Goldman Sachs Bet Against Its Own Deals, Senate’s Levin Says

Goldman Sachs Group Inc.'s new headquarters building
People walk outside Goldman Sachs Group Inc.'s new headquarters building at 200 West Street in New York, on April 19, 2010. Photographer: JB Reed/Bloomberg

Goldman Sachs Group Inc., the most profitable securities firm in Wall Street history, made an estimated $3.7 billion in 2007 by placing “heavy bets” against mortgage-linked securities, including some it created, a U.S. senator said today.

Carl Levin, a Michigan Democrat who leads the Senate’s Permanent Subcommittee on Investigations, released e-mails and other documents that he said show “Goldman repeatedly put its own interest and profit ahead of the interests of its clients.”

The documents precede a showdown on Capitol Hill tomorrow between Levin’s panel and seven current and former Goldman Sachs employees. Chief Executive Officer Lloyd Blankfein, 55, and Fabrice Tourre, 31, an executive director who was named in the Securities and Exchange Commission’s April 16 fraud lawsuit against the firm, are among Goldman employees set to answer questions.

“To sell to customers at the same time you’re betting against what you’re selling -- we think it’s not uncommon and we think it ought to end,” Levin said at a briefing for reporters today on tomorrow’s hearing. “We think there are a number of banks engaged in similar conduct but we had to focus on one.”

The subcommittee estimated that Goldman Sachs generated $3.7 billion from its short bets on a declining mortgage market in 2007, Levin said. The figure doesn’t take into account losses they suffered on mortgage-related securities they held, he said.

SEC, Justice Department

Levin said his committee isn’t responsible for determining whether there was any criminal activity, although he said the panel will decide after the hearing whether to refer the matter to the SEC or the Justice Department.

Blankfein will tell the committee tomorrow that the firm didn’t wager against clients and didn’t make a big bet against the housing market, according to the prepared text of his remarks.

“We didn’t have a massive short against the housing market and we certainly did not bet against our clients,” Blankfein will say, according to the text.

While the firm disagrees with the SEC’s complaint, “I also recognize how such a complicated transaction may look to many people,” Blankfein said. “We have to do a better job of striking the balance between what an informed client believes is important to his or her investing goals and what the public believes is overly complex and risky.”

‘Real Bad Feeling’

Among the evidence Levin presented today was an internal e-mail about a March 2007 presentation to the board of directors that describes how the firm’s mortgage derivatives desk started the quarter with a $6 billion “long” position on BBB- rated mortgages “and shifted the position to net short $10bn notional.”

An October 2007 internal e-mail sent to Daniel Sparks, who ran the mortgage business at the time and is among those scheduled to testify, includes the comment “real bad feeling across European sales about some of the trades we did with clients. The damage this has done to our franchise is very significant. Aggregate loss of our clients on just these 5 trades along (sic) is 1bln+.”

Michael Swenson, a managing director in Goldman Sachs’s structured products group who is also to appear tomorrow, boasted in his 2007 performance review that “I said ‘no’ to clients who demanded that GS should ‘support the GSAMP’ program as clients tried to gain leverage over us,” he said, referring to the name for Goldman’s own mortgage-backed deals. “Those were unpopular decisions but they saved the firm hundreds of millions of dollars.”

Ties That Bind

In a September 2007 e-mail to Blankfein, an employee describes having met with 10 or more individual “prospects” and clients and tells Blankfein about how their attitudes differ from institutional clients.

“The institutions don’t and I wouldn’t expect them to, make any comments like ur (sic) good at making money for urself (sic) but not us,” the e-mail said. “The individuals do sometimes, but while it requires the utmost humility from us in response I feel very strongly it binds clients even closer to the firm, because the alternative of take ur (sic) money to a firm who is an under performer and not the best, just isn’t reasonable. Clients ultimately believe association with the best is good for them in the long run.”

Goldman Sachs built a “conveyer belt” of mortgage deals and then bet against them, Levin said, actions that he said contributed to the worst financial crisis since the Great Depression.

‘Incalculable Harm’

“In a number of ways they contributed to the collapse of this economy,” Levin said. “The toxins that Goldman Sachs and others helped inject into our financial system has done incalculable harm.”

While Levin said he is ready to vote on a financial regulation package that is set to be considered by the Senate this week, he said he thinks it could be strengthened. He has proposed an amendment that would help resolve the conflicts of interest among Wall Street firms that he said are embodied in the documents. He also endorsed banning financial firms from engaging in so-called naked credit default swaps, or bets on a decline in creditworthiness by parties that have no exposure to the credit.

After Levin posted internal Goldman Sachs e-mails on his website on April 24 that he said show the firm “made a lot of money by betting against the mortgage market,” the firm responded with more than 70 pages of e-mails and other documents that it said showed the firm lost money on mortgages in 2008 and that executives didn’t have any kind of consensus that the market would fall.

$68 Million Bonus

Goldman Sachs contests the SEC’s claims that the firm defrauded investors when selling a debt instrument tied to mortgages by failing to inform them of the role played by hedge fund Paulson & Co. The company said on April 24 that Levin’s committee “cherry-picked” the evidence it released and jumped to conclusions “even before holding a hearing.”

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.

Pecora Era

While Levin said his committee hasn’t found any evidence that Blankfein was himself aware of the firm’s positions on specific deals, he said the documents show that Blankfein knew the firm was shorting the market in 2007.

The interrogation of Goldman Sachs 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.

“Looking at this crisis, it’s hard not to agree with the conclusion of another congressional committee, which found ‘the result of the unregulated activities of the investment bankers were enormous,’” Levin said in the briefing with journalists. “That conclusion came in 1934, when the Senate looked into the reasons for the Great Depression.”

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