Chapter 6. Shell Games (Beware of Geeks Bearing Grifts)


I've looked at the prospectuses, and they are not easy to read. If you want to understand the deal you'd have to read around 750,000 pages of documents.

 --Warren Buffett to Janet Tavakoli, January 10, 2008

On August 5, 2005, two days after Warren and I set up our meeting, Matthew ("Matt") Goldstein, at the time a senior writer for, wrote about problems with mortgage-backed CDOs. Eliot Spitzer, then New York Attorney General, had just sent Bear Stearns Co. (Bear Stearns) a subpoena. Hudson United, a small New Jersey bank, had tried to sell mortgage-backed CDOs it bought in 2002 back to Bear Stearns, the underwriter and seller of the CDOs. Hudson discovered its CDO investments were worth only a small fraction of the "market prices" that Bear Stearns had supplied Hudson up until it tried to sell them back.

In April 2005, I addressed the International Monetary Fund in Washington about the hidden risks of off-balance-sheet vehicles, securitizations, and the failure of the rating agencies to reflect these risks in their ratings. Sophisticated investors are baffled by the complexity; even multistrategy hedge funds such as Chicago-based Citadel had contacted me about securitizations. I told Goldstein that investors seemed to rely on ratings and rarely ask how the underlying assets are priced or whether they will get full price if they need to sell the investment: "There are huge transparency issues. In some cases, investors ...

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