April 27 (Bloomberg) -- Goldman Sachs Group Inc., Wall Street’s most profitable firm, will face off against a U.S. Senate subcommittee today in a pivotal hearing that could have repercussions for the future of the financial industry.
Carl Levin, a Michigan Democrat who leads the Senate’s Permanent Subcommittee on Investigations, released documents that he said showed the company “put its own interest and profit ahead of the interests of its clients,” a conflict he called on Congress to end. Lloyd Blankfein, Goldman Sachs’s chairman and chief executive officer, will dispute that assertion and argue the firm was merely managing its own risk.
The hearing takes place as the Senate debates financial reform legislation that could prevent banks from trading for their own accounts and require them to separate derivatives businesses from regulated depository subsidiaries. It also follows a U.S. regulator’s civil-fraud lawsuit against Goldman Sachs and an employee, Fabrice Tourre, for misleading investors in a mortgage-linked investment, charges the firm denies.
“This market is not free until it is free of self-dealing and until it is free of conflict of interest,” Levin, 75, said at a press briefing yesterday. “It is not free until it ends the gambling operation that results in gambling debts that the public ends up paying.”
The hearing, set to begin at 10 a.m. in Washington, will start with questioning of Tourre; Michael Swenson, a managing director in the structured-products group; Joshua Birnbaum, a former managing director in the same group; and Daniel Sparks, a ex-partner who ran the mortgage department.
“I deny -- categorically -- the SEC’s allegation,” Tourre, 31, will say today, according to a prepared text of his remarks released by Goldman Sachs. “I will defend myself in court against this false claim,” he said, adding that a deal at the center of the suit “was not designed to fail.”
Later in the day, the subcommittee will hear from David Viniar, the firm’s chief financial officer, and Craig Broderick, the chief risk officer. Blankfein, 55, will be the final witness, facing the panel alone at the end of the hearing.
“We didn’t have a massive short against the housing market and we certainly did not bet against our clients,” Blankfein will tell the committee, according to a prepared text of his remarks.
Must Do Better
While the firm contests the SEC’s complaint, “I also recognize how such a complicated transaction may look to many people,” Blankfein said in his remarks. “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.”
Goldman Sachs fell to $150.70 at 9:04 a.m. in New York Stock Exchange composite trading from $152.03 yesterday, before Levin’s statements were made public. The shares tumbled 17 percent since the SEC filed its suit.
Yesterday U.S. Senate Republicans blocked Democrats from advancing their plan to overhaul Wall Street regulation as the two sides debate provisions including consumer protections and derivatives. Both parties are trying to tap into voter anger at Wall Street and the bank bailouts that took place as Americans grappled with record home foreclosures and rising unemployment.
Goldman Sachs would probably be hardest hit among large U.S. banks if Congress bans firms from trading for their own account. Viniar, the CFO who’s scheduled to testify today, estimated in January that approximately 10 percent of the company’s revenue derives from trading that has no connection with customer business. That would have been about $4.5 billion last year.
‘Closer to Home’
Viniar said in his prepared remarks for today’s testimony that the firm decided, starting in late 2006, to “get closer to home,” or reduce its exposure to the residential housing market. He said Goldman Sachs was “on occasion” short the market in 2007, though it lost money on residential mortgage products in 2008.
Employees of Goldman Sachs, which set a Wall Street pay record in 2007 when Blankfein was awarded a $67.9 million bonus, are among the biggest political donors in the last two decades.
Nine of the 10 members of Levin’s committee have accepted campaign finance donations from the firm’s employees, both individually and through a political action committee, since 1989, according to the Center for Responsive Politics, a Washington-based research group. The exception is Senator Edward Kaufman, a Democrat from Delaware, who never raised money for an election because he was appointed to fill Vice President Joseph Biden’s former seat and hasn’t run for a full term.
Arizona Republican John McCain, who ran for president in 2000 and 2008, has accepted the most of any member of the subcommittee with $337,065, while Jon Tester, a Democrat from Montana, has taken just $6,400, the group’s data show.
While the spotlight is on Goldman Sachs at today’s hearing, Levin emphasized that the firm’s actions represent practices that he said are widespread on Wall Street.
“To sell to customers at the same time you’re betting against what you’re selling -- we think it’s not uncommon and think it ought to end,” Levin said yesterday. “We think there are a number of banks engaged in similar conduct, but we had to focus on one.”
Levin, whose committee first subpoenaed information from Goldman Sachs in June, estimates that the firm made $3.7 billion in 2007 by placing “heavy bets” against mortgage-linked securities, including some it created. The figure doesn’t take into account losses Goldman Sachs suffered on mortgage-related securities it held, he said.
“We respectfully disagree with Chairman Levin’s statement,” Lucas van Praag, a spokesman for Goldman Sachs, said yesterday. “We did not have a big bet against the housing market, as our performance in residential mortgages demonstrates, and we believe we at all times worked appropriately with our clients.”
Goldman Sachs released data on April 24 that showed the firm reaped gains on its mortgage trading activities in 2007 and then lost money in the same unit in 2008.
‘Real Bad Feeling’
Among the evidence Levin released yesterday was an internal e-mail 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 Sparks, who ran the mortgage business and is among those testifying today, 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+.”
Swenson, the managing director in the structured-products group who is also to appear today, 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 Sachs’s own mortgage-backed deals. “Those were unpopular decisions but they saved the firm hundreds of millions of dollars.”
‘Money on Table’
Swenson said the firm “left money on the table” by reducing its short positions, according to his prepared testimony for today’s hearing. Sparks said in his remarks that he is “proud” of what the mortgage department accomplished.
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 those of 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.
Conflicts of Interest
Levin said his committee isn’t responsible for determining whether any crimes occurred, although he said the panel will decide after the hearing whether to refer the matter to the SEC or the Justice Department.
“The SEC and the courts will resolve the legal question of whether Goldman’s actions broke the law,” Levin said. “The question for us is whether Goldman’s actions in 2007 were appropriate and whether we should act, legislatively, to bar similar actions in the future.”
While Levin said he is ready to vote on a financial regulation package in 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 so-called naked credit-default swaps, or bets on a decline in creditworthiness by parties that have no exposure to the underlying loans or bonds.
After Levin posted internal Goldman Sachs e-mails on his Web site 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.
Goldman Sachs disputes the SEC’s claims that the firm defrauded investors when selling a collateralized debt obligation 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 topped that 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.
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 ultimate harm here is not just to the clients who were not well-served by their investment bank, the harm here is to all of us,” Levin said yesterday. “The toxins that Goldman Sachs and others helped inject into our financial system have done incalculable harm to people who have never heard of a synthetic CDO and who have no defenses against the harm that such exotic Wall Street creations can cause.”
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