Goldman Sachs' secret bets.
WASHINGTON — Goldman Sachs' chief acknowledged Wednesday that the investment bank engaged in "improper" behavior in 2006 and 2007 when it made huge bets on a housing downturn while peddling as safe more than $40 billion in securities backed by risky U.S. home loans.
Lloyd Blankfein, Goldman's chairman and chief executive, made the surprising concession at the opening hearing of the Financial Crisis Inquiry Commission, a 10-member panel that Congress created to investigate and lay out for the public the causes of the worst financial crisis since the Great Depression.
Blankfein and senior officers of three other of the nation's most prominent banks told the panel that serious flaws in their risk models and business practices contributed to Wall Street's meltdown and the massive taxpayer bailouts that followed. The commission also heard testimony that the banks and quasi-government mortgage giant Fannie Mae recklessly took on as much as 95 times more risk than they could cover, and that Wall Street excels "at pulling the wool over the eyes of the American people."
Blankfein faced the toughest questioning.
Commission Chairman Phil Angelides, a former California state treasurer, warned Blankfein that he'd be "brutally honest" in his questioning. He asked why Goldman thought it was necessary to take out protection against investment-grade mortgage securities it was selling by purchasing insurance-like contracts known as credit-default swaps. Angelides likened it to selling a car with knowledge it had faulty brakes and then taking out an insurance policy on the buyer.
"I do think the behavior is improper, and we regret . . . the consequence that people have lost money in it," Blankfein told Angelides.
Until Wednesday, Goldman had insisted that it was merely managing its risks when it placed "hedges," in the form of wagers against the housing market, various venues including in secret offshore deals, with insurance giant American International Group and on a private London exchange.
In November, McClatchy reported exclusively that Goldman failed to tell investors about its contrary bets while selling $39 billion in risky mortgage securities it had issued, and another $18 billion in similar bonds issued by other firms. The Securities and Exchange Commission and Congress are investigating Goldman's swap dealings, said knowledgeable people who asked not to be identified because of the sensitivity of the issue.
While conceding that its contrary bets were improper, Blankfein said that in most cases Goldman took those positions to offset bets it had underwritten for clients seeking to wager on a housing downturn.
Similarly, he said that the firm got into the business of securitizing subprime loans to marginally qualified buyers on behalf of "sophisticated investors who sought that exposure."
Angelides, who crusaded for corporate accountability as California treasurer from 1999-2007, pressed Blankfein to explain why Goldman plunged deeper into subprime mortgages despite an FBI warning to Congress in 2004 that the lax lending standards could lead to a crisis. He also needled Blankfein for seeming to resist taking responsibility.
Goldman's purchase of the dicey loans, Blankfein admitted, allowed subprime mortgage lenders "to go out and originate more loans. So to that extent, we . . . played a part in making that market."
After the hearing, Angelides told McClatchy that he was "troubled" that Blankfein "never admitted that there was any responsibility of Goldman Sachs to make sure the products themselves were good products."
All the executives, including J.P. Morgan Chase Chief Executive Jamie Dimon, Morgan Stanley Chairman John Mack and Bank of America President and Chief Executive Brian Moynihan, acknowledged that they'd paid a huge price for failing to build the possibility of declines in home prices into their risk-management models.
That failure had disastrous consequences, since the banks packaged mortgages into investments that were sold worldwide as securities, often with top ratings from credit-rating agencies such as Moody's Investors Service. When home prices fell, these securities plummeted in value, the credit agencies' credibility plunged and distrust over banks' ability to cover tens of billions of dollars in swap bets created waves of panic that froze financial markets.
The lesson learned is that "given enough time, everything will happen, not can happen," Blankfein said. He noted that in the aftermath of the housing meltdown his firm models for even the most improbable scenarios in all its lines of business.
Dimon, whose company has been the least tarnished by the crisis, said that in retrospect it should have been obvious that mortgages given to people with little or no proof of income was a terrible idea.
However, he cautioned, until the market meltdown "you never saw losses in these products, because home prices were going up."
The sector's failure, he added, was the assumption that prices can only go up.
"I would say that was one of the big misses," Dimon said. "That is now part of the stress test" that J.P. Morgan conducts.
Moynihan, who's new in his job, said that post-crisis, his company tests for a range of improbable but possible scenarios in all areas where it extends credit.
Another criticism of the big banks that packaged mortgages into securities is that they didn't retain portions of what they were selling. They weren't exposed themselves to the risk that they were exposing others to. In plain speaking, they weren't eating their own cooking.
"We did eat our own cooking, and we choked on it," Mack said, referring to his firm's mistake in hanging on to too many of the securities.
Michael Mayo, a managing director and financial services analyst for the U.S. branch of French bank Calyon Securities, rattled off 10 causes of the financial crisis, including excessive investment in real estate, the surge in exotic bets such as credit-default swaps, and the fact that U.S. investment banks allowed leverage — the ratio to which their risks outstripped capital — to approach 40-to-1.
"I'm shocked and amazed more changes have not taken place," Mayo said. "There seems an unwritten premise that Wall Street, exactly how it exists today, is necessary for the economy to work. That's not true. ... Wall Street has done an incredible job at pulling the wool over the eyes of the American people."
Kyle Bass, whose Dallas-based hedge fund cashed in by betting on a housing downturn beginning in 2006, told the panel that AIG and other insurers could never have taken on such risk if they had been required to put up initial cash, or collateral, whenever they wrote protection via a swap contract.
He said that at one point in 2007, Fannie Mae had taken on risk exceeding 95 times the minimum capital it was required to hold, meaning its had set aside less than two tenths of a percent of its potential losses before it was placed in conservatorship in September 2008.
One commission member, Brooksley Born, enjoyed an element of sweet revenge Wednesday.
As the chair of the Commodity Futures Trading Commission in the Clinton administration, Born tried to persuade Congress to let her agency regulate exotic financial instruments such as swaps, but her views were overridden then Federal Reserve Chairman Alan Greenspan and then-Treasury Secretary Lawrence Summers, now a top Obama adviser.
On Wednesday, Born got a former executive of now-defunct investment bank Lehman Brothers to acknowledge that the "excessive" political lobbying power of large financial firms resulted in legislative changes that contributed to the crisis.
Surrounded by reporters during a recess, J.P. Morgan's Dimon maintained that "the people who should be blamed are the people in the management of the companies that failed."
Reacting to that assertion, Angelides told McClatchy that "there are some companies that survived because they got massive federal assistance," including Goldman and other banks whose officers testified Wednesday.
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