Sunday, September 4, 2011


management disagreed with his negative views, and used the bank’s own funds to make large
proprietary investments in mortgage related securities that, in 2007, had a notional or face value
of $128 billion and a market value of more than $25 billion. At the same time, Deutsche Bank
allowed Mr. Lippmann to develop for the bank a $5 billion proprietary short position in the
RMBS market, which it later cashed in for a profit of approximately $1.5 billion. Despite that
gain, in 2007, due to its substantial long investments, Deutsche Bank incurred an overall loss of
about $4.5 billion from its mortgage related proprietary investments.
The two case studies illustrate how investment banks engaged in high intensity sales
efforts to market new CDOs in 2007, even as U.S. mortgage delinquencies climbed, RMBS
securities incurred losses, the U.S. mortgage market as a whole deteriorated, and investors lost
confidence. They demonstrate how these investment banks benefitted from structured finance
fees, and had little incentive to stop producing and selling high risk, poor quality structured
finance products. They also illustrate how the development of complex structured finance
products, such as synthetic CDOs and naked credit default swaps, amplified market risk by
allowing investors with no ownership interest in the “reference obligations” to place unlimited
side bets on their performance. Finally, the two case histories demonstrate how proprietary
trading led to dramatic losses in the case of Deutsche Bank and to conflicts of interest in the case
of Goldman Sachs.
Investment banks were a major driving force behind the structured finance products that
provided a steady stream of funding for lenders to originate high risk, poor quality loans and that
magnified risk throughout the U.S. financial system. The investment banks that engineered, sold,
traded, and profited from mortgage related structured finance products were a major cause of the
financial crisis.
Federal law has never established a “super-regulator” with jurisdiction to police 1240 compliance and conduct across
banking, brokerage, investment advisory, and insurance sectors, and that remains the case today.
1241 See Section 16 of the Banking Act of 1933, Pub. L.73-66 (also known as the Glass-Steagall Act).
A. Background
(1) Investment Banks In General
Historically, investment banks helped raise capital for business and other endeavors by
helping to design, finance, and sell financial products like stocks or bonds. When a corporation
needed capital to fund a large construction project, for example, it often hired an investment bank
either to arrange a bank loan or to raise capital by designing, financing, and marketing an issue of
shares or corporate bonds for sale to investors. Investment banks performed these services in
exchange for fees.
Today, investment banks also participate in a wide range of other financial activities,
including providing broker-dealer and investment advisory services, and trading commodities
and derivatives. Investment banks also often engage in proprietary trading, meaning trading with
their own money and not on behalf of a customer. Many investment banks are structured today
as affiliates of one or more banks.
Under the Glass-Steagall Act of 1933, certain types of financial institutions had been
prohibited from commingling their services. For example, with limited exceptions, only brokerdealers
could provide brokerage services; only banks could offer banking; and only insurers
could offer insurance. Each financial sector had its own primary regulator who was generally
prohibited from regulating services outside of its jurisdiction.1240 Glass-Steagall also contained
prohibitions against proprietary trading.1241 One reason for keeping the sectors separate was to
ensure that banks with federally insured deposits did not engage in the type of high risk activities
that might be the bread and butter of a broker-dealer or commodities trader. Another reason was
to avoid the conflicts of interest that might arise, for example, from a financial institution
pressuring its clients to obtain all of its financial services from the same firm. A third reason was
to avoid the conflicts of interest that arise when a financial institution is allowed to act for its
own benefit in a proprietary capacity, while at the same time acting on behalf of customers in an
agency or fiduciary capacity.
Glass-Steagall was repealed in 1999, after which the barriers between banks, brokerdealers,
and insurance firms fell. U.S. financial institutions not only began offering a mix of
financial services, but also intensified their proprietary trading activities. The resulting changes
in the way financial institutions were organized and operated made it more difficult for regulators
to distinguish between activities intended to benefit customers versus the financial institution
itself. The expanded set of financial services investment banks were allowed to offer also
contributed to the multiple and significant conflicts of interest that arose between some
investment banks and their clients during the financial crisis.
Section 3(a)(38) of the Securities Exchange Act of 1934 1242 states: “The term “market maker” means any specialist
permitted to act as a dealer, any dealer acting in the capacity of block positioner, and any dealer who, with respect to
a security, holds himself out (by entering quotations in an inter-dealer communications system or otherwise) as being
willing to buy and sell such security for his own account on a regular or continuous basis.” See also SEC website,; FINRA website, FAQs, “What Does a Market Maker Do?”
1243 See SEC website,; FINRA website, FAQs, “What Does a Market
Maker Do?”
1244 1/2011 “Study on Investment Advisers and Broker-Dealers,” study conducted by the U.S. Securities and
Exchange Commission, at 55,
1245 See Responses to Questions for the Record from Goldman Sachs at PSI_QFR_GS0046.
( 2) Roles and Duties of an Investment Bank:
Market Maker, Underwriter, Placement Agent, Broker-Dealer
Investment banks typically play a variety of significant roles when dealing with their
clients, including that of market maker, underwriter, placement agent, and broker-dealer. Each
role brings different legal obligations under federal securities law.
Market Maker. A “market maker” is typically a dealer in financial instruments that
stands ready to buy and sell for its own account a particular financial instrument on a regular and
continuous basis at a publicly quoted price.1242 A major responsibility of a market maker is
filling orders on behalf of customers. Market markers do not solicit customers; instead they
maintain buy and sell quotes in a public setting, demonstrating their readiness to either buy or
sell the specified security, and customers come to them. For example, a market maker in a
particular stock typically posts the prices at which it is willing to buy or sell that stock, attracting
customers based on the competitiveness of its prices. This activity by market makers helps
provide liquidity and efficiency in the trading market for the security.1243 It is common for a
particular security to have multiple market makers who competitively quote the security.
Market makers generally use the same inventory of assets to carry out both their marketmaking
and proprietary trading activities. Market makers are allowed, in certain circumstances
specified by the SEC, to sell securities short in situations to satisfy market demand when they do
not have the securities in their inventory in order to provide liquidity. Market makers have among
the most narrow disclosure obligations under federal securities law, since they do not actively
solicit clients or make investment recommendations to them. Their disclosure obligations are
generally limited to providing fair and accurate information related to the execution of a particular
trade.1244 Market makers are also subject to the securities laws’ prohibitions against fraud and
market manipulation. In addition, they are subject to legal requirements relating to the handling
of customer orders, for example using best execution efforts when placing a client’s buy or sell
Underwriter and Placement Agent. If an investment bank agrees to act as an
“underwriter” for the issuance of a new security to the public, such as an RMBS, it typically
See Sections 11 and 12 of Securities Act of 1933. See also Rule 10b-5 of the Securities 1246 Exchange Act of 1934.
See also, e.g., SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 201 (1963) (“Experience has shown that
disclosure in such situations, while not onerous to the advisor, is needed to preserve the climate of fair dealing which
is so essential to maintain public confidence in the securities industry and to preserve the economic health of the
country.”). See also SEC Study on Investment Advisers and Broker-Dealers at 51 (citations omitted) (“Under the socalled
‘shingle’ theory …, a broker-dealer makes an implicit representation to those persons with whom it transacts
business that it will deal fairly with them, consistent with the standards of the profession. … Actions taken by the
broker-dealer that are not fair to the customer must be disclosed in order to make this implied representation of
fairness not misleading.”).
purchases the securities from the issuer, holds them on its books, conducts the public offering, and
bears the financial risk until the securities are sold to the public. By law, securities sold to the
public must be registered with the SEC. Underwriters help issuers prepare and file the registration
statements filed with the SEC, which explain to potential investors the purpose of a proposed
public offering, the issuer’s operations and management, key financial data, and other important
facts. Any offering document, or prospectus, given to the investing public in connection with a
registered security must also be filed with the SEC.
If a security is not offered to the general public, it can still be offered to investors through
a “private placement.” Investment banks often act as the “placement agent,” performing
intermediary services between those seeking to raise money and investors. Placement agents
often help issuers design the securities, produce the offering materials, and market the new
securities to investors. Offering documents in connection with private placements are exempt
from SEC registration and are not filed with the SEC.
In the years leading up to the financial crisis, RMBS securities were registered with the
SEC, while CDOs were sold to investors through private placements. Both of these securities
were also traded in a secondary market by market makers. Investment banks sold both types of
securities primarily to large institutional investors, such as other banks, pension funds, insurance
companies, municipalities, university endowments, and hedge funds.
Whether acting as an underwriter or placement agent, a major part of the investment
bank’s responsibility is to solicit customers to buy the new securities being offered. Under the
securities laws, investment banks that act as an underwriter or placement agent for new securities
are liable for any material misrepresentation or omission of a material fact made in connection
with a solicitation or sale of those securities to investors.1246
The obligation of an underwriter and placement agent to disclose material facts to every
investor it solicits comes from two sources: the duties as an underwriter specifically, and the
duties as a broker-dealer generally. With respect to duties relating to being an underwriter, the
U.S. Court of Appeals for the First Circuit observed that underwriters have a “unique position” in
the securities industry:
SEC v. Tambone, 550 F.3d 106 (1st 1247 Cir. 2008) [citations omitted].
1248 Section 11 of the Securities Act of 1933, codified at 15 U.S.C. § 77a.
1249 In the Matter of Richmark Capital Corporation, Securities Exchange Act Rel. No. 48758 (Nov. 7, 2003) (citing
Chasins v. Smith Barney & Co., Inc., 438 F.3d 1167, 1172 (2d Cir. 1970) (“The investor… must be permitted to
evaluate overlapping motivations through appropriate disclosures, especially where one motivation is economic selfinterest”)).
1250 FINRA Notice No. 96-60.
1251 See FINRA Rules 2210(d)(1)(A) and 2211(a)(3) and (d)(1) (by rule all institutional sales material and
correspondence may not “omit any material fact or qualification if the omission, in the light of the context of the
material presented, would cause the communications to be misleading.”). See also FINRA Rule 2310 and IM-2310-
“[T]he relationship between the underwriter and its customer implicitly involves a
favorable recommendation of the issued security. … Although the underwriter cannot be
a guarantor of the soundness of any issue, he may not give it his implied stamp of approval
without having a reasonable basis for concluding that the issue is sound.”1247
In addition, Section 11 of the Securities Act of 1933 makes underwriters liable to any
investor in any registered security if any part of the registration statement “contained an untrue
statement of a material fact or omitted to state a material fact required to be stated therein or
necessary to make the statements therein not misleading.”1248
Broker-Dealer. Broker-dealers also have affirmative disclosure obligations to their
clients. With respect to the duties of a broker-dealer, the SEC has held:
“[W]hen a securities dealer recommends a stock to a customer, it is not only obligated to
avoid affirmative misstatements, but also must disclose material adverse facts to which it
is aware. That includes disclosure of ‘adverse interests’ such as ‘economic self interest’
that could have influenced its recommendation.”1249
To help broker-dealers understand when they are obligated to disclose material adverse
facts to investors, the Financial Industry Regulatory Authority (FINRA) has further defined the
term “recommendation”:
“[A] broad range of circumstances may cause a transaction to be considered
recommended, and this determination does not depend on the classification of the
transaction by a particular member as ‘solicited’ or ‘unsolicited.’ In particular a
transaction will be considered to be recommended when the member or its associated
person brings a specific security to the attention of the customer through any means,
including, but not limited to, direct telephone communication, the delivery of promotional
material through the mail, or the transmission of electronic messages.”1250
There is no indication in any law or regulation that the obligation to disclose material
adverse facts is diminished or waived in relation to the level of sophistication of the potential
3 (suitability obligation to institutional customers).
CDO squared transactions will generally be referred to 1252 in this Report as “CDO2.” Some Goldman materials also
use the term “CDO^2.”
(3) Structured Finance Products
Over time, investment banks have devised, marketed, and sold increasingly complex
financial instruments to investors, often referred to as “structured finance” products. These
products include residential mortgage backed securities (RMBS), collateralized debt obligations
(CDOs), and credit default swaps (CDS), including CDS contracts linked to the ABX Index, all of
which played a central role in the financial crisis.
RMBS and CDO Securities. RMBS and CDO securities are two common types of
structured finance products. RMBS securities contain pools of mortgage loans, while CDOs
contain or reference pools of RMBS securities and other assets. RMBS concentrate risk by
including thousands of subprime and other high risk home loans, with similar characteristics and
risks, in a single financial instrument. Mortgage related CDOs concentrate risk even more by
including hundreds or thousands of RMBS securities, with similar characteristics and risks, in a
single financial instrument. In addition, while some CDOs included only AAA rated RMBS
securities, others known as “mezzanine” CDOs contained RMBS securities that carried the riskier
BBB, BBB-, and even BB credit ratings and were more susceptible to losses if the underlying
mortgages began to incur delinquencies or defaults.
Some investment banks went a step farther and assembled CDO securities into pools and
resecuritized them as so-called “CDO squared” instruments, which further concentrated the risk in
the underlying CDOs.1252 Some investment banks also assembled “synthetic CDOs,” which did
not contain any actual RMBS securities or other assets, but merely referenced them. Some
devised “hybrid CDOs,” which contained a mix of cash and synthetic assets.
The securitization process generated billions of dollars in funds that allowed investment
banks to supply financing to lenders to issue still more high risk mortgages and securities, which
investment banks and others then sold or securitized in exchange for still more fees. This cycle
was repeated again and again, introducing more and more risk to a wider and wider range of
Credit Default Swaps. Some investment banks modified still another structured finance
product, a derivative known as a credit default swap (CDS), for use in the mortgage market.
Much like an insurance contract, a CDS is a contract between two parties in which one party
guarantees payment to the other if the assets referenced in the contract lose value or experience a
negative credit event. The party selling the insurance is referred to as the “long” party, since it
profits if the referenced asset performs well. The party buying the insurance protection is referred
to as the “short” party because it profits if the referenced asset to perform poorly.
Each of the five indices tracked a different basket of subprime RMBS securities. 1253 One index tracked a basket of
20 AAA rated RMBS securities; the second a basket of AA rated RMBS securities; and the remaining indices
tracked baskets of A, BBB, and BBB- rated RMBS securities. Every six months, a new set of RMBS securities was
selected for each index. See 3/2008 Federal Reserve Bank of New York Staff Report No. 318, “Understanding the
Securitization of Subprime Mortgage Credit,” at 26. Markit Group Ltd. administered the ABX Index which issued
indices in 2006 and 2007, but has not issued any new indices since then.
The short party, or CDS buyer, typically pays periodic premiums, similar to insurance
premiums, to the long party or CDS seller, who has guaranteed the referenced assets against a loss
in value or a negative credit event such as a credit rating downgrade, default, or bankruptcy. If the
loss or negative credit event occurs, the CDS seller is required to pay an agreed upon amount to
the CDS buyer. Many CDS contracts also tracked the changing value of the referenced assets
over time, and required the long and short parties to post cash collateral with each other to secure
payment of their respective contractual obligations.
CDS contracts that reference a single, specific security or bond for protection against a
loss in value or negative credit event have become known as “single name” CDS contracts. Other
CDS contracts have been designed to protect a broader basket of securities, bonds, or other assets.
By 2005, investment banks had standardized CDS contracts that referred to a “single
name” RMBS or CDO security. Some investment banks and investors, which held large
inventories of RMBS and CDO securities, purchased those single name CDS contracts as a hedge
against possible losses in the value of their holdings. Other investors, including investment banks,
began to purchase single name CDS contracts, not as a hedge to offset losses from the RMBS or
CDO securities they owned, but as a way to profit from particular RMBS or CDO securities they
predicted would lose value or fail. CDS contracts that paid off on securities that were not owned
by the CDS buyer became known as “naked credit default swaps.” Naked CDS contracts enabled
investors to bet against mortgage related assets, using the minimal capital needed to make the
periodic premium payments and collateral calls required by a CDS contract.
The key significance of the CDS product for the mortgage market was that it offered an
alternative to investing in RMBS and CDO securities that would perform well. Single name CDS
contracts instead enabled investors to place their dollars in financial instruments that would pay
off if specific RMBS or CDO securities lost value or failed.
ABX Index. In January 2006, a consortium of investment banks, led by Goldman Sachs
and Deutsche Bank, launched still another type of structured finance product, linked to a newly
created “ABX Index,” to enable investors to bet on multiple subprime RMBS securities at once.
The ABX Index was administered by a private company called the Markit Group and consisted of
five separate indices, each of which tracked the performance of a different basket of 20 designated
subprime RMBS securities.1253 The values of the securities in each basket were aggregated into a
single composite value that rose and fell over time. Investors could then arrange, through a
broker-dealer, to enter into a CDS contract with another party using the ABX basket of subprime
RMBS securities as the “reference obligation” and the relevant ABX Index value as the agreed
Subcommittee Interview of Joshua Birnbaum (4/22/2010); Subcommittee 1254 Interview of Rajiv Kamilla
upon value of that basket. For a fee, investors could take either the “long” position, betting on the
rise of the index, or the “short” position, betting on the fall of the index, without having to
physically purchase or hold any of the referenced securities or raise the capital needed to pay for
the full face value of those referenced securities. The index also used standardized CDS contracts
that remained in effect for a standard period of time, making it easier for investors to participate in
the market, and buy and sell ABX-linked CDS contracts.
The ABX Index allowed investors to place unlimited bets on the performance of one or
more of the subprime RMBS baskets. It also made it easier and cheaper for investors, including
some investment banks, to short the subprime mortgage market in bulk.1254 Investment banks not
only helped establish the ABX Index, they encouraged their clients to enter into CDS contracts
based upon the ABX Index, and used it themselves to bet on the mortgage market as a whole.
The ABX Index expanded the risks inherent in the subprime mortgage market by providing
investors with a way to make unlimited investments in RMBS securities.
Synthetic CDOs. By mid-2006, there was a large demand for RMBS and CDO securities
as well as a growing demand for CDS contracts to short the mortgage market. To meet this
demand, investment banks and others began to make greater use of synthetic CDOs, which could
be assembled more quickly, since they did not require the CDO arranger to find and purchase
actual RMBS securities or other assets. The increasing use of synthetic CDOs injected even
greater risk into the mortgage market by enabling investors to make unlimited wagers on various
groups of mortgage related assets and, if those assets performed poorly, expanding the number of
investors who would realize losses.
Synthetic CDOs did not depend upon actual RMBS securities or other assets to bring in
cash to pay investors. Instead, the CDO simply developed a list of existing RMBS or CDO
securities or other assets that would be used as its “reference obligations.” The parties to the CDO
were not required to possess an ownership interest in any of those reference obligations; the CDO
simply tracked their performance over time. The performance of the underlying reference
obligations, in the aggregate, determined the performance of the synthetic CDO.
The synthetic CDO made or lost money for its investors by establishing a contractual
agreement that they would make payments to each other, based upon the aggregate performance
of the underlying referenced assets, using CDS contracts. The “short” party essentially agreed to
make periodic payments, similar to insurance premiums, to the other party in exchange for an
agreement that the “long” party would pay the full face value of the synthetic CDO if the
underlying assets lost value or experienced a defined credit event such as a ratings downgrade. In
essence, then, the synthetic CDO set up a wager in which the short party bet that its underlying
assets would perform poorly, while the long party bet that they would perform well.
See, e.g., “Senate’s Goldman Probe Shows Toxic Magnification,” Wall Street 1255 Journal (5/2/2010) (showing how
a single $38 million subprime RMBS, created in June 2006, was included in 30 CDOs and, by 2008, had caused
$280 million in losses to investors).
1256 See “Banks’ Self-Dealing Super-Charged Financial Crisis,” ProPublica (8/26/2010), (“A typical CDO could net the
bank that created it between $5 million and $10 million – about half of which usually ended up as employee bonuses.
Indeed, Wall Street awarded record bonuses in 2006, a hefty chunk of which came from the CDO business.”). Fee
information obtained by the Subcommittee is consistent with this range of CDO fees. For example, Deutsche Bank
received nearly $5 million in fees for Gemstone 7, and the head of its CDO group said that Deutsche bank received
typically between $5 and 10 million in fees, while Goldman Sachs charged a range of $5 to $30 million in fees for
Camber 7, Fort Denison, and the Hudson Mezzanine 1 and 2 CDOs. 12/20/2006 Gemstone 7 Securitization Credit
Report, DB_PSI_00237655-71 and 3/15/2007 Gemstone CDO VII Ltd. Closing Memorandum, DB_PSI_00133536-
41; Subcommittee interview of Michael Lamont (9/29/2010); and Goldman Sachs response to Subcommittee QFRs
at PSI-QFR-GS0249.
1257 See, e.g., discussion of the Hudson CDO, below; Subcommittee interview of Daniel Sparks (4/15/10) (Goldman
tried selling subprime loans but could not; it was easier and more efficient to securitize them and then sell the
securitized product to transfer loans in bulk; it was also easier to sell CDOs than individual underlying positions).
Synthetic CDOs provided still another vehicle for investors looking to short the mortgage
market in bulk. The synthetic CDO typically referenced a variety of RMBS securities. One or
more investors could then take the “short” position and wager that the referenced securities as a
whole would fall in value or otherwise perform poorly. Synthetic CDOs became a way for
investors to short multiple specific RMBS securities that they expected to incur delinquencies,
defaults, and losses.
Synthetic CDOs magnified the risk in the mortgage market, because arrangers had no limit
on the number of synthetic CDOs they could create. In addition, multiple synthetic CDOs could
reference the same RMBS and CDO securities in various combinations, and sell financial
instruments dependent upon the same sets of high risk, poor quality loans over and over again to
various investors. Since every synthetic CDO had to have a “short” party betting on the failure of
the referenced assets, at least some poor quality RMBS and CDO securities could be included in
each transaction to attract those investors. When some of the high risk, poor quality loans later
incurred delinquencies or defaults, they caused losses, not in a single RMBS, but in multiple cash,
synthetic, and hybrid CDOs whose securities had been sold to a wide circle of investors.1255
Conflicts of Interest. Investment banks that designed, obtained credit ratings for,
underwrote, sold, managed, and serviced CDO securities, made money from the fees they charged
for these and other services. Investment banks reportedly netted from $5 to $10 million in fees
per CDO.1256 Some also constructed CDOs to transfer the financial risk of poorly performing
RMBS and CDO securities from their own holdings to the investors they were soliciting to buy
the CDO securities.1257 By selling the CDO securities to investors, the investment banks profited
not only from the CDO sales, but also eliminated possible losses from the assets removed from
their warehouse accounts. In some instances, unbeknownst to the customers and investors, the
investment banks that sold them CDO securities bet against those instruments by taking short
positions through single name CDS contracts. Some even took the short side of the CDO they
constructed, and profited when the referenced assets lost value, and the investors to whom they
had sold the long side of the CDO were required to make substantial payments to the CDO.
The following two case studies examine how two investment banks active in the U.S.
mortgage market constructed, marketed, and sold RMBS and CDO securities; how their activities
magnified risk in the mortgage market; and how conflicts of interest negatively impacted investors
and contributed to the financial crisis. The Deutsche Bank case history provides an insider’s view
of what one senior CDO trader described as Wall Street’s “CDO machine.” It reveals the trader’s
negative view of the mortgage market in general, the poor quality RMBS assets placed in a CDO
that Deutsche Bank marketed to clients, and the fees that made it difficult for investment banks
like Deutsche Bank to stop selling CDOs. The Goldman Sachs case history shows how one
investment bank was able to profit from the collapse of the mortgage market, and ignored
substantial conflicts of interest to profit at the expense of its clients in the sale of RMBS and CDO
B. Running the CDO Machine:
Case Study of Deutsche Bank
This case history examines the role of Deutsche Bank USA in the design, marketing, and
sale of collateralized debt obligations (CDOs) that incorporated or referenced residential
mortgage backed securities (RMBS).
From 2004 to 2008, U.S. financial institutions issued over $1.4 trillion worth of CDO
securities. At first, this complex structured finance product proved highly profitable for
investment banks which established CDO departments and trading desks to create and market the
securities. By early 2007, however, due to declining housing prices, accelerating mortgage
delinquencies, and RMBS losses, investor interest in CDOs began to drop off sharply. In July
2007, the major credit rating agencies began lowering credit ratings for many CDO securities, at
times eliminating the investment grade ratings that had supported CDO sales. Despite waning
investor interest, U.S. investment banks continued to issue new mortgage related CDOs
throughout 2007, in an apparent effort to sustain their fees and CDO departments. Some
investment banks supported the CDO market by purchasing existing CDO securities for
inclusion in new, even more complex CDOs, seeking customers in Europe and Asia, or retaining
risky CDO securities on their own books.
Deutsche Bank was a major player in the CDO market, both in creating new CDO issues
and trading these securities in the secondary market. Deutsche Bank’s top global CDO trader,
Greg Lippmann, began to express concerns that the CDO market was unsustainable. By the
middle of 2006, Mr. Lippmann repeatedly warned and advised his Deutsche Bank colleagues and
some of his clients seeking to buy short positions about the poor quality of the assets underlying
many CDOs. He described some of those assets as “crap” and “pigs,” and predicted the assets
and the CDO securities would lose value.
At one point, Mr. Lippmann was asked to buy a specific CDO security and responded
that it “rarely trades,” but he “would take it and try to dupe someone” into buying it. He also at
times referred to the industry’s ongoing CDO marketing efforts as a “CDO machine” or “ponzi
scheme.” Deutsche Bank’s senior management disagreed with his negative views, and used the
bank’s own funds to make large proprietary investments in mortgage related securities that, in
2007, had a notional or face value of $128 billion and a market value of more than $25 billion.
Despite disagreeing with his negative views on the mortgage market, Deutsche Bank
allowed Mr. Lippmann, in 2005, to develop a large proprietary short position for the bank in the
RMBS market. Since carrying that short position required the bank to pay millions of dollars in
premiums, senior management also required Mr. Lippmann to defray or eliminate those costs by
convincing others to take short positions in the mortgage market, thereby generating fees for the
bank from arranging those shorts. In 2006, Mr. Lippmann generated an estimated $200 million
in fees by encouraging his clients, such as hedge funds, to buy short positions. Simultaneously,
Mr. Lippmann increased the size of the bank’s short position by taking the short side of credit
default swaps (CDS) referencing individual RMBS securities, an investment strategy often
referred to as investing in “single name CDS” contracts. Over a two-year period from 2005 to
2007, Mr. Lippmann built a massive short position in single name CDS contracts totaling $5
billion. From 2007 to 2008, at the direction of the bank’s senior management, he cashed in that
position, generating a profit for his trading desk of approximately $1.5 billion, which he claims
made more money on a single position than any other trade had ever made for Deutsche Bank in
its history. Despite that gain, due to its substantial long investments, Deutsche Bank incurred an
overall loss of about $4.5 billion from its mortgage related proprietary investments.1258
To understand how Deutsche Bank continued to issue and market CDO securities even as
the market for mortgage related securities began collapsing, the Subcommittee examined a
specific CDO in detail, called Gemstone CDO VII Ltd. (Gemstone 7). In October 2006,
Deutsche Bank began assisting in the gathering of assets for Gemstone 7, which issued its
securities in March 2007. It was the last in a series of CDOs sponsored by HBK Capital
Management (HBK), a large hedge fund which acted as the collateral manager for the CDO.
Deutsche Bank made $4.7 million in fees from the deal, while HBK was slated to receive $3.3
million. It was not the last CDO issued by Deutsche Bank. Even after Gemstone 7 was issued in
March of 2007, Deutsche Bank issued 9 additional CDOs.
Gemstone 7 was a hybrid CDO containing or referencing a variety of high risk, subprime
RMBS securities initially valued at $1.1 billion when issued. Deutsche Bank’s head global
trader, Mr. Lippmann, recognized that these RMBS securities were high risk and likely to lose
value, but did not object to their inclusion in Gemstone 7. Deutsche Bank, the sole placement
agent, marketed the initial offering of Gemstone 7 in the first quarter of 2007. Its top tranches
received AAA ratings from Standard & Poor’s and Moody’s, despite signs that the CDO market
was failing and the CDO itself contained many poor quality assets.
Nearly a third of Gemstone’s assets consisted of high risk subprime loans originated by
Fremont, Long Beach, and New Century, three lenders known at the time within the financial
industry for issuing poor quality loans and RMBS securities. Although HBK directed the
selection of assets for Gemstone 7, Mr. Lippmann’s CDO Trading Desk was involved in the
process and did not object to including certain RMBS securities in Gemstone 7, even though Mr.
Lippmann was simultaneously referring to them as “crap” or “pigs.” Mr. Lippmann was also at
the same time advising some of his clients to short some of those same RMBS securities. In
addition, Deutsche Bank sold five RMBS securities directly from its inventory to Gemstone 7,
several of which were also contemporaneously disparaged by Mr. Lippmann.
The Deutsche Bank sales force aggressively sought purchasers for the CDO securities,
while certain executives expressed concerns about the financial risk of retaining Gemstone 7
assets as the market was deteriorating in early 2007. In its struggle to sell Gemstone 7, Deutsche
Bank motivated its sales force with special financial incentives, and sought out buyers in Europe
and Asia because the U.S. market had dried up. Deutsche Bank also talked of providing HBK’s
marks, instead of its own, to clients asking about the value of Gemstone 7’s assets, since HBK’s
1258 Subcommittee interview of Greg Lippmann (10/18/2010); Net Revenues from ABS Products Backed by U.S.
Residential Mortgages, DB_PSI_C00000003.
marks showed the CDO’s assets performing better. Deutsche Bank was ultimately unable to sell
$400 million, or 36%, of the Gemstone 7 securities, and agreed with HBK to split the unsold
securities, each taking $200 million onto its own books. Deutsche Bank did not disclose to the
eight investors whom it had solicited and convinced to buy Gemstone 7, that its global head
trader of CDOs had an extremely negative view of a third of the assets in the CDO or that the
bank’s internal valuations showed that the assets had lost over $19 million in value since
Gemstone 7 also demonstrated how CDOs magnified risk by including or referencing
within itself 115 different RMBS securities containing thousands of high risk, poor quality
subprime loans. Many of those RMBS securities carried BB ratings, which are non-investment
grade credit ratings and were among the highest risk securities in the CDO. Gemstone 7 also
included CDO securities that, in themselves, concentrated the risk of their underlying assets.
Over 75% of Gemstone’s assets consisted of RMBS securities with ratings of BBB or lower,
including approximately 33% with non-investment grade ratings, yet Gemstone’s top three
tranches were given AAA ratings by the credit rating agencies. The next three tranches were
given investment grade ratings as well. Those investment grade ratings enabled investors like
pension funds, insurance companies, university endowments, and municipalities, some of which
were required by law, regulation, or their investment plans to put their funds in safe investments,
to consider buying Gemstone securities. Eight investors actually purchased them. Within eight
months, the Gemstone securities began incurring rating downgrades. By July 2008, all seven
tranches in the CDO had been downgraded to junk status, and the long investors were almost
completely wiped out. Today, the Gemstone 7 securities are nearly worthless.
Deutsche Bank was, in Mr. Lippmann’s words, part of a “CDO machine” run by
investment banks that produced hundreds of billions of high risk CDO securities. Because the
fees to design and market CDOs ranged from $5 to $10 million per CDO, investment bankers
had a strong financial incentive to continue issuing them, even in the face of waning investor
interest and poor quality assets, since reduced CDO activity would have led to less income for
structured finance units, smaller bonuses for executives, and even the disappearance of CDO
departments, which is eventually what occurred. The Deutsche Bank case history provides a
cautionary tale for both market participants and regulators about how complex structured finance
products gain advocates within an organization committed to pushing the products through the
pipeline to maintain revenues and jobs, regardless of the financial risks or possible impact on the
1259 See Sections 11 and 12 of Securities Act of 1933. See also Rule 10b-5 of the Securities Exchange Act of 1934.
For a more detailed discussion of the legal obligations of underwriters, placement agents, and broker-dealers, see
Section C(6) on conflicts of interest analysis, below.
(1) Subcommittee Investigation and Findings of Fact
As part of its investigation into the CDO market and the Deutsche Bank case study, the
Subcommittee collected and reviewed hundreds of thousands of Deutsche Bank documents
including reports, analyses, memoranda, correspondence, transcripts, spreadsheets, and email.
The Subcommittee also collected and reviewed documents from HBK Capital Management,
several financial institutions that purchased Deutsche Bank CDO securities, and the Securities
and Exchange Commission (SEC). In addition, the Subcommittee conducted 14 interviews,
including interviews with current and former Deutsche Bank and HBK executives, managers,
sales representatives, and traders; spoke with personnel from the financial institutions that
invested in Gemstone 7; and consulted with a number of experts from the SEC, academia, and
Based upon the Subcommittee’s review, the Report makes the following findings of fact.
1. CDO Machine. From late 2006 through 2007, despite increasing mortgage
delinquencies, RMBS losses, and investor flight from the U.S. mortgage market, U.S.
investment banks continued to issue new CDOs, including Deutsche Bank which
issued 15 new CDOs securitizing nearly $11.5 billion of primarily mortgage related
assets from December 2006 to December 2007.
2. Fee Incentives. Because the fees charged to design and market CDOs were in the
range of $5 to $10 million per CDO, investment banks had strong incentives to
continue issuing CDOs despite increasing risks and waning investor interest, since
reduced CDO activity meant less revenues for structured finance units and even the
disappearance of CDO departments and trading desks, which is eventually what
3. Deutsche Bank’s $5 Billion Short. Although Deutsche Bank as a whole and through
an affiliated hedge fund, Winchester Capital, made proprietary investments in long
mortgage related assets, the bank also permitted its head CDO trader to make a $5
billion short investment that bet against the mortgage market and produced bank
profits totaling approximately $1.5 billion.
4. Proprietary Loss. By 2007, Deutsche Bank, through its mortgage department and an
affiliated hedge fund, had substantial proprietary holdings in the mortgage market,
including more than $25 billion in long investments and a $5 billion short position,
which together resulted in 2007 losses to the bank of about $4.5 billion.
5. Gemstone 7. In the face of a deteriorating market, Deutsche Bank aggressively sold
a $1.1 billion CDO, Gemstone 7, which included RMBS securities that the bank’s top
CDO trader had disparaged as “crap” and “pigs,” and which produced $1.1 billion of
high risk, poor quality securities that are now virtually worthless.
(2) Deutsche Bank Background
CDOs In General. According to the Securities Industry and Financial Markets
Association, $1.4 trillion worth of CDOs were issued in the United States from 2004 through the
end of 2007.1260 The following chart depicts the dramatic rise and fall of the U.S. CDO market
over the last ten years, with total CDO issuance reaching its peak in 2006 at $520 billion, and
then falling to a low of $4 billion in 2009.1261
Total Annual CDO Issuance
Total CDO Issuance
($ in billions)
2000 67.99
2001 78.45
2002 83.07
2003 86.63
2004 157.82
2005 251.27
2006 520.64
2007 481.60
2008 61.89
2009 4.34
In 2006 and 2007, investment banks created around half a trillion dollars in CDO
securities each year, even as U.S. housing prices began to stagnate and decline, subprime
mortgages began to default at record rates, and RMBS securities began to incur dramatic losses.
By the middle of 2007, due to the increasing risks, U.S. institutional investors like pension funds,
hedge funds, and others began to purchase fewer CDO securities, and investment banks turned
their attention increasingly to European and Asian investors as well as the issuers of new CDOs
who became the primary buyers of CDO securities.1262 In 2007, U.S. investment banks kept
issuing and selling CDOs despite slowed sales, which meant that investment banks had to retain
an increasing portion of the unsold assets on their own balance sheets.1263
1260 10/15/2010 “Global CDO Issuance,” Securities Industry and Financial Markets Association,
1261 Chart prepared by the Subcommittee using data from 10/15/2010 “Global CDO Issuance,” Securities Industry
and Financial Markets Association, By 2004, most, but not all, CDOs
relied primarily on mortgage related assets such as RMBS securities. Subcommittee interview of Gary Witt, former
Managing Director of Moody’s RMBS Group (10/29/2009).
1262 See 7/12/2007 email from Michael Lamont to Boaz Weinstein at Deutsche Bank, DBSI_01201843; “Banks’
Self-Dealing Super Charged Financial Crisis,” ProPublica (8/26/2010),
dealing-super-charged-financial-crisis; and “Mortgage-Bond Pioneer Dislikes What He Sees,” Wall Street
Journal (2/24/2007).
1263 “Banks’ Self-Dealing Super Charged Financial Crisis,” ProPublica (8/26/2010).
The credit rating agencies marked a “sea change” in the CDO market in 2007, in which
investment banks issued CDOs at near record levels in the first half of the year, but then sharply
reined in their efforts after the mass rating downgrades of RMBS and CDO securities began in
July 2007:
“[The CDO] market in the U.S. was very active in terms of issuance throughout the first
half of 2007.… The year 2007 saw a sea change for the CDO market. Moody’s rated
more than 100 SF [structured finance] CDO transactions in each of the first two quarters,
but the number fell sharply to 40 in the third quarter and to just eight in the fourth quarter
as the sheer speed and magnitude of the subprime mortgage fallout significantly
weakened investors’ confidence.”1264
In the years leading up to the financial crisis, the typical size of a CDO deal was between
$1 and $1.5 billion,1265 and generated large fees for investment banks in the range of $5 to $10
million per CDO.1266
CDOs at Deutsche Bank. From 2004 to 2008, Deutsche Bank issued 47 asset backed
CDOs for a total securitization of $32.2 billion.
To handle these transactions, a number of large investment banks
established CDO departments and trading desks charged with designing, underwriting, selling, or
trading CDO securities. The CDO origination desks typically worked with the investment
banks’ structured finance sales forces to sell the resulting CDO securities. This structure meant
that stopping the issuance of CDO securities would require the investment banks to lose out on
the fees, prestige, and market share tied to CDO sales. In addition, whole CDO departments,
with their dedicated bankers, traders, and supervisors, would have to disappear, which is
eventually what happened after the CDO market crashed.
1267 According to analysts, in both 2006 and
2007, Deutsche Bank ranked fourth globally in issuing asset backed CDOs, behind Merrill
Lynch, JPMorgan Chase, and Citigroup.1268
1264 Moody’s 2008 Global CDO Review (3/3/2008).
1265 “Wall Street’s money machine breaks down,” (11/12/2007),
1266 See “Banks’ Self-Dealing Super-Charged Financial Crisis,” ProPublica (8/26/2010), (“A typical CDO could net the
bank that created it between $5 million and $10 million – about half of which usually ended up as employee
bonuses. Indeed, Wall Street awarded record bonuses in 2006, a hefty chunk of which came from the CDO
business.”). Fee information obtained by the Subcommittee is consistent with this range of CDO fees. For example,
Deutsche Bank received nearly $5 million in fees for Gemstone 7, and the head of its CDO Group said that Deutsche
bank received typically between $5 and 10 million in fees per CDO, while Goldman Sachs charged a range of $5 to
$30 million in fees for its Camber 7, Fort Denison, and Hudson Mezzanine 1 and 2 CDOs. 12/20/2006 Gemstone 7
Securitization Credit Report, DB_PSI_00237655-71; undated Gemstone 7 Securitization Credit Report,
MTSS000011-13; 3/15/2007 Gemstone CDO VII Ltd. Closing Memorandum, DB_PSI_00133536-41;
Subcommittee interview of Michael Lamont (Deutsche Bank) (9/29/2010); 3/21/2011 letter from Deutsche Bank’s
counsel to the Subcommittee, PSI-Deutsche_Bank-0001-04; Goldman Sachs response to Subcommittee QFRs at
1267 Chart, ABS CDOs Issued by DBSI (between 2004 and 2008), PSI-Deutsche_Bank-02-0005-23.
1268 See “Global ABS CDO Issuance” chart, Reuters (4/20/2010),; “Banks in Talks to End Bond Probe,” Wall Street
At Deutsche Bank, five different parts of the Securitized Product Group played key roles
in its CDO business. They were the CDO Group (North America); the CDO sales force,
formally called Securitized Products; the CDO Syndication Desk which helped promote and
track CDO sales; the mortgage department; and the CDO Trading Desk, formally called ABS
(Asset Backed Security) Trading, CDO Trading, and ABS Correlation Trading.
The CDO Group had two co-heads, Michael Lamont and Michael Herzig, and
approximately 20 employees. The heads of the group reported to Richard D’Albert, Global Head
of Deutsche Bank’s Securitized Product Group. The CDO Group designed and structured the
bank’s CDOs, analyzed the assets that went into the CDOs, monitored the purchasing and
warehousing of those assets, obtained CDO credit ratings, prepared CDO legal documentation,
acted as the CDO underwriter or placement agent on behalf of Deutsche Bank, and oversaw the
issuance of the CDO securities.1269
The CDO sales force sold the resulting CDO securities for Deutsche Bank. It received
assistance from the CDO Syndication, sometimes called the “syndicate,” which helped promote
the deals with investors and tracked CDO sales. The CDO sales force was headed by Sean
Whelan and Michael Jones. They reported to Munir D’auhajre, overall head of sales, who
reported, in turn, to Fred Brettschneider, the head of the Institutional Client Group of Deutsche
Bank Americas. The CDO sales force had approximately 20 employees. In the United States,
the CDO Syndication had about seven employees, and was headed by Anthony Pawlowski, who
reported to Mr. Lamont and Mr. Herzig, who headed the CDO Group.
The Deutsche Bank mortgage department was responsible for purchasing residential
mortgages from a variety of sources, warehousing those mortgages, and securitizing the
mortgages into RMBS securities for which Deutsche Bank acted as the underwriter or placement
agent. Some of those RMBS securities were later included or referenced in CDOs issued by the
The CDO Trading Desk was headed by Greg Lippmann, who served as global head of
Deutsche Bank’s CDO, ABS, and ABS Correlation Trading Desks.1270
Journal (12/2/2010),
Those desks were
responsible for trading a variety of RMBS, CDO, and other asset backed securities on the
secondary market. Mr. Lippmann had a staff of approximately 30 employees, 20 in the United
States and 10 in London. Like the head of the CDO Group, Mr. Lippmann reported to Mr.
D’Albert, the head of the bank’s Securitized Product Group. Mr. Lippmann was also the head of
Talks+to+End+Bond+Probe. See also 10/2006, “CDO Primary Update Progress Report,” prepared by Deutsche
Bank, DBSI_PSI_EMAIL03970167-72, at 68 (ranking Deutsche Bank as third in CDO issuances as of October
1269 Subcommittee interview of Michael Lamont (9/29/2010).
1270 Organizational Chart for Deutsche Bank Global CDO Group, DB_PSI_C00000001.
risk management for all new issue CDOs and described himself as “involved in underwriting,
structuring, marketing and hedging our warehouse risk for new issue cdos.”1271
The CDO Trading Desk conducted trades for both clients and other Deutsche Bank
entities. It was further divided into three trading desks, designated the CDO, ABS, and ABS
Correlation Desks. Each traded certain structured finance products, tracked relevant market
news and developed expertise in its assigned products, and served as a source of asset and
market information for other branches of Deutsche Bank. The CDO Desk focused on buying and
selling CDO securities; the ABS Desk concentrated on trading RMBS and other asset backed
securities as well as short trading strategies involving credit default swap (CDS) contracts in
single name RMBS; and the ABS Correlation Desk acted primarily in a market making capacity
for Deutsche Bank clients, trading both long and short RMBS and CDO securities and CDS
contracts with the objective of taking offsetting positions that minimized the bank’s risk.1272
Mr. Lippmann was well known in the CDO marketplace as a trader. He had joined
Deutsche Bank in 2000, after a stint at Credit Suisse trading bonds. One publication noted that
Mr. Lippmann “made his name with big bets on a housing bust,” continuing: “Mr. Lippmann
emerged as a Cassandra of the financial crisis, spotting cracks in the mortgage market as early as
2006. His warnings helped Deutsche brace for the crisis. He also helped investors — and
himself — land huge profits as big bets that the housing market would collapse materialized.”1273
(3) Deutsche Bank’s $5 Billion Short
In 2006 and 2007, Deutsche Bank’s top CDO trader, Greg Lippmann, repeatedly warned
his Deutsche Bank colleagues and some clients outside of the bank about the poor quality of the
assets underlying many RMBS and CDO securities. Although senior management within the
bank did not agree with his views, they allowed Mr. Lippmann, in 2005, to establish a large short
position on behalf of the bank, essentially betting that mortgage related securities would fall in
value. From 2005 to 2007, Mr. Lippmann built that position into a $5 billion short.
(a) Lippmann’s Negative Views of Mortgage Related Assets
Emails produced to the Subcommittee provide repeated examples of Mr. Lippmann’s
negative views of mortgage related assets, particularly those involving subprime mortgages. At
times, he expressed his views to colleagues within the bank; at other times he expressed them in
connection with advising a client to bet against an RMBS security by taking a short position. At
times, Mr. Lippmann recommended that his clients short poor quality RMBS assets, even while
his trading desk was participating in a selection process that included those same assets in
1271 7/14/2006 email from Greg Lippmann to Melissa Goldsmith at Deutsche Bank, DBSI_PSI_EMAIL01400135-
1272 Subcommittee interview of Greg Lippmann (10/18/2010).
1273 “Lippmann, Deutsche Trader, Steps Down,” New York Times (4/21/2010), See also Michael Lewis, The Big
Short (2010), at 64.
Gemstone 7. The following emails by Mr. Lippmann, written during 2006 and 2007, provide
examples of his negative views.
Emails regarding LBMLT 2004-3 M8, a subprime RMBS security issued by Long
Beach: “[T]his bond blows.”1274 (2/24/2006)
Email providing Deutsche Bank trader his opinion regarding RMBS shelves:
[“[Y]ikes didn’t see that[.] … [H]alf of these are crap and rest are ok[.] …[C]rap-heat
pchlt sail tmts.”1275 (4/5/2006)
Email advising an investment banker at JPMorgan Chase regarding subprime RMBS
securities issued by Aegis Asset Backed Securities Trust (“aabst”), Bay View
Financial Acquisition Trust (“bayv”), Home Equity Mortgage Loan Asset Based
Trust (“inabs”), Park Place Securities Inc. (“ppsi”), and Structured Asset Investment
Loan (“sail”): “This is a good pool for you because it has a fair number of weak
names but not so many that investors should balk (I wouldn’t add more of these) and
also has only a few names that are very good.”1276 (6/23/2006)
Email advising an investment banker at Oppenheimer Funds: “[Y]ou can certainly
build a portfolio by picking only bad names and you have largely done that as Rasc
ahl is considered bad as is Fremont (bsabs fr, fhlt, jpmac fre, sabr fr, nheli fm deals)
ace, arsi and lbmlt.”1277 Mr. Lippmann listed ACE Securities Corp. as a “bad name”
even though it was created by and associated with Deutsche Bank itself.1278
1274 2/24/2006 emails between Greg Lippmann and Rocky Kurita at Deutsche Bank, DBSI_PSI_EMAIL00966290.
Mr. Lippmann’s negative comments did not begin in 2006; as early as May 2005, he wrote that the “real money
flows are buying protection.” 5/11/2005 email from Greg Lippmann to Rocky Kurita at Deutsche Bank,
1275 4/5/2006 email from Greg Lippmann to Deutsche Bank employee, DBSI_PSI_EMAIL01073270. The
acronyms in the email refer to the following lenders: Home Equity Asset Trust (“heat”), People’s Choice Home
Loan Securities Trust (“pchlt”), Structured Asset Investment Loan (“sail”), and Terwin Mortgage Trust (“tmts”).
1276 6/23/2006 email from Greg Lippmann to Derek Kaufman at JPMorgan, DBSI_PSI_EMAIL01344930-33.
1277 8/4/2006 email from Greg Lippmann to Michelle Borre at Oppenheimer Funds, DBSI_PSI_EMAIL01528941-
43. The acronyms in the email refer to the following lenders: Residential Asset Securities Corp. (“Rasc”), American
Home Loans (“ahl”), Fremont (“fr,” “fre,” “fm,” and “fhlt”), Bear Stearns Asset Backed Securities (bsabs),
JPMorgan Acquisition Trust (“jpmac”), Securitized Asset Backed Receivables Trust (“sabr”), Nomura Home Equity
Loan, Inc. (“nheli”), ACE Securities Corp. (“ace”), Argent Securities Inc. (“arsi”), and Long Beach Mortgage Trust
1278 Subcommittee interview of Greg Lippmann (10/18/2010); Subcommittee interview with Deutsche Bank’s
counsel (3/7/2011); 3/21/2011 letter from Deutsche Bank’s counsel to the Subcommittee (ACE is one of “Deutsche
Bank’s own shelf offerings.”), PSI-Deutsche_Bank-32-0001-04. See also 3/2/2011 letter from Deutsche Bank’s
counsel to the Subcommittee (“Deutsche Bank has no ownership interest in ACE Securities Corp. (‘ACE’). All
shares of ACE are held by Altamont Holdings Corp, a Delaware corporation. Deutsche Bank Securities, Inc.
(‘DBSI’), however, is an administrative agent for ACE and in that role has authority to act on behalf of ACE in
connection with offerings of asset-backed securities, including RMBS offerings. … Deutsche Bank hired the
AMACAR Group, LLC (‘AMACAR’) to assist in the creation of ACE to act as a registrant and depositor in
Email to co-head of the Deutsche Bank CDO Group and to Global Head of Deutsche
Bank’s Securitized Product Group: “I was going to reject this [long purchase of a
synthetic CDO] because it seems to be a pig cdo position dump 60^ but then I noticed
winchester [Deutsche Bank affiliated hedge fund] is the portfolio selector…..any
idea???”1279 (8/4/2006)
Email responding to a hedge fund trader at Spinnaker Capital asking about a
subprime RMBS security issued by Credit Based Asset Servicing and Securitization,
LLC (“cbass”): “That said I can probably short this name to some CDO fool.”1280
Email responding to a hedge fund trader at Spinnaker Capital asking about MABS
2006-FRE1, a subprime RMBS security that contained Fremont loans and was issued
by Mortgage Asset Securitization Transactions Asset-Backed Securities Trust: “This
kind of stuff rarely trades in the synthetic market and will be tough for us to cover i.e.
short to a CDO fool. That said if u gave us an order at 260 we would take it and try
to dupe someone.”1281 (9/1/2006)
Email describing MABS 2006-FRE1, a subprime RMBS security that contained
Fremont loans and was issued by Mortgage Asset Securitization Transactions Asset-
Backed Securities Trust, as a “crap bond.”1282 (9/01/2006)
Email describing MSHEL 2006-1 B3, an RMBS security issued by Morgan Stanley
as “crap we shorted”; referring to GSAMP 2006-HE3 M9, an RMBS security issued
by Goldman Sachs, as “this bond sucks but we are short 20MM”; and noting with
regard to ACE, which was created by and associated with Deutsche Bank, that “ace is
generally horrible.”1283 (9/21/2006)
Email responding to a hedge fund trader at Mast Capital: “Long Beach is one of the
weakest names in the market.”1284 (10/20/2006)
Email to a client selecting bonds to short: “u have picked some crap right away so u
have figured it out.”1285
connection with RMBS offerings sponsored and/or underwritten by Deutsche Bank.”), PSI-DeutscheBank-31-0004-
1279 8/23/2006 email from Greg Lippmann to Michael Lamont and Richard D’Albert, DBSI_PSI_EMAIL01605465.
1280 8/30/2006 email from Greg Lippmann to Bradley Wickens at Spinnaker Capital, DBSI_PSI_EMAIL01634802.
1281 9/1/2006 email from Greg Lippmann to Bradley Wickens at Spinnaker Capital, DBSI_PSI_EMAIL02228884.
1282 9/1/2006 email from Greg Lippmann to Bradley Wickens at Spinnaker Capital, DBSI_PSI_EMAIL01645016.
1283 9/21/2006 email from Greg Lippmann to Deutsche Bank employee, DBSI_PSI_EMAIL01689001-02. In an
October 2006 email, a Deutsche Bank employee wrote to Mr. Lippmann and others that a number of RMBS such as
LBMLT, HEAT, INABS, AMSI/ARSI, RAMP/RASC, and CWL “would be impossible to sell to the public” due to
their poor quality. 10/2/2006 email from Axel Kunde at Deutsche Bank to Sean Whelan with copy to Mr.
Lippmann, DBSI_PSI_EMAIL02255361.
1284 10/20/2006 email from Greg Lippmann to Craig Carlozzi at Mast Capital, DBSI_PSI_EMAIL01774820-21.
Email regarding GSAMP 06-NC2 M8, an RMBS security that contained New
Century loans and was issued by Goldman Sachs: “[T]his is an absolute pig.”1286
Email describing ABSHE 2006-HE1 M7, a subprime RMBS security issued by Asset
Backed Securities Corporation Home Equity Loan Trust, as a “crap deal”; and
describing ACE 2006 HE2 M7, a subprime RMBS securitization issued by ACE
Securities Corp., as: “[D]eal is a pig!”1287 (3/1/2007)
When asked about these emails, Mr. Lippmann told the Subcommittee that he generally
thought all assets in CDOs were weak, and that his descriptions were often a form of posturing
while negotiating prices with his clients. In a number of cases, however, Mr. Lippmann was
assisting his clients in devising short strategies or communicating with Deutsche Bank
colleagues, rather than negotiating with clients over prices. As will be seen later in this Report,
some of the RMBS securities he criticized were, at virtually the same time, being included by his
trading desk in Gemstone 7, which was later sold by Deutsche Bank’s CDO Group.
In addition to disparaging individual RMBS securities, Mr. Lippmann expressed repeated
negative views about the CDO market as a whole. At times during 2006 and 2007, he referred to
CDO underwriting activity by investment banks as the workings of a “CDO machine” or “ponzi
scheme.”1288 In June 2006, for example, a year before CDO credit ratings began to be
downgraded en masse, Mr. Lippmann sent an email to a hedge fund trader warning about the
state of the CDO market: “[S]tuff is flat b/c [because] the cdo machine has not slowed but I am
fielding 2-4 new guys a day that are kicking the tires so we probably don’t go tighter.” 1289 A
few months later, in August 2006, Mr. Lippmann wrote about the coming market crash: “I don’t
care what some trained seal bull market research person says this stuff has a real chance of
massively blowing up.”1290
When asked about his comments, Mr. Lippmann told the Subcommittee that the CDO
market was not really a ponzi scheme, because people did receive an investment return, and
asserted that he had used the term because he was “grasping at things” to prove he was right in
his short position.1291
1285 12/4/2006 email from Greg Lippmann to Mark Lee at Contrarian Capital, DBSI_PSI_EMAIL01866336. The
acronyms in the email refer to the following lenders: Bear Stearns Asset Backed Securities (“bsabs”), Option One
Mortgage Loan Trust (“omlt”), and Ameriquest Mortgage Securities, Inc. (“amsi”).
Mr. Lippmann also told the Subcommittee that that while he knew that the
major credit rating agencies had given AAA ratings to an unusually large number of RMBS and
CDO securities and most people believed in the ratings, he did not. He also told the
1286 12/8/2006 email from Greg Lippmann to Peter Faulkner at PSAM LLC, DBSI_PSI_EMAIL01882188.
1287 3/1/2007 email from Greg Lippmann to Joris Hoedemaekers at Oasis Capital UK, DBSI_PSI_EMAIL02033845.
1288 In the 1920s, Charles Ponzi defrauded thousands of investors in a speculation scheme that “involves the payment
of purported returns to existing investors from funds contributed by new investors.” “Ponzi Schemes – Frequently
Asked Questions,” SEC,
1289 6/8/2006 email from Greg Lippmann to Bradley Wickens at Spinnaker Capital, DBSI_PSI_EMAIL01282551.
1290 8/29/2006 email from Greg Lippmann to Bradley Wickens at Spinnaker Capital, DBSI_PSI_EMAIL01628496.
1291 Subcommittee interview of Greg Lippmann (10/18/2010).
Subcommittee that he “told his views to anyone who would listen” but most CDO investors
disagreed with him.1292
In March 2007, Mr. Lippmann again expressed his view that mortgage related assets
were “blowing up”:
“I remain firm in my belief that these are blowing up whether people like it or not and
that hpa [housing price appreciation] is far less relevant than these bulls think. Can’t
blame them because if this blows up lots of people lose their jobs so they must deny in
hope that that will help prevent the collapse. At this price I’m nearly just as short as I’ve
ever been.”1293
(b) Building and Cashing in the $5 Billion Short
Mr. Lippmann did not just express negative views of RMBS and CDO securities to his
colleagues and clients, he also acquired a significant short position on those assets on behalf of
Deutsche Bank. Despite the views of virtually all other senior executives at the bank that RMBS
and CDO securities would gain in value over time, Mr. Lippmann convinced the bank to allow
him to initiate and build a substantial proprietary short position that would pay off only if
mortgage related securities lost value.
Initiating the Short Position. In 2005, Deutsche Bank was heavily invested in the U.S.
mortgage market and, by 2007, had accumulated a long position in mortgage related assets that,
according to Deutsche Bank, had a notional or face value of $128 billion and a market value of
more than $25 billion.1294 These positions had been accumulated and were held primarily by the
Deutsche Bank mortgage department, the ABS Trading Desk, and a Deutsche Bank affiliated
hedge fund, Winchester Capital, which was based in London.1295
Mr. Lippmann told the Subcommittee that, despite the bank’s positive view of the
mortgage market, in the fall of 2005, he requested permission to establish a proprietary trading
1292 Subcommittee interview of Greg Lippmann (10/18/2010).
1293 3/4/2007 email from Greg Lippmann to Harvey Allon at Braddock Financial, DBSI_PSI_EMAIL02041351-53.
On June 23, 2007, Mr. Lippmann wrote to a Deutsche Bank colleague, “Yup this is the beginning of phase 2 (the
bulls still can’t see it), sales by the longs and how do you think the foreign banks will feel when they see that the
true mark for what they have is … this could be the end of the cdo biz.” 6/23/2007 email from Greg Lippmann to
Michael George, DBSI_PSI_EMAIL02584591.
1294 According to Deutsche Bank, as of March 31, 2007, it held a total long position in mortgage related securities
whose notional or face value totaled $127.8 billion, including $4.3 billion at “ABS Correlation London”; $5 billion
at “CDO Primary Issue/New York”; $102 billion at “RMBS/New York”; $7.6 billion at “SPG-Asset Finance/New
York”; and $8.9 billion at “Winchester Capital/London.” 3/2/2011 letter from Deutsche Bank’s counsel to the
Subcommittee, PSI-DeutscheBank-31-0004-06. The market value of those positions was substantially lower. For
example, according to Deutsche Bank, the $102 billion long investment held by its RMBS/New York office had a
market value of about $24 billion. 3/21/2011 letter from Deutsche Bank’s counsel to the Subcommittee, PSIDeutsche_
1295 Id.
position that would short RMBS securities.1296 He explained that he made this request after
reviewing data he received from a Deutsche Bank quantitative analyst, Eugene Xu. He said that
this data showed that, in regions of the United States where housing prices had increased by
13%, the default rates for subprime mortgages had increased to 7%.1297 At the same time, he
said, in other regions where housing prices had increased only 4%, the subprime mortgage
default rates had quadrupled to 28%.1298 Mr. Lippmann explained that he had concluded that
even a moderate slow down in rising housing prices would result in significant subprime
mortgage defaults, that there was considerable correlation among these subprime mortgages, and
that the defaults would affect BBB rated RMBS securities. Mr. Lippmann stressed that his

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