WASHINGTON — In December 2006, Goldman Sachs embarked on a frantic effort to shed billions of dollars in risky mortgage securities and purchase exotic insurance to protect itself against what it had concluded could be the collapse of America's housing market.
Yet for nine months, until Sept. 20, 2007, the Wall Street giant didn't disclose its actions in key filings with the Securities and Exchange Commission, in telephone conferences with analysts or in its press releases.
A McClatchy review of hundreds of pages of subpoenaed company records released by a Senate panel Tuesday, as well as Goldman's SEC filings, has revealed how closely the company guarded its secret exit plan.
Goldman's failure to tell the investors who bought its risky mortgage securities that it had made an array of wagers against housing is at the heart of the furor now enveloping the nation's premier investment house, the only major Wall Street firm to exit the subprime mortgage market with minimal damage.
By the time Goldman finally began to divulge its strategies to the SEC, credit markets were freezing up and the investment bank was well on its way to making billions of dollars in revenue from its negative bets, known in the industry as "shorts."
Consider this contrast between the firm's public face and its private maneuvering.
On March 7, 2007, Goldman's chief financial officer, David Viniar, chaired an internal meeting of the company's risk committee. Notes of the meeting report that the committee discussed the "accelerating meltdown" among subprime mortgage lenders, the progress of the company's mortgage division in "closing down every subprime exposure possible" and signs that subprime woes were beginning to affect commercial real estate.
Sheara Fredman, a vice president in the company's finance division, also sent Viniar "talking points" in advance of the firm's quarterly earnings announcement stressing that that its short bets had enabled Goldman's mortgage division to earn $266 million during the quarter despite the deteriorating subprime market.
During the March 13 conference call with analysts, however, Viniar made no mention of Goldman's short bets or the $266 million gain. Instead, he said the market had seen "a little bit of nervousness" but the housing weakness had been "so far largely contained."
It's still unclear whether the federal laws designed to protect consumers from deceptive marketing required Goldman to reveal more information earlier than it did.
Goldman spokesman Samuel Robinson said: "We are not required to disclose individual trading positions. Rather, we disclose the financial performance of the firm. In this regard, net revenues from the residential mortgages business represented around 1 percent of the firm's total net revenues in 2007."
The wagers, however, saved Goldman from billions in losses.
SEC disclosure rules revolve around the idea that information that's "material" to a company's or an investment's fortunes should be disclosed, but it's not clear whether Goldman will face legal liability for choosing not to reveal its exit plan to its shareholders, who benefited from the strategy.
However, Goldman's limited disclosures in the offering circulars it gave the investors that bought its mortgage securities could cause legal problems.
At issue is whether Goldman's bets against the housing market were so "material," or relevant to investors, that their disclosures could have convinced them not to buy its products. Without purchasers for its risky securities, Goldman's exit strategy would have flopped.
Materiality in such cases "is a complicated, mixed question of law and fact, decided on a case-by-case" basis, said Frank Partnoy, a University of San Diego law professor, "and we won't know the answer until a judge rules."
Asked why Goldman disclosed in late 2007 but not earlier, that it had been "net short" for most of the year, company spokesman Robinson said: "Companies don't report on every single area of activity in every quarter."
He said that the September 2007 disclosure was in response to "intense investor and analyst interest."
Goldman has stressed that it limited its mortgage dealings to Qualified Institutional Investors such as pension funds and insurance companies that have fewer legal rights to disclosure about securities' risks.
Goldman's decision to retreat from the cresting housing market came at a senior-level meeting Viniar organized on Dec. 14, 2006, after its mortgage traders reported losses for 10 straight days.
The day after the meeting, Goldman mortgage chief Dan Sparks instructed his team in an e-mail to reduce the company's inventory of billions of dollars in risky mortgage loans, to cash out losing bets that home prices would keep rising, to monitor the current value of its offshore mortgage securities more closely and to "be ready for the good opportunities that are coming."
Three days later, Fabrice Tourre, the mortgage trader who's now a defendant in the SEC suit, wrote that his unit had "a big short on."
As the traders escalated their bets against the housing market in the ensuing weeks, Goldman President Gary Cohn and other top executives paid close attention.
As subprime mortgage lenders began to collapse under the weight of rising loan defaults, Goldman was cashing in.
In a Feb. 22, 2007 e-mail, Sparks told traders Josh Birnbaum, Michael Swenson and David Lehman to cash in $3 billion in bets.
"You called the trade right, now monetize a lot of it," he wrote. "You guys are doing very well." During the same period, Goldman marketed more than $11 billion in securities backed by risky mortgages — $4.8 billion in ubprime loans to questionable borrowers, and $6.2 billion in so-called Alt A loans, a slightly less risky category whose borrowers had low credit scores, according to company prospectuses filed with the SEC.
Goldman's "short" bets, which it began to place as early as 2005, were carried out using insurance-like contracts known as credit-default swaps. Goldman would pay an annual premium that usually amounted to 1 to 2 percent of the face value of the contract but collect big if the securities collapsed.
The newly released Goldman records show that it executed the strategy by:
_ Selling bundles of securities in the Cayman Islands. At least 16 of these deals included exotic bets on subprime securities in which Goldman would profit if the underlying loans defaulted. Goldman stood to make $2 billion if one deal, known as Hudson Mezzanine SP, cratered. The securities initially received the top investment-grade rating of Triple A on Dec. 27, 2006, but had been reduced to junk status on July 31, 2008.
_ Using swaps to make short bets on companies tied to the housing market. According to a person familiar with these bets, Goldman wagered against: Washington Mutual, Inc., which later collapsed in the biggest bank failure in U.S. history; Countrywide Mortgage, Fremont General Corp. and National City Corp., subprime lenders that failed, and Wall Street investment banks Bear Stearns and Merrill Lynch, both of which were rescued by taxpayers after running up huge mortgage debt.
_ Making huge short bets by buying swaps on a subprime index on the private London exchange that it helped create and profiting when defaults rose in a basket of 20 subprime mortgages.
Despite the drama inside 85 Broad Street, Goldman's former headquarters, what the company released to the public in its quarterly disclosure statements was less than dramatic.
In its first quarter 2007 public earnings release, Goldman observed "significant weakness" in the subprime sector, but Viniar said those problems thus far had been "largely contained."
During the first half of 2007, Goldman continued to peddle exotic deals pegged to the performance of mortgage-backed securities while it shorted other aspects of the mortgage market. Several offshore deals were given priority over those requested by clients, the Senate investigators found.
In an e-mail pressing the sales staff to unload a deal called Timberwolf, a top Goldman mortgage executive urged the marketing team to "get 'er done," promising "ginormous credits" as a reward. The value of the product later plummeted.
In June 2007, Goldman soft-peddled its increasingly dark view of the mortgage market. In a quarterly filing to the SEC, the company glossed over the calamity its traders were seeing on a daily basis, reiterating that, "The broader credit environment remained strong, although the subprime sector within the mortgage market continued to be weak."
When Viniar spoke with analysts, he added that the mortgage business _ in the context of all of Goldman's business _ "is just not that big."
Yet in an internal e-mail on July 25, when Cohn wrote him to point out big write-offs in subprime mortgages, Viniar responded: "Tells you what might be happening to people who don't have the big short."
In September, Goldman finally acknowledged its short position _ although other documents and its internal e-mails indicate that the company had been net short for most of the year.
"Significant losses on non-prime loans and securities were more than offset by gains on short mortgage positions," the company reported on Sept. 20. When he spoke to analysts about those results, Viniar said that the company's overall "short position was profitable." But, he added that under the company's policy not to reveal any unit's results: "I can't tell you the actual profits of the shorts."
Not until October, after the SEC's accounting branch pressed Goldman for more details of its subprime exposure, did Goldman reveal in a letter that it held a net short subprime position "during most of 2007 . . . and therefore stood to benefit from declining prices in the mortgage market."
A week later, Goldman's controller, Sarah Smith, informed the SEC that between Nov. 24, 2006, and Aug. 31, 2007, Goldman had reduced its investment in subprime mortgages from $7.8 billion to $462 million.
In short, Goldman turned a potential financial catastrophe into a profit. On Tuesday, Blankfein said the firm's net profit from its mortgage business was less than $500 million.
The uproar over Goldman's behavior reached a crescendo this week, when the Senate Permanent Subcommittee on Investigations took sworn testimony from Goldman chief executive Lloyd Blankfein and six other current and former company executives.
It also was disclosed that the Justice Department is considering a criminal inquiry of whether Goldman fraudulently misled investors in its subprime mortgage deals.
These developments came after the SEC filed a civil fraud suit April 16 against the company and one of its vice presidents, Fabrice Tourre. Both have denied wrongdoing.
During the 10-hour Senate hearing, Blankfein and the other company executives denied that Goldman had bet massively "short" on the housing market. Blankfein also said that Goldman had merely acted as a market maker carrying out its clients' wishes.
Michigan Democratic Sen. Carl Levin, the panel chairman, pilloried Blankfein for failing to own up to his firm's harm to clients that absorbed huge losses on subprime securities peddled by Goldman's sales crew, some of whom privately derided several of its deals as "junk," "shitty" and "crap" in internal e-mails.
Subcommittee members from both political parties were infuriated that Blankfein and Viniar refused to acknowledge that Goldman's net short bets against the housing market, peaking at $13.9 billion on June 25, 2007, amounted to a huge negative wager.
"The question is did you bet big-time in 2007 against the housing mortgage business? And you did," Levin told Blankfein.
"No, we did not," Blankfein shot back.