Money and Power (92 page)

On January 22, ACA sent to Tourre a list of 86 “sub-prime mortgage positions that we would recommend taking exposure to synthetically,” 55 of which were on Paulson’s original list of 123 names. Three days later, Goldman sent Schwartz a draft of an engagement letter for the deal. She then replied she had a few questions, about ACA’s potential fees for the deal and a preferred legal counsel ACA would like to use. She also seemed worried still that ACA might lose the deal. “[D]o you believe that we have this deal?” she asked. “[D]o we need to do the work
on the engagement letter before we know if we have the deal?” Thirty minutes later, Tourre responded that “Paolo at Paulson is out of the office until Wednesday of next week”—he was skiing with his family in Jackson Hole, Wyoming. “We are trying to get his feedback on the target portfolio you have in mind, as well as on the compensation structure we have been discussing with you. Subject to Paolo being comfortable with those 2 aspects, it sounds like we will be in a position to engage you on this transaction.”

By a strange coincidence, Schwartz also happened to be in Jackson Hole and ran into Pellegrini. They agreed to meet for a drink on the afternoon of January 27 to discuss the proposed portfolio to be included in the ABACUS deal. They met at the bar, both with their laptops. “[H]e may [be] as much of a nerd as I am since he brought a laptop to the bar,” Schwartz wrote. “[A]nd he also seemed to have a worksheet from DB [Deutsche Bank] and another manager.” They talked about what collateral the ABACUS deal should reference and Schwartz noted that Pellegrini seemed to have plenty of data about each mortgage-backed security that might be referenced in the deal. He wanted to know why so many securities needed to be part of the deal. “I said Goldman needed 100 [individual securities] to help sell the debt,” she later reported to Tourre. “We left it that we would both work on our respective engagement letters this week,” she wrote. “I certainly got the impression that he wanted to go forward on this with us.” Tourre responded, “[T]his is confirming my initial impression that Paolo wanted to proceed with you subject to agreement on portfolio and compensation structure.” They agreed to meet on February 5 to work more on the deal.

A few days before the Jackson Hole rendezvous, on January 18,
Gillian Tett, a columnist for the
Financial Times,
wrote a column featuring a number of foreboding messages she had received about how the real-estate debt bubble might end poorly. “Hi Gillian,” Tett quoted one correspondent. “I have been working in the leveraged credit and distressed debt sector for 20 years … and I have never seen anything quite like what is currently going on. Market participants have lost all memory of what risk is and are behaving as if the so-called wall of liquidity will last indefinitely and that volatility is a thing of the past. I don’t think there has ever been a time in history when such a large proportion of the riskiest credit assets have been owned by such financially weak institutions … with very limited capacity to withstand adverse credit events and market downturns. I am not sure what is worse, talking to market players who generally believe that ‘this time it’s different,’ or to more seasoned players who … privately acknowledge that there is a bubble waiting
to burst but … hope problems will not arise until after the next bonus round.” Tett also recounted how she had spoken to an analyst at
JPMorgan who made the case for the “CDO boom” and how “there is a very strong case to be made that the CDO market has played a major role in driving down economic and market volatility over the past 10 years.” Tett concluded with the prescient thought that “if there is any moral from my inbox, it is how much unease is bubbling, largely unseen, in today’s Brave New financial world.”

Tett’s column made the rounds in Birnbaum’s structured finance group at Goldman. On January 23, Tourre forwarded it to
Marine Serres, his “gorgeous and super-smart” French girlfriend living in London, and suggested she read it because it was “very insightful.” Tourre rambled on to Serres, in an odd mixture of worry, self-deprecating humor, and love note. She was also working at Goldman at the time, as an associate in the structured products sales department. “More and more leverage in the system,” he wrote to her, and then went on briefly in French, which has been translated as “the entire system is about to crumble at any moment.… The only potential survivor, the fabulous Fab.” Tourre then switched back to writing in English, following the “fabulous Fab” comment with “as Mitch would kindly call me, even though there is nothing fabulous abt me, just kindness, altruism and deep love” for Serres. (Mitch Resnick was a Goldman mortgage-backed securities salesman.) He wrote to her that he was “standing in the middle of all these complex, highly levered, exotic trades he created without necessarily understanding all the implications of those monstruosities [
sic
]!!! Anyway, not feeling too guilty about this, the real purpose of my job is to make capital markets more efficient and ultimately provide the US consumer with more efficient ways to leverage and finance himself, so there is a humble, noble and ethical reason for my job … amazing how good I am at convincing myself!!! Sweetheart, I am now going to try to get away from ABX and other ethical questions, and immediately plunge into
Freakonomics,
” the best-selling book she had recommended to him. (“I love when you advise me on books I should be reading,” he continued before waxing poetic about his love for her.)

Tourre seemed to be increasingly stressed by the ABACUS assignment. On January 29, he started a long e-mail chain, in French, to
Fatiha Boukhtouche, a postdoctoral fellow at Columbia University, where she was researching the causes of autism. Boukhtouche and Tourre appeared to be friends with benefits, despite Tourre’s pledge of love a few days earlier to Serres, then far off in London. “Yep, work is still as laborious, it’s bizarre I have the sensation of coming each day to work and re-living the same agony—a little like a bad dream that repeats itself,” he wrote to
Boukhtouche. “In sum, I’m trading a product which a month ago was worth $100 and which today is only worth $93 and which on average is losing 25 cents a day.… That doesn’t seem like a lot but when you take into account that we buy and sell these things that have nominal amounts that are worth billions, well it adds up to a lot of money.

“When I think,” he continued, “that I had some input into the creation of this product (which by the way is a product of pure intellectual masturbation, the type of thing which you invent telling yourself: ‘Well, what if we created a “thing,” which has no purpose, which is absolutely conceptual and highly theoretical and which nobody knows how to price?’) [I]t sickens the heart to see it shot down in mid-flight … it’s a little like Frankenstein turning against his own inventor;) Anyway I don’t want to bore you with my stories, I’m going to look in the yellow pages for the phone number of the ABX market and I’ll send it to you, because I believe that a soft and sensual feminine intervention is necessary for Fab’s survival[.] Kisses Fab).” Her response, filled with more “bizzzzzzzzzoux” (kisses), was to wonder how she could help him in a way that was “soft and sensual.”

Despite his concern that Frankenstein might be turning on him, he continued to market his monstrous creations. That same day, he shared with his Goldman colleagues that he had received a new-business inquiry from GSC—a firm that had passed on the ABACUS deal before ACA took it, “given their negative views on most of the credits that Paulson had selected,” Tourre wrote—wanting “to see from us a trade” using the same structure as the ABACUS deal but with a different portfolio of securities. “This is a trade we would show to IKB”—a large German bank that couldn’t seem to get enough of the long side of these trades—“for the reverse inquiry program we have been working with them on.” In response to a question from a colleague, Tourre explained a “few nice things about this idea,” which he summarized by saying, “In a nutshell, we have a lot of flexibility from a risk management standpoint, while committing to take little risk”—a thought that may best summarize one of the more important of Goldman’s business aspirations after nearly 140 years of existence. The digital conversation was clearly not sitting well with Jonathan Egol. “Where are you going with this?” he asked. To which Tourre replied, in Goldman fashion, “LDL.”

On January 31, as the two of them were planning on a weekend dinner date, Tourre wrote to Boukhtouche, “[W]ell I don’t know what you’ve done to the ABX markets, but you must have some sort of influence since today was a relatively calm day.” He then launched into a mini-tirade on the frustrations of life at Goldman Sachs. “[N]evertheless
I am still stuck at work at 10 pm,” he continued, “but it’s been six years since I’ve been functioning on this @!$#@!$@$# schedule, so who cares!!! On top of which I have to ‘mentor’ others, in view of the fact that I am now considered a ‘dinosaur.’ In this business (at my firm the average longevity of an employee is about 2–3 years!!!) people ask me about career advice. I feel like I’m losing my mind and I’m only 28!!! OK, I’ve decided two more years of work and I’m retiring;).” That same day Goldman priced another CDO deal—Camber 7—and made a profit of $10 million. After taking an overnight flight to London, Dan Sparks relayed the good news to his boss, Tom Montag. “Need you to send message to [two members of the deal team] telling them what a great job they did,” Sparks wrote. “They structured like mad and travelled [
sic
] the world, and worked their tails off to make some lemonade from some big old lemons.”

Also on January 31, the ABACUS deal team at Goldman gave Schwartz, at ACA, an update. They suggested removing two names from the hundred-name portfolio because they were “both on negative credit watch by Moody’s” and in their place Goldman wrote that Paulson wanted to include two GSAMP deals. “We will continue our discussions with Paolo to confirm his agreement with the proposed transaction as structured and look forward to discussing the transaction and the draft Engagement Letter.”

On February 2, Tourre and ACA met again with Paulson at his offices to discuss the portfolio to be included in ABACUS. “I am at this [ACA] [P]aulson meeting, this is surreal,” Tourre wrote to a Goldman colleague, without elaborating. Later that day, ACA e-mailed a list of eighty-two mortgage-backed securities that Paulson and ACA agreed should be in ABACUS, plus a list of another twenty-one “replacement” bonds, and then sought Paulson’s approval. “Let me know if these work for you,” ACA wrote. Three days later, Paulson finalized the list of ninety-two bonds, with Tourre’s agreement, and sent an e-mail of them to ACA. That same day, ACA gave preliminary approval to the portfolio to be included in ABACUS. On February 8, Tourre wrote to Sparks that he was finishing up the engagement letters for the ABACUS deal that “will help Paulson short senior tranches off a reference portfolio of … subprime RMBS risk selected by ACA.” Tourre wanted to know if the trade needed the approval of the “Mortgage Capital Committee,” an internal Goldman group set up to approve such things, even though he thought there would be “no commitment for us to take down any risk.” Responded
David Rosenblum: “Still reputation risk, so I suggest yes to MCC.” On February 20, Tourre updated his Goldman colleagues with
the latest ABACUS thinking and said that he thought Goldman’s fee would likely be increased to $19 million, from $15 million.
David Lehman responded to Tourre, “As u know, I am for doing this deal for them/with them, let’s just make sure we are charging enough for it given our axe as principal in this type of risk.” Lehman was concerned that Goldman get paid enough on the deal since it also wanted to sell similar securities to get short and that as an underwriter on the ABACUS deal might end up being long some of the mortgage-related risk when overall it wanted to be short. (Which is exactly what happened—Goldman did get stuck owning some of the long side of the deal when it could not sell the whole thing.) He encouraged Tourre to meet with Birnbaum and Swenson “live” as a “gut check and walk them through it.”

Tourre responded that he thought the team “will be on board with this” but conceded he needed to speak with Birnbaum. “It is really Josh I need to walk carefully through my thinking,” he wrote Lehman on February 21. “Sparks is really relying on us at this point. He is mostly focused on covering our single-names/idiosyncratic short trades to get better observability [
sic
]”—a reference to the ongoing efforts to establish “the big short.” Lehman responded, again, that it was important to “[w]alk Josh through the $, if that makes sense let’s go.” Lehman also said he needed reminding about whose idea ABACUS was in the first place. “My idea to broker the short,” Tourre replied. “Paulson’s idea to work with a manager. My idea to discuss this with ACA.” Finally, on February 26, after further discussion, Paulson and ACA reached agreement on the ninety bonds that would make up the reference portfolio for ABACUS. That same day, Goldman and ACA prepared a sixty-five-page “flip book,” or PowerPoint presentation, that would be used to market ABACUS to investors who might be willing to take the long side of the trade while Paulson took the short side.

——

A
S THE
ABX index fell in the first few months of 2007, Goldman’s mortgage department minted money, some “several hundred million dollars,” according to the
Wall Street Journal.
But there were limits to how far Goldman wanted to push this bet, especially since the whole world seemed to be on the other side of it against the firm and a few other bold hedge-fund managers. There was also the matter of the losses Goldman would have to take as it lowered the value of its long positions on its books. Goldman knew the pain of the losses would hit well before the profits from the shorts could be realized. On February 2, Sparks wrote to Viniar, Ruzika, and Montag, “Gasvoda alerted me last night that we will take a write-down to some retained [long] positions next week as the loan
performance data from a few second lien sub-prime deals just came in (comes in monthly) and it is horrible. The team is still working through the numbers, but the amount will likely be in the $20mm loss zone.” He informed his bosses that the team was also working on trying to return the souring mortgage loans to their originators, such as New Century,
Washington Mutual, and Fremont, as was permitted by contract. That was becoming more difficult as these companies started to run into greater financial difficulties. “[T]here seem to be issues potentially including some fraud at origination,” Sparks wrote, “but resolution will take months and be contentious.” He concluded that his “[f]ocus is cleaning out rated bond positions and the put back process. Sorry for more bad news.” Montag wondered about Sparks’s “fraud at initiation” comment and Sparks replied, “We’ll be sorting through all the potential breaches of reps and warranties, and fraud at origination (appraisal, income, occupancy) would be a likely one. Fraud is usually borrower, appraiser or broker fraud—not necessarily fraud by the seller of the loans to us. But generally for reps & warranties the loan seller is responsible if fraud happened. The put backs will be a battle.”