Opening Remarks Overview:
The Senate committee presented a case that sought to refute the prior public statements of Goldman Sachs and establish that Goldman was, in fact, betting against clients and had rampant, and unacceptable, conflicts of interest. Senators Levin, Collins, McCain and McKaskill made statements that seem to anticipate many of the defenses that Goldman might make. An important theme of what the Senators are presenting is that, as Republican Senator McCain stated, Goldman will be judged in the court of public opinion, as well as in the legal courts. Their activity appears to be unethical and such activity needs to be reformed.
In the scheme of things, the committee seems well prepared and working with consistent themes: unethical behavior, non-productive gambling, that caused damage to the country even as Goldman reaped large profits.
Goldman employees read prepared statements that emphasized the prior talking points of the firm. They break no new ground. The statements will soon prove to inadequate to prepare them for the line of questioning that the Senators take.
Senator Levin launches in detailed review of certain particularly toxic 2007 Goldman deals, including Anderson CDO, a Freemont MBS and the Timberwolf CDO. Levin is unable to get Sparks to concede whether he has a duty to let clients know that they were betting against the deals. Levin notes that a Goldman employee identifies that Timberwolf is a “shitty deal” but then continued to make it a number one priority to sell the deal to clients. Sparks stammers and equivocates, and Levin concludes that he is unwilling to answer the question of whether they had a responsibility to reveal Goldman had an adverse interest to potential investors.
It seems clear that the Goldman executives were completely unprepared for this line of hostile questioning and have no ready responses. How this could be and how they could not have anticipated how they would be grilled, is a true mystery.
Collins notes that it seems to be Goldman’s strategy to burn through the time without answering anything. Whether this is true or not may be subject to debate. However, it seems clear that Goldman is doing a good job of making themselves look bad in this type of situation.
Josh Birnbaum is the first Goldman employee being quizzed that seems able to answer questions directly and explain their positions and their rationales. Unlike the other Goldman representatives, he agrees with Senator Collins that Goldman has a duty to act in the interest of its clients. He agrees that it may make sense for regulators to impose a fiduciary duty on broker dealers.
Senator Ted Kaufman highlights a WaMu subprime, second lien deal with 90% stated income loans. Doesn’t it seem fairly likely that a lot of these were going to fail? Sparks tries to argue that investors had an interest in these loans which, in hindsight, turned out to be a problem. Senator Kaufman asks, didn’t they do any diligence on the deals? Didn’t they think it was strange that there was such an explosion in these types of deals? Is it really possible that no one knew that these were going to be a problem?
Sparks replies that they made mistakes about the risk in these loans, but there were people in the firm and outside that wanted to take the long risk on these types of deals. Kaufman asks, how could you turn some lenders down and still accept loans from Long Beach?
Senator Coburn (R-Ok) notes that these questions should also be asked to the other leading banks. Without trust and transparency, markets can’t function properly. His key question for the hearings is: was Goldman making trades contrary to their investors and clients? To the witnesses, this is your chance to explain what was really happening.
Coburn focuses on Swenson’s self evaluation, where Swenson notes that he produced tremendous profits for the firm in 2007. Swenson noted in 2006 that the subprime market was going to have an unhappy ending. Senator Coburn asked if he shared this view with others at the firm or with clients they were selling these bonds to. Swenson’s defense is that in 2006, the market was still strong. Coburn asks if Swenson ever saw anything wrong with the ratings of the securities.
Coburn asks Tourre – Goldman released personal emails that were embarrassing to Tourre. Do you have any thoughts on why Goldman released these embarrassing emails and how did it make you feel?
Senator McKaskill quizzes Tourre and others on the Abacus deal and takes an aggressive stance with them, arguing that ACA was just a fig leaf for Paulson’s position on the deal. She also notes the close timing with Timberwolf CDO, which was put together by former Goldman employees. She asks Tourre if it is typical for deal sponsors to put together the securities in a synthetic CDO. He says that they would always have some input, subject to the deal manager (ACA).
Senator Pryor asks Sparks do you feel like Goldman had any responsibility for the financial crisis? Did you contribute to it? Sparks replies that he does take responsibility for his actions and notes passively that “credit got loose”. Swenson gets the message better – we didn’t do anything wrong. Pryor disagrees, noting that many people believe that Wall Street, if not the individuals in it, was a big cause of the crisis by creating all of the mortgage bonds. He also notes that none of the Goldman people seem to be clear on their ethical standards nor do the Goldman people seem to be taking any responsibility for their actions.
Senator Ensign (R-Nev) argues that Las Vegas casinos would take offense at being compared to Wall Street because Wall Street used other peoples money and changed the rules as the game was being played. He’d like to know if Goldman were more market manipulators than market makers. With that, he launches into a ripe area of attack – the influence of the banks on the rating agencies. Do you know of anyone who tried to influence the agencies? Do you think the agencies models were right? Do you think that Goldman paying the rating agencies for the ratings had the appearance of a conflict of interest? Unfortunately, he gets no response to these questions (interestingly, the rating agency emails the Senate committee released appear to have numerous instances of the banks, including Goldman, trying to push and arbitrage the rating agencies throughout 2006 and 2007).
Senator Ensign turns to Hudson CDO, a static synthetic mezzanine MBS deal, which he believes was made entirely of positions on Goldman’s books. Goldman was the only party that provided the shorts to the deal. Sparks argue that investors wanted to go long this security. If only Ensign would ask who those investors were!
He further asks if you all made huge amounts of money even when its clients lost huge amounts of money, do you think the right incentives are in place for ethical behavior? Sparks continues to equivocate. Birnbaum continues to confidently state the party line, as does Swenson.
Senator Tester asks Birnbaum when he thinks the housing market started to decline. Birnbaum believes housing prices started to decline at the middle or end of 2006. Did it change your view of the subprime market and did you share these thoughts with others? Birnbaum acknowledges that he did share his thoughts that subprime would be declining. The unfinished thought of the Senator presumably was that despite this view, Goldman continued to sell deals to investors, without sharing these views.
Senator Tester asks Sparks if Goldman did anything wrong. Sparks said he didn’t do anything inappropriate, though they did make mistakes. When questioned on synthetic CDOs, Sparks argues that there were investors who wanted to take long risk in these deals. Why did you issue deals like Abacus, Anderson, Timberwolf, etc. when you knew that subprime would be declining? Sparks did not expect these deals to be reduced to junk, which is bad. Do you think that the investors and ratings had all of the information they needed to rate the deal? Sparks says he is surprised that Moody’s would think that Paulson’s presence in Abacus would be relevant.
Senator Tester acknowledges that there is only so much the Goldman guys can say but he states that we can’t let something like this happen again and it would’ve have been nice to have experts in the industry help.
Back to Levin, who wants to drill down into the Hudson CDO. AIB, a potential investor in the deal, says that it is junk, which apparently, a salesperson acknowledges. The “junk” in the deal is Goldman inventory of MBS. Goldman was the sole buyer of protection on the entire $2 billion deal. Senator argues that the purpose of this deal was to unload Goldman’s junk and profit from the deal if it fails. The pitch book for the deal indicates that Goldman’s interests are aligned with investors and, with a good deal of outrage, states that this was obviously not the case. He then quotes an email where Sparks congratulates his team for “making lemonade from some big old lemons”. Levin then lectures Sparks – you ought to have plenty of regrets for this, but I don’t think you will.
Senator Coburn drills down again on the Abacus deal. Coburn notes that Schwartz of ACA had an email with Pelligrini of Paulson & Co. where Pelligrini thanked her for her efforts on selecting the portfolio.
These hearings aren’t a perfect way to deal with the problems in the market, and are laden with politics and grandstanding. But it is relatively encouraging to see the Senate finally address the types of questions that we’ve been asking on this blog and that many other financial markets observers have been asking, as well. It certainly appeared, for a fairly long period of time, that all of this would continue to get glossed over. In general, I would state that the members of this Senate committee seem to have a fairly good grasp of the complex market issues and the need to come up with a solution to the problems that the CDO and MBS deals created.
Final update (4:20 PM), with some more editorial at the end:
Senator Levin is grilling Tourre on the Abacus deals and how ACA got the impression that Paulson was an equity investor. He’s making Tourre squirm on the issue of whether the statement that ACA and Goldman mutually agreed upon the portfolio is accurate. He gets Tourre to admit that this is not entirely accurate.
He gets Tourre to concede that they did not disclose that Paulson helped select the deals. He then asks if Goldman intended to retain the remaining sliver in the Abacus deal. Tourre says that they did not intend to retain it, though they did end up with it.
Senator Coburn turns to short positions that Goldman took in companies that were sensitive to mortgages, including Merrill and Bear Stearns. Senator Coburn notes that after Goldman sold Timberwolf to Bear Stearns, they took a short position in the stock of Bear Stearns. This seems pretty devastating.
Birnbaum denies knowledge of Bear buying Timberwolf and denies that there was any connection between people buying “shitty” Goldman CDOs and Goldman shorting the companies who bought the bonds. There are many people who would like to see this line of inquiry pursued even further.
I can’t believe that anyone could conclude that this went well for Goldman. They might have avoided making their case with the SEC any worse (which was obviously a primary objective). However, overall the disclosure of their practices and the refusal of the Golman representatives to take any responsibility for their role in the crisis will be very damaging to the firm’s reputation. The Senators laid out evidence that Goldman cleared their own book of risk by dumping it on other investors, that they knew that market was declining but continued to sell deals that had little chance of succeeding, that the reason they were selling these deals was not to meet investor demand but to get them out of MBS and CDO positions, that there were many obvious conflicts of interests utter lack of transparency which accrued to Goldman’s benefit and for which they got paid very well even as their “clients” were suffering massive losses from the same deals.
An answer that the Goldman representatives did not provide, but which seems obvious from the details the Senators discussed, is that the reason Goldman continued to sell these MBS and CDO deals in 2007 even though they strongly suspected the housing market would “not meet a happy end” was so that Goldman could get out of its unsold inventory and positions. This strikes me as a significant inversion of the notion of investor demand. The demand for these deals was from Goldman, so they could clear out their positions and they were willing to tolerate losses on them to accomplish this. This may not have been legally forbidden activity, but it seems quite likely that it will be the subject of additional regulation in the future and that Goldman’s ability to do this next time around may be much more limited. It also seems like a better solution would have been for Goldman not to have been long so much of this inventory in the first place, the accumulation of which probably helped obscure what the real demand for the product was.