Dismiss Notice
Join Physics Forums Today!
The friendliest, high quality science and math community on the planet! Everyone who loves science is here!

How Did Goldman Sachs Make Money From 2008 Housing Crash?

  1. Sep 11, 2016 #1
    Here's what I understand (please feel free to correct me on anything if I'm wrong):

    i.) Goldman Sachs created MBSs (mortgage backed securities) with sub-prime mortgages that they bought.

    They essentially bought up a ton of these mortgages and packaged them all together into a giant securities that they sold shares of to clients. On top of the sales fees they might have gotten, they also got a steady stream of small income from these mortgages from the monthly mortgage payments themselves in whatever remaining shares they hadn't sold.

    ii.) However, the real money-maker came from betting AGAINST their OWN created MBSs. Here, they created something called synthetic CDOs (collateralized debt obligations), which were just bets against their own MBSs. If the MBSs failed (i.e., the sub-prime mortgage holders failed to make their payments), then Goldman would stand to gain from that loss.

    Goldman sold what they knew were bad MBSs to clients, while betting against those same MBSs. It was a win-win guarantee. If Goldman's MBSs held up financially, they'd gain a small profit (as would their clients who bought shares in them, due to the monthly mortgage payment profits). If the MBSs failed, then they'd gain a huge profit from their CDOs.

    But, critics say the KNEW the MBSs were bad (which Goldman denies).


    Assuming my understanding of things is correct, who paid Goldman on their synthetic CDO gains? When they bet against their own created MBSs, who was taking the other side of the bet? And why was the amount so high (their profits from the CDOs, I mean)?
    Last edited: Sep 11, 2016
  2. jcsd
  3. Sep 11, 2016 #2

    Vanadium 50

    User Avatar
    Staff Emeritus
    Science Advisor
    Education Advisor
    2017 Award

    A good explanation is here: http://www.investopedia.com/financial-edge/0510/the-goldman-sachs-accusation-explained.aspx

    Goldman-Sachs got their money from fees. The SEC complaint says that the mortgages were picked by Paulson & Co, who was betting on them to fail. This is legal, so long as it is disclosed. However, it was not. Mortgages that were selected to be losers were sold as selected to be winners to the unsuspecting. The SEC doesn't like this.
  4. Sep 11, 2016 #3


    User Avatar
    Staff Emeritus
    Science Advisor

    Apparently Goldman recently (January 2016) settled with the government on this matter.

    One has to look at individual deals. One, Abacus, completed in April 2007, in which John Paulson took the short side involved two major investors who took the long side: IKB, a large German bank, and ACA Capital Management, a New York-based investment firm. However, Paulson apparently worked with ACA to choose the 90 underlying mortgage-backed securities, which would seem to be a conflict of interest. Paulson and his company made about $20 billion on such deals.

    Short side means the investment in question decreases in value (due to defaults) while the long side means the investment retains or increases in value (mortgages are paid).

    Counterparties to Goldman's deals were other financial institutions and possibly some institutional clients. I don't know if GS took the short side on any deals.

    John Paulson took short sides on a number of deals that Goldman put together. One should read Michael Lewis's The Big Short, which describes some of what was going on during the 2005 - 2009 period. An excerpt from Lewis's book: http://www.vanityfair.com/news/2010/04/wall-street-excerpt-201004

    From the Vanity Fair article, "Goldman Sachs made it clear that the ultimate seller wasn’t Goldman Sachs. Goldman Sachs was simply standing between insurance buyer and insurance seller and taking a cut." So as Vanadium indicated, GS was collecting fees for brokering the deal.

    Of course, Goldman is not going to admit that they knew the MBSs/CDOs were going bad in 2007-2009, but I would imagine they (and others) did know that was the likely outcome for securities based on sub-prime mortgages.
    Last edited: Sep 11, 2016
Share this great discussion with others via Reddit, Google+, Twitter, or Facebook

Have something to add?
Draft saved Draft deleted