Archive | May, 2010

How to Get Me to Follow You on Twitter & Why

23 May

Perhaps I should have titled this post “how NOT to get me to follow you on Twitter.”  Sure, lets go with that.

First, before I even consider following someone, I check their profile.  Your profile should have at the very-least a few words about you and preferably a hyperlink to your website (since most of you have one these days, but its ok if you don’t).  I don’t care if your name is “GS_PMD” or something, if you don’t have a bio, you stand little chance of getting followed.  I make exceptions, but they are few and far between, i.e. if a substantial number of people I respect/follow already follow you or if you need no introduction (e.g. you’re a CNBC anchor).

Second, there’s nothing wrong with mixing business and personal tweets.  I’d rather follow people who act like people than those who act like robots that are all business, all the time.  However, I don’t need to know every song you’re listening to all day.  I don’t need to know your sexual predilections, however if you make it funny and/or can make it relevant, go for it.  For entity sites like @WSJ, @FT, @whateverco, I don’t expect alot of color, and that’s fine, but I sure as hell love that @sportscenter tweets just like the anchors speak.  Political correctness and staidness be damned!

Third: don’t spam.  This can take several forms, whether its serial autofellatio, following everyone and anyone (in hopes of gaining as many followers as possible, aka the “Tila Tequila” approach), or whatever.  Just be freaking normal, ok?  If you write something or want to tweet the same thing more than once, that’s fine, so long as its practiced with restraint, for example, tweeting a new post in the morning and again in the evening.  That, I don’t mind, since very few of us are staring at the screen all day long and may legitimately miss something worth seeing.  I say this with the caveat that, just like with email or any other distribution method, shameless self-promotion will quickly render you unfollowable, or, if I’m following you already, unfollowed, if not blocked if you’re a real schmuck about it.

Fourth: Don’t be an arrogant prick.  Really, I can’t say it any more clearly.  Its one thing to strongly advocate a position, analysis, or opinion; that’s good, shows conviction.  Hell, if you support something, I expect you to freakin’ fight for it!  However, its another thing altogether to be stubborn, and worse, offensively stubborn to the point of being presumptuous.  No one knows everything, about everything, all the time. I certainly don’t, and openly admit so (really, go check my history if you don’t believe me).  I expect the same modesty out of the people I follow.  Tangentially related to this point, please, try not to be a hypocrite.  I’m surely guilty of being one, myself sometimes, but I make an active effort to self-police, and frankly hope if I’m caught, people will call me out on it!  Rest assured, if I see egregious hypocrisy, I’ll call you out on it (nicely, at least at first).  Lets keep each other honest here, cool?

Now, getting to why I actually DO follow people, the most important thing is the quality of the content (the same message you’ll see in our “about” page here on Stone Street Advisors, which should come as no surprise to anyone).  I’m of the mindset (perhaps naively) that its pretty obvious to almost anyone with half a brain after a relatively short time who is worth following for what subject, and who isn’t.  Ideally, I like to follow people who give valuable insight about whatever it is they’re tweeting, whether its a single-name investment observation or a quip about Lindsay Lohan being a role model for young girls.  Again, funny/interesting is better so long as it doesn’t kill the content.

Well, this turned out far different than I intended when I started it in the early AM hours today, but hopefully someone, somewhere got something out of this little rant.  To summarize: Be honest, (as) upfront (as possible), smart, prescient, and preferably, entertaining.  Otherwise, I’m probably not going to follow you.


I should have added, a few things, in no particular order:

If you want me to follow you (or continue following), you better be able to debate the merits of an argument while avoiding ad hominem attacks.  Of course, no one is perfect – we’re human, after all – but if you can’t or won’t make an effort, I’m not going to follow you.   Simply: Grow some damn skin.  We’re inevitably going to engage in debates that get intense and we’ll be on different sides.  In the heat of the moment, sometimes we cross the line from argument to personal attack.  Its subconscious most of the time, but it happens.  That’s not to endorse such behavior – quite the opposite –  just acknowledging human nature.  If it happens, shrug if off, apologize, kiss and make up, whatever.  Life goes on, and debates via twitter (or via whatever medium) shouldn’t ruin relationships.

Whether you tweet under your true identity, under a pseudonym, or some combination thereof makes no difference to me.  Either way your reputation is based upon the content you produce, and to a lesser extent, the way you go about producing it.  @Kiddynamiteblog (etc) didn’t get invited to go speak with Treasury Department officials last year for nothing.  You’re probably not reading this right now because I’m some famous “big name.”  I’m not going to get into it here since I’ve beat it to death elsewhere, but I cannot stress it enough: if you don’t realize that anyone who tweets (or blogs, or generally publicly states his/her opinion) has a reputation at stake, then I’m probably not going to end up following you.

Which gets me to my last point: If you aren’t going to stand behind what you say, tweet, whatever, don’t freaking say it.  I’ve gone through a bunch of my old tweets, and I’ve said some pretty stupid, short-sighted stuff that in hindsight, I’d like to take back.  But I said it, and so it remains, as it should, in my opinion.

That is all.


Dear Krugman: We Are Greece

17 May

Professor Krugman, in your op-ed piece at WSJ titled “We’re Not Greece” on May 13, you raise some valid points, but in all respect sir, I don’t think that you really see what’s going on out “in the trenches”.

Point 1 (US As a Safe Haven):

In your article, you specifically state: “One answer is that we have a much lower level of debt — the amount we already owe, as opposed to new borrowing — relative to G.D.P. True, our debt should have been even lower. We’d be better positioned to deal with the current emergency if so much money hadn’t been squandered on tax cuts for the rich and an unfunded war. But we still entered the crisis in much better shape than the Greeks.

True, the amounts that we already owe (which in all fairness ballooned during the Bush years to fund 2 wars, which you discuss in your article) were relatively low compared to the GDP rate at that time under much rosier growth assumptions. The record rate of change of the national debt in the past 2 years relative to a deteriorating “real” GDP has changed the picture considerably. When you have such a large structural problem of unemployment, is it really fair to attribute the transfer payments from the Government to the official GDP figures to say that we are growing? Programs like ‘Cash For Clunkers’ basically takes future growth and pushes it ahead to the present, which truly distorts the underlying picture.

If our Government cannot reduce the rate of change of spending for the country, all we are doing is keeping our foot on the accelerator in a Toyota that has bad brakes. Eventually, at some point we are going to run out of road or gas. If we can reduce the rate of change in spending (i.e. slowly take our foot off the accelerator), we can at least attempt to bring our debt problems in line. I haven’t seen that from our administration and their plans for the future.

Point 2 (The US Has A Clear Path To Recovery)

You state “The U.S. economy has been growing since last summer, thanks to fiscal stimulus and expansionary policies by the Federal Reserve. I wish that growth were faster; still, it’s finally producing job gains — and it’s also showing up in revenues. Right now we’re on track to match Congressional Budget Office projections of a substantial rise in tax receipts. Put those projections together with the Obama administration’s policies, and they imply a sharp fall in the budget deficit over the next few years.

I have to disagree with you. Based on my research out in the trenches (collar counties of Chicago and Chicago proper, as well as the boroughs of NYC) I don’t see real economic growth. The small businesses that I talk to do not see growth. The throngs of unemployed people (many of whom are long term unemployed) do not see real growth in terms of jobs. Yes, there are jobs being created Mr. Krugman, but those jobs are temporary in nature. Many state unemployment rules dictate that you must work X hours before becoming eligible to receive unemployment benefits (again), however these ‘temporary’ jobs have a duration that lasts just typically under that requirement. So, while the recipient of that temporary job has immediate income coming in, that income will not be put as quickly injected back into the overall economy. The temporarily employed person (hopefully) is going to save that money (almost assuredly the wages will be substantially lower than the person’s previous job) because they know that within X period of time, they will be back at square one. Many will try to reduce their debt burden, which, inherently is a good thing, but they will find themselves back at square one once the temporary job is over. Census workers are a case in point. The ‘growth’ that is occurring in the jobs market is only short term, and I’m willing to bet that when the Census is completed, you’re going to see a spike in the unemployment rate, which will reverse the “gains” made during the 1st and 2nd quarters of this year.

CBO’s projections of a substantial rise in tax receipts is laughable, as are the projections of the Obama administration. If business spending is constrained due to arduous regulations designed to stifle growth, that is going to ripple through the economy. The incomes of the employed people won’t grow in this environment, which means that the amounts of taxes collected by the Government will decrease. I implore you to ask a middle class worker in the Chicago area which suffers from a crippling structure of taxes (City, County, State, Federal – similar to NYC, only our taxes at the City and County levels are substantially higher) what an increase in taxes at the Federal level will do to their ability to spend.

Point 3: “We Demand More Than We Pay For”

In your op-ed, you blast the assertion that many people are making in calling for the reduction in entitlement programs. You state: “That said, we do have a long-run budget problem. But what’s the root of that problem? “We demand more than we’re willing to pay for,” is the usual line. Yet that line is deeply misleading.  First of all, who is this “we” of whom people speak? Bear in mind that the drive to cut taxes largely benefited a small minority of Americans: 39 percent of the benefits of making the Bush tax cuts permanent would go to the richest 1 percent of the population.

Greece has the same entitlement problem, most notably people thought that they could work for 40 years and that the Government would be there for them to “bail them out” and provide them all with cushy pensions in their retirement years. The same thing goes for the average US citizen, who has already shown that they cannot accept personal responsibility for their actions. You saw it with the housing bubble: when prices were rising, people took all of the credit for building their “net worth” – what’s worse, they kept leveraging up and discussing it at cocktail parties about how many HELOC’s they had. When the music stopped, instead of accepting responsibility for their borderline reckless behavior (some of it actually borders on the edge of criminality – knowingly lying about one’s income, debt levels in order to obtain that HELOC to keep up with their counterparts at cocktail parties), these same people, many of whom actually get a tax “refund” and therefore don’t really pay any taxes (or very little at all) cried foul at the easiest target around – us evil bankers.

My point is simple, Professor Krugman: If you had 40-50 years in which to save for your retirement, and you chose not to do so, collective society should not have to pay extra taxes for you to continue to try to live your life keeping up with the Joneses. Everyone decries leaving debt around for future generations, however this is what is happening today. The younger generation, with already unacceptably high unemployment rates (around 27%) is now being forced to pay for those who have had their shot at the brass ring of life. While we are trying (hopefully) to save for our retirements so that we don’t end up in the cycle of depending on the Government to subsidize our way of life into retirement, we are being saddled with paying for the previous generation who failed to do so and now look to absolve all personal responsibility and shift the blame to someone else.

If the economy doesn’t see robust growth, which I honestly don’t believe we will—growth that creates real (not Government or temporary) jobs (remember, Government must create clear, business-friendly regulations that do not penalize or demonize businesses for becoming successful), we are going to find ourselves in the same position as Greece. The debt issued over the last 2 years in addition to the 8 years of debt created is not going to go down. We will become a nation that is much like the person who pays the minimum monthly balance (almost 100% interest), kicking the can down the road so that future generations are paying for the mistakes that the existing generations have created. Did President Obama say in his campaign that “he was not going to kick the can down the road” several times? What are we doing presently?

What’s so different about Greece, where people dodge paying taxes, but still believe that they are entitled to be taken care of by the Government while saddling the younger generation with all of the burden for their past mistakes? There has to be some vicious cuts to these entitlement programs – it will not be popular, it will be very painful, but it should serve as a lesson to future generations of what not to do. It should hopefully engrain in the younger generation that it is up to them to save for their retirements. Financial literacy needs to improve vastly in this nation to achieve that. What we do now will determine the next century for this nation.


Krugman, Paul – “We’re Not Greece“, Wall Street Journal Op-Ed, May 13, 2010 –

Newest Addition to the Team, Taste_Arbitrage: Flash Crash

14 May

I have tried my best to keep my frustrations to myself over the course of the past week but it has simply become too much. Before the super terrific congressional blue ribbon panel starts to impose all sorts of rules on the trading of securities, I thought it would be helpful if I cleared some things up about the “flash crash” and the number of things people are blaming it on.

The straw that broke the camel’s back as far as my patience was concerned is this nugget from an anonymous NYSE floor trader I have a host of problems with this drivel. First and foremost, to those of you who have never ventured onto the NYSE floor and my have some delusions of grandeur from seeing CEO’s ring opening bells or old videos of traders singing ‘Wait till the sun shines, Nellie’, I am sorry to ruin your fantasy but it is a goddamn graveyard down there. I went on a prep school field trip and was simply amazed by how many people continue to grasp at it like it is a viable way to make a living, and that was ten years ago. I was also on the Boston Stock Exchange a few weeks before they closed down and it is clear that is not the way to trade. To paraphrase Danny Devito’s speech from ‘Other People’s Money’ I am sure this guy makes the best goddamn buggy whip you ever saw, but this business is dead.’ There should be zero floor traders anywhere. Next up, there was by no means a “wiping out $1 trillion in wealth” in a matter of minutes. Fluctuations in price do not wipe anything out, especially when they rebound almost instaneously. If that is going to be a point of contention then there should never be any selling of securities ever. Markets are not established to go up ad infinitum, they are to exchange securities at prices that counterparties see fit. David Weidner, resident asshat at the WSJ, felt the need to reprint people blaming it on the shadow banking system. Since clearly he and whomever raised that point have no idea what that means I highly recommend they read Paul McCulley’s latest GCB piece out of PIMCO. He invented the term and it has absolutely nothing to do with brokerages pricing equities. Please, do some level of homework before you start spewing of conspiracy theories about market structure.

I could try to explain to you what did happen and contrary to what you may be reading today it was not all because of some mystery trader at Waddell & Reed. However a far better run down of the entire thing has already been covered. Barry Ritholtz posted the play by play from another young institutional analyst. Although we differ on the true problem here, he gives a very clear view of how things transpired last Thursday. “So what happened here? Three things:

1. Sellers probably had orders in algorithms – percentage-of-volume strategies most likely, maybe VWAP – and could not cancel, could not “get an out.” These sellers could be really “quanty” types, or high freqs, or they could be vanilla buy side accounts. It really doesn’t matter. The issue here is that the trader did not anticipate such a sharp price move and did not put a limit on the order. The fact that the technology may have failed does not mean the
trader deserves a do-over, it means that the trader and the broker who provided the algorithm need to decide whether any losses should be split.

2. Sell stop orders were triggered which forced market sell orders into an already well offered market.

3. While the market was well offered, it was not well bid. Liquidity disappeared. For example, in P&G, 200 shares traded at $44.10 at 2:51:04 in the afternoon and one second later, at 2:51:05, three hundred shares traded at $47.08. That’s a three dollar jump in one second. Bids disappeared, spreads blew out, and no one was trading except a handful of orphaned algo orders, stop sell orders, and maybe a few opportunists who had loaded up the order book with low ball bids (“just in case”). High frequency accounts and electronic market makers were, by all accounts, nowhere to be found.”

for his entire piece (which I advise any and all to read) here it is at Barry’s blog

I keep hearing how terrible this event was, and if nothing is changed it could happen again. Oh no, what ever shall we do?! Here’s a thought, if you think the price of a security is too low and you think it’s insane that it doesn’t seem to have a bid, you should just go ahead and bid. That’s it. If the price is too low, pay it and make money. Only one group of people on earth that should be upset about what happened last week are PM’s like Tony Welch that the WSJ looked at earlier this week They are guys who saw what they thought to be a price irregularity and pounced on it, only to get their trade cancelled for no reason whatsoever by people making up rules ex post facto. Especially when another PM that sits within spitting distance of his desk gets his fill cleared because he was a minute later and didn’t get as good of a price. I know a lot of people are under the impression that “regular investors” could be hurt by drastic market moves like this, but since the overwhelming majority of that buy side money is with large institutions guess what, they are all trading electronically with algos too, because it is the best way to do things. It’s faster, it’s cheaper, and most of all it helps these bohemouths keep from showing their side and getting front run all day. If somebody decides to put market orders out there they need to understand what they are doing and live with the consequences of that. It only hinders markets to do things like implement circuit breakers or time stops to let people that are too slow to catch up and adjust accordingly. It could easily lead to the sort of problems that are often seen in commodity markets where nothing trades for days or weeks on end because these measures get triggered immediately and the markets force zero liquidity on the day in the name of orderly price movement. Prices do not and should not move in any orderly fashion, they should move however the fuck they see fit.

What happened last week was simply markets correctly repricing risk during a day which had a whole host of unfavorable variables. In doubt? I recommend you take a look at LIBOR-OIS over the past two weeks.Risk was simply becoming more expensive. If you don’t want to be a part of that don’t trade on electronic exchanges. It had no ill effects on long term investors. It may have hurt the PnL on a few intraday traders but I must reiterate that is the only way exchanges work. They are prone to drastic swings when new information enters and that is a good thing. If anyone believes they have a better idea of how something should be priced they should simply participate and make money off of their knowledge.

That said, happy hunting out there.


Macro View: Double Dipping

14 May

Quick Synopsis

  • I expect that the US economy will double dip into a recession in the back half of 2010
  • By 2012, the US will be forced to take drastic austerity measures, including severe cuts to entitlement programs
  • The risk of a debt downgrade for the US increases substantially in the first half of 2011

I have to start off by saying thanks to @Prof_Pinch for the lively macroeconomics discussion last night, it definitely got my mind thinking. He posted a rather interesting chart showing the M3 supply in Europe breaking a historical trend to the downside. Another chart showed Japan’s monetary supply, which subsequently stopped growing and was relatively flat throughout much of the lost decade. That got me thinking about the US’s prospects of a “lost decade”. We face many of the same problems as Greece, mainly the vast amount of entitlement programs that exist. The only difference is that we don’t have (relatively) widespread tax evasion. But, we have a more perplexing issue that has been sorely exposed during this downturn: a large population of people utilizing entitlement programs with a shrinking base of people to pay for said entitlement programs. That is going to force the US to undertake austerity measures eventually that makes the ones that the Greeks are currently undertaking look easy.

The problem is a complex one, but the key risks that I see for the US in the coming 5 years are:

  1. Persistently high unemployment in the population under 50 will result in substantial declines to government tax receipts
  2. Increased risk of a double dip recession as the transfer payments enacted under EUC 08 begin to trail off (i.e. people begin to exhaust unemployment transfer payments at an accelerating rate) resulting in less spending to stimulate the economy
  3. Inflation will begin to skyrocket, further weakening the buying power of those remaining in the population who are the key to pulling us out of a recession
  4. Bank credit will remain extremely tight
  5. Regulatory risk with a detrimental impact on small business innovation and job creation across all sectors of the economy.

More Spending, But Less Economic Growth

Personal Savings

From the chart you can see that while the savings rate experienced a record jump during the crisis vs. previous recessionary periods, I want to draw your attention to the record low savings rates after the 2001 recession and during the housing boom. That spending is what drove the economy out of previous recessions (and also played a part in why the personal balance sheets of many Americans is now obliterated). The rate of change away from saving and back into spending is at the levels that got us out of the 2001 recession, and appear to be well on their way to getting back to the 2004-2006 levels. However, economic growth remains sluggish. The amount of people on unemployment who are receiving transfer payments from the government are, by default not saving that cash. So, we have transfer payments coming into the economy in addition to those who are in the position to spend cash (while sacrificing their savings) but we have sluggish growth. One potential explanation could be that the consumer’s purchasing power has been substantially weakened, so those same amount of dollars from 2001 and 2004-2006 levels are weaker than today. I tend to highly discount the Government’s official measure of “inflation” as you can clearly see the consumer’s dollar has been weakened just by taking a stroll through your local grocery store. For the sake of fairness, high tax municipalities like Chicago (Cook County) and NYC also add to the weakening of consumer purchasing power.


This chart offers another perspective on the savings rate by overlaying it with the non-farm payrolls numbers. As the onset of the crisis began, before we witnessed a large number of job losses, the savings rate spiked to over 650 billion. Over the past few recessions, the savings rate has spiked as people initially clamp down on spending over economic uncertainty, but then confidence returns and they begin to spend again. This is economics 101, more demand for products usually means more hiring (except where “productivity gains” play an increasing factor). While I won’t delve into the whole “productivity” scenario, it’s importance in this recent downturn and recovery is pretty significant. Quite simply, the US has maximized productivity so much that we have basically automated ourselves out of entire workforce sectors. That partially explains why the deluge of spending in the economy has failed to produce the growth needed to result in a meaningful increase in payrolls and a significant drop in the headline unemployment rate.

Monetary Supply

This is what we were discussing yesterday evening. Consider the following chart:


While Europe has broken the uptrend in terms of monetary supply, we in the US are fortunate enough that we still have a bit to go in terms of breaking the trend. However, we are close. If that happens, and the rate of change in the deterioration of the monetary supply accelerates to the downside, I believe that a shrinking monetary supply (excluding the printing presses running constantly in DC) puts us at increased odds of a double dip. That assertion may be a stretch, and I must admit that I am straining to really make it “fit”, but when I add this up with what’s discussed above I believe this just shows the strain that we are under. Looking at @Prof_Pinch’s charts out of Europe and Japan further reinforces that – we know that the Eurozone is in trouble, and Japan is also in trouble of seeing slower growth. If they deteriorate further, so will we. China is in the midst of a 2006-type bubble that will pop, so it’s not quite prudent to continue to depend on them to float the consumption lifestyle of the USA.

On Materiality, Goldman, Abacus $GS

12 May

As my last post stated, the SEC – absent some sort of damning evidence we’ve yet to see – has its hands full proving Goldman’s lack of disclosure of Paulson & Co’s involvement in the Abacus CDO was material and amounts to fraud. They’re up against some interesting precedents, for example, TSC Industries Inc v. Northway, Inc, in which the judge’s logic went as follows, and found (see,_Inc._v._Northway,_Inc.):

“If the test was too stringent, it would cause the dismissal of otherwise meritorious lawsuits; if it were too lenient, corporate officers would be inclined to overwhelm shareholders with such a large volume of information that truly valuable facts might escape them. He formulated the test as follows: an omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote. In other words, the court must determine whether under all the circumstances, the omitted fact would have assumed actual significance in the decision of the shareholder. Thus, materiality is a mixed question of fact and law.”

As I’ve argued, I don’t buy that full, explicit disclosure of Paulson’s involvement would have changed anything (excepting perhaps, as Steve Randy Waldman said, if IKB decided they’d be violating their mandate, but thats another conversation altogether).

I’ll try to post some more later,

On The SEC’s ABACUS Case Against Goldman Sachs

8 May

Back in Sophomore (maybe Junior) year Finance class, we learn some very basic approaches to investment analysis. Before we ever touch upon analytical methods, we learn high-level stuff, for example, first and foremost you should analyze a potential investment on its merits; extraneous information is, at best, of secondary, tertiary, or just no concern. If I’m considering buying the ABACUS synthetic CDO deal at the heart of the SEC’s case against Goldman, my primary focus is to analyze the RMBS transactions in the reference portfolio selected by ACA (NOT Paulson – ACA could have throw out EVERY/ANY security Paulson suggested if they thought it was a crap bond), the structure of the deal. Once I’ve done the granular analysis of EVERY bond in the reference portfolio – as close to loan-level as possible, especially with the 20+ person diligence team that IKB reportedly employed – and decided everything looked good, then and only then would I get into other considerations. Have we covered all our bases? Are we missing anything? What are other smart people doing with this/similar transactions?

I firmly believe this story pretty cut & dry: IKB/ACA/ABN did their diligence (well, let’s give them the benefit of the doubt they did, at least) and determined they wanted to buy the deal. They had the blessing of the Ratings Agencies (which, with the wisdom of hindsight – key word – we know was not a very bright idea), they had other “smart” people reinforcing their view (long live confirmation bias!), and the financial industry, as a whole, was generally still long housing.

Anyone who claims that the buyers (longs) would have backed-out if they knew some no-name Hedge Fund manager with ZERO mortgage investing experience suggested part of the reference portfolio is material is full of it. The buyers were arrogant, over-confident in their experience and ability to analyze complex structured finance transactions. Hell, if they WERE made explicitly aware of Paulson’s “involvement” they probably would have enjoyed a good, hearty laugh at his expense and quite possibly even bought MORE of the deal when they knew they were up against such a rube, a novice, a guy in WAY over his head.

One person on the other side of this debate says that in order for me to make such a claim I must be either clairvoyant or have worked on IKB’s deal team in 2007. While I think that’s a bit of a non-sequitur, I’ll allow it, and then accuse the SEC of the same apparent psychic abilities. How on Earth do they presume to prove what IKB WOULD have done? How could anyone prove what they WOULD have done in the past? Sure, I WOULD have prepared differently for the GMAT’s if I knew I was going to run out of time on the math section, but I didn’t KNOW that would be the outcome, since I knew the material very well. Similarly, IKB “KNEW” structured finance RMBS investing, they just didn’t know or expect the outcome we know so well with the benefit of hindsight.

That’s it. Everything else is irrelevant. IKB knew the material that was going to be on the test (the composition of the reference portfolio and all other relevant deal information), they had the ability (experienced deal team) to prepare for the test (analyze the deal), they just came to what turned out to be the wrong conclusion, and didn’t do as well as they expected.

Ultimately, whether Paulson’s involvement will be decided in court, and what I have to say is, unfortunately, just words on a page.  I agree there is the possibility that when all of the information is made available (emails, etc), there may have been an intent to deceive, or scienter,but that’s for the courts/lawyers/etc to decide.

Update: Since I published this in haste (my bad), I should have rephrased the bolded text three paragraphs up, to ask “How does the SEC believe they can use the ‘reasonable person’ test in this situation?”  That is, this is a market, which by definition necessarily includes two parties both of whom believe themselves to be reasonable with different, nay, opposing views.   Thanks to @_phlox for the legal edit.