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Porter Stansberry: The big banks are in big trouble

Tuesday, April 20, 2010 By Porter Stansberry in the S&A Digest: We wrote it. Did you short it? Goldman eventually admitted it had insured roughly $20 billion worth of subprime CDOs with AIG and had major exposure to the firm. But the New York Federal Reserve and Goldman Sachs never revealed this critical fact: Goldman didn't merely buy insurance on a bunch of random subprime CDOs. It actually bought insurance on special CDOs it had put together and sold to its own clients. In other words, Goldman knew more about these CDOs than anyone else. Goldman bought insurance on these CDOs because it knew they'd collapse. This is tantamount to building a house, planting a bomb in it, selling it to an unsuspecting buyer, and buying $20 billion worth of life insurance on the homeowner – who you know is going to die!  These facts all came to light because of research done by the office of Darrell Issa, the ranking Republican on the House Committee on Oversight and Government Reform. These new documents will certainly lead to a full investigation of the Goldman-AIG dealings and the subsequent $180 billion bailout led by the New York Federal Reserve. My bet? Heads will roll. If you own Goldman Sachs, you'd better sell. – Porter Stansberry, February 24, 2010, S&A Digest Last week, the SEC targeted Goldman Sachs in a civil fraud case. The lawsuit alleges Goldman sold investors a collateralized debt obligation (CDO) linked to the performance of certain mortgages without disclosing John Paulson's hedge fund, Paulson & Co, helped design the product and was betting against those mortgages.  Paolo Pellegrini, Paulson's lead mortgage analyst, worked with Goldman to pick a group of mortgages most likely to be downgraded. Paulson & Co then paid Goldman $15 million for the service. ACA Financial, a bond insurance company, made a few changes to the structure of the product. Then Goldman sold these to its clients, who readily bought because of their triple-A rating. John Paulson made $1 billion from his bets against this particular mortgage product, named Abacus. The buyers, which included ACA Financial and the German bank IKB, lost $1 billion.  The idea behind the SEC's lawsuit is these mortgage securities were fraudulently constructed: They were made to fail. If the SEC is able to prove its case in court, the ramifications for the other banks that put together CDOs will be tremendous. For example, a judge last week rejected Merrill Lynch's motion to dismiss an MBIA lawsuit over billions in mortgage backed CDOs that MBIA had insured. The judge ruled the insurance contracts were based on the securities' triple-A rating. Since the triple-A rating might have been fraudulently obtained, the lawsuit should continue. If these suits aren't settled, the big banks could end up losing hundreds of billions to the insurance companies and other mortgage investors. Crux Note: Few analysts have been as prescient as Porter Stansberry since the crisis began. He correctly predicted the troubles at General Motors, Fannie and Freddie, and GE... now he sees big trouble at Goldman and the big banks.  To be the first to know exactly how Porter is playing these situations, consider a subscription to Porter Stansberry's Investment Advisory. You can learn more here. More from Porter Stansberry: Porter Stansberry: Two stocks to sell immediately Porter Stansberry: The one idea that destroyed America Porter Stansberry: The 3 types of stocks you should always short