Mr. Martens once again reminded the jury of Mr. Tourre’s central role in preparing the marketing materials for the Abacus deal.

To prove a case for fraud against Mr. Tourre, Mr. Martens must prove three elements:  An omission or misrepresentation in the marketing materials (check), scienter, i.e a knowing or negligent state of mind (I think we can put a check mark here too), and materiality, i.e. the fact that it would make a difference in a prudent investor’s decision.  (The SEC does not need to prove actual reliance in its case as would a private party who might be suing for the damages of fraud.)  So the case against Mr. Tourre all comes down to whether the SEC can prove materiality.

Englishmen Talking Structured Products

With its final two witness, the SEC failed to close the loop on materiality.  The SEC had two chances to do so in witnesses presented by videotape.  Two English lawyers, as it turned out, who were the representatives of their respective “entities”.  (Some members of the jury understandably seemed to be dozing during this admittedly somnolence-inducing but critical testimony.)

The first witness was Alisdair Hunter representing Loreley, a special purpose vehicle which had the misfortune of going long on Abacus tranches.  Mr. Hunter’s representation as Loreley’s witness is an interesting back story.  He might be said to be a special purpose vehicle himself since he was previously Loreley’s lawyer and seems to have been appointed as a Director for the sole purpose of providing testimony on their behalf.

Mr. Hunter did not come near making the case of materiality.  Loreley seems to have relied on IKB bank as investment adviser.  But we never heard from IKB which the SEC has been unable to get to testify in this case.  (There is an elaborate legal back story to that.)  So we have no evidence that the omission of Paulson’s role was material to the investment advice given by IKB to to Loreley.  So Mr. Hunter’s testimony might be classified as close but no cigar.

Next came the equally soporific and sad-looking Dean Atkins, the man in charge of (I’m not joking) “A(sset) B(acked) S(ecurities) Exotica” at ABN Amro.  He defined “exotica” as “non-vanilla” and thankfully Mr. Martens did not challenge an Englishman’s definition of exotica.  ABN Amro was the effective guarantor (“intermediator” the traders like to call such) of ACA’s ill advised long trade on the Abacus super senior tranches.  Mr. Atkins, once a high flying Cambridge graduate with an economics degree, lost his job, or, as he put it, his job no longer existed, after the Abacus portfolio went south and ABN had to pay ACA which had to pay Goldman which had to pay Paulson.  The sweet fee ABN Amro was earning for the risk suddenly meant a major loss for the Exotica Desk.  (I’ll write significant risk protection–and pay for intermediation if you don’t trust my credit–if anyone posts some of their stationary for sale on eBay.)

Ms. Chepiga Comes to the Rescue

Mr. Atkins dutifully reported in his deposition that he considered the unknown role of Paulson material to ABN Amro’s decision to “intermediate” ACA’s long position.  He said it was a “conflict of interest” for the short to help pick the portfolio.  I was counting Mr. Tourre out 7, 8. 9…when Ms. Chepiga came to the rescue with her powerful cross.  Ms. Chepiga is an elegant litigator who goes right to the heart of the matter without any wasted motion.  Everything she says and does has a purpose and is carefully thought out and constructed.  Even her pauses resonate thoughtfulness. Here she impeached Mr. Atkins in a few deft strokes.  Apparently in an earlier deposition, Mr. Atkins had stated that it really didn’t matter to him who picked the portfolio he was intermediating a long position on.  He said the underlying securities were what ABN Amro based its decision upon.  Mr. Martens tried valiantly to rehabilitate the witness but the damage was done.  Fabrice would live to fight another day.

Next week We Get to See Some of the Big Fish that Got Away

The final week of trial will feature a host of Goldman Sachs executives put on by the defense.  Much of that is likely to focus on the issue of how responsible Mr. Tourre was for what went down with Abacus.  The defense will no doubt skillfully cast doubt on whether Mr. Tourre was the mastermind of the fraud, but in the end I think what we will see is that Mr. Tourre was the principal responsible party and if there was a fraud he should be held accountable.  It is a pity that other higher ups at Goldman Sachs who were supposed to be supervising the young Mr. Tourre are not also held responsible and banned from the securities business.  They are more of a menace to the financial markets than the somewhat naive and oblivious Mr. Tourre.

Ethics and Law

The now satisfying part of this trial from an ethical and legal point of view is that we are finally down to the ultimate legal and ethical issue that is at the heart of the transaction.  Is it illegal to fail to disclose in sales material presented to a sophisticated long investor client that a short party in a synthetic RMBS has helped to pick the reference portfolio?  Or as specifically raised in this case, does Goldman have a duty to disclose Paulson’s role in picking the reference portfoilio to its clients who are considering taking a long position in that portfolio?  This is the very hard question that will be handed to the jury.

One question I have been asking myself as the trial proceeds is whether the legal answer to this question is different from the ethical answer.  I’m going to wait until the jury decides before I provide my answer.  Mr. Tourre claimed at the very end of his testimony that “I haven’t done anything wrong.” He is not a lawyer and does not appear to do much ethical soul-searching, and thus neither the court nor I will regard his as the last word on the matter.


SEC Scores Knockdown in Last Hour of Tourre’s Testimony

Fabrice Tourre is down and probably out.

Improbably, after a week of pointless diversion with Gail Kreitman and Laura Schwartz and ACA, in the last hour of his examination of Mr. Tourre, Mr. Martens tied him to fraud against the non ACA investors. Mr. Martens produced ample evidence of Mr. Tourre’s deep involvement in producing marketing materials and sales instructions for long investor clients that failed to mention Paulson’s role. While ACA should have known that Paulson was short, these other investors and potential investors were not privy to Paulson’s role.

The SEC presented a solid case for legal fraud based upon one of the main ethical issues about which America wants accountability from Wall Street–fraud against a client.

Now the only question is whether a week of dithering about ACA will distract the jury from the solid documentary case it presented on fraud against the other investors. Will the SEC hand the case back to Mr. Tourre by going back to ACA and Laura Schwartz’s unsympathetic confusion about Paulson?

Mr. Tourre has two of the most gifted attorneys I have witnessed in action in Pamela Chepiga and Sean Coffey.  Ms. Chepiga was again exceptional in court in attempting to rehabilitate Mr. Tourre.  But its hard to see where they can go with the fraud evidence presented today.  Mr. Tourre seemed clearly at the center of the failure to inform potential investors about Paulson’s role.  While others may have been involved at Goldman, he was the one with principal operational responsibility for the deal.

Everything else the SEC has thrown at Coffey and Chepiga was easy for this dynamic duo.  This time, however, they have been handed a difficult case.  The contours of the defense as presented by Mr. Tourre is that there are two separate transactions going on in Abacus.  One between Goldman and the longs and one between Goldman and Paulson.  Tourre has tried to present the market-making business as matching longs and shorts.  What makes this defense difficult is that the offering documents contain all the characteristics of an underwriting document requiring a lot more disclosure than just putting two trades together.  The securities sold by Goldman were far from cookie cutter and thus the “market-making” characterization just doesn’t fit all that well for the massive deals Tourre and others at the Asset-Backed security Correlation Desk were putting together in 2006-2007.

I would add that I thought showing the emails Mr. Tourre wrote to his girlfriend was tawdry on the SEC’s part and backfired, allowing him to seem like an immature romantic. Mr. Tourre came across as an decent if mercurial young man who committed securities fraud and should be held accountable.

SEC v. Tourre: Fabrice Takes the Stand and is a Little Fabulous

At 3:06 pm of the 8th day of trial Fabrice Tourre took the stand to testify. In two hours of intense questioning, SEC Chief Litigation Counsel Matthew T. Martens took dead aim at Fabrice but failed to land anything but a glancing blow.  Indeed, Fabrice proved to be a crafty and effective counter puncher.

To date the SEC has been unable to offer any testimony that, even if true, would link Tourre to fraud against ACA.  The government’s last hope was that Fabrice would implicate himself on the stand.  After the first two hours of questioning, Fabrice avoided handing the case back to the SEC.

The SEC’s case would find Fabrice guilty of defrauding ACA by deliberately concealing Paulson’s short position.  The fatal flaw in the SEC’s case is that its chief witness, ACA’s Laura Schwartz could not remember any conversation with Tourre about Paulson’s role.  In a continuation of his brilliant cross examination from yesterday, Tourre’s lawyer Sean Coffey got Ms. Schwartz to admit that her misunderstanding about Paulson’s role did not come from direct words with Tourre.  (Mr. Coffey’s only missteps were calling Ms. Schwartz Ms. Kreitman more than once visibly annoying Judge Forrest.) Instead, the SEC contends, Tourre’s fraud was perpetrated in two ways–(1) indirect communication through Gail Kreitman, the harried Goldman sales manager who in prior testimony testified that she had never heard of Paulson, and (2) by the non-act of Tourre failing to respond to an email from Ms. Schwartz early on in the construction of the deal inquiring about “Paulson’s equity position.”  Never mind that ACA went all the way through to the closing–4 months–without noticing that there was no equity component in the multitude of documents that followed that email in the first week of negotiations with Goldman.  Tourre, for his part, said he did not remember reviewing the email.

Martens drew blood when he got Tourre to concede that as written in Schwartz’s email,  the phrase “Paulson’s equity position” could only mean that Paulson assuming a cash equity position.  (This was an unnecessary admission by Tourre since another possible interpretation was that Paulson had a negative view of equity, but Tourre could not think fast enough on his feet to offer any other explanation.)  This was the high point in Martens examination.   But as he intoned about the momentousness of this interpretation I found myself thinking how overwrought it seemed to be basing a federal securities fraud case on the failure to answer a vague email from a company that failed to perform even the slightest due diligence about Paulson over a 4 month period.  How sad, I thought, that this is what our search for truth and accountability for ethics on Wall Street has come to.  I also thought that when I get home I’m going to answer those thousand or so emails I have not fully responded to over the last decade.

Tourre, Goldman veteran and University of Chicago economics PhD student, then proceeded to school Mr. Martens on the basics of making a market on Wall Street.  Martens led with his chin, not once but three, four or five times, and each time Tourre struck a blow.  Mr. Martens seemed oblivious to displaying a lack of understanding about basic market principles.  Repeatedly, he asked Mr. Tourre whether the role of a portfolio selection agent such as ACA was to fill a synthetic portfolio with RMBS tranches that had the best chance of succeeding.  Mr. Tourre happily corrected Mr. Martens by pointing out that a synthetic CDO deal needed shorts as well as longs and the role of a portfolio selection agent was to pick stocks that would attract long and short.  The bigger the deal, the more action created by the PSA, the happier everyone is (at least at the outset of the deal)–longs, shorts, underwriters and not least the PSAs themselves who earn larger fees for bigger deals.  After about the third try or so, Mr. Martens seemed to get the point and finally, mercifully, he moved on to other topics.

At the end of his questioning for the day, Mr. Martens was attempting, without success, to make something of the fact that other CDO managers turned down the role ACA believed it had won, as Ms. Schwartz’s put it, in a “beauty contest.”  What is actually interesting about this line of questioning is that the Goldman Sachs higher-ups didn’t want Fabrice to use some of the more “flexible” CDO managers.  It seems that in early 2007 Fabrice was too low on the Goldman Sachs totem pole to know the firm was actually placing huge short bets into the RMBS market.  Abacus was a sidelight.  The real action was in the Timberwolf, Anderson, and Hudson deals where Goldman went short hundred of millions in deals it sold long to its customers.  If the SEC wants to nail someone from Goldman they should heed Deep Throat’s admonition to “follow the money.”

Tourre was energized and plucky on the stand.  He smiled repeatedly though it did not seem to me that he was connecting with the jury who were looking on with rapt interest.  He seemed happy, and perhaps a bit too overeager, to get out of his seat and assume his rightful role as the star of his own trial.  This might not have made his lawyers too happy.  At this point only Fabulous Fabrice can sink Mr. Tourre.  As we have seen, Fabulous Fabrice is given to excessive flourishes in emails.  His lawyers will no doubt be holding their breath while he takes his star turn on the stand.



SEC v Tourre Week 2: A Misunderstanding For Sure But No Fraud Yet Proven

The trial took a dramatic turn this afternoon when Mr. Tourre’s lawyer Sean Coffey brilliantly cross examined the SEC’s main witness, Laura Schwartz.

Ms. Schwartz, as the New York Times described was indeed a “convincing, well spoken witness” who testified directly and sincerely to the jury.  However, Mr. Coffey’s cross examination was devastating to the SEC’s case.  In her direct testimony, Ms. Schwartz, the head of ACA’s CDO Asset Management group, had dutifully responded to prompting by the SEC’s lead attorney Martens, repeating numerous times that it was her “understanding” that Paulson was long in Abacus.  This was a incorrect misunderstanding.  But who was responsible for the misunderstanding?  Ms. Schwartz had what appeared to be a canned answer that it was her “discussions with Goldman Sachs,” “emails” and “documents.”   Not one time did Ms. Schwartz specifically mention Mr. Tourre  as the source of her misunderstanding.  The closest the SEC came to Mr. Tourre was an unanswered email from Schwartz to Tourre inquiring about Paulson’s equity position.  In fact, at no point did the SEC elicit any testimony that ANYONE had misled Ms. Schwartz other than her old colleague from Merrill Lynch days, Gail Kreitman–the same Ms. Kreitman who yesterday testified that she did not understand the Abacus deal and did not know who Paulson was at the time of the Abacus transaction.

It is telling that as the trial goes on the SEC’s witnesses almost never mention Mr. Tourre.

Without any facts presented that Tourre or anyone else (other than possibly the harried Ms. Kreitman) caused Ms. Schwartz and ACA to falsely believe Paulson was long, there appears to be no case stated against Mr. Tourre.  This is not a case of “he said, she said” because she didn’t say. Ms. Schwartz was the SEC’s best shot at proving fraud.  However, Ms. Schwartz only testified that it was her “understanding” that Paulson was long but she did not point to any specific communication with Mr. Tourre where he stated Paulson was long.  The closest the SEC came to that is that somehow Mr. Tourre perpetrated this fraud through Ms. Kreitman.  And then there is that unanswered email inquiring about Mr. Paulson’s equity position.  Since Ms. Schwartz’s testimony did not on its face prove any fraud, one wonders if there are any factual issues for the jury to decide.  Based on the evidence presented so far, it would appear that a motion to dismiss the case should be granted by Judge Forrest.

Mr. Coffey’s cross examination should be taught in law school advocacy courses.  It took him 17 minutes before the afternoon break to dismantle the notion that Paulson’s negative position was materially important information to ACA.  Mr. Martens was scheduled on direct until 330 but he unexpectedly ended 15 minutes early. breaking early proved to be a mistake.  Mr. Coffey declined Judge Forrest’s offer to collect his thoughts and begin cross after the 330 break.  He quickly rose to his feet and in a carefully scripted set of questions got Ms. Schwartz to concede that Paulson’s negative position “should not have affected the credit process.”

ACA had very elaborate and carefully thought out standards for what mortgage bundles it would include in a deal and those standards would not be affected by the long or short position of someone who suggested the inclusion of particular mortgage bundles in a portfolio. Of course, unfortunately for ACA, it turned out that ACA’s standards were not nearly as sophisticated and finely tuned as the standards employed by Paolo Pellegrini and his team over at Paulson & Co.  (Meeting Mr. Pellegrini in a hotel bar in Jackson Hole, Ms Schwatrz marveled that Mr. Pellegrini was “as nerdy as me” because he brought a computer to the meeting to discuss particular mortgage tranches.)

Also damaging to the SEC’s case was the tape recorded conversation of Ms. Schwartz speaking with a sophisticated middle eastern client who wanted to execute a long-short position whereby a 10% long equity position would be offset by a 30-40% short position.  It seemed from these conversations that ACA was quite willing to do business with an investor who wanted to take what amounted to a substantial net short position.  More about this conversation will come out in the continuation of Mr. Coffey’s cross examination tomorrow.

The underwhelming impact of ACA’s testimony over two days in part stemmed from the many conversations about its fees in the tapes and emails offered into evidence.

Putting aside the legal issues, from an ethical perspective ACA is a less sympathetic party than IKB, the other long in the Abacus transaction.  IKB was a customer of Goldman Sachs.  ACA was not.  Goldman had what amounts to an affirmative duty to its customer not to deceive it by withholding information.  Put another way, ethically and perhaps legally as well (that is a long nuanced legal discussion in itself) Goldman Sachs  owed more to its client IKB than simply to refrain from fraud.  It had a duty of candor that might not apply to a non-client.  With ACA the legal standard of accountability is fraud.  There is no client or customer relationship of implied trust.  From an ethical perspective it is more difficult to argue that Goldman owed any duty to ACA other than to not act fraudulently.

ACA made no effort to find out anything about Paulson over four months in 2007 when the Abacus deal was conceived and closed. If they had even done the slightest check on a company they were entering into a major transaction with they would have realized Paulson was only short in the market.  ACA would appear to have been sophisticated enough to know what it was getting into and careless enough to have not done any due diligence on Paulson.  Is this the kind of party that the securities laws protect?

Oh yeah–lets remember Mr. Tourre is on trial.  He is scheduled to begin his testimony late tomorrow afternoon.

SEC v Tourre Week 2: “Whatever Happens Happens”

“Whatever happens, happens.”  That is how Alan Roseman, the former CEO of ACA, explained the Abacus portfolio that made over a billion dollars profit for Paulson & Co. Paulson bought the short side of the deal from Goldman Sachs which sold a  nearly identical losing bet to ACA and the IKB Bank.  What Roseman meant the hypothetical portfolio referenced in the Abacus deal was set in stone at the closing.  Once the bets were placed, neither the long or the short parties could do anything to affect the outcome of the bet.  They just had to wait and see what happened to the underlying securities.

The SEC, skillfully led by second seat attorney Bridget Fitzpatrick, put Roseman on the stand to prove two things:  (1) That ACA did not know that Paulson was short in the Abacus transaction, and (2) to assert the materiality of this omission to ACA.  Fitzpatrick got to her points quickly and Roseman delivered the punchlines clearly and unequivocally.

Roseman’s testimony came as welcome relief from two tedious days of testimony from former Goldman Sachs salesperson Gail Kreitman, an experienced and much in demand Wall Street professional that Goldman Sachs hired at the Managing Director level in 2006.  It is unclear why the SEC put Ms. Kreitman on the stand. Her role in the Abacus matter stemmed from managing the “relationship” between the traders on the desk Tourre worked at and the responsible parties ACA, most notably Laura Schwartz, the head of ACA’s CDO Asset Management group.

We learned over two days of testimony that Ms. Kreitman had professional dealings with Ms. Schwartz that predated Ms. Kreitman’s arrival at Goldman Sachs in 2006, and that Ms. Kreitman thought Ms. Schwarz was very “detail oriented.”  The significance of Ms. Kreitman’s statement that Paulson was long in Abacus was severely undermined by the fact that she admitted several times in her testimony that she did not understand how the Abacus deal worked. Moreover, her testimony was called into question by Tourre’s lawyer who pointed out that in a  2009 deposition she said did not even know who Paulson was at the time of the Abacus deal.

Ms. Kreitman, we also learned, is a very busy person. At one point she said that in a typical day at Goldman Sachs she might have 200 communications.  This seemed improbable until the court played a tape recording of one of her conversations.  As I listened to her and the ACA employee on the phone I felt like I do when I accidentally turn iTunes into 2x speed. The relevance of her testimony about Abacus reminded me of the old Woody Allen joke about how great it was to take a course in speed reading because it enabled him to read War and Peace in 45 minutes.  “Its about Russia,” he reported.

Ms. Kreitman’s experience we also learned was limited to cash CDO deals, not the synthetic kind like Abacus.  Its a headscratcher as to what her testimony was supposed to prove.  Was the SEC now asserting that Mr. Tourre committed a fraud against his own firm?  It all seemed not worth forcing Ms. Kreitman to have to face 400 “While You Were Out” phone messages when she returns to work.

Mr. Roseman’s testimony was a little more relevant.  After all, he was the CEO of ACA so what he knew and when he knew it about Paulson’s role would appear on the surface to be important.  However, as Tourre’s attorney, Brandon O’Neil,  deftly brought out in a 5 minute cross-examination before the jury adjourned, all of Roseman’s knowledge came from Laura Schwartz, the ACA executive in charge of the Abacus deal.  Moreover, if you read the fine print on internal ACA memorandum Roseman relied upon to approve the transaction, it very clearly specified that “all credits in the portfiolio have been reviewed under ACA’s credit standards.”  In other words, ACA did their own independent due diligence on the deal.  This undercut Mr. Roseman’s testimony that Paulson’s short position was material to ACA’s long position.  I have in this blog been critical of the SEC’s lawyers, but I’m wondering whether Tourre’s lawyers noticed this detail in the ACA memo that was magnified to cinema screen size for the jury to see.

Tomorrow, the real fun begins when Laura Schwartz takes the stand.  Her testimony will be a delicate balance.  Having made the losing bet in Abacus it will be understandable that she will want to come across as the detail oriented master of the CDO universe others have testified her to be and the not one of the sad sack foils to Paulson’s brilliant short of the CDO market.  Conversely, however, it will be hard to show that such a sophisticated party could really be duped by the relatively inexperienced Tourre into believing that Paulson was long when it was so massively short on the market generally and in the deal itself.  It would seem to take a very inexperienced and naive investor to be that clueless and susceptible.  It will be interesting to see how the SEC walks this very fine line in Ms. Scwartz’s testimony.

After Schwartz, we will get the main event–Tourre himself.  We will learn what role, if any, Tourre played in defrauding ACA.  The jury will get to see for itself whether Tourre was the evil mastermind that (single-handedly?) duped Goldman Sachs’s clients or the unfortunate one whom the SEC caught standing in a game of musical chairs where partners and managing directors were granted reserved seating.

Day 4 at SEC v Tourre: Surreal, as the French Would Say

Man, that inveterate dreamer, daily more discontent with his destiny, has trouble assessing the objects he has been led to use, objects that his nonchalance has brought his way, or that he has earned though his own efforts.” Andre Breton, Manifesto of Surrealism (1924)

magritte1There are two fundamental ethical and legal issues in this case.  The SEC is losing one and it has the wrong person in the dock for the second.

The first issue is whether the investors other than ACA knew that Paulson was involved in the selection of the portfolio.  For some reason the SEC has been putting the bulk of their attention and the jury’s in proving that the ACA did not know. The other investors–e.g IKB–clearly did not and all of the term sheets and offering materials did not disclose Paulson’s role.  This was amply proven in court today.

The problem with SEC’s presentation on the lack of disclosure is that the defense team made a very good case in the afternoon for why this should not have mattered to the investors.  In general we found out from Goldman Sachs journeyman mortgage trader Jonathan Egol that parties on the long and short side did not know of each other’s identity.  Indeed the defense elicited that Goldman had slightly different deals with the longs and the shorts, exposing them in fact to a long risk that they ultimately had to pay off on to Paulson.

Egol, a calm and careful witness was even asked at one point whether he would ever do such a thing–sell securities built to lose to IKB and he said he had personally know the people at IKB for years and would never.  He was allowed to give off the airs of a relationship-based investment banker rather than the glorified trader he really is.

All in all, the defense has been able to portray the Abacus deal as a big boy and girl bet that went well for Paulson and bad for the long side.  The jury is being hammered with this day after day by both sides now. Short good, long bad.  Paulson wins, others lost.  What’s the problem? They even managed to slip in via Egol that BOTH longs and shorts initiated the transaction rather than Paulson alone, thus rebutting the idea that Paulson was fishing for suckers. One email describes Abacus as a “Paulson-sponsored reverse inquiry transaction” as though both Paulson and IKB woke up one day and had the exact same idea about which securities to go short and long on.

The $1 billion question is why, to rebut the defense’s case. the SEC will be calling ASA officials who obviously knew that Paulson was long instead of IKB who obviously didn’t. I for one would like to see a competent attack of the defense’s position that the role of Paulson was immaterial to IKB.  We are not going to find that out by talking with ASA officials.

The sad part of all this is that more effective lawyering by the SEC could poke holes in the defense’s characterization.  We might actually get to some interesting and contestable factual issues.  But I seriously doubt the SEC is up to the task of combating Tourre’s lawyers.

Why is Tourre the wrong man in the dock?  Because the second big ethical and legal issue in the case is that Goldman was selling a long position to two clients when the firm itself was betting and making billions on the short side.  Tourre it turns out was too low on the Goldman totem pole to know this was going on at higher levels of the company.  The SEC proved that point today.  It all crystallized in my mind when the SEC made a great deal of a February 2, 2007 email by Tourre saying it was “surreal” that Paulson was shorting so many banks that were long in mortgage securities.  The use of surreal in this context corroborates that Tourre himself personally did not realize what a bad bet Abacus was for IKB.  Tourre’s lawyer hinted this would be Tourre’s testimony about what he meant by his “surreal” comment when he took the stand during a conference with the jury out.  The jury is going to be hard pressed to doubt a Frenchman when he describes what he means by “surreal.”  I am personally looking forward to hearing whether he pronounces it with an accent.

Whom should the SEC have indicted?  Someone on a long list of more senior people at Goldman Sachs who approved the Abacus deal to sell a billion dollar long position to their clients when they knew that the firm was going massively short in the market.  Egol very helpfully read out the name, rank, and responsibilities of almost two dozen possibilities in court today.



Day 3 of SEC v. Tourre: Where’s Shorty?

SEC lawyers continue to allege that ACA did not know that Paulson & Co was taking a short position in the Abacus transaction.  The problem with this position is that the more facts the SEC elicits the more unlikely this conclusion seems.

SEC lawyer Martens scored some rare points when he got former Paulson & Co Managing Director Paolo Pellegrini to conceded that, because of prompting by Tourre’s lawyer, he was more sure in today’s testimony that he told ACA’s Laura Schwartz of Paulson’s position than he was in an earlier deposition.

Martens and Pellegrini played nice today after press criticism of their ego clashes in yesterday’s proceedings.  The only misstep was when martens called Pellegrini Mr. Tourre, confusing whom he was prosecution and whom he was examining.

The problem with the SEC’s position is that by early 2007 everyone in the mortgage security business was aware that Paulson had raised billions of dollars specifically to short the market. (Everyone but ACA?) Moreover, even if Pellegrini did not make direct statements to ACA its hard to imagine what ACA could have been thinking was going on as Paulson kept sending suggested mortgage securities to the Abacus portfolio that were chosen precisely for their likelihood of failure.  Didn’t somebody have to be the short in Abacus?  Who else would it be besides Paulson?

All this will get settled soon when ACA’s Laura Schwarz takes the stand.  The cross-examination of Schwartz by Tourre’s attorneys will be, after Tourre’s examination by Martens, the highlight of this trial.

The big looming question is what will be left of the government’s case if, as appears likely, it loses the factual battle over what ACA knew or should have reasonably concluded about Paulson’s position.  Plan B had better be a lot more compelling than Plan A and perhaps it will be to the SEC’s advantage if the jury was bored and tuned out in week one.

What does ACA’s “innocence” have to do with Tourre’s guilt?  isn’t the point that Tourre and Goldman defrauded the investors?

What also came out in today’s proceeding was the operational and technical brilliance of Paulson’s team of Pellegrini and Shu as compared with the talented but relatively plodding mortgage desk at Goldman.  To be fair to Goldman, eventually, after a momentous December 2006 meeting the firm reversed course on the mortgage markets and the firm made $17 billion in profit in 2007.  But it was the geniuses over at Paulson that showed the way to Goldman. In court we learned why. Pellegrini and Shu are brilliant technical analysts who perfectly complemented Paulson’s big picture insights.

Goldman learned its lesson by betting against Paulson and losing.  Once they realized the error of their ways they took no prisoners, even among their clients, to go from a massive long position to a massive short position.  Abacus was actually a minor even for Goldman in this transformation.  So much so that we learned in court someone on the Goldman mortgage desk did not want to use a certain “helpful to work with” portfolio selection agent for the Abacus deal because it was needed for deals where Goldman itself would be the party with the short interest.