Goldman Traders Tried to Manipulate Market in 2007, Report Says

Goldman Sachs Group Inc.'s Michael J. Swenson
Goldman Sachs Group Inc.'s Michael Swenson. Photographer: Andrew Harrer/Bloomberg

Goldman Sachs Group Inc. mortgage traders tried to manipulate prices of derivatives linked to subprime home loans in May 2007 for their own benefit, according to a U.S. Senate report.

Company documents show traders led by Michael J. Swenson sought to encourage a “short squeeze” by putting artificially low prices on derivatives that would gain in value as mortgage securities fell, according to the report yesterday by the Permanent Subcommittee on Investigations. The idea, abandoned after market conditions worsened, was to drive holders of such credit-default swaps to sell and help Goldman Sachs traders buy at reduced prices, according to the report.

“We began to encourage this squeeze, with plans of getting very short again,” Deeb Salem, a trader in the structured product group, said in a 2007 self-evaluation excerpted in the report. Swenson, Salem’s supervisor, sent e-mails in May 2007 urging traders to offer prices that will “cause maximum pain” and “have people totally demoralized.” In interviews with the committee, Salem and Swenson denied attempting a short squeeze, the report said.

Salem “claimed that he had wrongly worded his self-evaluation,” the report said. “He said that reading his self-evaluation as a description of an intended short squeeze put too much emphasis on ‘words.’”

The subcommittee cited the episode as an example of how Goldman Sachs traders placed the firm’s interests ahead of its clients’ as the value of mortgage-linked investments tumbled in

2007. The subcommittee, led by Senator Carl M. Levin, a Michigan Democrat and Tom Coburn, Republican of Oklahoma, has called on regulators to craft strict bans on proprietary trading and conflicts of interest to keep the problems from recurring.

‘Poor Quality Investments’

“Conflicts of interests related to proprietary investments led Goldman to conceal its adverse financial interests from potential investors, sell investors poor quality investments, and place its financial interests before those of its clients,” according to the subcommittee.

Goldman Sachs traders abandoned the short-squeeze attempt after discovering on June 7, 2007, that two Bear Stearns Cos. hedge funds that specialized in subprime-mortgage investments were collapsing. Salem e-mailed Swenson and another colleague to suggest trying to buy short positions, known as “protection,” on collateralized debt obligations, or CDOs, from hedge fund Magnetar Capital LLC, according to the subcommittee’s report.

“We need to go to magnetar and see if we can buy a bunch of cdo protection… Can tell them we have a protection buyer, who is looking to get into this trade now that spreads have tightened back in.”

‘Great Idea’

Swenson expressed “no concerns about the proposed deception” and responded to Salem that it was a “great idea,” according to the report.

The report comes almost a year after the committee spent more than 10 hours grilling Lloyd C. Blankfein, Goldman Sachs’s chairman and chief executive officer, and six current and former employees in one of the most hostile political showdowns in the aftermath of the financial crisis.

That hearing happened 12 days after the Securities and Exchange Commission sued New York-based Goldman Sachs for fraud in a case that the firm settled for $550 million in July.

In an effort to address questions raised by the SEC lawsuit and the subcommittee, Blankfein convened a committee of Goldman Sachs executives to review the firm’s practices. In January, the firm published 39 recommendations aimed at better managing conflicts and client relationships, as well as governance and employee training.

Citigroup, Merrill Lynch

Goldman Sachs disagrees with “many of the conclusions” in the report and cited the business standards committee as evidence that “we take seriously the issues explored by the subcommittee,” the firm said in a statement released by Lucas van Praag, a company spokesman.

As rivals including Citigroup Inc. and Merrill Lynch & Co. posted losses on mortgage-related investments during 2007, Goldman Sachs reported record earnings that benefited from the firm’s negative view of the subprime-mortgage market.

Blankfein and other executives at the firm have said that its traders placed “short” bets, which profited when prices of mortgage-linked securities fell, to hedge against losses. He also said in last year’s hearing that Goldman Sachs was acting as a “market maker” in selling CDOs and other mortgage-backed investments to clients as the company’s own traders were betting against them.

‘Massive Short’

“We didn’t have a massive short against the housing market, and we certainly did not bet against our clients,” Blankfein, 56, who received a record $67.9 million bonus for his performance in 2007, told the subcommittee last year. “Rather, we believe that we managed our risk as our shareholders and our regulators would expect.”

The subcommittee said that documents uncovered in its two-year investigation of the financial crisis show that Goldman Sachs’s mortgage traders did have a large short position during 2007 and the sales team aggressively sought clients to buy CDOs that the traders expected would decline in value.

One executive “instructed Goldman personnel not to provide written information to investors about how Goldman was valuing” a CDO called Timberwolf, according to the report, “and its sales force offered no additional assistance to potential investors trying to evaluate the 4,500 underlying assets.”

Joshua S. Birnbaum, who ran a unit called the ABX Trading Desk, said in an October 2007 internal presentation that a short position established by the structured product group after the collapse of two Bear Stearns hedge funds was “not a hedge” against CDOs and residential mortgage-backed securities, or RMBS, owned by the firm, the report said.

‘Not a Hedge’

“By June, all retained CDO and RMBS positions were identified already hedged,” the presentation said. “In other words, the shorts were not a hedge.”

The subcommittee’s report describes four CDOs that the firm created and sold in an effort to reduce Goldman Sachs’s exposure to subprime-mortgage risk. It describes Goldman Sachs as having given misleading descriptions of some of the CDOs and in some cases seeking out buyers who were inexperienced with them.

The report also says that the mortgage desk reversed its view on how it marked derivatives values based on its position in the market. Clients with short positions complained that Goldman Sachs was undervaluing those bets during the squeeze attempt. After the traders abandoned that strategy in June 2007 and increased their wagers against the mortgage market, other clients complained the firm was overvaluing the short positions.

“Once it began buying CDS shorts, the SPG Desk immediately changed its CDS short valuations and began increasing their value,” the report said. “Clients with long positions began to complain that the marks were too high, and internal Goldman business units also raised questions.”

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