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BREAKING NEWS FROM CNBC'S STEVE LIESMAN: THE GOVERNMENT SAYS THAT THE PORTFOLIO OF MORTGAGES AT THE HEART OF ITS FRAUD CASE AGAINST GOLDMAN WAS DOOMED TO FAIL BECAUSE FINANCIAL INSURER ACA, WHICH OVERSAW ITS CONSTRUCTION, TOOK ADVICE FROM HEDGE FUND PAULSO

THE GOVERNMENT SAYS THAT GOLDMAN MISREPRESENTED PAULSON'S INTENTIONS TO ACA THAT IT WOULD GO LONG THE PORTFOLIO, WHEN, IN FACT, IT PLANNED TO GO SHORT.

HOWEVER, DOCUMENTS REVIEWED BY CNBC SHOW ACA ITSELF SUGGESTED SECURITIES THAT ENDED UP LOWERING THE OVERALL QUALITY OF THE 92 SECURITIES INSIDE THE COLLATERILIZED DEBT OBLIGATION.

ACA APPEARS TO HAVE THOUGHT IT WAS DOING ITS JOB IN UPGRADING THE QUALITY. BUT EXPERTS CONTACTED BY CNBC AND THE DOCUMENTS SHOW THE EFFECT IN SOME CASES WAS THE OPPOSITE.

ACA THREW OUT 68 OF 123 SECURITIES SUGGESTED BY PAULSON. THOSE 68 SECURITIES HAD HIGHER DELINQUENCY RATES THAN THOSE THAT REMAINED. IN EFFECT, ACA WAS DOING THE JOB IT WAS ADVERTISED TO DO.

BUT DOCUMENTS SHOW ACA ADDED 14 SECURITIES WITH LOWER CREDIT RATINGS THAN THE OVERALL PORTFOLIO.

DOCUMENTS ALSO SHOW THAT ACA ADDED OTHER SECURITIES WITH A HIGHER PERCENTAGE OF MORTGAGES FROM CALIFORNIA AND INTEREST ONLY LOANS --- TWO FAVORITES OF THE SHORTS BECAUSE THEY WERE PERCEIVED TO HAVE A HIGHER CHANCE OF FAILING.

THE APPARENT REASON FOR ADDING THESE SECURITIES WAS THAT THEY HAD LOWER DELINQUENCY PERCENTAGES OVERALL. BUT THEY ALSO HAD THE VERY CHARACTERISTICS THAT PAULSON AND OTHER SHORTS AT THE TIME BELIEVED WOULD LEAD TO HIGHER DELIQUENCIES IN THE FUTURE.

CNBC ASKED ONE INVESTOR WHO WAS SHORT MORTGAGES DURING THIS TIME HOW HE WOULD HAVE RESPONDED TO THE SECURITIES SUGGESTED BY ACA. HIS RESPONSE: "I'D SAY, THANK YOU SIR. MAY I HAVE ANOTHER."

DOCUMENTS REVIEWED BY CNBC SHOW IT WAS ACA SUGGESTING THESE SECURITIES. NOT PAULSON.

REPORTING BY CNBC HAS SHOWN THAT ACA WAS TOLD BY PAULSON IT WOULD SHORT THE PORTFOLIO, APPEARING TO CONTRADICT A CLAIM BY THE GOVERNMENT THAT IT WAS UNAWARE OF PAULSON'S INTENTIONS.

THE NEW INFORMATION SUGGESTS THAT ACA DID IN FACT TAKE ACTIONS IT BELIEVED WOULD LEAD TO A HIGHER QUALITY PORTFOLIO.

BUT IT'S ACTIONS APPEARED TO REFLECT CONVENTIONAL THINKING OF THE TIME THAT MISUNDERSTOOD WHERE THE SUBPRIME MARKET WAS HEADING AND DIDN'T GRASP THE WARNING SIGNALS THAT FLASHED TROUBLE AHEAD.

PAULSON AND THE SHORTS DID.

IN TESTIMONY TO THE GOVERNMENT, FORMER PAULSON HEDGE FUND MANAGER PAOLO PELLIGRINI TOLD SEC ATTORNEYS: "OUR VIEW BECAME THE NORM AND WE MADE ALL THE MONEY."

ACA COLLAPSED SHORTLY AFTER TAKING ON NEARLY 85% OF THE RISK IN THE GOLDMAN PORTFOLIO.

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