Goldman Sachs (GS) Group Inc., which survived the U.S. real estate collapse five years ago with the help of derivative bets against subprime mortgages, is promoting the opposite trade to clients as housing recovers.
The firm, which teamed with four other dealers to create the ABX indexes, benchmark contracts that offered investors a way to protect against the risks of a crash, said in a Nov. 28 report on its top 10 market themes for 2013 that clients should buy some of the derivatives.
Home prices are recovering from a six-year slump, helped by Federal Reserve efforts to push mortgage rates to record lows and buyers competing for a shrinking supply of properties. The bank’s analysts said after “the positive surprise” from housing this year, versions of the ABX that have already rallied are still attractive compared with real estate investments such as homebuilder shares, which have almost doubled over the past 12 months.
“You’re going to get a further lift because of the steady improvement in the indexes’ underlying assets and the housing market,” said Adrian Miller, a fixed-income strategist at GMP Securities LLC in New York. “Yes, there’s room to go, but how much juice is left in the trade is another question.”
The credit-default swaps enabled speculators to bet against housing, and helped meet demand from investors for the high yields of loans to homeowners with poor credit. As the credit crisis grew, investors followed the price of the contracts as a gauge of losses at banks and hedge funds.
Goldman Sachs has taken a more bullish view on housing since at least March, when it was raising money for a new fund to buy home-loan bonds to benefit from an improving real-estate market.
The group sold their stockpile of subprime bonds and collateralized debt obligations, and bought credit-default swaps protecting against losses, according to the panel.
They “quickly shot past ‘home,’” leading to their first large net short position in February 2007, the report said. By June, the net short position reached a peak of about $13.9 billion, including $9 billion in ABX bets against top-rated bonds that Goldman Sachs had earlier acquired as “disaster protection,” in case the subprime market as a whole lost value, the subcommittee calculated.
The resulting position was referred to by Viniar as the “big short,” a term later used as the title of a Michael Lewis book about the financial crisis.
As the worst housing slump since the 1930s deepened and millions of Americans failed to meet mortgage payments, the ABX index linked to the 2006 mortgages fell to as low as 23.3. While banks, including Bear Stearns Cos., struggled, Goldman Sachs posted record earnings in 2007.