Posted on Wed, Apr. 13, 2011
last updated: March 15, 2013 11:58:13 AM
WASHINGTON — Goldman Sachs, which paid $550 million last summer to settle federal fraud charges from an offshore mortgage deal, failed to tell investors in a second, $2 billion bundle of risky mortgage securities that it was secretly betting on their default, a Senate panel charged Wednesday.
When the securities' value plunged, Goldman reaped a $1.35 billion profit at the expense of its investors, the Permanent Investigations Subcommittee said in a scathing summary of a two-year investigation into the chain of deceit and greed that caused the nation's financial crisis.
Democratic Sen. Carl Levin of Michigan, the subcommittee chairman, accused the Wall Street giant of deep conflicts of interest, "abusive practices" toward its investors and "disgraceful" tactics in exiting the subprime home loan market.
At a marathon hearing last year, Levin charged that Goldman's top brass secretly encouraged the firm's traders to make huge "short" bets against the housing market before it began to crash in 2007. Goldman Chief Executive Officer Lloyd Blankfein denied Levin's assertion that the firm was "massively short."
Levin said that the subcommittee would refer to the Justice Department and the Securities and Exchange Commission, for possible enforcement action, the testimony of witnesses at four sets of hearings into the financial meltdown last year, including that of Blankfein and half a dozen other Goldman executives.
Levin also indicated that he'd recommend other, more specific referrals to prosecutors, but neither he nor his aides would describe them.
Goldman spokesman Michael DuVally said the company's executives gave "truthful and accurate" testimony, but also issued a statement suggesting the world's leading investment bank had been chastened.
"While we disagree with many of the conclusions of the report, we take seriously the issues explored by the subcommittee," he said.
While Goldman was the centerpiece of the 639-page report and 700 newly disclosed documents, the panel's investigators laid out a tableau of abuses, malfeasance and profiteering, focusing on a few major financial industry players, unlike the recent sweeping report of the Financial Crisis Inquiry Commission.
"Using emails, memos and other internal documents," Levin said, "this report tells the inside story of an economic assault that cost millions of Americans their jobs and homes, while wiping out investors, good businesses and markets."
Detailing four case studies pieced together from millions of subpoenaed documents, the report assailed leaders of Washington Mutual, the Seattle thrift that collapsed in the biggest bank failure in U.S. history; federal regulators who neglected to rein it in, and Wall Street credit ratings agencies that buckled to pressure and big bucks from investment banks, blessing their risky mortgage securities with Triple-A ratings.
In addition, it took the Germany's Deutsche Bank to task for peddling mortgage securities scorned as "crap" and "pigs" by one of its senior executives, Gregg Lippmann, who referred to the broad market for risky mortgages as a "Ponzi scheme." Lippmann secretly bet as much as $5 billion of the company's money on a sharp drop in the value of mortgage securities, reaping $1.5 billion in profits to offset some of the bank's heavy mortgage losses.
Unlike the crisis inquiry commission, which fractured in partisan disputes, the Senate subcommittee report was presented as fully bipartisan. Republican Sen. Tom Coburn of Oklahoma, the ranking minority member, joined Levin at a news conference, decrying the expenditure of over $8 million on the independent commission "that didn't report anything of significance."
Coburn also assailed Congress for failing to police the financial industry.
"We can prevent the next one of these from happening if Congress does its job," Coburn said.
How regulators treat the report will determine whether Goldman's legal troubles stemming from its hasty exit from the subprime mortgage market in late 2006 and 2007 could reach a new crescendo or are now behind it.
The SEC sued Goldman in April 2010, accusing the firm and one of its young executives, Fabrice Tourre, of helping a hedge fund client dupe foreign investors in an exotic $1 billion deal that amounted to a bet on the performance of a package of home mortgage securities.
Upon settling the case in July for $550 million, Goldman said that SEC officials had completed reviews of its other deals and saw no need for further enforcement action.
The subcommittee report, however, accuses Goldman of conflicts of interest in three other deals in which it allegedly withheld key information from clients, the most serious known as Hudson Mezzanine-2006-1.
According to the report, Goldman executives selected the securities that would be included in the $2 billion deal with no input from investors, which included the Wall Street investment bank Morgan Stanley. Goldman didn't disclose that it would be holding the "short" position — betting on the default of the securities, even when a representative of one investor, the National Australia Bank, directly asked, it said.
Goldman used the deal "to transfer the risks" of $1.2 billion in risky home loans to investors, the report said. Goldman not only rid itself of risky assets, but also wound up with net profits of $1.35 billion, the report said.
A spokeswoman for Morgan Stanley, which lost most of its $1.5 billion investment, declined comment.
The report specifies Goldman's legal duties to sell investors only "suitable" products and to disclose "material information that a reasonable investor would want to know." Levin acknowledged, however, that federal law enforcement agencies have yet to successfully prosecute a single person on Wall Street as a result of the economic meltdown.
But, he said, "There's still time. Hope springs eternal."
The report added new flesh to the litany of tales of greed and neglect fueling the housing bubble whose bursting sank the economy. For example:
_ Two Washington Mutual loan offices in Los Angeles were writing subprime loans with such soaring default rates that company officials reported their failures to higher-ups. Not only was no disciplinary action taken, but also the loan officers were rewarded with trips to Hawaii for setting sales records.
_ Internal Washington Mutual documents lifted any mystery about the reason the firm plunged into the subprime market. According to the company's data, upon sale of a subprime mortgage to investors or Wall Street, the firm booked a 1.5 percent gain on sale, more than seven times the 0.19 percent gain from selling a conventional, fixed-rate mortgage.
_ Mass ratings downgrades by Moody's Investors Service and Standard & Poor's in July 2007 exposed the risky nature of mortgage investments that the same ratings agencies considered to be as safe as Treasury bills a few months earlier. But internal emails show that the credit rating agencies knew their ratings wouldn't "hold," yet delayed taking action "to preserve market share."
_ Goldman was net "short" by more than $10 billion at times, but when the price of short bets rose in the spring of 2007, its traders tried to engineer a new version of a "short squeeze," which occurs when people betting against a security are forced to buy it back because it's gaining value. In this case, Goldman sought to mark down the value of bets against the housing market, allegedly to scare some players into selling so the firm could more cheaply enlarge its bets on, and its profits from, a housing slump.
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