Wall Street powerhouse Goldman Sachs helped create a housing bubble by selling securities backed by risky subprime mortgage loans and then profited off that bubble's bursting by secretly betting against the market, a Senate investigation has found.
A day before a high-profile hearing featuring numerous Goldman Sachs officials, the Senate Permanent Subcommittee on Investigations released a flurry of excerpts from internal bank documents that the panel says show that the embattled firm misled the American public about its role in the build-up to the financial crisis in September 2008.
"The evidence shows that Goldman Sachs helped build and operate that conveyor belt that fed toxic mortgages and mortgage securities into the financial system and then made large bets against the market that it helped create -- taking the big short, and reaping the profits from it," the panel's chairman Sen. Carl Levin said at a briefing today.
"In doing so, it sold to its clients products that it clearly no longer believed in. The ultimate harm here is not just to the clients that were not well served by their investment bank -- the harm here is to all of us. The toxins that Goldman Sachs and others have helped inject into the financial system have done incalculable harm to people."
In summary, Levin said, "They misled the country."
In testimony prepared for the subcommittee's hearing, Goldman Sachs CEO Lloyd Blankfein defended the firm against the panel's findings.
"We didn't have a massive short against the housing market and we certainly did not bet against our clients. Rather, we believe that we managed our risk as our shareholders and our regulators would expect," he said.
Blankfein said while Goldman did find the last two years of the financial crisis to be profitable, it lost about $1.2 billion "from activities in the residential housing market."
Blankfein also thanked the government for Goldman's $10 billion share of the hundreds of millions of dollars of Troubled Asset Relief Program funds invested by the government into U.S. banks at the height of the financial crisis in 2008.
"I want to express my gratitude and the gratitude of our entire firm. We held the government's investment for approximately eight months and repaid it in full along with a 23 (percent) annualized return for taxpayers," he said.
Goldman's Short E-mails
In early 2007, Goldman e-mails reveal, the firm decided to take short positions -- in other words, to bet against -- the mortgage market, after the firm had sold billions of dollars worth of securities comprised of risky loans that would soon go sour.
In a 2007 performance review, Goldman's Josh Birnbaum, former managing director of the structured products group, wrote, "I concluded that we should not only get flat, but get VERY short. ... Much of the plan began working by February as the market dropped 25 points and our very profitable year was underway."
An e-mail from Blankfein in early 2007 asked, "Could/should we have cleaned up these books before and are we are doing enough right now to sell off cats and dogs in other books throughout the division."
The e-mails, Levin said, contradict the firm's claims that it did not make a directional bet on the mortgage market. In fact, Levin said, the e-mails show that the bank had made a "tactical decision" to short the market, a decision that ultimately helped it rake in a hefty profit.
As 2007 went on, the housing market worsened -- and Goldman's profits grew. The downturn, said Goldman's chief financial officer David Viniar in an e-mail in July 2007, "tells you what might be happening to people who don't have the big short."
"Short mortgages," Viniar e-mailed to Blankfein, "saved the day."
The more the loans backing the securities they had sold started to sour, the more Goldman profited. One e-mail to Michael Swenson in May 2007 referenced one mortgage-backed security that had gone bad.
"Bad news ... wipes out the m6s and makes a wipeout on the m5 imminent ... costs us about 2.5 [million dollars] ... good news ... we own 10 [million dollars] protection on the m6 marked at $50…we make 5 [million dollars]," he wrote, referring to the successive failure of tranches of mortgage-backed loans.
In October 2007, a presentation by chief risk officer Craig Broderick said, "Starting early in '07 our mortgage trading desk started purring on big short positions ... and did so in enough quantity that we were net short, and made money (substantial $$ in the 3rd quarter) as the subprime market weakened."
Said Levin, "Goldman profited while the market dropped, taking many Goldman clients with it, not to mention the damage that was done to the U.S. economy."
The firm's gains left its employees gloating. In Michael Swenson's performance review for the year, he said, "The 2007 year is the one that I am most proud of to date ... extraordinary profits (nearly $3bb to date) ... [D]uring the early summer of 2006 it was clear that the market fundamentals in subprime and the highly levered nature of [collateralized-debt obligations] was going to have a very unhappy ending."
The e-mails, Levin emphasized, fly in the face of the bank's public statements that it did not make "a significant amount of money in the mortgage market."
"There is no doubt they made huge money betting against the market in 2007," Levin said, arguing that the bank had made $3.7 billion in all.
Goldman's 'Really Bad Feeling'
But other parties involved in Goldman's deals were left hurting. At a time when many other banks were hemorrhaging money in the midst of the subprime market's collapse, Goldman was raking in the cash. The firm, however, had not been forthcoming with its clients, Levin said today.
In October 2007, an employee said in an e-mail to Daniel Sparks, the former head of Goldman's mortgage department, "Real bad feeling across European sales about some of the trades we did with clients. The damage this has done to our franchise is very significant."
But the most high-profile case of Goldman misleading clients involves banker Fabrice Tourre, charged by the SEC with misleading investors.
The feds have alleged that Goldman did not tell investors that a massive hedge fund, Paulson & Co., that had hand-picked the subprime mortgages that went into the investment was also betting against those same securities. The bank has aggressively defended itself against the agency's investor fraud charges.
Now, Levin said, internal bank documents show that Goldman knew that Paulson had designed the portfolio and bet against it.
"They knew about Paulson's involvement in the selection. They knew Paulson was going short. Their own documents show that," Levin said.
In an e-mail exchange between Tourre and Sparks in early 2007, the two employees wrote, "Gerstie and I are finishing up engagement letters with ACA and Paulson for the large RMBS COO ABACUS trade that will help Paulson short senior tranches." "Still reputational risk."
Another e-mail from Tourre to Birnbaum in May 2007 said, "100% Baa2 RMBS selected by ACA/Paulson."
Within nine months of the ABACUS 2007-AC1 deal, 99 percent of the mortgages in the portfolio had been downgraded, a near-perfect failure rate. Investors lost more than $1 billion on the deal while Paulson raked in $1 billion.
Goldman earned $15 million for its part in the transaction.
Hearing to Be Held Tuesday
"They misled the country, I believe, and they were not fair to their customers," Levin said.
Over the course of the panel's 18-month investigation into Goldman, which has included two subpoenas, committee aides said they had obtained around two million documents. Asked if the panel had met with witnesses such as Tourre over the weekend, an aide would only say that they have met with a number of Goldman executives over the past few weeks.
On Tuesday morning the panel's much-anticipated hearing will start at 10 a.m. with witnesses including Blankfein, Tourre, and five others from the firm.
Levin today said he will wait until after the hearing to decide whether to refer the panel's findings to the Justice Department and the SEC for possible criminal charges.
Also today, the Michigan lawmaker responded to the firm's accusations that the panel had cherry-picked certain documents to portray the bank in a negative manner.
"We believe that the documents we present fairly and accurately describe what happened," he said.
And he added that Goldman, in his mind, was not alone in its actions.
"We think a number of banks engaged in similar conduct."