In rare letter to shareholders, Goldman denies double-dealing

McClatchy NewspapersApril 7, 2010 

WASHINGTON — Goldman Sachs' top officers denied in a letter to shareholders made public Wednesday that the company bet against investors who bought its subprime mortgage securities in 2006 and 2007 as the firm readied itself for a sharp drop in the U.S. housing market.

The eight-page letter opening the firm's 2009 annual report comes as the world's most prestigious investment bank seeks to rebuild its image in the face of negative publicity over executive bonuses and two federal investigations into its subprime dealings.

Goldman "did not generate enormous net revenues or profits by betting against residential mortgage-related products, as some have speculated," Chief Executive Lloyd Blankfein and President Gary Cohn said.

"Rather, our relatively early risk reduction resulted in our losing less money than we otherwise would have when the residential housing market began to deteriorate rapidly."

Goldman made the earliest and safest exit of any major Wall Street firm from that market for mortgage securities backed by loans to marginally qualified homebuyers. When it crashed, Goldman recorded $1.7 billion in related losses.

The Permanent Investigations subcommittee of the Senate Homeland Security and Governmental Affairs Committee began an investigation of Goldman's mortgage securities dealings in response to a McClatchy series in November. McClatchy reported that Goldman had marketed more than $40 billion of securities tied to risky home loans in 2006 and 2007 while secretly betting on a downturn in the housing market.

People familiar with the Senate inquiry and a separate Securities and Exchange Commission investigation, who declined to be identified because of the sensitivity of the matter, said that both probes relate to Goldman's alleged use of exotic insurance-like contracts known as credit-default swaps to make contrary bets against its own mortgage products.

Blankfein and Cohn said that their firm made bets, using swaps and other instruments, as part of its role as a "market maker," in which it executes both long and short trades on behalf of clients. After covering clients' positions, they said, Goldman might take risks in "thousands of different instruments at any given time" to vigilantly "keep exposures in line with risk limits" established by senior management.

"We are not 'betting against'" clients, they wrote.

Legal experts have said that investors might not have bought the mortgage securities if they'd known that Goldman was betting in the other direction.

Goldman took out credit-default swaps worth as much as $22 billion with global insurance giant American International Group before the housing market began its sharp slide in late 2007, the first stage of what snowballed into a global financial crisis.

When the underlying securities began to decline in value, Goldman required AIG to post $7.5 billion in cash. In late 2008, when the federal government committed $182 billion to save AIG from collapse, Goldman wound up collecting an additional $12.9 billion from AIG for the swaps and other deals.

Blankfein and Cohn said that, because Goldman had required AIG to post collateral as the securities lost value, the firm's "direct exposure to AIG was minimal."

They also emphasized the company's recent decision to revise compensation policies to hold employees "accountable for the future impact of their decisions."

Despite record profits of $13.4 billion in 2009, bonuses for Blankfein, Cohn and 28 other top executives were limited to restricted stock — $9 million in shares each for Blankfein and Cohn — that they can't sell for five years.

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Goldman's letter to shareholders

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McClatchy Newspapers 2010

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