Probe, suit force Goldman to defend actions in crisis

By Zachary A. Goldfarb
Washington Post Staff Writer
Tuesday, April 27, 2010; A11

Most big Wall Street firms sold investments that contributed to the financial crisis. And most suffered in the markets, with some forced out of business.

But it's Goldman Sachs, the bank that not only survived but prospered from the crisis, whose executives are being called before a congressional firing line Tuesday over accusations that the firm bet against the American homeowner, betrayed its clients and helped fuel the financial meltdown.

Chief executive Lloyd C. Blankfein and several current and former deputies will answer questions from the Senate Permanent Subcommittee on Investigations, which has concluded an 18-month probe of Goldman's activities.

Like most other investment banks, the committee charges, Goldman turned high-risk loans into investments, then sold them to customers around the world.

Unlike most others, however, Goldman also profited by betting against the housing market as it began to falter and unloaded bad investments to other parties, according to the committee.

Goldman says its strategy was guided mainly by a desire to hedge risks and avoid the costly fallout that hit other banks.

The Senate panel's findings -- as well as a recent suit by the Securities and Exchange Commission against Goldman for allegedly defrauding clients -- raise the question of whether the bank's actions moderated or magnified the financial crisis.

While it is no doubt true that Goldman's actions protected the firm, the Senate's findings suggest they did so at the cost of others in the market. The panel is not charging that Goldman did anything illegal, but is looking to blame the firm for a role in the meltdown.

"Goldman Sachs was slicing, dicing and selling toxic mortgage-related securities on Wall Street . . . but its executives continue to downplay the firm's role in the financial engineering that blew up the financial markets," said Sen. Carl M. Levin (D-Mich.), chairman of the subcommittee. "Goldman Sachs made billions of dollars from betting against the housing market, and it placed those bets in some cases at the same time it was selling mortgage-related securities to its clients. They have a lot to answer for."

In prepared testimony, Blankfein says the company was trying reduce its overall risk in the mortgage market. He calls the filing of the SEC suit "one of the worst days in my professional life."

Blankfein says the firm never "consistently or significantly net 'short the market' in residential mortgage-related products."

Internal e-mails, however, suggest that the company's actions to short, or bet against, the housing market yielded considerable profit.

A 2007 presentation by the chief risk officer, Craig Broderick, says that "starting early in '07 our mortgage trading desk started putting on big short positions . . . and did so in enough quantity that we're netshort, and made money (substantial $$ in the 3rd quarter) as the subprime market weakened."

A summary of a Goldman board of directors meeting says that "although broader weakness in the mortgage market resulted in significant losses in cash positions, we were overall net short the mortgage market and thus had very strong results."

An e-mail from a mortgage trader named Fabrice Tourre urges his colleagues not to approach "sophisticated" hedge funds about selling them mortgage investments because "they know exactly how things work."

Rather, Tourre suggested that Goldman approach "buy-and-hold ratings-based buyers" who might not do as much research into the investment.

Clients did not take well to Goldman's suggestions.

An e-mail from an unnamed Goldman employee to Daniel Sparks, head of the mortgage unit, says there is a "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."

The recent allegations facing Goldman are twofold. The SEC alleges that Goldman broke the law when it sold a specific mortgage-related investment to clients because it did not disclose key information about the investment to the clients. Goldman disputes this.

The second allegation is that Goldman participated in activity that, although unregulated and legal, spread risk throughout the system and may have only been in the interests of the Goldman executives earning fees.

"Where does the right to engage in profitable projects cross the line?" said Joe Mason, a banking professor at Louisiana State University. "And what are the legal and ethical and moral responsibilities of the underwriter?"

The recent focus on Goldman has been on whether it mistreated its clients by taking out positions against investments it had sold them. Some analysts say that misses the point.

"In political terms, shorting the housing market makes Mom and Dad out there in Middle America very unhappy, and the politicians are responding to this," said Christopher Whalen, an analyst at Institutional Risk Analytics. "It was really Wall Street's creation of deceptive, opaque, impossible-to-value securities that was the problem."

Financial analyst Janet Tavakoli said Goldman's defense that it was trying to hedge risks falls flat.

"But what they were hedging, they had reason to know, shouldn't have been created in the first place," she said.

And she points out that in the process of hedging, Goldman put at risk other big financial firms, such as American International Group, which was on the other side of many of Goldman's bets against the housing market.

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