Wall Street giant Goldman Sachs (Goldman) disputes a U.S. Senate report which named it a major contributor to the financial crisis. The report, released by the Permanent Subcommittee on Investigations (the subcommittee), targeted Goldman for short selling mortgage securities to investors.
Goldman’s home mortgage short was not the issue of concern in the investigation since shorting is not an inherently wrong strategy for Wall Street investment. What is under federal scrutiny is how particular individuals within the colossal financial institution did it.
Goldman created about $100 billion worth of complex and high-risk mortgage backed bonds (MBBs) including residential mortgage-backed securities (RMBS), collateralized debt obligation (CDO) securities and credit default swaps (CDS) in the years leading up to the financial crisis between 2004 and 2007. Both Goldman and its investors held the MBBs, but when Goldman saw delinquency and defaults start to pick up in 2006, it sold off or wrote down most of its own holdings by packaging them into RMBS and CDOs to sell to investors – essentially placing itself in a short position.
What Goldman did not do was disclose (and if it did, it did so obscurely) its short position to investors. Instead, it sold the high-risk MBB packages to investors and marketed them as financially sound bond investments despite its knowledge of the mortgage market’s impending fall. Goldman carried on with this policy all the way to the crash in December 2007. The revenue from its peak net short position totaled $13.9 billion. [For all 646 pages of the subcommittee’s report, see Wall Street and the Financial Crisis: Anatomy of a Financial Collapse.]
Hudson Mezzanine and Timberwolf were two Goldman CDO pools examined in the report. Goldman took a 100% short position with the $2 billion Hudson CDO and made a $1.7 billion gain. With Timberwolf, Goldman did not make a profit off of its short (Timberwolf lost 80% of its value within five months and is worth nothing today) but it did sell the securities to investors at prices above their book value. In one case, Goldman marked Timberwolf as 55 cents on the dollar but later sold similar securities to an Israeli bank for 78.25 cents.
Goldman chief executive Lloyd C. Blankfein was called to testify before a Senate hearing after the report was issued, and in his defense of the firm he explains Goldman was only creating a market for securities and derivatives which had no investors. This is not true. In reality, the firm was playing the part of the underwriter for a ready multitude of investors ready to buy – and buy they certainly did.
The Goldman short on the mortgage market played a significant role in shaping the current financial landscape by distorting the true value of market capital, inventory and pricing. It knew the American economy was taking a turn downwards and its action only made that fall uglier and the healing tougher.
first tuesday take: The Goldman housing short has roamed the news since before Goldman was accused of fraud by the Securities and Exchange Commission (SEC) in 2010 and buckled down to fork over a measly $550 million in a civil suit settlement. However, with the dangerous deflation-potential stage of the financial crisis over, the survivors of the storm (hello, California negative equity homeowners burdened with excessive mortgage amounts!) should finally get a clearer picture of what just happened and why.
What negative equity homeowners will find, as the Senate report confirmed, is how the rentier class – Wall Street bankers and investors – knowingly derived long-term income from those homeowners’ losses. [For more information on banking abuses as explained by Nobel Prize-winning economist Paul Krugman, see the April 2011 first tuesday article, Retribution deferred: lenders prove too powerful to be prosecuted.]
Rentiers is the sociological term for creditors. Those in this group who are lenders play no active role in an economy as they do not produce any goods or services. Goldman and other likeminded rentiers make income, income, income while California homeowners have to pay, pay, pay. It is the lords over the serfs again. Alas, so little has changed over time.
Today, we deal with the consequences of what the rentiers did: a thrashed economy attempting to recover, a depressed consumer confidence and a gloomy housing market outfitted with defaults and foreclosures, failing loan modifications, poor sales and struggling underwater homeowners emotionally attached to their shelter.
RE: “Misdirection in Goldman Sachs’s Housing Short” from the NY Times