Born to Lose: Goldman Sachs’ Abacus 2007 – AC1 and its victims.

Posted By Cliff Tuttle | April 17, 2010

SUMMARY: As the SEC investigates whether investors were defrauded by subprime mortgage security offerings, don’t forget about the other victims: the subprime borrowers.

Its in all the papers, including the New York Times. The SEC is charging Goldman Sachs with securities fraud because it sold mortgage-backed securities to overseas banks, insurance companies and other institutional investors without telling them the whole story. According to the SEC, the mortgages that backed these securities involved such extreme risks that Goldman knew there would be losses and secretly planned to profit on that information through a hedge fund.

The SEC claims that Goldman was betting that Abacus 2007 – AC1 and 25 similar pools of mortgage backed securities would fail. Thus, says the SEC, Goldman customers tallied big losses, while Goldman anticipated the losses and even arranged to turn a profit on the side.

The source of the loans pooled in Abacus 2007 AC1 was Countrywide Mortgage. Countrywide was closed by the FDIC in the aftermath of the 2008 crash and was acquired in a regulatory assisted merger by Bank of America.

Subprime mortgages were once in high demand. The high risk was supposedly balanced by the high return. If one failed, the ones that didn’t fail were supposed to earn enough premium revenue to balance the loss. This outcome was also offset by the much larger number of conventional mortgages, with reasonable underwriting standards and reasonable risk.

But the appetite of the market for securities backed by high yield/high risk mortgages was insatiable. Eventually, their numbers became so great that the pooled risks reached a tipping point. When the housing bubble inevitably burst, disaster followed.

Many blamed greedy homeowners, living beyond their means, for the cascade of events that nearly brought down the world economy. But the homeowner/borrowers simply snapped up the sometimes too-good-to-be true offers that were put together by lenders to the specifications of the people who packaged them for sale to investors. These borrowers could never have obtained such extraordinary deals if the securities market had not ordered them up in large quantities.

Mortgage brokers and bankers had also found ways to persuade nervous borrowers. Those without sufficient credit scores to qualify for low interest fixed-rate mortgages were told that they could use the opportunity to build better credit. Then, after making 12 successive payments on time, they would have a credit score sufficient to refinance at lower rates. Ideally, the refinance could be accomplished before the variable interest rate took its first jump.

That strategy often worked in the past. But times changed. Adjustable rate mortgagors increasingly found themselves stuck when the interest rate escalated. They couldn’t sell, they couldn’t refinance and they couldn’t pay. That meant one thing: default.

As we protect investors, it should be remembered that they were not the only victims of this chicanery. Countrywide and others procured subprime mortgages by the millions to meet the specifications of the securities bundlers. Every one of them involved borrowers who, more likely than not, were betting their economic future on the transaction.

What would have happened if these victims had been given disclosures that the people who put together the terms of the transaction actually expected them to default? Armed with that explosive fact, how many subprime borrowers would have decided to pass on the offer? We’ll never know.

CLT

Welcome

CLIFF TUTTLE has been a Pennsylvania lawyer for over 45 years and (inter alia) is a real estate litigator and legal writer. The posts in this blog are intended to provide general information about legal topics of interest to lawyers and consumers with a Pittsburgh and Western Pennsylvania focus. However, this information does not constitute legal advice and there is no lawyer-client relationship created when you read this blog. You are encouraged to leave comments but be aware that posted comments can be read by others. If you wish to contact me in privacy, please use the Contact Form located immediately below this message. I will reply promptly and in strict confidence.

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