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Shaky local loans made billions for Goldman Sachs and hedge funds

If John Paulson is ever in Tampa, he might check out the house at 1409 E Holland Ave. It's among dozens of Tampa Bay homes that helped him and Goldman Sachs make millions of dollars betting that the U.S. housing market would collapse.

In 2006, the buyer of the Tampa house got 100 percent financing from a California lender even though she had declared bankruptcy less than two years before. Her $127,000 loan — which soon went into default — became part of the now-infamous Abacus mortgage deal created by Goldman and Paulson, a New York hedge fund manager.

On Tuesday, a U.S. Senate committee grilled Goldman executives about how the bank profited from a housing meltdown that nearly wrecked the global economy. The Securities and Exchange Commission has charged Goldman with defrauding investors by not disclosing that Paulson, who was betting that home prices would slump, had a big hand in selecting the shaky mortgage-backed bonds that made up the Abacus portfolio.

The Abacus deal "was new and complex, but the deception and conflicts are old and simple,'' said Robert Khuzami, director of the SEC's enforcement division.

"Complex'' hardly describes Abacus, which Goldman marketed to banks and other big investors in 2007 by way of a 66-page book full of terms like "tranches'' and "collateralized debt obligations.''

But it's fairly easy to see why so many of the loans underlying the Abacus deal were doomed to default. At the peak of the boom, First Franklin of California made thousands of loans to risky borrowers, including these in the Tampa Bay area:

• A St. Petersburg woman who owed the IRS several thousand dollars and had been unable to pay a $95,000 judgment stemming from a business deal. Yet when she bought a house for $138,000 in 2006, First Franklin financed the full amount at a hefty 10.625-percent interest rate. The house soon went into foreclosure.

• A Clearwater couple who declared bankruptcy in 2003 after running up $213,000 in debts and losing their home to foreclosure. Just three years later, they bought another house for nothing down with $243,000 in First Franklin loans. That house, too, went into foreclosure.

• A Plant City truck driver who declared bankruptcy in 2003 with $242,000 in debt. In 2006, First Franklin loaned him the full amount on a $368,000 house. The house is in foreclosure.

To raise money so it could make more loans, First Franklin packaged the Tampa Bay mortgages and thousands of others, mostly from Florida and California, into a bond that was sold to investors. Known as FFML 2006-FF11, it was one of 11 bonds issued in 2006 that were made up of First Franklin loans.

A year later, FF11 landed in what appeared to be elite company — 90 bonds selected for inclusion in Abacus, the new investment product that Goldman Sachs was promoting. What investors didn't know, the SEC says, was that Abacus had, in essence, been designed to fail.

Convinced the housing bubble was about to burst, Paulson, the hedge fund manager, searched mortgage data for bonds like FF11 whose underlying loans were apt to default. Then he paid Goldman $15 million to create an investment — Abacus — that hinged on the performance of risky bonds, many of which Paulson himself selected.

"Goldman wrongly permitted a client that was betting against the mortgage market to heavily influence which mortgage securities to include in an investment portfolio,'' the SEC suit says. Meanwhile, Goldman "was telling other investors that the securities were selected by an independent, objective third party.''

Within a year of Abacus' creation, enough borrowers in the Tampa Bay area and elsewhere were behind in their payments that 99 percent of the bonds had been downgraded. Abacus investors ultimately lost more than $1 billion, while Paulson made $1 billion.

The SEC did not accuse Paulson of wrongdoing. But the suit charges Fabrice Tourre, a Goldman vice president who worked with Paulson to create Abacus and who realized the product would be a hard sell if investors knew of Paulson's involvement.

On Tuesday, Tourre denied he had done anything wrong. But he once gloated over his role in a deal so complicated few understood it.

"The whole building is about to collapse anytime now,'' he wrote in a 2007 e-mail to a friend. "Only potential survivor, the fabulous Fab(rice Tourre) standing in the middle of all these complex, highly leveraged exotic trades he created.''

Although Goldman Sachs allegedly failed to disclose key aspects of the Abacus deal, some experts think investors could have done more due diligence themselves. Services like INTEX provide data on the credit and payment histories of borrowers whose loans make up mortgage-backed bonds.

"Paulson did a great trade, but there are a lot of big investors involved in this transaction,'' says Jack Chen, a former analyst for Moody's Investors Service who now has his own consulting business. "You really have to ask, did anybody else do their homework? Did they ask to look at any of this mortgage data that was available?''

The fallout from First Franklin's bad loans wasn't confined to big institutional investors.

The California lender, which employed more than 2,000 people in 2007, shut down last year. Several of its Tampa Bay borrowers wound up in bankruptcy. And some of the homes sit vacant, reminders of the time not too long ago when almost anyone could buy a house — even if they didn't have any money.

Susan Taylor Martin can be reached at

Shaky local loans made billions for Goldman Sachs and hedge funds 04/27/10 [Last modified: Tuesday, April 27, 2010 10:34pm]
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