Goldman Clashes With Senate’s Levin Ahead of Blankfein Hearing

Senator Carl Levin, co-sponsor of The Hedge Fund Transparency Act
Senator Carl Levin, left, brings a hearing of the Senate Armed Services Committee to order in Washington, Jan. 27, 2009. Photographer: Brendan Smialowski/Bloomberg News

Goldman Sachs Group Inc. and U.S. Senator Carl Levin fired opening shots ahead of a congressional hearing this week, releasing conflicting evidence of the investment bank’s tactics during the mortgage market’s collapse.

Levin, a Michigan Democrat who leads the Senate’s Permanent Subcommittee on Investigations, posted internal Goldman Sachs e-mails on his website yesterday that he said show the firm “made a lot of money by betting against the mortgage market.” Goldman Sachs responded with documents indicating the firm lost money on mortgages in 2008 and that executives didn’t know the market would fall.

Chief Executive Officer Lloyd Blankfein, 55, and six current and former Goldman Sachs employees will have to face questions from Levin’s panel against the backdrop of fraud claims from the U.S. Securities and Exchange Commission. The regulator sued the firm on April 16, saying it defrauded investors when selling a debt instrument tied to mortgages.

Goldman Sachs, which contests the SEC’s claims, said Levin’s committee has “cherry-picked” evidence and jumped to conclusions “even before holding a hearing.”

“Investment banks such as Goldman Sachs were not simply market-makers, they were self-interested promoters of risky and complicated financial schemes that helped trigger the crisis,” Levin, 75, said in a statement released with the e-mails.

One of the e-mails provided by Levin yesterday shows Blankfein telling colleagues on Nov. 18, 2007, that the firm was making more money from its so-called short bets on mortgages than it lost on its investments related to home loans.

‘Mortgage Mess’

“Of course we didn’t dodge the mortgage mess,” Blankfein wrote in an e-mail dated Nov. 18, 2007, that was among eight pages of documents made public by the Senate’s Permanent Subcommittee on Investigations. “We lost money, then made more than we lost because of shorts. Also, it’s not over, so who knows how it will turn out ultimately.”

Another document contains an exchange between Chief Financial Officer David Viniar and Gary Cohn, the firm’s president and chief operating officer, about the fixed-income division’s profit and loss statement in July 2007. Cohn’s e-mail describes how the firm’s mortgage unit is up “in the index book,” while recording writedowns on residential mortgages and collateralized debt obligations. One method the firm used to make bets against the mortgage market was to take short positions on the so-called ABX index.

“Tells you what might be happening to people who don’t have the big short,” Viniar replies, according to the documents.

Losses Overwhelmed Gains

Documents released yesterday by Goldman Sachs show that the firm’s gains from shorting subprime mortgages in 2007 were overwhelmed by losses in 2008 when higher-quality mortgages suffered more than the firm anticipated.

“Goldman Sachs did not have access to any special information that caused us to know that the U.S. housing market would collapse,” the firm stated in an “executive summary” of its arguments released yesterday. “As a result of the spread of the crisis from subprime to all residential mortgages, Goldman Sachs had overall net losses of approximately $1.7 billion with respect to residential mortgage-related products for fiscal 2008.”

A lawyer for Goldman Sachs wrote a letter to Levin April 23 asking the subcommittee to warn the firm of any information the panel plans to release so it has a chance to respond. The letter followed Levin’s statement at a hearing the same day that “investment banks such as Goldman Sachs were not market makers helping clients; they were self-interested promoters of risky and complicated financial schemes that were a major part of the 2008 crisis.”

‘Already Drawn Conclusions’

“The statement suggests that you and the subcommittee have already drawn conclusions about the conduct of Goldman Sachs,” K. Lee Blalack II from the law firm O’Melveny & Myers LLP wrote to Levin. “We strongly disagree with your statement at today’s hearing and believe that, if we were provided an opportunity to respond to your specific findings, Goldman Sachs could produce to you information that establishes that your findings are incorrect.”

Blalack, a partner in the Washington office of O’Melveny & Myers, is a former chief counsel and staff director of the Permanent Subcommittee on Investigations, according to his biography on the firm’s website.

As other banks struggled throughout the financial crisis, Goldman Sachs posted record earnings in 2007 and then set a new record in 2009. In late 2008, following the collapse of Lehman Brothers Holdings Inc., the firm was allowed to convert to a bank under the oversight of the Federal Reserve and received $10 billion of taxpayer money, which it repaid with interest about eight months later. Blankfein, whose $67.9 million bonus in 2007 was a record for a Wall Street CEO, received no bonus in 2008 and a $9 million all-stock bonus for last year.

Making Markets

Goldman Sachs disputes the criticism that the firm’s short position on mortgage securities during 2007 constituted a bet against its own clients. In a letter to shareholders earlier this month, Blankfein and President Gary Cohn said the positions “served to offset our long positions. Our goal was, and is, to be in a position to make markets for our clients while managing our risk within prescribed limits.”

The interrogation of Goldman Sachs, the most profitable securities firm in Wall Street history, may echo Ferdinand Pecora’s Depression-era investigation of powerful financiers like J.P. Morgan Jr., said some historians. Levin, who has served in the Senate for more than 30 years, and his panel have a reputation for thorough research.

“This is Pecora II,” said Charles Geisst, a finance professor at Manhattan College in Riverdale, New York, who has written about Wall Street’s history. “They have to squirm and they have to answer the questions.”

Pecora Commission

The Senate investigation into the causes of the Wall Street crash of 1929 became known as the Pecora Commission, after the former New York City assistant district attorney who was appointed its chief counsel. Congress went on to pass the Securities Act of 1933 and the Securities Exchange Act of 1934, portions of which Goldman Sachs and an employee, Fabrice Tourre, are accused of violating in the Securities and Exchange Commission’s suit filed on April 16.

The SEC said Goldman Sachs and Tourre, 31, failed to inform investors in a 2007 collateralized debt obligation that hedge fund Paulson & Co., led by billionaire John Paulson, played a role in choosing the mortgage securities that underpinned the CDO and planned to bet on its failure.

Goldman Sachs said it would never mislead investors and that ACA Management LLC and IKB Deutsche Industriebank AG, investors in the deal, had all the material information they needed. Tourre will tell Levin’s panel he did nothing wrong, according to a person briefed on his planned testimony.

SEC Enforcement Chief

Robert Khuzami, the SEC’s enforcement chief, oversaw a group that helped create CDOs when he worked at Deutsche Bank AG, the Wall Street Journal reported April 23, citing unidentified people familiar with the matter. It isn’t clear whether Khuzami reviewed any documents at Deutsche Bank related to CDOs, the newspaper said. Khuzami declined to comment because the terms of his SEC recusal prevent him from discussing Deutsche Bank, John Nester, an agency spokesman, told Bloomberg News.

Like Pecora’s, Levin’s hearings may have implications for financial regulation. They take place as the Senate starts considering a package of financial rules that would require better disclosure of derivatives trading and could force banks to split off divisions that trade for their own accounts.

Tougher Questioning

Blankfein may get tougher questioning than he received in front of the Financial Crisis Inquiry Commission led by former California state Treasurer Phil Angelides in January, Geisst said. Levin’s committee first subpoenaed information from Goldman Sachs on June 30 and sent a second subpoena on March 12, before conducting interviews with Goldman employees this month.

“Levin is smarter,” said Martin Mayer, a guest scholar of the Brookings Institution who has written books including “The Fed” and “The Bankers” about the financial system. “It’s a stronger committee.”

Levin has been chairman or the top Democrat on the Permanent Subcommittee for more than a decade. He delves deeply into the issues, said Jack Blum, who spent 14 years as an investigator for other Senate panels and has testified before Levin’s committee as a private citizen.

“What you’re going to expect is a guy who first of all really will have done his homework,” Blum said. “He’s a very influential senator.”

Blum said the permanent subcommittee also is one of the rare panels in which senators and their staffs cooperate across party lines.

Parade of Critics

Criticizing Goldman “is going to be everybody’s great moment,” Blum said. “It’s the parade you want to be in.”

Testimony is scheduled to begin at 10 a.m. Washington time on April 27. The first panel will question Tourre, Michael Swenson, a managing director in Goldman Sachs’s structured products group, and two former employees: Daniel Sparks, who was head of the mortgage department, and Joshua Birnbaum, who was a managing director in the structured products group.

A second panel will feature Chief Financial Officer David Viniar and Chief Risk Officer Craig Broderick, followed by a final panel at which Blankfein is slated to appear alone.

Levin’s chief investigator, Robert Roach, has been at the permanent subcommittee since September 1997 and has almost 20 years of experience working for congressional oversight committees. Staff director Elise Bean has focused on the pay gap between executives and average workers for almost as long.

Roach balances his investigative work with speeches at conferences that interact with his areas of expertise, such as a meeting on offshore bank jurisdictions held annually in Miami Beach. After an interview over drinks last year, Roach insisted on paying for his own $3 beer, saying he never let anyone, reporters included, pay for his meals.

Budget Watchdog

Keith Ashdown, chief investigator for the Republican staff led by Oklahoma Senator Tom Coburn, is a former executive at Taxpayers for Common Sense, the Washington-based budget watchdog group that first dubbed a proposal to build a bridge in Alaska the “Bridge to Nowhere.”

Created in 1948, the panel was led in the 1950s by then-Senator Joseph McCarthy of Wisconsin, who alleged that communists had infiltrated the federal government. McCarthy later was censured for hearings that Levin wrote in 2003 “destroyed careers of people who were not involved in the infiltration of our government.”

In the last two years, the committee focused on the role played by UBS AG and Liechtenstein’s LGT Group in facilitating offshore tax evasion worldwide. At a July 2008 hearing, UBS made worldwide headlines by announcing it would stop offering offshore banking services for U.S. customers.

Enron, Saddam Hussein

Under Levin’s leadership, the panel has exposed how banks such as Citigroup Inc. and JPMorgan Chase & Co. helped Enron Corp. structure fraudulent financial transactions, and investigated the dangers of buying prescription drugs over the Internet and how former Iraqi dictator Saddam Hussein abused the United Nations Oil-for-Food program.

The committee has focused on tax issues other than the UBS case in recent years. In 2003, it revealed how firms such as KPMG LLP, Ernst & Young LLP and PricewaterhouseCoopers LLP spent much of the 1990s devising and marketing tax shelters judged illegal by the Internal Revenue Service.

In 2007, Levin introduced legislation to limit tax benefits for companies that pay executives millions of dollars in stock options after his panel concluded the tax subsidies helped widen the divide between compensation of top officials and ordinary workers.

The panel’s shortcoming, Blum said, is that it rarely enjoys legislative jurisdiction in the areas it investigates, meaning any bill the probes produce must go through other committees. In the Goldman case, any ensuing legislation would probably go through the Senate Banking Committee or the Committee on Homeland Security and Governmental Affairs.

Still, Blum said, when Levin holds hearings, “the companies involved have a hell of an image problem.”

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