It is perhaps beyond the ability of an innocent public to
believe this, but there is a growing body of evidence that a few
mad scientists might have engineered the near-destruction of the
American financial system. Except they weren’t scientists,
per se – they were unscrupulous, market manipulating hedge
fund managers, and we can almost hear them cackling with glee as
they haul their ill-gotten billions to the bank.
In a civil suit filed Friday, the Securities and Exchange
Commission charged Goldman Sachs with fraud for helping hedge fund
manager John Paulson create collateralized debt obligations that he
had secretly designed to self destruct. That is, Goldman Sachs, at
the direction of Paulson, hand-picked mortgages that were certain
to go bad, and stuffed the mortgages into collateralized debt
obligations that temporarily masked the true value of the
loans.
Goldman did this for only one reason: to create instruments
against which Paulson and other hedge fund clients could bet with
virtually no risk. Meanwhile, Goldman cheerfully sold the CDOs to
unwitting customers, knowing full well that those customers would
be wiped out when the loans inevitably defaulted. Goldman and its
hedge fund clients also surely knew that the defaults would crash
the overall market for CDOs, hobble competing investment banks that
had CDOs on their books, and do serious damage to the financial
system.
Goldman isn’t the only bank that created these CDOs.
Deutsche Bank, UBS, and smaller outfits, such as Tricadia Inc.,
perpetrated similar scams. All told, well over $250 billion worth
of these so-called “synthetic” CDOs were sold into the
market in the two years leading up to the financial crisis of 2008.
Indeed, there is a distinct possibility that a majority of all the
CDOs sold during those two years were deliberately designed to
implode by hedge fund managers who were betting against both the
CDOs and the financial system as a whole.
For more than three years, the media has swallowed the hedge
fund party line that our economic troubles were solely caused by
mortgage companies lending too much money to undeserving home
buyers. No doubt, there was over exuberance and fraud in the world
of subprime lending, but that is not the full story. It is now
clear that the so-called “real estate bubble” was
fueled by an expanding market for CDOs. And the market for CDOs was
driven, in turn, by fraudulent deals similar to the ones that
Goldman did for Paulson. In short, we witnessed a classic
pump-and-dump scheme, only this time it was writ large, on the
scale of the U.S. financial system.
I predict that as the details of this doomsday machine come to
light, we will see that the hedge funds that profited from it all
know each other well. I predict further that it will become
apparent that what ties these hedge funds to each other is a common
acquaintance with associates of Michael Milken, the famous
financial criminal who pioneered the market for CDOs, and whose
criminal debt machine nearly brought the economy to ruins in the
1980s.
John Paulson, who launched his career with the assistance of a
host of Milken cronies, including Jerome Kohlberg and Leon Levy, is
one of the hedge fund managers in this network. He has been
described as a genius by the media, and perhaps that is what he is,
but we now know that he abides by the Milken code, which has it
that there is virtue in a clever con well-orchestrated. And never
in history has there been a more profitable con than
Paulson’s. His bets against the CDO market – the market
that he helped set up to collapse — earned him more than $3
billion over the course of just a few months in 2007.
Another hedge fund in this network is Magnetar Capital, whose
chairman and senior partner is Michael Gross, formerly a founding
partner of Apollo Management, which is run by Milken’s
closest crony Leon Black. Magnetar featured prominently in the
Milken network’s attack on biotech company Dendreon (see
“The Story of Dendreon” for details). This hedge fund
is currently under SEC investigation for helping to manufacture and
sell doomsday CDOs that it was simultaneously betting against with
credit default swaps. Reporter Yves Smith, who has been working on
this story from day one, reckons that Magnetar’s bogus CDOs
accounted, incredibly, for between 35% and 60% of the total demand
for subprime mortgages in 2006.
Given that the economy was being set up for a collapse by hedge
funds in this network, it is not surprising that it was
Milken-affiliated hedge fund managers who were most prominently and
vigorously shorting Bear Stearns, Lehman Brothers and other big
investment banks that were on the receiving end of the fraudulent
CDOs. These hedge fund managers include Greenlight Capital’s
David Einhorn (who launched his career with the former top partner
of Milken crony Carl Icahn, and likely worked in cahoots with
Milken to attack a company called Allied Capital); SAC
Capital’s Steven Cohen (who was investigated by the SEC for
trading on inside information provided by Milken’s shop at
Drexel Burnham); and Third Point Capital’s Dan Loeb (who got
his start dealing in Drexel Burnham paper alongside Milken’s
former employees at Jeffries & Co.).
It is also important to note that the pump-and-short CDO scam
could not have happened without the help of American International
Group’s financial products unit, which sold a lot of the
credit default swaps that the hedge funds used to bet against the
CDOs. That unit at AIG was run by Joseph Cassano, formerly one of
Milken’s top lieutenants at Drexel Burnham. Did Cassano know
that the CDOs were designed to implode? Perhaps not, but it is safe
to assume that his relationships with the hedge funds creating the
CDOs influenced his decision to insure them.
It is also a matter of significant interest that Cassano was
ordered to stop selling the credit default swaps in 2007, a sure
sign that somebody at AIG saw that a cataclysm was imminent, but he
did nothing to protect AIG from the massive losses that the
cataclysm was sure to entail. When presented with evidence that the
CDOs were rotten, Cassano held on to the CDS positions, rather than
sell them off to people who, unlike AIG, would not have the
resources to pay the hedge funds in the event of defaults.
This is not to suggest that these people hatched some kind of
dark conspiracy to destroy America. But it is to suggest that
relationships matter a great deal in the world of finance, and
there is one network of miscreants that has consistently shown
itself willing to profit from crookery, financial destruction and
the misery of others.
One thing is certain: we will learn more about this scam in the
weeks and months to come. And while news organizations like the New
York Times should be commended for bringing bits and pieces of this
story to light, their tepid prose fails to convey both the
odoriferousness of the short sellers’ misdeeds and the
magnitude of a scandal that helped bring the American financial
system to its knees.
Mark Mitchell is a
reporter for DeepCapture.com. He
previously worked as an editorial page writer for The Wall Street
Journal in Europe, a business correspondent for Time magazine
in Asia, and as an assistant managing editor responsible for the
Columbia Journalism Review’s online critique of business
journalism. He holds an MBA from the Kellogg Graduate School of
Management at Northwestern University. Email:
mitch0033@gmail.com