WASHINGTON — A Senate investigations panel confronted Goldman Sachs executives Tuesday with evidence that the firm peddled subprime mortgage securities its traders considered to be "crap" as they secretly made huge bets on a housing downturn.
Sen. Carl Levin, a Michigan Democrat, culminated more than 10 hours of often-contentious testimony by telling Goldman's top officer, chief executive Lloyd Blankfein, that the firm had "a fundamental conflict" with its clients' interests as it exited the home mortgage market in 2006 and 2007.
"And it raises a real ethical issue," said Levin, the chairman of the Senate Permanent Investigations Subcommittee.
Blankfein, whose company is facing civil fraud charges from the Securities and Exchange Commission over one of its subprime deals, declined to give ground. He denied that Goldman made massive "short," or negative, bets on subprime mortgage securities. Further, he said, Goldman had no obligation to divulge its short bets in its role as a market maker for sophisticated institutional investors.
"The investors we're dealing with ... know what they want to acquire," Blankfein said. If they raise questions about a deal, he said, "then the salesman owes them an honest answer."
The subcommittee reviewed 2 million subpoenaed Goldman documents during an 18-month investigation of the world's most prestigious investment bank, which has become a poster child for Wall Street's role in fueling the housing bubble that burst the global economy.
Levin and his subcommittee colleagues spent much of the day questioning four current and former Goldman traders and the company's chief financial and risk officers about more than 170 company e-mails and documents describing how the firm escaped the subprime market. Levin contended that Goldman racked up billions of dollars in profits in 2007 by making exotic, insurance-like bets on a housing collapse — sometimes wagering against securities in offshore deals that Goldman actually designed.
In one deal, which Levin raised again and again, a Goldman executive labeled the mortgage securities "shitty."
Levin recounted for Blankfein a litany of failed deals from 2006 and 2007 that totaled $3.5 billion in which he said that "clients lost, Goldman profited."
At another point, Levin repeatedly attacked Blankfein's contention that the firm was only modestly betting against the housing market. "You were short like crazy," he said. "You came out ahead in a market that crashed."
Levin also attacked the firm's trustworthiness. "You want to be trusted. I'm glad you want to be trusted, but I think you can understand why there's a lot of folks who have some real doubts."
Blankfein, who often seemed cowed by Levin's questioning, consistently repeated the company line that Goldman's clients understood the complexity of its deals. "The thing(s) we are selling to them are the risks they want." At other times, Goldman's CEO and the senators seemed to be talking different languages.
"It seems to me, and it's not like selling a lame horse or an unsound horse. It's not like selling a — a can of corn that's been through a cow and you're calling it corn when it's really something else," said Sen. Jon Tester, a Montana Democrat.
The panel barely noted that Goldman also reaped nearly $15 billion during the past two years from additional bets with American International Group against mortgage securities in deals based in the Cayman Islands. Most of those bets, Goldman says, offset credit protection it wrote for investors who took short positions on those deals.
David Viniar, Goldman's chief financial officer, said that the firm netted "less than $500 million" from its negative bets in 2007, but didn't protest when Levin told him that billions of dollars in other profits enabled the firm to limit losses on securities backed by mortgages to shaky borrowers.
John Coffee, a Columbia University law professor specializing in securities, said that some of the internal documents could put Goldman at legal risk if they show the firm's mortgage salesmen were "simply trying to unload what they believe(d) to be garbage ... cats and dogs," but didn't tell investors.
"I thought all they were doing was hedging," he said. "Now it looks like they had a very large short — that they were fundamentally betting against the market."
Much of the questioning echoed reports by McClatchy last November and December that Goldman had marketed $57 billion in risky mortgage securities in a series of deals in 2006 and 2007, including $39 billion backed by mortgages that it bought from lenders without telling investors that it was secretly making bets on a housing downturn.
Goldman also sold billions of dollars in offshore securities that included subprime mortgages. Securities experts told McClatchy at the time that the practice might have constituted fraud because investors might have opted not to buy the securities if they knew that Goldman was betting on their collapse.
Held before a packed, standing-room only Senate room, the hearing met was classic Washington theater, complete with protesters in prison uniforms demanding that Goldman executives do jail time and dozens of cameras trailing witnesses as they walked into the room.
Among the four present and former Goldman traders who testified was Fabrice Tourre, the 31-year-old Goldman vice president accused by the SEC on April 16 of fraudulently helping a Goldman client rig an offshore deal that cost two European banks $1 billion.
Tourre and the others said in sworn testimony that they feel bad about the housing crash, but also said that they'd done nothing wrong.
"I am saddened and humbled by what happened in the market," said Tourre, a Frenchman who took time off last week from his London-based job. "But I believe my actions were proper."
Dan Sparks, the former head of Goldman's mortgage department, told the panel that his team had no legal duty to tell investors that it was betting against its own products.
"Regret to me is something that you did wrong, and I don't have that," Sparks said. "That doesn't mean we didn't make mistakes ... That doesn't mean we didn't do deals that didn't turn out the way we hoped they would ... These deals performed horribly."
"You've got no regrets? You ought to have plenty of regrets," Levin told the four witnesses.
The bets Goldman took out involved purchasing exotic instruments called credit-default swaps. They work like an insurance policy, with a buyer being compensated if the underlying deal goes sour.
Beginning in December 2006, Goldman began a strategy to reduce its subprime risks by selling off its dicey securities and secretly making exotic bets against the market and the products it was selling to its clients.
Former Goldman trader Joshua Birnbaum indicated in his 2007 personnel performance review that he could capitalize on the "fear" in the market of a coming mortgage market collapse to reap profits for the firm.
Because "the world would think" Goldman would continue to invest in the mortgage market for the long term, he wrote, the firm should "flip our risk" and bet on an impending crisis.
"We could use that fear to our advantage if we could flip our risk," wrote Birnbaum, who left Goldman in 2008.
Missouri Democratic Sen. Claire McCaskill told them: "We're trying to home in on why so many people are unemployed in my state and why so many people lost money in their pension funds."
Comparing his panel's investigation to inquiries into the causes of the Great Depression, Levin said that what investigators see now is similar to what they saw in the 1930s. "The parallels are unmistakable to today's events," Levin said.
Levin said earlier that the panel would not decide whether to refer its evidence for possible civil or criminal action by the SEC or Justice Department until after the hearing.
Coffee said, however, that the courts might not find that Goldman transgressed, because it sold the securities only to sophisticated institutional investors, who have fewer protections under securities laws.
Nonetheless, he said Goldman has sustained "reputational damage," especially among European investors that took heavy losses on Goldman's mortgage securities.
"The business model of working both sides of a transaction, selling to investors, while betting against them is not stable and will cost them clients," he predicted. "I think they will need to re-examine that model or give up a lot of investor clients."
(Kevin G. Hall contributed to this article.)
ON THE WEB
Goldman CEO Blankfein's prepared testimony
Craig Broderick's prepared testimony
David Viniar's prepared testimony
Fabrice Tourre's prepared testimony
Daniel Sparks's prepared testimony
Josh Birnbaum's prepared testimony
Letter to the Banking Committee regarding regulatory reform
MORE FROM MCCLATCHY
Goldman Sachs: Low Road to High Finance
Pulitzer finalist: Judges honor McClatchy probes of Wall Street
Goldman executives: We made money betting against mortgage market
Where was Moody's board when top-rated bonds blew up
In Senate testimony, ratings agency heads won't take the blame