Main Investor in Goldman Deal May Have Caused Losses

ACA Management, the main investor in a failed mortgage-securities deal that prompted securities fraud charges against Goldman Sachs,appears to have caused at least some of the $1 billion loss itself, CNBC has learned.

Goldman Sachs
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Goldman Sachs

ACA, which selected the mortgage portolio along with hedge fund Paulson & Co, suggested securities that ended up lowering the quality of the deal. While ACA apparently thought the securities would improve the portfolio, experts contacted by CNBC say it had the opposite effect.

The revelation is a further blow to the Securities and Exchange Commission's civil fraud suit against Goldman. The agency contends Goldman didn't tell investors in the mortgage portfolio—including ACA—that Paulson was not only picking some of the securities but betting against—or shorting—them.

But as CNBC reported Wednesday, a top Paulson lieutenant testified that he told ACA what the hedge fund's position would be ahead of time. (Click here for story.) It also has emerged that ACA—not Paulson—had final say in what securities were included.

ACA actually threw out 68 of the 123 securities suggested by Paulson. Those 68 securities had higher delinquency rates than the remaining ones, according to documents reviewed by CNBC. However, those documents show that 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 as having a higher chance of failure.

The apparent reason for adding these securities was that they had lower delinquency percentages overall. But they also has the very characteristics that Paulson and other shorts at the time believed would lead to higher delinquencies 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 responses: “I’d say, ‘Thank you, sir. May I have another?’ ”

ACA’s actions appear to reflect the conventional thinking of that time that, in fact, failed to understand the downward direction of the subprime mortgage market or its warning signals of trouble ahead.

Paulson and those who shorted the deal did. In testimony to the government, former Paulson hedge-fund manager Paolo Pellegrini told SEC attorneys: “Our view became the norm, and we made all the money.”

ACA collapsed shortly after taking nearly 85 percent of the risk in the Goldman portfolio.