Goldman Sachs accused of selling mortgage-linked derivatives at inflated prices and trying to cause ‘maximum pain’ to investors.

In a frenzy to protect its interests at the start of the credit crisis, Goldman Sachs sold mortgage-linked derivatives to clients at inflated prices and misrepresented the nature of the deals, according to documents released by a Senate subcommittee.

Carl Levin, the Michigan Democrat who heads the Senate permanent subcommittee on investigations, said Goldman had “exploited” clients and top executives had lied to Congress during testimony in 2010.

“They gained at the expense of their clients and they used abusive practices to do it,” said Levin, adding there was still time for regulatory agencies to take action against Wall Street.

The bipartisan committee issued a report on Wednesday on Wall Street’s role in the 2007-09 financial crisis, and used Goldman Sachs as one of its case studies.

As the market for related credit derivatives ground to a halt in 2007, Goldman management became increasingly concerned about the company’s exposure.

Top executives held a meeting on 11 May 2007 to develop a “gameplan” to value those assets. A few days later, Dan Sparks, who headed Goldman’s mortgage division, estimated the company might have to take a $382m writedown on its portfolio.

“I think we should take the writedown, but market [the CDO securities] at much higher levels,” Sparks told Thomas Montag, then the head of sales and trading, in an email message, according to the report.

Another executive, Harvey Schwartz, expressed concern about that tactic, saying: “Don’t think we can trade this with our clients and then mark them down dramatically the next day.”

Nonetheless, Goldman’s collateralised debt obligation (CDO) sales team actively targeted clients who would be most receptive to buying related CDOs, in hopes of getting additional sales commissions, according to the subcommittee.

Levin and his panel’s report stopped short of accusing Goldman of illegal behaviour, but Levin said regulators at the Securities and Exchange Commission (SEC) or the Department of Justice could take the investigation further.

The SEC filed civil fraud charges against Goldman last year related to a CDO deal known as Abacus, which the subcommittee also examined in its report. Goldman paid $550m to settle the claims without admitting or denying wrongdoing.

Levin said he planned to refer certain issues from the report to the justice department and SEC, but he would not be more specific about the referrals.

The subcommittee’s report said Goldman management provided the sales team with “talking points” to reassure clients who were wary about the deals. The sales team also advocated pushing the products on to clients abroad who might be less familiar with the deterioration of the US housing market.

Goldman executives and traders used colourful and aggressive language in early 2007 as they strove to extract as much profit from clients as possible.

At one point, Goldman tried to engineer a short-squeeze in the CDO market to drive up prices and maximise its own gains, according to emails and other documents released by the subcommittee.

Michael Swenson, who was then head of Goldman’s structured products group and is now a managing director, said traders ought to “cause maximum pain” and “start killing” short investors, with the hopes of leaving “people totally demoralised”.

There were also interesting titbits from a Morgan Stanley employee who became increasingly frustrated by Goldman’s behaviour related to a CDO deal known as Hudson.

As mortgages went bad and ratings agencies downgraded related bonds, Morgan Stanley called for a rapid liquidation of the Hudson CDO. That process took more than a year to perform.

Morgan Stanley ultimately lost more than $930m on the Hudson deal, while Goldman earned almost $1.7bn by shorting related securities.

Full article


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