But what exactly were those securities? Paulson & Co worked with the investment pool's official picker, a company called ACA Management, to agree on 90 mortgage-backed securities pools. Goldman then combined their riskiest pieces and sold them to investors around the world. Here's the pitch they received.
And, boy, were these mortgage-backed securities some of the stinkiest. Of course, any educated investor should have known that. After all, the warnings went on for page after page in the offering documents. Too bad the average individual mortgage-holder didn't have the same information.
Looking at the mortgages in the pool, that trouble was almost inevitable. Of the 4,956 loans in the billion-dollar pool, about half were to borrowers who also took out a second mortgage, so they owed close to the entire appraised value of their homes. Only 1,400 were fixed rate; the rest had adjustable rates. More than one-third didn't document their income. Almost all the borrowers who weren't buying a home got a "cash-out" refinance borrowing against their home equity. And nearly 40 percent of the pool's value was backed by real estate in California and Florida.
According to the SEC, that's exactly what Paulson & Co. were looking for. "Paulson's selection criteria favored RMBS that included a high percentage of adjustable rate mortgages, relatively low borrower FICO scores, and a high concentration of mortgages in states like Arizona, California, Florida and Nevada that had recently experienced high rates of home price appreciation," the suit charges. The list of mortgage companies whose loans Paulson bet against is like a who's who of failed subprime lenders, including New Century, Option One and Argent.
What's amazing is that Goldman found ready buyers for their collateralized debt obligations. There was so much demand for these high-yielding investments that they were essentially selling photocopies of them. As Roger Lowenstein wrote in the New York Times, the dollars Goldman pooled together didn't actually end up going to help people buy homes. They were merely bets at a casino. But the reason these crazy mortgages got made in the first place is that JPMorgan and the other investment banks who put together the securities knew they could easily find buyers for the garbage, those BBB securities.
With all due respect to the SEC, which is charging that Goldman misled investors to believe its bonds were safe enough to invest in, the risks of those underlying securities were spelled out with crystal clarity in the offering documents. Here's more from JPMAC 2006-FRE1:
"The mortgage loans in the mortgage group are likely to experience rates of delinquency, foreclosure and bankruptcy that are higher, and that may be substantially higher, than those experienced by mortgage loans underwritten in a more traditional manner." Investors could lose money if there was "an overall decline in the residential real estate market in the areas in which the mortgaged properties are located."
Who didn't have fair warning of the risks of borrowing all of their home's value at an adjustable rate? The borrowers who took out the mortgages and are now going into foreclosure.