How Goldman secretly bet on the U.S. housing crash

[one...two...tree 2,762]

By Greg Gordon | McClatchy Newspapers

WASHINGTON — In 2006 and 2007, Goldman Sachs Group peddled more than $40 billion in securities backed by at least 200,000 risky home mortgages, but never told the buyers it was secretly betting that a sharp drop in U.S. housing prices would send the value of those securities plummeting.

Goldman's sales and its clandestine wagers, completed at the brink of the housing market meltdown, enabled the nation's premier investment bank to pass most of its potential losses to others before a flood of mortgage defaults staggered the U.S. and global economies.

Only later did investors discover that what Goldman had promoted as triple-A rated investments were closer to junk.

Now, pension funds, insurance companies, labor unions and foreign financial institutions that bought those dicey mortgage securities are facing large losses, and a five-month McClatchy investigation has found that Goldman's failure to disclose that it made secret, exotic bets on an imminent housing crash may have violated securities laws.

"The Securities and Exchange Commission should be very interested in any financial company that secretly decides a financial product is a loser and then goes out and actively markets that product or very similar products to unsuspecting customers without disclosing its true opinion," said Laurence Kotlikoff, a Boston University economics professor who's proposed a massive overhaul of the nation's banks. "This is fraud and should be prosecuted."

John Coffee, a Columbia University law professor who served on an advisory committee to the New York Stock Exchange, said that investment banks have wide latitude to manage their assets, and so the legality of Goldman's maneuvers depends on what its executives knew at the time.

"It would look much more damaging," Coffee said, "if it appeared that the firm was dumping these investments because it saw them as toxic waste and virtually worthless."

Lloyd Blankfein, Goldman's chairman and chief executive, declined to be interviewed for this article.

A Goldman spokesman, Michael DuVally, said that the firm decided in December 2006 to reduce its mortgage risks and did so by selling off subprime-related securities and making myriad insurance-like bets, called credit-default swaps, to "hedge" against a housing downturn.

DuVally told McClatchy that Goldman "had no obligation to disclose how it was managing its risk, nor would investors have expected us to do so ... other market participants had access to the same information we did."

For the past year, Goldman has been on the defensive over its Washington connections and the billions in federal bailout funds it received. Scant attention has been paid, however, to how it became the only major Wall Street player to extricate itself from the subprime securities market before the housing bubble burst.

Goldman remains, along with Morgan Stanley, one of two venerable Wall Street investment banks still standing. Their grievously wounded peers Bear Stearns and Merrill Lynch fell into the arms of retail banks, while another, Lehman Brothers, folded.

To piece together Goldman's role in the subprime meltdown, McClatchy reviewed hundreds of documents, SEC filings, copies of secret investment circulars, lawsuits and interviewed numerous people familiar with the firm's activities.

McClatchy's inquiry found that Goldman Sachs:

• Bought and converted into high-yield bonds tens of thousands of mortgages from subprime lenders that became the subjects of FBI investigations into whether they'd misled borrowers or exaggerated applicants' incomes to justify making hefty loans.
• Used offshore tax havens to shuffle its mortgage-backed securities to institutions worldwide, including European and Asian banks, often in secret deals run through the Cayman Islands, a British territory in the Caribbean that companies use to bypass U.S. disclosure requirements.
• Has dispatched lawyers across the country to repossess homes from bankrupt or financially struggling individuals, many of whom lacked sufficient credit or income but got subprime mortgages anyway because Wall Street made it easy for them to qualify.
• Was buoyed last fall by key federal bailout decisions, at least two of which involved then-Treasury Secretary Henry Paulson, a former Goldman chief executive whose staff at Treasury included several other Goldman alumni.

The firm benefited when Paulson elected not to save rival Lehman Brothers from collapse, and when he organized a massive rescue of tottering global insurer American International Group while in constant telephone contact with Goldman chief Blankfein. With the Federal Reserve Board's blessing, AIG later used $12.9 billion in taxpayers' dollars to pay off every penny it owed Goldman.

These decisions preserved billions of dollars in value for Goldman's executives and shareholders. For example, Blankfein held 1.6 million shares in the company in September 2008, and he could have lost more than $150 million if his firm had gone bankrupt.

With the help of more than $23 billion in direct and indirect federal aid, Goldman appears to have emerged intact from the economic implosion, limiting its subprime losses to $1.5 billion. By repaying $10 billion in direct federal bailout money — a 23 percent taxpayer return that exceeded federal officials' demand — the firm has escaped tough federal limits on 2009 bonuses to executives of firms that received bailout money.

Goldman announced record earnings in July, and the firm is on course to surpass $50 billion in revenue in 2009 and to pay its employees more than $20 billion in year-end bonuses.

THE BLUEST OF THE BLUE CHIPS

For decades, Goldman, a bastion of Ivy League graduates that was founded in 1869, has cultivated an elite reputation as home to the best and brightest and a tradition of urging its executives to take turns at public service.

As a result, Goldman has operated a virtual jobs conveyor belt to and from Washington: Paulson, as Treasury secretary, sent tens of billions of taxpayers' dollars to rescue Wall Street in 2008, and former Goldman employees populate some of the most demanding and powerful posts in Washington. Savvy federal regulators have migrated from their Washington jobs to Goldman.

On Oct. 16, a Goldman vice president, Adam Storch, was named managing executive of the SEC's enforcement division.

Goldman's financial panache made its sales pitches irresistible to policymakers and investors alike, and may help explain why so few of them questioned the risky securities that Goldman sold off in a 14-month period that ended in February 2007.

Since the collapse of the economy, however, some of those investors have changed their opinions of Goldman.

Several pension funds, including Mississippi's Public Employees' Retirement System, have filed suits, seeking class-action status, alleging that Goldman and other Wall Street firms negligently made "false and misleading" representations of the bonds' true risks.

Mississippi Attorney General Jim Hood, whose state has lost $5 million of the $6 million it invested in Goldman's subprime mortgage-backed bonds in 2006, said the state's funds are likely to lose "hundreds of millions of dollars" on those and similar bonds.

Hood assailed the investment banks "who packaged this junk and sold it to unwary investors."

California's huge public employees' retirement system, known as CALPERS, purchased $64.4 million in subprime mortgage-backed bonds from Goldman on March 1, 2007. While that represented a tiny percentage of the fund's holdings, in July CALPERS listed the bonds' value at $16.6 million, a drop of nearly 75 percent, according to documents obtained through a state public records request.

In May, without admitting wrongdoing, Goldman became the first firm to settle with the Massachusetts attorney general's office as it investigated Wall Street's subprime dealings. The firm agreed to pay $60 million to the state, most of it to reduce mortgage balances for 714 aggrieved homeowners.

Attorney General Martha Coakley, now a candidate to succeed Edward Kennedy in the U.S. Senate, cited the blight from foreclosed homes in Boston and other Massachusetts cities. She said her office focused on investment banks because they provided a market for loans that mortgage lenders "knew or should have known were destined for failure."

New Orleans' public employees' retirement system, an electrical workers union and the New Jersey carpenters union also are suing Goldman and other Wall Street firms over their losses.

The full extent of the losses from Goldman's mortgage securities isn't known, but data obtained by McClatchy show that insurance companies, whose annuities provide income for many retirees, collectively paid $2 billion for Goldman's risky high-yield bonds.

Among the bigger buyers: Ambac Assurance purchased $923 million of Goldman's bonds; the Teachers Insurance and Annuities Association, $141.5 million; New York Life, $96 million; Prudential, $70 million; and Allstate, $40.5 million, according to the data from the National Association of Insurance Commissioners.

In 2007, as early signs of trouble rippled through the housing market, Goldman paid a discounted price of $8.8 million to repurchase subprime mortgage bonds that Prudential had bought for $12 million.

Nearly all the insurers' purchases were made in 2006 and 2007, after mortgage lenders had lifted most traditional lending criteria in favor of loans that required little or no documentation of borrowers' incomes or assets.

While Goldman was far from the biggest player in the risky mortgage securitization business, neither was it small.

From 2001 to 2007, Goldman hawked at least $135 billion in bonds keyed to risky home loans, according to analyses by McClatchy and the industry newsletter Inside Mortgage Finance.

In addition to selling about $39 billion of its own risky mortgage securities in 2006 and 2007, Goldman marketed at least $17 billion more for others.

It also was the lead firm in marketing about $83 billion in complex securities, many of them backed by subprime mortgages, via the Caymans and other offshore sites, according to an analysis of unpublished industry data by Gary Kopff, a securitization expert.

In at least one of these offshore deals, Goldman exaggerated the quality of more than $75 million of risky securities, describing the underlying mortgages as "prime" or "midprime," although in the U.S. they were marketed with lower grades.

Goldman spokesman DuVally said that Moody's, the bond rating firm, gave them higher grades because the borrowers had high credit scores.

Goldman's securities came in two varieties: those tied to subprime mortgages and those backed by a slightly higher grade of loans known as Alt-A's.

Over time, both types of mortgages required homeowners to pay rapidly rising interest rates. Defaults on subprime loans were responsible for last year's housing meltdown. Interest rates on Alt-A loans, which began to rocket upward this year, are causing a new round of defaults.

Goldman has taken multiple steps to put its subprime dealings behind it, including publicly saying that Wall Street firms regret their mistakes. Last winter, the company cancelled a Las Vegas conference, avoiding any images of employees flashing wads of bonus cash at casinos.

More recently, the firm has launched a public relations campaign to answer the criticism of its huge bonuses, Washington connections and federal bailout. In late October, Blankfein argued that Goldman's activities serve "an important social purpose" by channeling pools of money held by pension funds and others to companies and governments around the world.

KNOWING WHEN TO FOLD THEM

For investment banks such as Goldman, the trick was knowing when to exit the high-stakes subprime game before getting burned.

New York hedge fund manager John Paulson was one of the first to anticipate disaster. He told Congress that his researchers discovered by early 2006 that many subprime loans covered the homes' entire value, with no down payments, and so he figured that the bonds "would become worthless."

He soon began placing exotic bets — credit-default swaps — against the housing market. His firm, Paulson & Co., booked a $3.7 billion profit when home prices tanked and subprime defaults soared in 2007 and 2008. (He isn't related to Henry Paulson.)

At least as early as 2005, Goldman similarly began using swaps to limit its exposure to risky mortgages, the first of multiple strategies it would employ to reduce its subprime risk.

The company has closely guarded the details of most of its swaps trades, except for $20 billion in widely publicized contracts it purchased from AIG in 2005 and 2006 to cover mortgage defaults or ratings downgrades on subprime-related securities it offered offshore.

In December 2006, after "10 straight days of losses" in Goldman's mortgage business, Chief Financial Officer David Viniar called a meeting of mortgage traders and other key personnel, Goldman spokesman DuVally said.

Shortly after the meeting, he said, it was decided to reduce the firm's mortgage risk by selling off its inventory of bonds and betting against those classes of securities in secretive swaps markets.

DuVally said that at the time, Goldman executives "had no way of knowing how difficult housing or financial market conditions would become."

In early 2007, the firm's mortgage traders also bet heavily against the housing market on a year-old subprime index on a private London swap exchange, said several Wall Street figures familiar with those dealings, who declined to be identified because the transactions were confidential.

The swaps contracts would pay off big, especially those with AIG. When Goldman's securities lost value in 2007 and early 2008, the firm demanded $10 billion, of which AIG reluctantly posted $7.5 billion, Viniar disclosed last spring.

As Goldman's and others' collateral demands grew, AIG suffered an enormous cash squeeze in September 2008, leading to the taxpayer bailout to prevent worldwide losses. Goldman's payout from AIG included more than $8 billion to settle swaps contracts.

DuVally said Goldman has made other bets with hundreds of unidentified counterparties to insure its own subprime risks and to take positions against the housing market for its clients. Until the end of 2006, he said, Goldman was still betting on a strong housing market.

However, Goldman sold off nearly $28 billion of risky mortgage securities it had issued in the U.S. in 2006, including $10 billion on Oct. 6, 2006. The firm unloaded another $11 billion in February 2007, after it had intensified its contrary bets. Goldman also stopped buying risky home mortgages after the December meeting, though DuVally declined to say when.

I'VE GOT A SECRET

Despite updating its numerous disclosures to investors in 2007, Goldman never revealed its secret wagers.

Asked whether Goldman's bond sellers knew about the contrary bets, spokesman DuVally said the company's mortgage business "has extensive barriers designed to keep information within its proper confines."

However, Viniar, the Goldman finance chief, approved the securities sales and the simultaneous bets on a housing downturn. Dan Sparks, a Texan who oversaw the firm's mortgage-related swaps trading, also served as the head of Goldman Sachs Mortgage from late 2006 to April 2008, when he abruptly resigned for personal reasons.

The Securities Act of 1933 imposes a special disclosure burden on principal underwriters of securities, which was Goldman's role when it sold about $39 billion of its own risky mortgage-backed securities from March 2006 to February 2007.

The firm maintains that the requirement doesn't apply in this case.

DuVally said the firm sold virtually all its subprime-related securities to Qualified Institutional Buyers, a class of sophisticated investors that are afforded fewer protections than small investors are under federal securities laws. He said Goldman made all the required disclosures about risks.

Whether companies are obliged to inform investors about such contrary trades, or "hedges," is "a very hot issue" in cases winding through the courts, said Frank Partnoy, a University of San Diego law professor who specializes in securities. One issue is how specific companies must be in disclosing potential risks to investors, he said.

Coffee, the Columbia University law professor, said that any potential violations of securities laws would depend on what Goldman executives knew about the risks ahead.

"The critical moment when Goldman would have the highest liability and disclosure obligations is when they are serving as an underwriter on a registered public offering," he said. "If they are at the same time desperately seeking to get out of the field, that kind of bailout does look far more dubious than just trading activities."

Another question is whether, by keeping the trades secret, the company withheld material information that would enable investors to assess Goldman's motives for selling the bonds, said James Cox, a Duke University law professor who also has served on the NYSE advisory panel.

If Goldman had disclosed the contrary bets, he said, "One would have to believe that a rational investor would not only consider Goldman's conduct material, but likely compelling a decision to take a pass on the recommendation to purchase."

Cox said that existing laws, however, don't require sufficient disclosures about trading, and that the government would do well to plug that hole.

In marketing disclosures filed with the SEC regarding each pool of subprime bonds from 2001 to 2007, Goldman listed an array of risk factors that grew over time. Among them was the possibility of a pullback in overheated real estate markets, especially in California and Florida, where the most subprime loans had been made.

Suits filed by the pension funds, however, allege that Goldman made materially false or misleading statements in its public offerings, failing to disclose that many loans were based on inflated appraisals and were bought from firms with poor lending practices.

DuVally said that investors were fully informed of all known risks.

"What's going to happen in the next few years," said San Diego's Partnoy, "is there's going to be a lot of lawsuits and judges will have to decide, should Goldman have disclosed more or not?"

(Tish Wells contributed to this article.)

Read more: http://www.mcclatchy...l#ixzz0lSCrvxFq

[Ali G. 37]

Interesting how tea-party advocates never read such articles.

Where is Lucktxn? As he seems to condone such sort of practices and call it capitalism. I'd rather be labeled "socialist" than be allowed to #### my own country and it's people, for my own personal gain. Actions that hopefully one day will be considered treason against the country and 'we the people'

Edited April 18, 2010 by Ali G.

[luckytxn 2,265]

So pretty much Goldman seems to have been smart and placed bets that the market would crumble. Since they had no crystal ball to know for sure they spent money to cover their rears. They could have lost this money if the market stayed going great but their foresight made them a bundle. I think this is a company that is worth investing in.

Every since I was young I knew that most securities firms always covered their rears just in case. It is an old tactic. Goldman did so and should be thanked.

[I AM NOT THAT GUY 5,715]

When the tech-rich Nasdaq crashed in 2000, losing nearly 80% of its value, plummeting from 5,000 to a low of 1,130 by Nov. 2002, hedge funds, like Paulston & Co., shorted tech stocks, crashing the market. Had Paulson been connected with insiders at the Nasdaq surely the SEC would have cried foul. Hedge funds bet against derivatives in 2007, eventually tanking the real estate market, causing defaults, bankruptcies and the run-on-the-bank, eventually seizing up credit at Wall Street’s biggest banks, investment houses and institutions. Hedge fund short-sellers like Paulson contributed to the financial collapse prompting Federal Reserve Board Chairman Ben S. Bernanke, President Barack Obama, Treasury Secretary Tim Geithner and certain key members of Congress to demand radical changes to the country’s banking system, including reinstating the depression-era Glass-Steagall Act.

Important parts of Glass Steagall were relaxed in 1999 under former President Bill Clinton, when Congress passed the Gramm-Leach-Bliley Act, permitting bank holding companies to engage in risky stock market investing. When Goldman Sachs encouraged Paulson to short CDOs in 2007, the stock and real estate markets collapsed, causing the cash crisis at major financial institutions. Calling derivatives “exotic trades,” Goldman executive Fabrice Tourre boasted about creating “without necessarily understanding all of the implications of those monstrosities,” which Paulson shorted in 2007-08. Paulson paid Goldman Sachs $15 million to devise investments designed to fail, selecting bands of subprime mortgages [loans for unqualified borrowers] and creating collateralized debt obligations. Several domestic and European banks lost billions on these risky investments.

SEC’s crackdown on Goldman Sachs is long overdue. While Goldman denies any wrongdoing cherry-picking rotten investments to bet against for Paulson, it’s clear that an inappropriate relationship existed. Goldman finds nothing wrong with creating investments to fit the investment strategy of its clients, in Paulson’s case, short-selling. Paulson made billions betting against CBOs, hammering down bank stocks, collecting insurance payments and then buying them back at bargain prices. “It was Goldman that made the representations to investors,” said SEC Enforcement Director Robert Khuzami, explaining why Paulson was not charged with fraud, ignoring the insider relationship. It’s not legal for investment firms to custom make investments at the request of clients to dupe investors. While Goldman Sachs sold risky derivatives, Paulson shorted the investments and made billions.

Goldman Sachs was the first to point fingers at former Nasdaq Chairman Bernard Madoff for his $60 billion Ponzi scheme. Now that Goldman Sachs has been exposed, it’s hard to know what’s worse: A Madoff-lke Ponzi scheme or a Goldman Sachs fraudulent security built on carefully cherry-picked bad investments, like subprime mortgages? Allowing Paulson to make billions on short-selling is an affront on every legitimate investor, seeking reasonable returns on real investments. It surely isn’t legal or ethical to ask a Wall Street investment firm to create an investment designed to fail so you can make billions selling short. Paulson made $15 billion in 2007 short-selling CBOs. He made another 3.79 billion in 2008 shorting bank stocks, especially those with high portfolios of derivative mortgage-backed securities. Both Goldman Sachs and Paulson were equally culpable.

http://www.examiner.com/x-45268-LA-City-Buzz-Examiner~y2010m4d18-Goldman-Sachs-Piracy

Who was it again that cried the sky is falling?

Henry Paulson’s bank bailouts, done under “great stress” during the worst financial crisis since the Great Depression, failed to win for U.S. taxpayers what Warren Buffett received for his shareholders by investing in Goldman Sachs Group Inc.

The Treasury secretary made 174 purchases of banks’ preferred shares that include warrants to buy stock at a later date. While he invested $10 billion in Goldman Sachs in October, twice as much as Buffett did the month before, Paulson gained certificates worth one-fourth as much as the billionaire, according to data compiled by Bloomberg. The Goldman Sachs terms were repeated in most of the other bank bailouts.

Paulson’s decisions to prop up the financial system included purchasing shares in institutions from Goldman Sachs, the most profitable Wall Street firm last year, to Saigon National Bank, a Westminster, California, lender whose market value is $3.8 million.

http://www.bloomberg.com/apps/news?pid=20601087&sid=aAvhtiFdLyaQ

[Pooky 3,880]

Goldman?

Oscar Goldman?

Where's Steve Austin when you need him?

[I AM NOT THAT GUY 5,715]

Selling Bionic Ears, but I thought Jamie was the one with the hearing problem.

[scandal 951]

Both Goldman Sachs and Paulson were equally culpable.

...

Who was it again that cried the sky is falling?

...

Henry Paulson’s bank bailouts, done under “great stress” during the worst financial crisis since the Great Depression, failed to win for U.S. taxpayers what Warren Buffett received for his shareholders by investing in Goldman Sachs Group Inc.

Someone is being very silly again. Apparently missed seeing this rather important bit in the OP:

New York hedge fund manager John Paulson was one of the first to anticipate disaster. He told Congress that his researchers discovered by early 2006 that many subprime loans covered the homes' entire value, with no down payments, and so he figured that the bonds "would become worthless."

He soon began placing exotic bets — credit-default swaps — against the housing market. His firm, Paulson & Co., booked a $3.7 billion profit when home prices tanked and subprime defaults soared in 2007 and 2008. (He isn't related to Henry Paulson.)

Yes, the subprime housing collapse is rather complicated, but do try to keep up. John Paulson, the Paulson of Paulson&Co hedge fund in the Examiner article a few posts back, HAS ABSOLUTELY NOTHING TO DO with Hank Paulson, Treasury Secretary under Bush who put TARP and the bank bailouts into place. Oh, neither Paulson is a Nazi, either. But don't let that prevent you from clouding the issues by posting a few Nazi pictures while you're at it.

[I AM NOT THAT GUY 5,715]

They both went to Harvard, and both are culpable:

http://www.dailyfinance.com/story/taxes/the-hedgie-and-the-treasurer-a-tale-of-two-paulsons/19443536/

[scandal 951]

They both went to Harvard, and both are culpable:

http://www.dailyfinance.com/story/taxes/the-hedgie-and-the-treasurer-a-tale-of-two-paulsons/19443536/

Ah. So another lame attempt at guilt by association. Both went to Harvard. So did George W Bush (Harvard Business) and Barack Obama (Harvard Law)- so they're guilty too, right? You make less and less sense as you go along.

Meanwhile, now we know which of the two parties is in favor of taking the fight to Goldman, and which is happy to lick their smelly feet.

SEC Said to Vote 3-2 to Sue Goldman Sachs Over CDO Disclosures

By Jesse Westbrook

April 19 (Bloomberg) -- The U.S. Securities and Exchange Commission split 3-2 along party lines to approve an enforcement case against Goldman Sachs Group Inc., according to two people with knowledge of the vote.

SEC Chairman Mary Schapiro sided with Democrats Luis Aguilar and Elisse Walter to approve the case, said the people, who declined to be identified because the vote wasn’t public. Republican commissioners Kathleen Casey and Troy Paredes voted against suing, the person said.

The SEC on April 16 accused Goldman Sachs, the most profitable company in Wall Street history, of creating and selling collateralized debt obligations in 2007 tied to subprime mortgages without disclosing that hedge fund Paulson & Co. helped pick the underlying securities. Goldman Sachs also didn’t disclose to investors that Paulson was betting against the securities, the SEC said.

SEC spokesmen John Nester and Myron Marlin didn’t immediately return a phone call and e-mail seeking comment.

Last Updated: April 19, 2010 14:34 EDT

[I AM NOT THAT GUY 5,715]

Both went to Harvard. So did George W Bush (Harvard Business) and Barack Obama (Harvard Law)

Wow! The plot thickens...

[Ali G. 37]

So pretty much Goldman seems to have been smart and placed bets that the market would crumble. Since they had no crystal ball to know for sure they spent money to cover their rears. They could have lost this money if the market stayed going great but their foresight made them a bundle. I think this is a company that is worth investing in.

Every since I was young I knew that most securities firms always covered their rears just in case. It is an old tactic. Goldman did so and should be thanked.

Did you even read the article? Here is another for you http://www.dailyfinance.com/story/credit/dodd-calls-on-republicans-to-support-financial-reform-bill/19445365/?icid=sphere_copyright

Securities and Exchange Commission case filed on Friday against Goldman Sachs (GS) for selling risky mortgage-backed securities without disclosing that the investments were partly selected by a hedge fund manager who made billions of dollars betting that the underlying securities would fail.

It's the equivalent of someone selling you a car and not telling you the brakes on it are faulty. Then taking out a life insurance policy on you. Actually, numerous corporations in America already do that with their workers. That is, take out life insurance policies on them and then cash in when they die. But hey, as you said socialism is the bad guy. Whereas such practices by private corporations against constitutionally protected Americans is just good business right.

[Hilarious Clinton 452]

It was a surprise that the bubble would burst? Damn, people are stupid.

[SuperDuper! 230]

It was a surprise that the bubble would burst? Damn, people are stupid.

It must be such a relief to NOT have those gallstones following you around anymore. We could not believe Steve for hanging on for so long!

[scandal 951]

It was a surprise that the bubble would burst? Damn, people are stupid.

Glad you're so smart to set us all straight.

Do a search on the word "surprise" anywhere in the OP or the posts that follow it, up until yours. You know what? It does not appear. The thread is not about any "surprise" that the bubble would burst, it's about Goldman's deceit. But of course you knew that. Because you're smart.