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Goldman Sachs Misled Congress After Duping Clients, Levin Says

Alex Constantine - April 13, 2011

" ... The Levin-Coburn panel levied its harshest criticism at investment banks, in particular accusing Goldman Sachs and Deutsche Bank AG of peddling collateralized debt obligations backed by risky loans that the banks' own traders believed were likely to lose value. ... "

Bloomberg News | April 13, 2011

untitled2 - Goldman Sachs Misled Congress After Duping Clients, Levin SaysApril 14 (Bloomberg) -- Goldman Sachs Group Inc. misled clients and Congress about the firm's bets on securities tied to the housing market, the chairman of the U.S. Senate panel that investigated the causes of the financial crisis said.

Senator Carl Levin, releasing the findings of a two-year inquiry yesterday, said he wants the Justice Department and the Securities and Exchange Commission to examine whether Goldman Sachs violated the law by misleading clients who bought the complex securities known as collateralized debt obligations without knowing the firm would benefit if they fell in value.

The Michigan Democrat also said federal prosecutors should review whether to bring perjury charges against Goldman Sachs Chief Executive Officer Lloyd Blankfein and other current and former employees who testified in Congress last year. Levin said they denied under oath that Goldman Sachs took a financial position against the mortgage market solely for its own profit, statements the senator said were untrue.

"In my judgment, Goldman clearly misled their clients and they misled the Congress," Levin said at a press briefing yesterday where he and Senator Tom Coburn, an Oklahoma Republican, discussed the 640-page report from the Permanent Subcommittee on Investigations.

Goldman and Deutsche

Much of the blame for the 2008 market collapse belongs to banks that earned billions of dollars in profits creating and selling financial products that imploded along with the housing market, according to the report. The Levin-Coburn panel levied its harshest criticism at investment banks, in particular accusing Goldman Sachs and Deutsche Bank AG of peddling collateralized debt obligations backed by risky loans that the banks' own traders believed were likely to lose value.

In a statement, New York-based Goldman Sachs denied that it had misled anyone about its activities. "The testimony we gave was truthful and accurate and this is confirmed by the subcommittee's own report," Goldman Sachs spokesman Lucas van Praag said.

"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," van Praag said.

'Divergent Views'

In a statement, Deutsche Bank spokeswoman Michele Allison said, "As the PSI report correctly states, there were divergent views within the bank about the U.S. housing market. Moreover, the bank's views were fully communicated to the market through research reports, industry events, trading desk commentary and press coverage. Despite the bearish views held by some, Deutsche Bank was long the housing market and endured significant losses."

The panel's report also examined the role of credit-rating firms in the meltdown, lax oversight by Washington regulators and the drop in lending standards that fueled the mortgage bubble and ultimately caused hundreds of bank failures.

The subcommittee's findings show "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 customers," said Coburn. "When that happens, no country can survive and neither can their financial institutions."

Final Assessment

The report is likely Washington's final official assessment of the turmoil beginning in 2007 that froze credit markets, took down investment banks Bear Stearns Cos. and Lehman Brothers Holdings Inc., sent housing finance giants Fannie Mae and Freddie Mac into government conservatorship and caused the worst economic collapse in the U.S. since the Great Depression.

The $700 billion taxpayer bailout that followed in October 2008 upended the relationship between Wall Street and the federal government, turning CEOs like Blankfein and Lehman's Richard Fuld into political punching bags. Populist anger at high-paid bank leaders helped fuel the passage of last year's Dodd-Frank law, which set out the biggest changes to financial oversight since the 1930s.

The Senate report comes less than a year after Goldman Sachs paid $550 million to resolve SEC claims that it failed to disclose that hedge fund Paulson & Co was betting against, and influenced the selection of, CDOs the company was packaging and selling.

Goldman Sachs, in its settlement with the SEC, acknowledged that marketing materials for the 2007 CDO deal contained "incomplete information."

Documents and Footnotes

The Senate subcommittee's bipartisan report, buttressed by 2,800 footnotes and thousands of internal documents from Goldman Sachs and other firms, may have more impact than previous investigations into the crisis.

It's an open question whether the Justice Department and the SEC will review its findings. Levin does not have the power to refer the allegations to federal authorities on his own. The subcommittee has a formal process for making referrals, which requires Levin to get the support of Coburn before making an official referral. Levin is going to recommend that the subcommittee make referrals, though he has not done it yet, staff members said.

The Levin report will be examined by policy makers including the SEC and Commodity Futures Trading Commission, which are writing hundreds of Dodd-Frank rules governing derivatives, mortgage securities and proprietary trading.

Coburn, the senior Republican on the subcommittee, said the review carries more heft than the three separate reports issued earlier this year by a politically divided Financial Crisis Inquiry Commission.

Goldman Practices

"We don't need commissions to do our job and this proves it," Coburn said. The FCIC "spent $8 million and 15 months" on its inquiry and "didn't report anything of significance."

The panel said Goldman Sachs relied on "abusive" sales practices and was rife with conflicts of interest that encouraged putting profits ahead of clients.

"While we disagree with many of the conclusions of the report, we take seriously the issues explored by the subcommittee," van Praag said. Van Praag pointed to the firm's recent examination of its business practices that prompted it to make "significant changes that will strengthen relationships with clients, improve transparency and disclosure and enhance standards for the review, approval and suitability of complex instruments."

In the case of one CDO, Hudson Mezzanine Funding 2006-1, Goldman Sachs told investors its interests were "aligned" with theirs while the firm held 100 percent of the short side, according to the report.

Gemstone CDO

The report detailed a $1.1 billion Deutsche Bank CDO known as Gemstone VII, which was backed with subprime loans that its then-top trader, Greg Lippmann, referred to as "crap." The head of the bank's CDO group, Michael Lamont, said in an e-mail cited in the report that he would try to sell the CDO "before the market falls off a cliff."

On lending, the panel alleges that executives at failed thrift Washington Mutual Inc. dumped its bad loans on clients while misleading them about their value.

"WaMu selected delinquency-prone loans for sale in order to move risk from the banks' books to the investors in WaMu securities," Levin said.

Compounding that problem, the subcommittee found, was an apparently cozy relationship between WaMu and its regulator, the Office of Thrift Supervision.

WaMu E-Mail

The report cited a July 2008 e-mail from then-OTS director John Reich to WaMu CEO Kerry Killinger, in which Reich said the regulator would issue a memorandum of understanding regarding the bank's problems.

"If someone were looking over our shoulders, they would probably be surprised we don't already have one in place," Reich wrote, apologizing twice for communicating the decision in an e-mail.

Under the Dodd-Frank regulatory overhaul, the OTS will be folded into other regulators in July.

"The head of OTS knew his agency had been providing preferential treatment to the bank," Levin said. "The OTS was abolished by Dodd-Frank, and for good reasons."

At yesterday's press briefing Levin called credit rating firms Moody's Investors Service and Standard & Poor's "a key cause to the crisis."

Triple-A Ratings

The raters, which the report says stamped the highest Triple-A grades on securities they knew were souring, were hamstrung by a system that has a built-in conflict of interest, Levin said. The Wall Street banks pay the firms for their ratings, leading to competitive pressure between the firms that may have pushed them to more readily place a high rating on a product.

The panel released nine "findings of fact" on the failures of the credit raters, including inadequate resources, inaccurate rating models and a failure to reevaluate old ratings when they recognized they might be inaccurate.

The raters also "shocked the financial markets" with mass downgrades of thousands of residential mortgage-backed securities and CDO ratings, according to the report.

"Perhaps more than any other single event, the sudden mass downgrades of RMBS and CDO ratings were the immediate trigger for the financial crisis," the report said.

-- With assistance from Christine Harper in New York. Editors: Lawrence Roberts, Dan Kraut


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