ABACUS.

ABACUS
In finance, the efficient-market hypothesis (EMH) asserts that financial markets are "informationally efficient". The EMH claims one cannot consistently achieve returns in excess of average market returns on a risk-adjusted basis. There are three major versions of the hypothesis: "weak", "semi-strong", and "strong". Weak EMH claims that prices on traded assets (e.g., stocks, bonds, or property) already reflect all past publicly available information. Semi-strong EMH claims both that prices reflect all publicly available information and that prices instantly change to reflect new public information. Strong EMH additionally claims that prices instantly reflect even hidden or "insider" information. There is evidence for and against the weak and semi-strong EMHs, while there is powerful evidence against strong EMH.

How Goldman's ABACUS deal worked. Fri Apr 16, 2010 9:59pm BST
NEW YORK (Reuters) - The U.S. Securities and Exchange Commission is accusing Goldman Sachs Group Inc of committing fraud in a complicated transaction involving securities known as collateralized debt obligations. The particular deal that Goldman entered into with Paulson and others was called ABACUS 2007-AC1. Here's how the deal worked, according to the SEC's complaint:
1) Hedge fund manager John Paulson tells Goldman Sachs in late 2006 he wants to bet against risky subprime mortgages using derivatives. The risky mortgage bonds that Paulson wanted to short were essentially subprime home loans that had been repackaged into bonds. The bonds were rated "BBB," meaning that as the home loans defaulted, these bonds would be among the first to feel the pain.
2) Goldman Sachs knows that German bank IKB would potentially buy the exposure that Paulson was looking to short. But IKB would only do so if the mortgage securities were selected by an outsider.
3) Goldman Sachs knows that not every asset manager would be willing to work with Paulson, according to the complaint. In January 2007, Goldman approaches ACA Management LLC, a unit of a bond insurer.
ACA agrees to be the manager in a deal, and to help select the securities for the deal with Paulson. In January and February 2007, Paulson and ACA work on the portfolio, coming to an agreement in late February.
Goldman never tells ACA or other investors that Paulson is shorting the securities, and ACA believes that Paulson in fact wanted to own some of the riskiest parts of the securities, according to the complaint.
4) Goldman puts together a deal known as a "synthetic collateralized debt obligation" designed to help IKB and Paulson get the exposure they want. IKB takes $150 million of the risk from subprime mortgage bonds in late April 2007. ABN Amro takes some $909 million (591 million pounds) of exposure as well, and buys protection on its exposure from ACA Management affiliate ACA Financial Guaranty Corp in May 2007.
Goldman's marketing materials for the deal never mention Paulson's having shorted more than $1 billion of securities. Goldman receives about $15 million in fees.
5) Months later, IKB loses almost all of its $150 million investment. In late 2007, ABN is acquired by a consortium of banks including Royal Bank of Scotland. In August 2008, RBS unwinds ABN's position in ABACUS by paying Goldman $840.1 million. Most of that money goes to Paulson, who made about $1 billion total.

SEC Accuses Goldman Sachs of Fraud. Bank accused of misleading investors in subprime mortgages. April 16, 2010. Wall Street powerhouse Goldman Sachs today was charged with civil fraud as the Securities and Exchange Commission claimed it misled investors about risky mortgage-backed securities. The complaint highlights what the SEC says were some of the underlying causes of the collapse of the subprime mortgage market, a catalyst of the Great Recession of 2008. Specifically, the SEC says the Wall Street bank and one of its vice presidents defrauded investors by misstating and omitting key facts about a financial product tied to subprime mortgages as the U.S. housing market was beginning to falter. The SEC alleges that Goldman Sachs structured and marketed a synthetic collateralized debt obligation, known in Wall Street jargon as a CDO. The value of this particular CDO hinged on the performance of subprime residential mortgage-backed securities. In other words, if the people with the subprime mortgages bundled in the securites made their payments on time, everything would be fine. But if they began to default on the loans, the value of the CDO would drop.
The government says Goldman Sachs failed to disclose to investors vital information about the CDO, in particular the role that a major hedge fund played in the portfolio selection process and the fact that the hedge fund had taken a short position against the CDO. Betting on failure. That's right. The person instrumental in selecting the mortgage-backed securites for the CDO was a short-seller who, at the time, was actually betting that their value would drop. If investors had been told this information, the SEC says, they likely would not have invested. "The product was new and complex but the deception and conflicts are old and simple," said Robert Khuzami, Director of the Division of Enforcement at the SEC. "Goldman wrongly permitted a client that was betting against the mortgage market to heavily influence which mortgage securities to include in an investment portfolio, while telling other investors that the securities were selected by an independent, objective third party." If Goldman Sachs was doing this, is it possible other Wall Street banks were engaging in similar actions? "The SEC continues to investigate the practices of investment banks and others involved in the securitization of complex financial products tied to the U.S. housing market as it was beginning to show signs of distress," said Kenneth Lench, Chief of the SEC's Structured and New Products Unit. The SEC alleges that one of the world's largest hedge funds, Paulson & Co., paid Goldman Sachs to structure a transaction in which Paulson & Co. could take short positions against mortgage securities chosen by Paulson & Co. based on a belief that the securities would experience credit events.
The SEC's action, so far, is civil in nature. The U.S. Attorney for the Southern District of New York, as well as New York Attorney General Andrew Cuomo, declined to comment on media inquiries about potential criminal actions.

Europeans won’t be amused by alleged Goldman scam. APR 16, 2010 14:02 EDT. Europeans won’t be amused by the alleged Goldman Sachs scam. ABN Amro, and therefore ultimately Royal Bank of Scotland, ended up losing $841 million in the allegedly fraudulent collateralised debt obligation investment concocted by the investment bank. Meanwhile, IKB, the bust German bank, lost nearly $150 million. These European banks were some of the biggest financial mugs in the last years of the credit bubble. But the allegations levelled by the Securities and Exchange Commission don’t concern the folly of the buyers and insurers of subprime mortgage investments. Goldman is accused of misleading investors. The UK and German states, which bailed the banks out, will be livid if the case is proved. Goldman denies the charges. The UK government could be the biggest loser if the allegations turn out to be true. After all, it had to rescue RBS only two months after the Scottish bank paid Goldman $841 million to unwind a guarantee it inherited when it acquired part of ABN Amro, the Dutch bank, according to the SEC. Of course, the hole at RBS was much bigger than that. Still, there must be a risk that the issue could become a political football given that the UK is in the midst of a tight election campaign in which banker-bashing is a popular activity among all the main parties. The Germans won’t be happy either if the SEC’s charges are proved. Again, IKB’s problems ran deeper than its purchase of the investment marketed by Goldman. But it was only months later, in the summer of 2007, that the bank was rescued at huge cost to the German taxpayer. Many European politicians are already suspicious about Goldman after revelations that it perfectly legally helped Greece hide the true extent of its debts just before it joined the euro. These new allegations, concerning activity that may have directly hurt the pockets of two of the region’s biggest and most powerful governments, could scarcely have come at a worse time.


Mathematicians must get out of their ivory towers. April 15 2010 19:21. A few years ago, Tim Johnson, a British academic at Heriot Watt university, was appointed to act as an official public “champion” for financial mathematics. It initially seemed an easy job. After all, before 2007, politicians were not very interested in things such as probability theory. So Dr Johnson mostly used his huge grant to conduct his research in peace. No longer. In the three years since the financial crisis exploded, financial mathematics has come in the line of fire, with “quants” and models blamed for fuelling the banking woes. Hence Dr Johnson now has his work cut out, as he tries to defend the world of maths. Or as he told a conference this week: “There [is] a sense of bewilderment amongst mathematicians [about] the view that mathematics was responsible for the crisis.” Is this sense of indignation fair? Up to a point, yes. During the past couple of decades, the world of finance has certainly borrowed heavily from disciplines such as maths and science, and some of this plagiarism has produced disastrous results. Just look at all those crazy investment decisions inspired by ultra complex – and flawed – models to assess subprime risk. But if you peer closely at all this plagiarism, it is dogged by a bitter irony. In public, banks like to boast of their ability to buy the “brightest and best”; in practice, though, the specific ideas that banks have been importing from disciplines such as maths or economics in recent years have not always been “cutting edge”. On the contrary, many of the imports that have been widely used – or abused – were distinctly out of date. Take the field of economics. About 15 years ago, the financial industry became almost religiously converted to the Efficient Market Hypothesis. But by the time that happened, the idea was already fairly old hat – and many academic economists had already become disenchanted with this crude vision of human behavior. Similarly, when finance has borrowed ideas from physics, it has been an old-fashioned Newtonian branch of physics, not the Theory of Relativity. And insofar as bankers have used maths in the past two decades, they – like 18th century scientists – have typically treated maths as a “mere” tool. Most academic mathematicians, however, prefer to view their discipline as a form of intellectual inquiry. Many also feel uncomfortable about assuming that maths offers crude “absolutes”. So, just as the Theory of Relativity has forced scientists to recognise that space and time can expand or shrink in a relativist manner, so too men such as Dr Johnson tend to think that calculations of “probability” can shift according to context. Money and statistics, in other words, are not crude, fixed entities (as bankers have tended to assume); instead, Dr Johnson’s vision of “maths” sounds more akin to the financial version of quantum mechanics. Intriguingly it also sounds similar to what some economists and sociologists are doing. Last week, for example, Cambridge university held the inaugural conference for the Institute for New Economic Thinking, a body that has been funded by George Soros (and others).
At that event a host of economists declared their determination to redefine their discipline, to move away from a crude reliance on models, or EMH – and towards a more interactive and subtle vision of human financial behaviour (or what Mr Soros calls “reflexivity”). The good news is that if these types of endeavours swell, it could potentially change how financial economics and mathematics is done. The bad news, however, is that it is still unclear whether this will occur. The level of debate between the mathematicians, economists and sociologists remains pretty low. And while many intellectuals and regulators in Europe now seem open to a radical new debate, the intellectual climate in America appears far more constrained. So much so, in fact, that when Mr Soros held the inaugural conference for his institute, he deliberately did this in the UK – and not the US, where (he claims) the sense of intellectual conformity remains too strong. Moreover, rewriting the rules of financial mathematics – or economics – risks challenging many vested interests. After all, it is far easier for a Wall Street bank to make profits by plugging numbers into a crude model, than to admit that money could be a cultural or relativist construct.
Nevertheless, now, at least, there is a chance to reshape the debate. What really damaged the financial system in recent years was not so much “maths” or “economics”; instead the crucial problem was bad maths (and economics) that was used and abused. Now, more than ever, mathematicians need to get out of their ivory towers or back offices and state that loudly, not just for their sake, but for economists. And, of course, those bankers.