Goldman's Big Short Is Levin’s Big Target: William D. Cohan

It has been almost a year since Goldman Sachs Group Inc. agreed to pay with the Securities and Exchange Commission relating to the creation and sale of Abacus 2007-AC1, a squirrelly synthetic collateralized-debt obligation that could only have been designed in the first decade of the new millennium. Now the firm is facing a whole new round of litigation.

This is potentially troubling not just for Goldman Sachs, but for all of Wall Street.

On May 10, Goldman Sachs said it had received subpoenas from unidentified regulators relating to the infamous Abacus deal and other CDOs the firm manufactured and sold during the housing bubble, which began to deflate in the last quarter of 2005. Goldman Sachs also said the Commodity Futures Trading Commission, the chairman of which is former Goldman Sachs partner Gary Gensler, is investigating the firm’s role in acting as a clearing broker for an unidentified broker-dealer and intends to "bring aiding and abetting, civil fraud and supervision-related charges" against the Goldman Sachs unit.

And on May 16, New York State’s attorney general, Eric Schneiderman, said he was investigating Goldman Sachs, Morgan Stanley and Bank of America Corp. over mortgage-securitization transactions completed before the financial crisis of 2008.

Unwelcome News

None of this is welcome news, of course, to the executives at Goldman Sachs’s new $2.4 billion headquarters in Lower Manhattan. They are still grappling with a wave of negative publicity –- a Bloomberg News poll on May 12 found that 54 percent of financial professionals had a negative view of the firm -- while the new Dodd-Frank law threatens some of the firm’s traditional free-wheeling, hugely profitable ways.

But the most potentially damaging recent threat to Goldman Sachs came in a May 3 letter from Democratic Senator Carl Levin of Michigan and Republican Senator Tom Coburn of Oklahoma to the Justice Department and the SEC. While the text of the letter hasn’t been made public, one can assume that it refers the two cops on the securities beat to the April 13 report that Levin’s Permanent Subcommittee on Investigations compiled on the causes of the financial crisis. Nearly 250 pages of the 640-page document are concerned with Goldman Sachs.

At a press conference when they released the report, the senators asked the agencies to investigate whether Goldman Sachs violated the law when it continued to sell mortgage-backed securities to clients and investors around the world while the firm made a large -- and hugely profitable -- proprietary bet against the mortgage market.

Levin said he was particularly upset that Goldman Sachs Chief Executive Officer Lloyd Blankfein and other Goldman Sachs executives may have perjured themselves. During their April 27, 2010, testimony in front of Levin’s committee, the senator asked Goldman executives about the firm’s proprietary bet against the mortgage market, beginning in December 2006. Blankfein and others repeatedly said -- under oath -- that the firm had never made such a bet.

Conflicts of Interest

"In my judgment, Goldman clearly misled their clients and they misled the Congress," Levin said at the press conference. Coburn said at the same press conference that the committee’s report shows "without a doubt the lack of ethics in some of our financial institutions who embraced known conflicts of interest to accomplish wealth for themselves, not caring about the outcome for their own customers. When that happens, no country can survive and neither can their financial institutions."

Not surprisingly, Goldman Sachs disagrees with the two senators; the firm still maintains that it was simply managing risk.

"The testimony we gave was truthful and accurate and this is confirmed by the subcommittee’s own report," Lucas van Praag, a Goldman Sachs spokesman, said in a statement. "The report references testimony from Goldman Sachs witnesses who repeatedly and consistently acknowledged that we were intermittently net short during 2007. We did not have a massive net short position because our short positions were largely offset by our long positions, and our financial results clearly demonstrate this point."

As Levin acknowledged, it is now up to the Justice Department and the SEC to determine "whether a crime was committed" and if Blankfein personally "violated the securities laws."

Goldman’s Credibility

But regardless of the outcome of those investigations, Goldman Sachs continues to damage its credibility and its reputation by insisting that it didn’t make a large proprietary bet against the mortgage market beginning in December 2006 and continuing throughout much of 2007. That claim flies in the face of evidence from its own files -- now, thanks to Senator Levin, in the public record –- which shows unequivocally that it did. The evidence is almost overwhelming, so a few examples will suffice.

According to Levin’s report, e-mail correspondence among Goldman Sachs’s senior executives routinely referred to the mortgage department’s net short positions as being in the "billions" of dollars. The phrase "net short" appears more than 3,400 times in the documents that Goldman Sachs produced for the subcommittee. At one point in 2007, David Viniar, Goldman Sachs’s chief financial officer, referred to the firm’s net short position in an e-mail as "the big short" and marveled at all the money the firm was making as a result. Blankfein, though, preferred to view it as nothing more than a prudent hedge. "The short position wasn’t a bet," he wrote in a September 2007 e-mail. "It was a hedge."

Not so, argued Josh Birnbaum, the trader on Goldman Sachs’s mortgage desk chiefly responsible for persuading the firm to establish "the big short." In early October 2007, Birnbaum "contradicted that position," according to the Levin report. In a document he drafted to argue that his desk should be "compensated like hedge fund managers and not as ordinary participants in Goldman’s traditional bonus pool system," he "explicitly addressed and rejected the contention" that the profitable net short positions managed by his desk were hedges for long assets held by other desks."

The Levin report, which described Birnbaum as "one of the chief architects of Goldman’s big short," quoted from his October 2007 document in which he claimed "the shorts were not a hedge."

Glowing Self-Evaluations

Then there were the traders’ own self-evaluations, now also in the public realm, that show clearly that the mortgage desk’s strategy had paid off and they wanted to get fully compensated as a result. Birnbaum wrote that his desk "alone" generated profits of $3 billion in 2007 and was "#1 on the street by a wide margin" and "#2 in the world trading subprime risk (behind Paulson Partners)," a reference to hedge-fund manager John Paulson, who famously made $4 billion personally betting the mortgage market would collapse.

Michael Swenson, Birnbaum’s boss, added that "it should not be a surprise to anyone that the 2007 year is the one that I am most proud to date" because he built "a number one franchise that was able to achieve extraordinary profits (nearly $3bb to date)." Another trader on the same desk, Deeb Salem, wrote, "Obviously the most important aspect of my 2007 and my contribution to the firm has been on the desk’s P&L. Mike, Josh and I were able to learn from our bad long positions at the end of 2006 and layout the game plan to put on an enormous directional short."

Even accounting for the typical puffery found in Wall Street self-evaluation forms, there is no taking away from what these traders accomplished for Goldman Sachs, especially since the final profit tally for their desk in 2007 was closer to $3.7 billion.

A 900-Page Trove

Why Blankfein and Goldman Sachs won’t admit what is so obvious to the firm’s own traders -- and to anyone with the patience to wade through Levin’s report and the 900 pages of internal Goldman Sachs documents he released with it -- is simply baffling. If Goldman Sachs didn’t have a "big short" on the mortgage market in place in 2007, how else to explain its $17.2 billion in pretax profits that year and the bonuses paid to its top four executives of some $200 million?

Blankfein alone was paid around $70 million in 2007, the most ever for the CEO of a publicly traded Wall Street firm. This was at a time when Goldman Sachs’s competitors were losing billions of dollars and Stanley O’Neal, the CEO of Merrill Lynch, and Charles Prince, the CEO of Citigroup, were forced to quit.

Until Goldman Sachs comes clean on this topic -- preferably before the Justice Department or the SEC forces it to -- it is difficult to see how the cloud that hangs over the firm and the rest of Wall Street can be lifted.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

    To contact the author of this story:
    William D Cohan

    To contact the editor responsible for this story:
    Tobin Harshaw at

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