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How Goldman secretly bet on the housing crash
2009-11-01
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. Muzi.com News 10095051-1 (muzi.com) 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. Muzi.com News 10095051-2 (muzi.com) Only later did investors discover that what Goldman had promoted as triple-A rated investments were closer to junk. Muzi.com News 10095051-3 (muzi.com) 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. Muzi.com News 10095051-4 (muzi.com) " 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." Muzi.com News 10095051-5 (muzi.com) 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. Muzi.com News 10095051-6 (muzi.com) "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." Muzi.com News 10095051-7 (muzi.com) Lloyd Blankfein , Goldman's chairman and chief executive, declined to be interviewed for this article. Muzi.com News 10095051-8 (muzi.com) 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. Muzi.com News 10095051-9 (muzi.com) 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." Muzi.com News 10095051-10 (muzi.com) 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. Muzi.com News 10095051-11 (muzi.com) 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. Muzi.com News 10095051-12 (muzi.com) 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. Muzi.com News 10095051-13 (muzi.com) McClatchy's inquiry found that Goldman Sachs : Muzi.com News 10095051-14 (muzi.com) -- 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. Muzi.com News 10095051-15 (muzi.com) -- 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. Muzi.com News 10095051-16 (muzi.com) -- 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. Muzi.com News 10095051-17 (muzi.com) -- 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. Muzi.com News 10095051-18 (muzi.com) 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. Muzi.com News 10095051-19 (muzi.com) 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. Muzi.com News 10095051-20 (muzi.com) 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. Muzi.com News 10095051-21 (muzi.com) 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. Muzi.com News 10095051-22 (muzi.com) THE BLUEST OF THE BLUE CHIPS Muzi.com News 10095051-23 (muzi.com) 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. Muzi.com News 10095051-24 (muzi.com) 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. Muzi.com News 10095051-25 (muzi.com) On Oct. 16 , a Goldman vice president, Adam Storch , was named managing executive of the SEC's enforcement division. Muzi.com News 10095051-26 (muzi.com) 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 . Muzi.com News 10095051-27 (muzi.com) Since the collapse of the economy, however, some of those investors have changed their opinions of Goldman. Muzi.com News 10095051-28 (muzi.com) 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. Muzi.com News 10095051-29 (muzi.com) 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. Muzi.com News 10095051-30 (muzi.com) Hood assailed the investment banks "who packaged this junk and sold it to unwary investors." Muzi.com News 10095051-31 (muzi.com) 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. Muzi.com News 10095051-32 (muzi.com) 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. Muzi.com News 10095051-33 (muzi.com) 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." Muzi.com News 10095051-34 (muzi.com) 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. Muzi.com News 10095051-35 (muzi.com) 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. Muzi.com News 10095051-36 (muzi.com) 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 . Muzi.com News 10095051-37 (muzi.com) 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 . Muzi.com News 10095051-38 (muzi.com) 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. Muzi.com News 10095051-39 (muzi.com)
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