VI. INVESTMENT BANK ABUSES:
CASE STUDY OF GOLDMAN SACHS AND DEUTSCHE BANK
C. Failing to Manage Conflicts of Interest: Case Study of Goldman Sachs
(5) How Goldman Created and Failed to Manage Conflicts of Interest in its Securitization Activities
In the years leading up to the financial crisis, Goldman was an active trader in the mortgage market, buying and selling a variety of mortgage related assets, including RMBS, CDO, ABX, and CDS instruments, as described in the prior section. In addition, Goldman was one of the leaders in mortgage related securitizations, helping to originate both CDO and RMBS securities. Goldman's 2006 and 2007 securitization activities are the focus of this section.
In 2006 and 2007, Goldman originated 27 CDOs and 93 RMBS securitizations with a total value of about $100 billion. |2006| Goldman designed the structure of each securitization, including the number of tranches, how the payments would be allocated, and the projected rate of return or "coupon rate" that would be paid to investors. In some, Goldman selected the assets to be securitized; in others, it hired a portfolio selection agent or collateral manager to help select the assets and manage the portfolio. For each securitization, Goldman typically housed all of the assets to be securitized in a "warehouse" account until the transaction was ready to go to market. The assets in the warehouse accounts were then included in Goldman's balance sheet. Goldman also typically worked with one or more credit rating agencies to obtain favorable credit ratings for the proposed securities.
In addition, Goldman typically established a domestic and an offshore corporation to act as the nominal owners of the securitization's incoming cash, assets, and collateral securities; to serve as the actual issuers of the securities; and to perform certain administrative services. Goldman also established arrangements for the servicing of any underlying mortgages. In some CDOs, Goldman or its affiliate provided additional services as well, acting in such roles as the collateral securities selection agent, the collateral put provider, or the liquidation agent charged with selling impaired assets. Goldman also used its global sales force to market its securities to investors around the world, typically selling Goldman-issued CDO securities through a private placement and RMBS securities through a public offering.
In late 2006, when subprime residential mortgages began to incur higher than expected rates of delinquency, fraud, and default, and its inventory of mortgage related assets began to lose value, Goldman took a number of actions. It sold the mortgage related assets in its inventory; returned poor quality loans to the lenders from which they were purchased and demanded repayment; limited new RMBS securitizations; sold or securitized the assets in its RMBS warehouse accounts; limited new CDO securitizations to transactions already in the pipeline; and sold assets from discontinued CDOs.
Throughout this process, Goldman made a concerted effort to sell securities from the CDO and RMBS securitizations it had originated, even when those securities included or referenced poor quality assets and began losing value. Many of the CDO and RMBS securities that Goldman sold to its clients incurred substantial losses. The widespread losses caused by CDO and RMBS securities originated by investment banks are a key cause of the financial crisis that affected the global financial system in 2007 and 2008.
This section of the Report examines how Goldman originated, marketed, and sold its mortgage related securities, in particular CDO securities, during late 2006 and in 2007, as the mortgage market deteriorated and as Goldman was profiting from its own net short positions. The section begins with general information about Goldman's securitization activities, followed by detailed case studies of four Goldman-originated CDOs: Hudson 1, Anderson, Timberwolf I, and Abacus 2007-AC1.
The evidence discloses troubling and sometimes abusive practices which show, first, that Goldman knowingly sold high risk, poor quality mortgage products to clients around the world, saturating financial markets with complex, financially engineered instruments that magnified risk and losses when their underlying assets began to fail. Second, it shows multiple conflicts of interest surrounding Goldman's securitization activities, including its use of CDOs to transfer billions of dollars of risk to investors, assist a favored client make a $1 billion gain at the expense of other clients, and produce its own proprietary gains at the expense of the clients to whom Goldman sold its CDO securities.
Under Goldman's sales policies and procedures, an affirmative action by Goldman personnel to sell a specific investment to a specific customer constituted a recommendation of that investment. |2007| Under federal securities law, when acting as an underwriter, placement agent, or broker-dealer recommending an investment to a customer, Goldman had an obligation to sell investments that were suitable for any investor and were not designed to fail. When acting in those roles and affirmatively soliciting clients to buy securities, Goldman also had an obligation to disclose material information that a reasonable investor would want to know, including material conflicts of interest or adverse interests in connection with its sale of a security. |2008|
In 2006 and 2007, when selling subprime CDO securities to customers, Goldman did not always disclose that the securities contained or referenced assets Goldman believed would perform poorly, and that the securities themselves were rapidly losing value. Goldman also did not disclose that the firm had built a large net short position betting that CDO and RMBS securities similar to the ones it was selling would lose value. In the case of the Hudson, Anderson, and Timberwolf CDOs, Goldman failed to disclose to potential investors that it was shorting the very securities Goldman was selling to them. In the case of the Abacus CDO, Goldman failed to disclose to potential investors that it had allowed an interested party to help select the CDO assets and act as the sole short party, with the expectation that the selected assets would lose value and that party would make money at the expense of the long investors to whom Goldman had sold the securities. Goldman created these and other conflicts of interest with its clients in connection with its CDO activities.
To understand Goldman's securitization activities, this section provides general background about its CDO and RMBS business and how Goldman changed its securitization activities when the mortgage market began to deteriorate in late 2006.
The Goldman Mortgage Department originated CDOs through two different desks within the Department. Approximately half of Goldman's CDOs were originated by its CDO Origination Desk, which assembled the assets, structured the CDOs, and worked with the Goldman sales force to market the resulting securities to a broad range of investors. The CDO Origination Desk was headed by Peter Ostrem from 2006 until May 2007, after which all remaining Goldman-originated CDOs were transferred to the Structured Product Group (SPG) Trading Desk and were overseen by David Lehman.
Goldman's other CDOs, which were part of a series issued under the name of Abacus, were originated by the Correlation Trading Desk, which was a sub-desk of the SPG Trading Desk. The Correlation Trading Desk specialized in arranging customized trades for investors and used the Abacus series of CDOs as one of its investment alternatives. The Correlation Trading Desk was headed by Jonathan Egol. The CDO Origination and Correlation Trading Desks were located on the same floor as the other SPG Trading Desks.
RMBS securitizations were handled by the Residential Whole Loan Trading Desk, headed by Kevin Gasvoda. Sub-desks within the Residential Whole Loan Trading area oversaw the purchase of residential loan pools, constructed the RMBS securitizations, and worked with the Goldman sales force to sell the resulting securities to investors.
After a desk originated a CDO or RMBS securitization and sold the Goldman-originated securities for the first time, all secondary trading of the securities was handled by the Structured Products Group's Asset-Backed Security (ABS) Desk. In mid-2007, Goldman shut down its CDO Origination Desk and directed the ABS Desk to sell all remaining Goldman-originated CDO securities, in addition to conducting the secondary trading it normally handled.
Daniel Sparks, as head of the Mortgage Department, oversaw all of Goldman's CDO and RMBS origination activities. Mr. Sparks reported at times to Jonathan Sobel, the prior department head, and Richard Ruzika, then head of Commodities Trading. He also worked with Justin Gmelich, a managing director asked to help him run the Department on a short term basis. Mr. Sparks also had frequent contact with more senior Goldman executives, including Thomas Montag, then global co-head of Securities Trading, and Donald Mullen, then head of Credit Trading. On occasion, he also received directives from Chief Financial Officer David Viniar and Co-Presidents Gary Cohn and Jon Winkelried.
As established earlier in the Report, all of Goldman's securitization activities from 2006 to 2007 took place against the backdrop of a subprime mortgage market that, in Goldman's view, was in distress and worsening.
On December 7, 2006, for example, Mr. Sparks sent this gloomy assessment to senior executive Thomas Montag:
"Generally, originators are struggling with EPDs [early payment defaults] which require them to buy back loans and take losses – thinly capitalized firms can't take much of it. Lower margins and volumes are also causing pain. Ownit [a mortgage originator] ... closed Monday. Premiums for these originators – all of whom are for sale – are rapidly falling. ... Likely fall-out – more originators close and spreads in related sectors widen." |2009|
A week later, on December 13, 2006, Mr. Sparks repeated his negative view of the subprime mortgage market before senior Goldman executives on the Firmwide Risk Committee. The committee minutes described his report as follows:
"Dan Sparks: Noted the stress in the subprime market; Concern around ‘06 originators, as two more failed last week; Concern around early payment defaults, $5BN in loans to subprime borrowers, warehouse lines to 6 subprime lenders, and $16MM in ‘06 residual positions and alt-a and subprime residual positions from ‘04-‘05; Street aggressively putting back early payment defaults to originators thereby affecting the originator's business. Rumors around more failures are in the market." |2010|
On December 14, 2006, CFO David Viniar held a meeting with senior Mortgage Department executives, reviewed their mortgage related holdings, and directed them to offset the risk posed by declining values. |2011| The Mortgage Department then initiated its first multi-billiondollar net short positions in 2007, essentially betting that subprime mortgage related assets would fall in value.
In early 2007, Mr. Sparks made increasingly dire predictions about the decline in the subprime mortgage market and issued emphatic instructions to his staff about the need to get rid of subprime loans and other assets. On February 8, 2007, for example, Mr. Sparks wrote:
"Subprime environment – bad and getting worse. Everyday is a major fight for some aspect of the business (think whack-a-mole). . . . [P]ain is broad (including investors in certain GSissued deals)." |2012|
On February 14, 2007, Mr. Sparks wrote some notes to himself:
"Bad week in subprime
collateral performance on loans was poor – we took a write-down on second lien deals and on the scratch and dent book last week . . . .
Synthetics market got hammered – around 150 [basis points] wider . . . .
Originators are really in a bad spot. Thinly capitalized, highly levered, dealing with significant loan putbacks, some with retained credit risk positions, now having trouble selling loans above par when it cost them 2 points to produce.
What is the next area of contagion." |2013|
That same day, February 14, 2007, Mr. Sparks exchanged emails with Goldman's Co- President Jon Winkelried about the deterioration in the subprime market:
Mr. Winkelried: "Another downdraft?"
Mr. Sparks: "Very large – it's getting messy . ... Bad news everywhere. Novastar bad earnings and 1/3 of market cap gone immediately. Wells [Fargo] laying off 300 subprime staff and home price appreciation data showed for first time lower prices on homes over year broad based." |2014|
On February 26, 2007, when Mr. Montag asked him about two CDO2 transactions being assembled by the CDO Origination Desk, Timberwolf and Point Pleasant, Mr. Sparks expressed his concern about both:
Mr. Montag: cdo squared–how big and how dangerous
Mr. Sparks: Roughly 2bb, and they are the deals to worry about. |2015|
On March 3, 2007, Mr. Sparks made notes after a telephone call: "Things we need to do .... Get out of everything." |2016| On March 7, 2007, Mr. Sparks again reported to Goldman's Firmwide Risk Committee on accelerating problems in the subprime mortgage market:
"– ‘Game Over' – accelerating meltdown for subprime lenders such as Fremont and New Century.
– The Street is highly vulnerable . ... Current strategies are to ‘put back' inventory and liquidate positions.
– The Mortgage business is currently closing down every subprime exposure possible." |2017|
On March 8, 2007, Mr. Sparks emailed several senior executives, including Mr. Viniar and Mr. Cohn about "Mortgage Risk": "[W]e are trying to close everything down, but stay on the short side." |2018|
Other Mortgage Department personnel gave similarly bleak assessments of the subprime mortgage market. As early as January 2007, Jonathan Egol, head of the Correlation Trading Desk, wrote to a colleague expressing his clients' views: "The mkt is dead." |2019| In February 2007, when discussing plans to issue an Abacus CDO with a Correlation Desk Trader, Fabrice Tourre, Mr. Egol repeated that assessment as his own:
Mr. Egol: [T]he paulson trade may already be dead (although given it is baa2 it may still have a decent shot).
Mr. Tourre: Don't think the Paulson trade is dead. Supersenior pretty much done with ACA, AAAs could be placed in 2 shots, this is sufficient. Remember we make $$$ per tranche placed. ...
Mr. Egol: You know I love it all I'm saying is the cdo biz is dead we don't have a lot of time left. |2020|
On March 8, 2007, in an email to senior management, Mr. Sparks listed a number of "large risks I worry about." |2021| At the top of the list was "CDO and Residential loan securitization stoppage – either via buyer strike or dramatic rating agency change." Mr. Sparks was referring to the possibility that Goldman would be unable to securitize and sell its remaining subprime mortgage related inventory by repackaging it into RMBS and CDOs for sale to customers. His concern was either that buyers would refuse to purchase such products ("buyer strike"), or that the ratings agencies might realize the poor quality and high risks associated with these products and downgrade them so they could not be sold with AAA ratings ("dramatic rating agency change"). In essence, Mr. Sparks was worried about Goldman's being left with a large inventory of unsold and unsaleable subprime mortgage related assets when the market finally collapsed. |2022|
At the same time Goldman personnel were expressing these negative views of the securitization business, the Mortgage Department was building its large net short positions in the first and third quarters of the year.
In response to the December 14, 2006 meeting at which CFO David Viniar ordered the Mortgage Department to offset the risk associated with its mortgage related holdings, the Department initiated an intensive effort to sell off the subprime RMBS and CDO securities and other assets in its inventory and warehouse accounts. |2023|
As described earlier, on the same day as the Viniar meeting, December 14, 2006, Kevin Gasvoda, head of the Mortgage Department's Residential Whole Loan Trading Desk, instructed his staff to undertake an immediate, concerted effort to sell the whole loans and RMBS securities in Goldman's inventory and warehouse accounts, focusing on RMBS securities from Goldmanoriginated securitizations. |2024| By February 9, 2007, the Goldman sales force reported a substantial number of sales, |2025| and by the end of February, Goldman's controllers reported that Goldman's inventory of whole loans had "decreased from $11bn to $7bn" with "subprime loans decreased from $6.3bn to $1.5bn," a reduction of more than two-thirds. |2026|
In addition, during the first quarter of 2007, the Mortgage Department drastically slowed its RMBS origination business and its purchase of whole loans and RMBS securities. |2027| Those actions meant that Goldman was not only reducing its inventory, but also reducing its intake of what had previously been a constant inflow of billions of dollars in whole loans and RMBS securities purchased as part of its securitization business.
In addition to selling whole loans and RMBS securities, the Mortgage Department wrote down the value of its remaining subprime mortgage portfolio. On February 8, 2007, for example, Mr. Gasvoda recommended that certain whole loan pools and RMBS securities be marked down by $22 million. |2028| On February 9, 2007, Mr. Sparks reported a $30 million writedown on non performing loans. |2029| Mr. Ruzika responded: "Ok, you've been communicating the write down was coming. Let's go through the residual risk and make sure we get to the correct number for the quarter." |2030| Residual risk referred to the non rated equity tranches that underwriters like Goldman often retained from the RMBS securitizations they originated; those tranches were also written down in value. Those writedowns not only implemented Goldman's policy of using current market values for its assets, but also effectively reduced the size of Goldman's "long" position in subprime mortgage related assets. As Mr. Ruzika wrote to Mr. Cohn: "working with Dan to uncover exactly what else needs to be written down so that we can pnl [profit and loss] it this quarter and be clean going into next quarter." |2031|
Loan Repurchase Campaign. In addition to its sales and writedowns, the Mortgage Department intensified its efforts to identify and return defaulted or otherwise deficient loans to the originating lender from which they had been purchased in exchange for a refund of the purchase price. Altogether in 2006 and 2007, Goldman made about $475 million in repurchase claims for securitized loans, and recovered about $82 million. |2032| It also made about $40 million in repurchase claims for unsecuritized loans, and recovered about $17 million. |2033|
In the years leading up to the financial crisis, most subprime loan purchase agreements provided that if a loan experienced an early payment default (EPD), meaning the borrower failed to make a payment within three months of the loan's purchase, or if the loan breached certain representations or warranties, such as representations related to the loan's characteristics or documentation, the loan could be returned or "put back" to the seller which was then obligated to repurchase it. In late 2006, as subprime loans began to experience accelerated rates of EPDs and fraud, |2034| Wall Street firms began to intensify their efforts to return those loans for refunds. Some subprime lenders began to experience financial distress due to unprecedented waves of repurchase requests that drained their cashflows. |2035|
Although Goldman, either directly or through a third party due diligence firm, routinely conducted due diligence reviews of the mortgage loan pools it bought from lenders or third party brokers for use in its securitizations, those reviews generally examined only a sample of the loans and did not attempt to identify and weed out all deficient mortgages. |2036| Instead, Goldman purchased loan pools with the expectation that they would incur a certain rate of defaults. In late 2006, however, like other Wall Street firms, Goldman began to see much higher than anticipated delinquency and default rates in the loan pools in its inventory and warehouse accounts, and in the subprime RMBS and CDO securitizations it originated. |2037| Defaulted loans generally could not be sold or securitized, and had to be terminated through foreclosure proceedings or sold in so-called "scratch and dent" pools that generally produced less money than the loans cost to buy. In addition, defaulted loans meant that the borrowers who took out those loans stopped making loan payments to the securitized loan pool, reducing the cashflow into the related securities. RMBS and CDO securities whose underlying assets incurred high rates of loan delinquencies and defaults experienced reduced cashflows, lost value, and sometimes failed altogether, resulting in substantial losses for investors.
In early 2007, Goldman's Mortgage Department initiated an intensive review of the loans in its inventory, warehouse accounts, and RMBS and CDO securitizations, to identify deficient loans and return them for refunds. On February 2, 2007, Mr. Sparks reported to senior Goldman executives Messrs. Viniar, Montag, and Ruzika that obtaining refunds from the loan originators would be "a battle":
"The team is working on putting loans in the deals back to the originators (New Century, WAMU, and Fremont – all real counterparties), as there seem to be issues potentially including some fraud at origination, but resolution will take months and be contentious. ... The put backs will be a battle." |2038|
To manage its loan repurchase campaign, Goldman expanded an operations center in St. Petersburg, Florida, |2039| and made extensive use of third party due diligence firms hired to review its securitized loan pools. |2040| Goldman instructed the firms to "re-underwrite" every loan in pools of mortgages purchased from specific lenders, including New Century, Fremont, Long Beach, and later Countrywide. |2041|
By March 2007, the average EPD rate for subprime loans in Goldman's inventory had climbed from 1% of aggregate volume to 5%, a dramatic increase. |2042| On March 7, 2007, Mr. Sparks described Goldman's exposure as follows:
"As for the big 3 originators – Accredited, New Century and Fremont, our real exposure is in the form of put-back claims. Basically, if we get nothing back we would lose around $60mm vs loans on our books (we have a reserve of $30mm) and the loans in the [CDO and RMBS] trusts could lose around $60mm (we probably suffer about 1/3 of this in ongoing exposures). ... Rumor today is that the FBI is in Accredited." |2043|
Five days later, on March 12, 2007, Mr. Sparks wrote: "The street is aggressively putting things back, like a run on the bank before there is no money left to fulfill the obligations." |2044|
One of the lenders that was an initial focus of Goldman's loan repurchase effort was New Century, a subprime lender whose loans Goldman had used in many Goldman-originated RMBS securitizations. After completing a review of one New Century loan pool, an analyst recommended "putting back 26% of the pool ... if possible." |2045| A putback rate of 26% meant that about one in four of the loans in the New Century pool had EPDs, were fraudulent, or otherwise breached New Century's contractual warranties. It also implied that about 25% of the expected mortgage payments might not be made to the relevant RMBS securitization. Unless the problem loans could be successfully "put back" to New Century in exchange for a refund, a fail rate of that magnitude would likely impair the performance of all of the securities dependent upon that pool of mortgages.
Goldman made a total of about $67 million in repurchase requests to New Century, which was among the five mortgage originators to whom Goldman directed the most repurchase requests in 2006 and 2007. |2046| In March 2007, however, New Century stopped paying Goldman's claims due to insufficient cash, and the loan repurchase team sought advice from Mr. Gasvoda:
"As you know, we have an extensive re-underwrite review underway on 06 NC2 [New Century second lien loans] and also other NC loans in the 2nds deals that are in the pipeline for scrubs. Should we change course at all here given the fact NC can't pay?" |2047|
Mr. Gasvoda responded:
"Yes .... I think priority s/b [should be] on Fremont and Long Beach on 2nd lien deals. Fremont first since they still have cash but may not for long. ... [O]n NC2 we need not halt that entirely but should pull back resources there. We should also move 06FM2 [Fremont second lien loans] up the priority list."
Goldman made a total of about $46 million in repurchase requests to Fremont, another subprime lender for whom Goldman had underwritten multiple securities and which was also among the five mortgage originators to whom Goldman made the most repurchase requests in 2006 and 2007. |2048| When Goldman personnel reviewed a loan pool purchased from Fremont, the results were even worse than for the New Century loans. Goldman concluded that "on average, about 50% of about 200 files look to be repurchase obligations." |2049| Later, Goldman came to a similar conclusion after reviewing certain loans purchased from Countrywide, again finding that about 50% of the loans reviewed were candidates for return to the lender. |2050|
Goldman made a total of about $34 million in repurchase requests to Long Beach, a subprime lender for whom Goldman had underwritten billions of dollars in RMBS securities and which was also among the five mortgage originators to whom Goldman made the most repurchase requests in 2006 and 2007. |2051| Goldman pressed both Long Beach and its parent Washington Mutual for repayment of millions of dollars in refunds. At one point, a Goldman executive involved in the repurchase effort sent an email to the head of Washington Mutual Home Loans Division, David Schneider. After noting that Long Beach second lien loans were "performing dramatically worse" than other 2006 RMBS securities, the Goldman executive wrote: "As you can imagine, this creates extreme pressure, both economic and reputational, on both organizations." |2052|
Goldman's loan repurchase campaign recovered substantial funds from some lenders, |2053| but little or none from others. |2054| Non performing loans that were not repurchased by the lender generally remained in Goldman's inventory or the relevant securitized loan pool. Many other securitizers engaged in similar loan repurchase efforts which continued in 2011. |2055|
Poor Quality RMBS Securities. As a result of its loan repurchase and writedown efforts, the Mortgage Department was keenly aware of the poor quality of many of the loan pools in its warehouse accounts. Nevertheless, during this time period, Goldman continued securitizing many of those loans and selling the resulting RMBS securities to clients.
In March 2007, for example, Goldman securitized over $1 billion in subprime loans that it had purchased from Fremont, originating an RMBS securitization called GSAMP Trust 2007- FM2. |2056| Goldman underwrote the security in the same month that it was attempting to return millions of dollars in deficient loans to the lender, |2057| and regulators ordered Fremont to stop issuing subprime loans. |2058| Goldman marketed and sold the RMBS securities to clients. Within seven months, by October 2007, the rating downgrades began; by August 2009, every tranche of the GSAMP securities had been downgraded to junk status. |2059|
On March 26, 2007, the Mortgage Department sought permission from Goldman's Mortgage Capital Committee to securitize and underwrite a new RMBS called GSAMP Trust 2007- HE2, which contained nearly $1 billion in subprime mortgage loans in a Goldman warehouse account, over 70% of which had been purchased from New Century. |2060| Goldman approved this securitization even though it knew at the time that New Century's subprime loans were performing poorly, many of the New Century loans in Goldman's inventory were problematic, and New Century was in financial difficulty. |2061| The securitization was approved for issuance in April 2007, the same month New Century declared bankruptcy. |2062| Goldman marketed and sold the RMBS securities to its clients. The securities first began to be downgraded in October of 2007, and all of the securities have since been downgraded to junk status. |2063|
Had Goldman not securitized the $2 billion in Fremont and New Century loans, the Mortgage Department would likely have had to liquidate the warehouse accounts containing them and either sell the loan pools or keep the high risk loans on its own books.
On April 11, 2007, a Goldman salesman forwarded to Mr. Egol a scathing letter from a customer, a Wachovia affiliate, which had purchased $10 million in RMBS securities backed by Fremont loans and underwritten by Goldman. The client wrote that it was "shocked" by the poor performance of the securities "right out of the gate," and concerned about Goldman's failure to have disclosed information about the poor quality of the underlying loans in the deal termsheet:
" As you know, we own $10mm of the GSAMP 06-S3 M2 bond . ... We are shocked by how poorly this bond has performed right ‘out of the gate' and had asked [Goldman] to send us the attached ProSupp [Prospectus Supplement]. After having read the ProSupp and compared it to the termsheet we have several concerns:
* According to the Prosupp, approximately $2.2mm ... of loans were delinquent when they were transferred to the trust. However, there is no mention of delinquent loans anywhere in the termsheet that was sent to investors when the deal was priced.
* According to the Prosupp, approximately $3.3mm ... are re-performing loans. However, there is no mention of reperforming loans anywhere in the termsheet.
* Approx. 53.14% of the loans in the deal allow for a Prepayment Premium and that all Prepayment Premiums collected from borrowers are paid to the Class P certificateholders. None of this was disclosed in the termsheet and my concerns are two-fold: (1) The presence of Prepayment Premiums effects prepayment speeds which affects ... [the deal's performance]; (2) Prepayment Premiums are not staying inside the deal for the benefit of all investors but are being earmarked for the Class P holder (which is not mentioned in the termsheet). Note that ... $1.2mm in Prepayment Premiums has already been paid out to the Class P holder.
* ... [T]he servicer must charge off any loan that becomes 180 days delinquent, giving rise to a Realized Loss inside the deal. Currently losses are at 9.71% of the original deal balance, or approximately $48mm despite the fact that the deal is only 11 months old (note that this figure already exceeds Moody's expec[ta]tion for cumulative losses for the deal over the ENTIRE LIFE of the deal). I will also note that there are an additional $57.5mm of loans in the delinquency pipeline. This seems to indicate significant fraud at either the borrower or lender level ....
* ... [A]ny subsequent recoveries on the charged-off loans do not inure to the benefit of all investors in the deal but ONLY to the Class X1 certificateholder. This is not mentioned anywhere in the termsheet. Who owns the Class X1 notes? Is that Goldman or an affiliate? How much has been recovered so far? This is a material fact to me especially considering that loss severities are coming in at around 105% on the charged-off loans." |2064|
Reduced RMBS Business. By the end of 2007, Goldman had substantially reduced its RMBS securitization business. In November 2007, in response to a request, Goldman provided specific data to the SEC about the decrease in its inventory of subprime mortgage loans and RMBS securities. Goldman informed the SEC that the value of its subprime loan inventory had dropped from $7.8 billion on November 24, 2006, to $462 million on August 31, 2007. Over the same time period, the value of its inventory of subprime RMBS securities had dropped from $7.2 billion to $2.4 billion, a two-thirds reduction. |2065| The graph below, which was prepared by the Subcommittee using the data provided by Goldman to the SEC, illustrates the rapid decline in Goldman's subprime holdings. |2066|
[SEE CHART NEXT PAGE: Goldman Sachs Long Cash Subprime Mortgage Exposure, prepared by the Permanent Subcommittee on Investigations, Hearing Exhibit 163.]
Goldman reduced its inventory of subprime loan pools and RMBS securities through outright sales, writedowns, and its loan repurchase campaign. It was equally aggressive in reducing its subprime CDO warehouse inventory.
In January 2007, after the CDO Origination Desk worked to sell securities from a CDO called Camber 7, Mr. Sparks wrote to Mr. Montag: "Need you to send message to peter ostrem and darryl herrick telling them what a great job they did. They structured like mad and traveled the world, and worked their tails off to make some lemonade out of some big old lemons." |2067|
In February 2007, the Mortgage Department conducted a review of the CDOs in its origination pipeline. |2068| As part of that review, Mr. Sparks cancelled four pending CDOs that had acquired some but not all of the assets needed for the CDOs to go to market. |2069| On February 25, 2007, Mr. Sparks reported to Mr. Montag and Mr. Ruzika:
"The CDO business liquidated 3 warehouses for deals of $530mm (about half risk was subprime related). Business also began liquidation of $820mm [redacted] warehouse – all synthetics done, cash bonds will be sold in the next few days." |2070|
The Mortgage Department rushed several remaining CDOs to market, including Anderson, Timberwolf, and Point Pleasant, which issued their securities in March and April 2007. |2071| In May and June 2007, the Mortgage Department began closing all of its remaining CDO warehouse accounts and transferring the assets to the SPG Trading Desk for sale. |2072| On June 22, 2007, Mr. Lehman reported that the ABS Desk had just sold another $50 million in RMBS securities from the CDO warehouse accounts for a profit of $1 million, and that: "[o]nly 40mm RMBS A3/A- remain in the WH [warehouse] accounts, ½ of which is Long Beach paper - continue to work." |2073|
Throughout 2007, Goldman sought to sell all of its remaining subprime assets from the CDO warehouse accounts as well as the new securities issued by Goldman-originated CDOs. |2074|
Aggressive Sales Efforts. On March 9, 2007, Mr. Sparks emailed a call for "help" to Goldman's top sales managers around the world to "sell our new issues – CDOs and RMBS – and to sell our other cash trading positions." |2075| In response, Mr. Sparks and key sales managers had a dialogue about "reaching the next wave of players here and abroad." |2076|
The Goldman sales manager for Europe and the Middle East suggested that Mr. Sparks focus the CDO sales efforts abroad, because the clients there were not involved in the U.S. housing market and therefore were "not feeling pain":
"The key to success in the correlation melt-down 2 years ago was getting new clients/capital into the opportunity quickly. Saved/made us a lot of money. Lots of banks and real money clients in Europe and middle east and lots of macro hedge funds are not involved and not feeling pain. In Europe we need a summary of key opportunities/axes and I will get the team to focus on. 2-3 most important things plus sales talking points rather than laundry list." |2077|
Mr. Ostrem, head of the CDO Origination Desk, agreed with expanding Goldman's CDO sales efforts in Europe and the Middle East: "I agree with [sales manager's] comments on new clients. Middle east, french banks, macro hedge funds could and are making these deals ‘work' currently." |2078| The following week, Mr. Lehman issued three new sales directives or "axes" to the Goldman sales force placing a priority on selling securities from the Anderson, Timberwolf, and Hudson CDOs: |2079|
"As per [European/Middle East sales manager's] suggestion last Friday, below are the three main focus areas for SP CDOs/SPG Trading, including Anderson Mezzanine, Timberwolf CDO^2 and secondary CDO positions (Hudson Mezzanine and high grade BBBs)."
Goldman's New York sales office forwarded the axe sheet to the European/Middle East sales office saying: "London – this is for you." |2080|
In an additional effort to expand Goldman's sales effort, the Mortgage Department's sales syndicate provided a list of "non-traditional buyers" to the CDO and SPG Trading Desks:
"We have pushed credit sales to identify accounts in the credit space that would follow yield into the ABS [asset-backed security] CDO market, and tried to uncover some non-traditional buyers. ... Below is a list of higher delta accounts uncovered so far; and we continue to push for leads. We are working with sales on these accounts to push our axes." |2081|
Goldman personnel worked diligently to pitch CDO securities to various clients, internal documents show. On March 30, 2007, for example, Fabrice Tourre reported to senior Mortgage Department executives about his efforts and plans to sell the CDO securities:
"This transaction [Abacus 2007-AC1] has been showed to selected accounts for the past few weeks. Those selected accounts had previously declined participating in Anderson mezz, Point Pleasant and Timberwolfe. ... Plan would still be to ask sales people to focus on Anderson mezz, Point Pleasant and Timberwolfe, but if accounts pass on these trades, steer them towards available tranches in ABACUS 07-AC1 since we make $$$ proportionately with the notional amount of these tranches sold. Wanted to make sure everyone is comfortable with this plan." |2082|
In April 2007, the Mortgage Department issued a new directive to its sales force with a list of new and old CDO securities in its inventory that it wanted sold, including Timberwolf and Anderson as well as CDOs known as Point Pleasant and Altius. |2083| Dissatisfied with the pace of sales, Mr. Sparks suggested issuing a separate axe for each CDO and offering additional sales credits: "Why don't we go one at at a time with some ginormous credits - for example, let's double the current offering of credit for timberwolf." |2084| A sales manager responded: "We have done that with timberwolf already. Don't want to roll out any more focus axes until we get some traction there but at the same time, don't want to stop showing inventory."
"Gameplan" for CDO Valuation Project. By May 2007, CDO sales had slowed significantly. Goldman executives became concerned about the lack of sales prices to establish the value of its CDO holdings. |2085| Goldman needed accurate values, not just to establish its CDO sales prices, but also to value the CDO securities for collateral purposes and to comply with Goldman's policy of using up-to-date market values for all of its holdings. Mr. Sparks expressed concern that the value of the remaining CDO assets were rapidly declining, warning one senior executive: "We are going to have a very large mark down – multiple hundreds. Not good." |2086|
On May 11, 2007, Goldman senior executives, including Mr. Cohn and Mr. Viniar, held a lengthy meeting with Mortgage Department personnel, their risk controllers, and others to develop a "Gameplan" for a CDO valuation project. |2087| The Gameplan called for the Mortgage Department, over the course of about a week, to use three different valuation methods to price all of its remaining CDO warehouse assets and unsold securities from the Goldman-originated CDOs then being marketed to clients. |2088|
A few days later, on May 14, 2007, while the CDO valuation project was underway, Mr. Montag asked Mr. Sparks for an estimate of how much the firm would need to write down the value of its CDO assets. Mr. Sparks responded that the "base case from traders is down [$]382 [million]." He also wrote:
"I think we should take the write-down, but market [the CDO securities] at much higher levels. I'm a little concerned we are overly negative and ahead of the market, and that we could end up leaving some money on the table." |2089|
The valuation project's results were summarized in a presentation dated Sunday, May 20, 2007, prepared for a 9:00 p.m. conference call that night with Mr. Viniar, in which Mr. Mullen, Mr. Sparks, Mr. Lehman, and others also participated. |2090| Using the three valuation methods, the presentation estimated that the loss in value and the total writedowns required for the firm's CDO assets were between $237 and $448 million. |2091| The executive summary of the presentation also expressed concern about Goldman-originated CDO securities, especially its two CDO2 transactions, Timberwolf and Point Pleasant, since "[t]he complex structure of these positions makes them difficult to value and distribute." |2092| The presentation estimated that the market value of those CDO securities, plus the equity and super senior tranches that had been retained by Goldman, was $4.3 billion. The executive summary also estimated the market value of the remaining assets from the CDO warehouse accounts at $1.5 billion, and expressed particular concern about selling $742 million in CDO securities from non Goldman originated CDOs due to "limited liquidity and price transparency in this space." The executive summary stated that since "securitization is no longer a viable exit, the warehouse collateral will be marked to market on an individual basis." |2093|
The presentation also presented "Next Steps." It recommended that Goldman "unwind the warehouses" and use "[i]ndependent teams to continue to value" the CDO securities, equity tranches, and super senior tranches from the Goldman-originated securitizations. It also recommended that sales of the Goldman-originated CDO securities be targeted, first, at four hedge fund customers, Basis Capital, Fortress, Polygon, and Winchester Capital. |2094| The presentation also attached a list of 35 other target customers with notes regarding the status of efforts to sell them CDO securities in the past. |2095|
The CDO valuation project undertaken in May provided clear notice to Goldman senior management at the highest levels that its CDO assets had fallen sharply in value, and that despite their lower value, the Mortgage Department planned to aggressively market them to customers. In an earlier draft of the presentation, the Mortgage Department had also stated that it expected Goldman's CDO and CDO2 securities "to underperform":
"The complexity of the CDO^2 product and the poor demand for CDOs in general has made this risk difficult to sell and the desk expects it to underperform." |2096|
Mr. Sparks reviewed that draft language and made comments about other items on the same page, but did not change the phrase, "the desk expects it to underperform." |2097| The same phrase appeared in several earlier versions of the presentation as well, but was removed from the final version sent to Mr. Viniar. |2098|
CDO Desk Shutdown. In May 2007, Goldman decided to stop issuing new CDOs, and the head of its CDO Origination Desk, Peter Ostrem, left the firm. |2099| Mr. Sparks named as his replacement David Lehman, who was a senior member of the Structured Product Group (SPG) and head of its CMBS Trading Desk, but had little experience in either underwriting or CDOs. |2100| On May 19, 2007, Mr. Lehman received an email from a former Goldman managing director who wrote: "Congratulations, but seems like you have a lot ofwork [sic] ahead of you." |2101| Mr. Lehman asked Mr. Egol: "What do u th[in]k he means by ‘lot of work to do?'" |2102| Mr. Egol responded:
"I know what he means. If you talk to people knowledgeable about cdos, you will find that external perception of GS franchise in this space is much lower than Sparks and Sobel believed. Over the last 2 years, GS [Goldman Sachs] is perceived to be a bottom quartile abs [asset-backed security] cdo underwriter and to have done several poor deals. There is a reason [the CDO desk] didn't sell much paper. The fact that [the CDO desk] was basically giving money away in these no-fee principal deals and could still only get TCW, GSC (both street wh—e managers) and some start up managers to work with GS is a stain that will take time to remove. The HG [high-grade] deals in particular are very poor. I thought the alladin deals had some potential but fortius 2 is going to be a real mess.
"These are not just my views – they are from customers whose views resonate in the market. Sales people have just been too timid internally or not engaged enough with their accounts to provide accurate feedback. It pains me to say it but citi, ubs, db [Deutsche Bank], lehman and ms [Morgan Stanley] have much stronger franchises – among large dealers only ML [Merrill Lynch] is more reviled than [Goldman's] business. ...
"I should add altius 3 is a doozy as well. I'll spare you the detailed list." |2103|
That May 19, 2007 email provided Mr. Lehman with additional notice of the poor quality of the CDO securities he was charged with selling.
The CDO valuation project presentation given the next day, May 20, 2007, recommended that all assets from the CDO warehouse accounts be transferred to the SPG Trading Desk for sale. A CDO "transition book" was created to account for profits and losses from some of the assets, and the transfer took place the following week. |2104| In addition, by June 1, 2007, Goldman eliminated the CDO Origination Desk as a separate entity, and moved all of the remaining Goldman-originated CDO securities to the SPG Trading Desk, where Mr. Lehman was based. |2105| As a result, the SPG Trading Desk, which was a secondary trading desk and had little experience with the greater disclosure obligations involved with selling newly minted securities, became solely responsible for selling all Goldman-originated CDO securities.
Renewed Sales Efforts. After the transfer of the CDO assets, the SPG Trading Desk began to work with the Goldman sales force to identify potential customers and sell the CDO products. On May 24, 2007, a Goldman salesperson contacted Messrs. Sparks and Lehman regarding two potential customers interested in Timberwolf and Point Pleasant securities. |2106| With respect to one customer, the salesman wrote that it was "[n]ot experts in this space at all but [I] made them a lot of money in correlation dislocation and will do as I suggest." With respect to the second customer, the Goldman salesperson wrote that the customer had "just raised another $1bln for their ABS [asset backed security] fund and they are very short the ABX so are natural buyers of our axe." |2107|
A couple of weeks before the CDO valuation project, Goldman's Australia sales representative, George Maltezos, announced he had found a potential Australian buyer for a Goldman CDO being constructed by the Correlation Desk: "I think I found white elephant, flying pig and unicorn all at once." |2108| On the same day the project identified Basis Capital as a primary target for CDO sales, May 11, 2007, Mr. Maltezos sent Mr. Lehman an email saying he would contact the Basis principals as soon as they returned from a business trip the following day. |2109|
On May 24, 2007, the CDO sales dry spell ended, when Paramax Capital Group, a U.S. investment adviser, purchased $40 million in AA Timberwolf securities. |2110| On May 30, Mr. Lehman announced the sale of $20 million in AAA Timberwolf securities to Tokyo Star Bank in Japan. |2111|
CDO Sales in Asia. On June 11, 2007, Mr. Lehman received a note from the Mortgage Department's sales syndicate desk asking whether the directive listing high priority CDO sales could be sent to the Japan sales office, which oversaw sales throughout Asia:
"Know there was sensitivity w/ sending this out, but asia sales management is asking again. Do you want to consider sending more broadly for asia sales or do you want to stick with the more targeted approach?" |2112|
The Japan sales group wrote that the head of the Japan office "is saying that we need it to go more broadly to all Sales at least in Japan. Given her request twice now and her help in getting focus, think we should at least push this in Japan." |2113| Mr. Lehman responded: "Fine – let's send to all Japan sales then." |2114|
The Japan sales office responded to the new directive with several quick sales. On June 13, 2007, the Japan sales office sent out this celebratory note:
" We have moved over $250mm of SP CDO axes to account in Japan, Australia and Korea over the past 2+ weeks. These are HUGE orders for the firm as they have helped reduce balance sheet risk and further exhibits the importance of the Asia franchise to the global Structured Products Group business. Note that in line with these trades we have paid out over $14mm of gross credits – this is clearly the top focus for us now in SP [Structured Product] CDO space. ... Call the SPG Asia desk in Tokyo for updated axes and offer levels. We hope to trade another $20mm of CDO^2 risk with a Japanese account in the coming week+. Thanks." |2115|
Mr. Lehman replied: "Thx for sending this out." |2116|
A few days later, Mr. Lehman reported to senior management that the Japan sales office had been successful in selling another $20 million in CDO securities. Mr. Lehman wrote:
"Great job by [Japan sales] (again) on our CDO^2 axes. Tonight we will trade $20mm Point Pleasant A1s @90.7 to Tokyo Star Bank .... We hope to trade another $20mm of these bonds next week w/ this account." |2117|
Mr. Lehman sent an email to the head of the Japan sales office letting him know that Goldman's senior management was aware of the sales effort: "Montag ve[r]y involved in this fyi." The Japan sales manager responded: "Yes – he made that clear when he spent almost 20 minutes on the desk with me in TKO [Tokyo] last week going through every potential lead." |2118| That same day, the Japan sales manager sent out a new email urging the trading team to bring in another $20 million from Tokyo Star Bank and promising them additional sales incentives:
"To reward your strong effort and in hopes of the follow on 20mm order from the client on this deal, we plan on paying you a total bonus GC payment of $40 / bond (double our $20/bond for AAA's on our axes that are not lower mezz AAA). We look forward to additional trades from Tokyo Star Bank on our CDO axes." |2119|
During June and July, additional sales took place in Japan, Korea, Taiwan, and Australia. |2120| Goldman also made sales to customers in Europe and the Middle East. |2121|
Despite the sales in June and July, Goldman continued to have a significant inventory of unsold CDO securities. On August 15, 2007, Mr. Mullen even made a casual reference to "our cdo business which remains unsaleable." |2122| If Goldman's CDOs remained unsaleable, however, it was not for lack of trying. In August and September 2007, Goldman switched from its targeted customer approach to issuing broad directives to its entire sales force in the United States and abroad urging them to concentrate on its CDO securities. On August 17, 2007, for example, the SPG Trading Desk issued a new directive to certain salespersons asking them to place a priority on selling interests in two Timberwolf super senior tranches. |2123| These tranches were first in line to receive payments within the CDO and so had the lowest risk. Super senior CDO positions were often sold through CDS contracts, sometimes called super senior swaps, in which the customer took the long side and the CDO originator took the short side, and that's what Goldman wanted the sales force to market. But the following week, on August 23, 2007, Goldman sent a new directive to the sales force urging them to find customers willing to take the short side of the super senior tranches, so the Mortgage Department could take the long side and cover some of its shorts. |2124| When asked his opinion of the directive, the head of Japan sales office expressed skepticism about sales to Asian customers:
"The only question in my mind is that we have not seen many accounts pushing hard to find ways to get short (typically they are long only). That being said, the reality of the current market may have finally sunk in and investors may be able to convince their boards [n]ow to put on this sort of trade." |2125|
On September 5, 2007, notwithstanding "the reality of the current market," the SPG Trading Desk issued a "Refresh of Axe Priorities" to its entire sales force. |2126| The directive placed a priority on selling Goldman's residual CDO equity tranches as well as a variety of other assets to help Goldman cover and lock in the profits from its big short. Mr. Sparks emailed senior sales executives:
"Please let me know how these are going. I am personally going to work to do a better job making sure you understand the things we are trying to achieve as a business. In addition to this, the super-senior ABX trade [Jonathan] egol sent around and general securities financing trades are priorities for us." |2127|
Mr. Sparks forwarded this email to Mr. Cohn, who responded "Great to see." |2128| On September 6, Mr. Sparks emailed the syndicate desk about the "Refresh of Axe Priorities": "Want to get you to send out daily 1-3 priority axes for department – let's discuss." |2129|
Goldman has at times suggested that many of its CDO sales were not the result of affirmative client solicitations and recommendations made by the firm, but were in response to client requests–generally known as "reverse inquiries." In a letter to the Financial Crisis Inquiry Commission, for example, Goldman's General Counsel, Gregory Palm, made the following statement about Goldman's role as an underwriter of synthetic CDOs:
"Goldman Sachs' CDOs containing primarily residential mortgage-related synthetic assets were initially created in response to the request of a sophisticated institutional investor that approached the firm specifically seeking that particular exposure. Reverse inquiries from clients were a common feature of this market. ... These transactions often are initiated by our clients, and when proposed by us are often in response to previously expressed investment interests of the client. We are responding to our clients' desires either to establish, or to increase or decrease, their exposure to a position based on their own investment views." |2130|
Mr. Palm's characterization of Goldman as playing only a passive, responsive role is at odds with the firm's documented and concerted efforts to market its CDO securities in the face of investor disinterest and falling values. Throughout 2007, Goldman issued directives to its sales force to sell specific CDO securities on a "first priority" basis. It expanded its selling efforts to "nontraditional buyers" as well as to banks, hedge funds, and other clients in Asia, Europe, and the Middle East. It offered its sales force substantial incentives, such as "ginormous" sales credits, to push the sales to clients. |2131| Under its CDO Gameplan, Goldman "targeted" four primary and 35 secondary clients for CDO sales, and celebrated selling CDO securities to several of them. The weight of this evidence demonstrates that Goldman was soliciting sales rather than responding solely to client inquiries.
One issue that gained intensity as the mortgage market continued its decline was Goldman's practice of selling CDO securities to customers at one price only to mark down the value substantially within days or weeks of the sale, where Goldman had an ongoing client relationship.
Goldman used a mark-to-market process to manage its risk, which required valuing its holdings on a daily basis to reflect their current market value. |2132| In practice, many of its mortgage related assets were marked on a monthly rather than daily basis, including many of its CDO securities. |2133| Nonetheless, Goldman appears to have been more active in re-marking the value of its mortgage related assets than other Wall Street firms and to have used lower marks than many of its competitors. |2134| Goldman also had a process for automatically marking down its internal value of any asset held longer than a specified period of time, in order to encourage its trading desks to sell their aged assets. |2135|
During 2007, Goldman's markdowns of the value of its CDO securities became a source of dispute with its customers. |2136| Some clients were negatively affected in a variety of ways when lower values were assigned to Goldman's CDO securities. Some had purchased their CDO securities through "repo" financing arrangements with Goldman; under those arrangements, a decline in the value of the CDO securities being financed required the client to post more cash margin with Goldman. In a few other instances, clients had invested in CDO securities through a CDS contract with Goldman. If the CDO securities declined in value, the CDS contracts required those clients to post more cash collateral with Goldman. In other cases, clients did not have to post additional cash collateral, they simply incurred losses from the lower values. |2137|
Lower marks also had significance for Goldman internally, since a CDO security with a marked down value might reduce the firm's profits and reduce its long position. Alternatively, if Goldman held the short side of an investment, a lower mark might increase the firm's profits, increase the value of its short position, and bring in more cash from the long parties. When the firm held a proprietary position in opposition to the position held by a client, the fact that Goldman was marking the value of its own position created a conflict of interest, since Goldman would benefit as the client lost money.
Gameplan Markdowns. When, on May 11, 2007, Goldman executives and the Mortgage Department decided to embark upon a CDO valuation project, Goldman's Chief Risk Officer, Craig Broderick, sent an email to his team to discuss the consequences of lower CDO values for Goldman's clients. He wrote:
"Sparks and the Mtg [Mortgage] group are in the process of considering making significant downward adjustment to the marks on their mortgage portfolios esp[ecially] CDOs and CDO squared. This will potentially have a big P&L [profit and loss] impact on us, but also on our clients due to the marks and associated margin calls on repos, derivatives and other products. We need to survey our clients and take a shot at determining the most vulnerable clients, knock on implications, etc." |2138|
Mr. Broderick called for a client survey to identify which clients were "most vulnerable" to financial difficulty if Goldman's CDO securities were marked down in value, and they either incurred losses or were required to post more cash margin or collateral. He also wrote: "This is getting lots of 30th floor attention right now." |2139|
Some Goldman managing directors also raised the issue of selling CDO securities to clients at a price that would be marked down almost immediately. In a May 11 email to colleagues, for example, Goldman senior executive, Harvey Schwartz, wrote: "[D]on't think we can trade this with our clients andf [sic] then mark them down dramatically the next day." |2140| Later that day, in an exchange of emails with Mr. Schwartz, Mr. Montag, and Mr. Sparks, Don Mullen acknowledged Mr. Schwartz's concern "about the representations we may be making to clients as well as how we will price assets once we sell them to clients." |2141| The Goldman executives also agreed, however, not to "slow or delay" efforts to sell the CDO securities, if the sales force received "strong bids." |2142|
The May 2007 CDO valuation project resulted in lower values for many of Goldman's CDO assets. While those internal markdowns were taken at month's end, around May 25, 2007, Goldman continued to price the CDO securities it was selling at much higher levels, creating the potential for a rapid markdown after an asset was sold. |2143|
"Monster CDO Re-Mark." Six weeks later, in mid-June, the Mortgage Department learned that two Bear Stearns hedge funds with a $17 billion portfolio of subprime assets were in financial distress. The Mortgage Department immediately initiated an effort to build a new, large short position to take advantage of the expected drop in the value of subprime mortgage assets. |2144| Within two weeks, Goldman had amassed a large number of CDS contracts shorting a variety of subprime mortgage assets. By June 22, 2007, Goldman's short position reached its peak size of approximately $13.9 billion. |2145|
The Bear Stearns hedge funds failed in mid-June, subprime assets plummeted in value, and Goldman established its big short by the end of the month. After its new net short was in place, the Mortgage Department implemented a series of large markdowns in the value of its RMBS and CDO assets. The markdowns had the dual effect of increasing the value of Goldman's net short position, while reducing the value of many of its customers' holdings. Due to their financing arrangements or CDS contracts, the lower values meant that some of the affected clients also had to post more margin or cash collateral with the firm. Goldman issued broad and deep markdowns of its clients' positions at month's end in June, July and August 2007, as well as on intermittent dates in response to mass ratings downgrades of specific RMBS securities in July and August or to individual customer credit issues.
One of the markdowns took effect on July 25, 2007, |2146| which Mr. Sparks called "the CDO monster remark." |2147| In an email to Mr. Mullen, Mr. Sparks wrote: "We made massive mark adjustments this week, pushed them through because of basis and counterparty exposure." |2148| In a separate email to Mr. Montag, Mr. Sparks made clear that by "basis," he meant Basis Capital, an Australian hedge fund that had financed the purchase of Timberwolf and other CDO securities using Goldman funds and defaulted on its margin and collateral obligations. Goldman then repurchased those securities at a low price and adjusted its marks for other clients. |2149|
The CDO markdown drew an immediate negative reaction from Goldman's customers. On July 31, 2007, an internal report was sent to a dozen Goldman senior executives and Mortgage Department personnel regarding pending "mortgage derivative collateral disputes," meaning customers who were disputing the lower valuations and resulting cash margin and collateral calls. |2150| The email identified the "10 largest disputes," naming AIG Financial Products, Morgan Stanley, and Deutsche Bank, among others. It stated: "The overall derivative collateral dispute amount is now $7.0 billion." |2151| The email also noted that the total in dispute from the prior week had been $3 billion, which suggests that the July 25 markdowns had caused the amount in dispute to more than double in a week. Mr. Montag immediately forwarded the report to Mr. Blankfein: "7 billion of collateral disputes!!!" |2152|
Mr. Blankfein responded: "Make sure they prioritize weaker credits where our risk is threatening." |2153| In other words, Mr. Blankfein directed Goldman personnel to focus on disputes with clients that had the weakest credit, and might have fewer resources to pay the amounts owed to Goldman as a result of the downward marks. The same markdowns causing losses for those clients were simultaneously increasing the profitability of Goldman's net short.
Two weeks later, the Mortgage Department implemented another large markdown, this time related to Goldman's Abacus CDOs. This markdown took place on August 16, 2007, after the Correlation Trading Desk adjusted its correlation assumptions in a way that resulted in steep markdowns for Abacus CDO customers and a corresponding $94 million increase in the value of the Correlation Trading Desk's net short positions on the same CDOs. |2154| The Mortgage Department as a whole reported a $121 million profit that same day. Mr. Sparks reported to senior management: "94mm ... is from correlation adjustment in ABX (from 50 to 70%) as market observability better recently, rest is from outright shorts." |2155| Also on August 16, 2007, Mr. Egol listed the Correlation Trading Desk's Top Ten Winners and Losers due to Goldman's markdowns and calculated that "[t]he aggregate P&L in the book is $405mm (ie net markdown to customers), much of this is scattered across a bunch of cashflow CDOs." |2156|
Goldman's internal marks demonstrate that, at the time it sold its CDO securities, Goldman's senior management knew its sales force was selling CDO securities at inflated prices and that the CDO securities were also rapidly losing value. In addition, soon after selling the CDO securities, Goldman marked down their value, causing some customers to incur substantial losses within days or weeks of a purchase and undergo substantial margin and collateral calls that caused additional financial distress. |2157|
One Goldman salesperson expressed remorse over the impact on their customers of CDO sales followed by large markdowns within days or weeks of the client's purchase:
"Real bad feeling across European sales about some of the trades we did with clients. The damage this has done to our franchise is significant. Aggregate loss for our clients on just ... 5 trades alone is 1bln+." |2158|
At the same time, the salesperson thought the sales force deserved a bigger share of the profits generated for the firm:
"In addition team feels that recognition (sales credits and otherwise) they received for getting this business done was not consistent with the money it ended up making/saving the firm." |2159|
A Goldman salesperson in Taiwan sought help in explaining Goldman's markdowns to a bank whose CDO investment had been marked down from about 97 to about 45 cents on the dollar in a matter of weeks:
"[B]ank just bought the altius deal from gs [Goldman Sachs] 5 weeks ago and the mtm [mark-to-market] dropped over 50%. We understand the liquidity is thin, but I really need some info to support this price. ... This is very important as this transaction has a lot to do with our reputation in taiwan market. I understand all deals are down and spread is trading wider now. Unless the principal is at risk now, the mtm is not supposed to drop so quickly during such short period of time." |2160|
On August 2, 2007, Stacy Bash-Polley, a Goldman senior sales executive, sent an email to Messrs. Montag, Mullen, Schwartz, and Sparks outlining eight specific instances in which clients had complained that Goldman's marks were significantly lower that those of other dealers. |2161| Her summary of client concerns included the following:
"–They have not agreed with our process and recently asked other dealers to analyze – say that we are off significantly from where other dealers are modeling this ....
–We took their mark on Fort Denison from 93.16 to 40.00[.] They admit the AAA CDO mkt is off substantially but feel that this particular bond [has objective characteristics that should make it] ... perform better than the junior AAA market as a whole. Meanwhile, we took Hudson Mezz ... AAA from 80.4 to 65. They would like our thoughts as to why Fort Den[ison] was marked down so much more. ...
–The Alt-A marks were particularly punitive. ... Our offerings are still 10-20 points higher than the marks. Look at GSAMP 2007-7. On financing, [customer] said our HC [haircuts] ... were by far the most onerous of all dealers. ...
–They bought AAA cdos .... They have communicated to sales that GS is by far an outlier and they will never be able to buy another cdo from us based on their lack of confidence in understanding how we are coming up with marks. ...
–Issues with their CDO marks. Said we were many many points behind where other dealers were marking similar positions." |2162|
Even before this email, Goldman's sales force had been vocal in its criticism of Goldman's low marks which were making their sales job more difficult. On June 21, 2007, Mr. Sparks stated in an email: "sales is making significant noise about gs notable conservatism in marking and haircuts." |2163| Mortgage Department personnel dismissed such criticisms out of hand. One managing director responded: "Would have tho[ugh]t that bsam event [failure of Bear Stearns Asset Management hedge funds] would provide reasonable explanation as to why our marking and haircuts r ok." Mr. Sparks replied: "Kind of stunning – but we are hearing it."
Goldman generally declined to offer any written explanations of its marks to clients, and rarely offered any financial accommodation or compromise regarding the marks or related collateral calls. |2164| On one occasion, when a sales representative asked about providing information about the firm's CDO marks to a customer, Mr. Lehman wrote: "We cannot put this on paper - It concerns me they want something specifically in writing." |2165| When told that other dealers had provided the customer with marks and a written description of their CDO pricing methodologies, Mr. Lehman responded: "Our marking policy is a market price (bid and/or offer) – We do not have a written methodology for pricing and we should tell them that." |2166| In another instance, when a client asked for marks for the two prior months related to a CDO it was considering buying, Mr. Lehman wrote: "Verbal only .... Want to give them our tho[ugh]ts on market levels, not ‘marks.'" |2167| In his 2007 performance self-evaluation, the head of the SPG Trading Desk, Michael Swenson, wrote:
"I spent numerous hours on conference calls with clients discussing valuation methodologies for GS issued transactions in the subprime and second lien space .... I said ‘no' to clients who demanded that GS should ‘support the GSAMP' program [Goldman RMBS securities] as clients tried to gain leverage over us. Those were unpopular decisions but they saved the firm hundreds of millions of dollars." |2168|
In November 2007, Goldman analysts issued a research report to clients about the crisis in the mortgage market. |2169| Goldman predicted that the mortgage market crisis was likely to continue and would have serious implications for a significant number of financial institutions: "Writedowns and losses will continue to mount . . . . [M]anagements will need to repair some seriously damaged balance sheets." |2170| Goldman estimated that industry-wide losses reflecting markdowns in subprime mortgage CDOs would approach $150 billion, of which about $40 billion would be taken in the third and fourth quarters of 2007. |2171|
Customers who purchased CDO assets from Goldman in 2007 generally suffered substantial losses from those investments, and several went bankrupt, including IKB, a German bank, and Basis Capital, the Australian hedge fund. |2172| Goldman was not only aware of its clients' predicaments, but in some cases, Goldman purchased CDS protection or equity puts on its clients' stock, essentially betting that the stock price would fall or the company would lose value. For example, after ACA Financial Guaranty Corp., the parent company of ACA Management which acted as the collateral manager of Abacus 2007-AC1, purchased Abacus securities, Goldman purchased the short side of a CDS contract that referenced ACA Financial Guaranty. ACA Financial Guaranty encountered extreme financial distress in late 2007. |2173|
At the Subcommittee hearing, Goldman executives were asked about the four Goldmanoriginated CDOs highlighted in this Report, Hudson 1, Anderson, Timberwolf, and Abacus 2007- AC1. |2174| Senator John Tester noted Mr. Birnbaum's testimony that, in 2007, Goldman could "see some things happening," |2175| and that Goldman itself was betting against the mortgage market. Senator Tester asked Mr. Sparks, in light of those developments, "how [he] got comfortable with sales," and how he "in good faith" sold the CDO securities to Goldman's customers – how he could "sell them out and collect the fees and make the dough?" |2176| Senator Tester and Mr. Sparks then had the following exchange:
Senator Tester: Every one of these [CDOs] were – it looks like a wreck waiting to happen because they were all downgraded to junk in very short order.
Mr. Sparks: Well, Senator, at the time we did those deals, we expected those deals to perform.
Senator Tester: Perform in what way?
Mr. Sparks: To not be downgraded–
Senator Tester: Perform to go to junk, so that the shorts made out?
Mr. Sparks: To not be downgraded to junk in that short a time frame. In fact, to not be downgraded to junk." ...
Senator Tester: Do you feel confident that the information about each one of these [CDOs] ... was given to the investors, all of the information that was out there, and the credit rating agencies too?
Mr. Sparks: Well, I generally feel that the disclosure for the new issues that Goldman Sachs brought was good." |2177|
While Mr. Sparks testified that, in 2007, the Mortgage Department expected its CDOs "to perform," a contemporaneous draft presentation that he helped prepare in May 2007 stated that the "desk expects [the CDOs] to underperform." |2178| Many other emails provide his negative views of the CDO market at the time, including emails in which Mr. Sparks described the subprime market as "bad and getting worse," |2179| and directed Goldman's mortgage traders to "get out of everything," |2180| and "stay on the short side." |2181| He wrote, among other things: "Game over," |2182| "bad news everywhere," and "the business is totally dead." |2183| As Senator Tester noted, many of Mr. Sparks's dire predictions were made before three of the four CDOs discussed at the hearing were even offered to customers. |2184|
Mr. Sparks also testified that the Mortgage Department did not expect the Goldman-issued CDOs to be downgraded, but all were within a year of issuance. In April 2007, for example, six of the 20 RMBS deals that comprised the ABX Index were downgraded, |2185| and the Hudson CDO that referenced them followed soon after. Many of the RMBS securities referenced in the other three CDOs were downgraded within three months of the issuance of the last CDO in April 2007, making the downgrade of the CDOs themselves all but inevitable. |2186| For example, when Moody's and S&P announced their first mass downgrades of RMBS securities on July 10, 2007, the S&P downgrade affected 35% of the assets in Timberwolf. |2187| Ultimately, all of the CDOs discussed at the Subcommittee's hearing were downgraded to junk status. On October 26, 2007, a Goldman employee sent an email about Abacus 2007-AC1, even noting this dubious distinction:
"This deal was number 1 in the universe of CDO's that were downgraded by Moody's and S&P. 99.89% of the underlying assets were downgraded." |2188|
In late 2006 and 2007, Goldman's securitization business was marked, not just by its hard sell tactics, but also by multiple conflicts of interest in which Goldman's financial interests were opposed to those of its clients. The following examples illustrate the problem.
In 2006 and 2007, Goldman originated 27 CDO and 93 RMBS securitizations. Beginning in December 2006, Goldman originated and aggressively marketed some of these securities at the same time that subprime and other high risk loans were defaulting at alarming rates, the subprime and CDO markets were deteriorating, and Goldman was shorting subprime mortgage assets. At times, Goldman originated and sold RMBS securities that it knew had poor quality loans that were likely to incur abnormally high rates of default. At times, Goldman went further and sold RMBS securities to customers at the same time it was shorting the securities and essentially betting that they would lose value. Two examples illustrate how Goldman constructed and sold poor quality RMBS securities and profited from the decline of the very securities it had sold to its clients.
Long Beach RMBS. The first example involves Washington Mutual Bank (WaMu) and its subprime lender, Long Beach Mortgage Corporation. WaMu, Long Beach, and Goldman had collaborated on at least $14 billion in loan sales and securitizations. |2189| In February 2006, Long Beach had a $2 billion warehouse account with Goldman, which was the largest of Goldman's warehouse accounts at that time. |2190|
Long Beach was known within the industry for originating some of the worst performing subprime mortgages in the country. As explained in Chapter III, in 2005, a surge of early payment defaults in its subprime loans required Long Beach to repurchase over $837 million of nonperforming loans from investors, as well as book a $107 million loss. |2191| Similar EPD problems affected its loans in 2006 and 2007. WaMu reviews and audits of Long Beach, as well as examinations by the Office of Thrift Supervision, repeatedly identified serious deficiencies in its lending practices, including lax underwriting standards, unacceptable loan error and exception rates, weak risk management, appraisal problems, inadequate oversight of third party brokers selling loans to the firm, and loan fraud. While these reviews were not available to the public, the performance of Long Beach paper was. Long Beach securitizations had among the worst credit losses in the industry from 1999-2003; in 2005 and 2006, Long Beach securities were among the worst performing in the market. |2192|
Nevertheless, in May 2006, Goldman acted as co-lead underwriter with WaMu to securitize about $532 million in subprime second lien mortgages originated by Long Beach. Long Beach Mortgage Loan Trust 2006-A ("LBMLT 2006-A") issued approximately $495 million in RMBS securities backed by those Long Beach mortgages. The top three tranches, representing about 66% of the principal loan balance, received AAA ratings from S&P, even though the pool contained subprime second lien mortgages – loans which could recover funds in the event of a default only after the primary loan was repaid — and even though the loans were issued by one of the nation's worst performing mortgage lenders. Yet Goldman was able to use two-thirds of that extremely risky debt to issue AAA rated securities which Goldman then sold to its customers.
In less than a year, the Long Beach loans began incurring delinquencies. In February 2007, a Goldman analyst reported internally that all of Goldman's 2006 subprime second lien RMBS securities were deteriorating in performance, but "deals backed by Fremont and Long Beach collateral have generally underperformed the most." |2193| The analyst predicted "lifetime losses in the teens, and over 20% in some deals." By May 2007, the cumulative net loss on the LBMLT 2006-A mortgage pool had climbed to over 12%, eliminating most of the financial cushion protecting the investment grade securities from loss. That month, S&P downgraded six out of the seven credit ratings for the mezzanine tranches of the securitization. The Long Beach securities plummeted in value.
Goldman held some of the unsold Long Beach mezzanine securities on its books, meaning LBMLT 2006-A securities that carried credit ratings of BBB or BBB-. Goldman had also purchased the short side of a CDS contract that would pay off if those same securities lost value. On May 17, 2007, Deeb Salem, a trader on the Mortgage Department's ABS Desk, learned of additional losses in the Long Beach securitization and wrote to his supervisor Michael Swenson with the news:
"[B]ad news … [The loss] wipes out the m6s [mezzanine tranches] and makes a wipeout of the m5 imminent. … [C]osts us about 2.5 [million dollars]. … [G]ood news ... [W]e own 10 [million dollars] protection at the m6 … [W]e make $5 [million]." |2194|
In other words, Goldman lost $2.5 million from the unsold Long Beach securities still on its books, but gained $5 million from the CDS contract shorting those same securities. Overall, Goldman profited from the decline of the same type of securities it had earlier sold to its customers.
By May 2008, even the AAA securities in LBMLT 2006-A had been downgraded to default status. By March 2010, the securities recorded a cumulative net loss of over 66%. |2195|
Fremont RMBS. The second example involves Fremont Loan & Investment, another subprime lender notorious for issuing poor quality loans. |2196| In March 2007, Fremont reported in an 8-K filing with the SEC that the FDIC filed a cease and desist order to which the company consented. Among other matters, it order Fremont to stop "[m]arketing and extending adjustable–rate mortgage products to subprime borrowers in an unsafe and unsound manner that greatly increases the risk that borrowers will default on the loans or otherwise causes losses." |2197|
Even before the actions taken by regulators in March 2007, Goldman was aware of the poor quality of at least some of Fremont's loans. In a November 2006 exchange of emails, for example, two Goldman sales representatives were discussing trying to sell Fremont RMBS securities to a client. One salesperson forwarded to the other the client's explanation of why it did not want to buy the securities and its low opinion of Fremont's loan pools: "Fremont refused to make any forward looking statements so we really got nothing from them on the crap pools that are out there now." |2198| In March 2007, Goldman initiated a detailed review of its Fremont loan inventory to identify deficient loans that it could return to the lender for a refund. Mr. Gasvoda placed a priority on reviewing Fremont loans "since they still have cash but may not for long." |2199| One loan pool review conducted on March 14, 2007, found that "on average, about 50% of about 200 files look to be repurchase obligations," meaning that fully half of the reviewed loans should be returned to the lender. |2200| Goldman eventually made about $46 million in repurchase requests to Fremont, which was one of the top five mortgage originators from whom Goldman made repurchase requests in 2006 and 2007. |2201|
Despite these and other indications of Fremont's poor quality loans, Goldman continued to underwrite and market securities backed by Fremont loans. In an internal February 2007 memorandum to its Mortgage Capital Committee, Goldman wrote that it had a "significant relationship with Fremont," based upon past securitizations, whole loan purchases, and warehouse fees. |2202| In March 2007, at the same time it was sending millions of dollars in loan repurchase requests to Fremont, Goldman securitized over $1 billion in Fremont subprime loans in one of its warehouse accounts, originating GSAMP Trust 2007-FM2. |2203| At Goldman's request, Moody's and S&P rated the securities, even though analysts at both rating firms expressed concern about the quality of Fremont loans. At S&P, for example, in a January 2007 email to his supervisor, a credit ratings analyst wrote: "I have a Goldman deal with subprime Fremont collateral. Since Fremont collateral has been performing not so good, is there anything special I should be aware of?" |2204| One supervisor told him: "No, we don't treat their collateral any differently," while another wrote that, as long as the analyst had current FICO scores for the borrowers, he was "good to go." |2205| Both agencies gave AAA ratings to the top five tranches of the securitization. |2206|
Goldman marketed and sold the Fremont securities to its customers, while at the same time purchasing $15 million in CDS contracts referencing some of the Fremont securities it underwrote. |2207| Seven months later, by October 2007, the ratings downgrades had begun; by August 2009, every tranche in the GSAMP securitization had been downgraded to junk status. |2208|
In both examples involving Long Beach and Fremont RMBS securities, Goldman obtained CDS protection and essentially bet against the very securities it was selling to clients. In each case, Goldman profited from the fall in value of the same securities it sold to its clients and which caused those clients to suffer substantial losses.
As with some of its RMBS securities, Goldman at times originated CDO securities using assets that it believed were of poor quality and would lose value, and sold the securities at higher prices than it believed they were worth. |2209| In addition, Goldman took steps that created multiple conflicts of interest with the clients to whom it sold the CDO securities, and placed its financial interests ahead of those of its clients. Four examples involving the Hudson 1, Anderson, Timberwolf, and Abacus 2007-AC1 CDOs illustrate the problems. Those problems include troubling and sometimes abusive practices related to how Goldman designed the CDOs and selected their assets; marketed and sold the CDO securities; designated the value of the CDO securities preand post-sale; and executed its duties as liquidation agent and collateral put provider.
Hudson Mezzanine Funding 2006-1 (Hudson 1) was a $2 billion synthetic CDO that referenced mezzanine subprime RMBS assets |2210| and assets linked to the ABX Index. |2211| This CDO was the second in a series of three "Hudson" branded CDOs, which according to Goldman marketing materials were intended "to create a consistent, programmatic approach to invest in attractive relative value opportunities in the RMBS and structured product market." |2212| One key feature of the three Hudson CDOs was that Goldman itself, without any third party participation, selected the CDO's assets, which were supposed to remain with the CDO until they reached maturity or were deemed "credit risk assets," at which point Goldman, acting as the liquidation agent for the CDO, was responsible for selling them. |2213| In each of the Hudson CDOs, Goldman played multiple roles in its formation and administration, including selecting assets and serving as the underwriter, initial purchaser of the CDO securities, collateral put provider, |2214| senior swap counterparty, and credit protection buyer. |2215| In Hudson 1, Goldman took 100% of the short side of the CDO, and when the Hudson 1 securities declined in value, Goldman made a $1.35 billion profit at the expense of the clients to whom it had sold the Hudson 1 securities.
Transferring Risk. Hudson 1 was conceived and designed by Goldman to transfer the risk associated with a large collection of ABX assets in its inventory, in which Goldman held the long side of CDS contracts referencing mezzanine subprime RMBS securities that were tracked by the ABX and that might go down in value. The objective of the CDO was to transfer the risk of unwanted financial assets off of Goldman's books. In response to questions from the Subcommittee, Goldman explained that Hudson 1 was "initiated by the firm as the most efficient method to reduce long ABX exposures." |2216| Contemporaneous notes from Goldman's Firmwide Risk Committee meetings also stated that Hudson 1 was an "exit for our long ABX risk." |2217| Goldman records show that the firm used Hudson 1 to short $1.2 billion worth of the ABX assets in the firm's inventory as well as $800 million in single name CDS contracts referencing subprime RMBS securities carrying mostly BBB or BBB- credit ratings. Hudson 1 was one of several methods Goldman used to transfer its risk associated with its subprime mortgage holdings during the fall of 2006. |2218|
Conceiving Hudson 1. In the months leading up to the creation of Hudson 1, Goldman had accumulated billions of dollars in ABX assets referencing mezzanine subprime RMBS securities. |2219| By August 2006, Goldman management had decided that this ABX trade had "run its course," and directed the Mortgage Department's ABS Desk to sell off its ABX holdings. |2220| After several weeks of effort, however, the ABS Desk was unable to find many buyers, and its ABX mezzanine assets, which were dropping in value, were losing millions of dollars for the firm. |2221|
On September 19, 2006, Jonathan Sobel and Daniel Sparks called an 8:00 a.m. meeting to discuss the ABX problem with Joshua Birnbaum, head of ABX trading, and Michael Swenson, head of both the Structured Product Group (SPG) Trading Desk and ABS Trading Desk. |2222| Mr. Swenson was unable to attend, and in a later email from Mr. Birnbaum who recounted the meeting to him, Mr. Sobel and Mr. Sparks wanted to know whether the Mortgage Department should sell all of its ABX mezzanine holdings or "double down" the ABX holdings, which could happen only if it found a "structured place to go with the risk." |2223|
Later that day, Mr. Sparks approached Peter Ostrem, who headed the desk that originated CDOs for Goldman, and asked "if there was something [the CDO Desk] could do with ABX." |2224| Mr. Ostrem spoke with Darryl Herrick, who worked for him on the CDO Desk and who eventually became the Hudson 1 deal captain, about crafting a CDO to reduce the firm's ABX risk. The two brainstormed a structure that became the foundation of Hudson 1. |2225|
That same evening, September 19, 2006, Mr. Swenson scheduled a meeting with several traders on the ABS Desk he oversaw, Joshua Birnbaum from the ABX Desk, and Mr. Ostrem and other personnel from the CDO Origination Desk to discuss "ABX and Single-Name Opportunities." |2226| After the meeting, around 8:00 p.m., Mr. Ostrem sent his CDO team an email announcing "Hudson Mezz - new":
"We have been asked to do a CDO of $2bln [billion] for the ABS desk. Approx. $1.2bln will be CDS off single-names referenced from the AB[X] index 06-1 and 06-2. This is a trade we need to execute for the desk over the next 4-6 weeks and involves selling half the equity (at least 30mm to sell) and the seniors and the mezz (at least half of the BBBs to get true sale). I would like everyone to work together on this one. We expect to charge ongoing 10bp [basis point] liquidation agent fees and 1-1.5pts upfront. ... Obviously important to overall SP [Structured Product] floor and Sobel and Sparks are focused on this happening." |2227|
Also that evening, Mr. Swenson emailed Mr. Sobel to inform him they were "proceeding with the CDO solution, the CDO team has 60 single-names that they will be able to begin to build a deal around." |2228|
The next day, Mr. Sobel reported to senior executives at Goldman's Firmwide Risk Committee that the CDO Desk was working on the first ever ABX CDO, which would function as an exit for the firm's long ABX position. |2229| Later that same afternoon Mr. Sobel sent an email to Goldman senior executive Thomas Montag, discussing the Mortgage Department's ABX losses and stating: "I think most hedge funds have been right on this (i.e. they've been short). ... The synthetic CDO seems like a viable takeout here." |2230|
A Goldman risk officer, Arbind Jha, began contacting Goldman mortgage traders and CDO personnel for regular Hudson updates. |2231| In fact, the day after the ABS and CDO teams came up with the Hudson 1 concept, Mr. Jha emailed Mr. Birnbaum asking about the CDO: "Sobel this morning mentioned in the Firmwide Risk Committee meeting that we are looking at CDO exit for our long ABX risk. Wanted to get some color on this." |2232| On another occasion, Mr. Jha asked Darryl Herrick:
"Do we really have scenario risk on $2bn [billion] not'l [notional]? $1.2bn of not'l is being sourced from ABX desk - this risk is already being captured in our risk number for SPG Trading desk. ... The remaining $0.8bn will be composed of single name CDS. Since we do not have any pre-existing long (credit), we will be going short after we price this CDO and therefore will have a risk mitigating impact on our risk. Please correct me if I am getting this wrong." |2233|
Designing Hudson 1. At the time Hudson 1 was conceived, no other investment bank had issued a CDO in which the majority of assets referenced ABX assets. |2234| Prior to that, the major credit rating agencies refused to rate any CDO with more than a 5% exposure to credit default swaps (CDS) using an ABX index as the reference obligation. |2235| CDS that used an ABX index as the reference obligation allowed the parties to the CDS to make a pure bet on the composite performance of a basket of 20 RMBS securities. Credit rating agencies were concerned that the inclusion of ABX assets in CDOs would increase market-wide correlation and make CDO performance more volatile.
In order to get around that limitation and create a CDO that the credit rating agencies would be willing to rate, Goldman took several steps. First, it decided Hudson 1 would reference the two ABX 06-1 indices and the two ABX 06-2 indices that referenced RMBS securities with BBB and BBB- ratings. Since each of those four indices tracked 20 subprime mezzanine RMBS securities, altogether they tracked 80 RMBS securities. |2236| Next, Goldman created 80 single name CDS contracts, each of which used as its reference obligation one of the subprime mezzanine RMBS securities tracked by the ABX indices. |2237| Goldman's ABS Desk took the short position in each of those 80 contracts, while Goldman's CDO Origination Desk took the long position. |2238| By taking the short position in the 80 single name CDS contracts, the ABS Desk essentially offset its long position in the corresponding ABX contracts. Next, the CDO Origination Desk entered into a CDS contract with Hudson 1, taking the short side while the Hudson CDO assumed the long side of the 80 single name CDS contracts. The end result was that Hudson 1 took the long side and assumed the risk associated with the long position for $1.2 billion worth of CDS single name contracts referencing the RMBS securities comprised the ABX 06-1 and 06-2 BBB and BBB- indices. |2239| By transferring the long CDS position to Hudson, Goldman effectively transferred the risk associated with its ABX long assets to any investors who bought the Hudson securities.
In order to attract investors and convince them to buy the Hudson securities, Goldman decided to make use of a pricing difference between CDS contracts referencing the ABX Index versus single name RMBS securities. |2240| In 2006, at the time Hudson was being constructed, the price of CDS contracts that used an ABX index as the reference obligation was lower than the price of CDS contracts that used an individual RMBS security as its reference obligation. Because Goldman exercised complete control over the CDO and created CDS contracts referencing assets from its own inventory, Goldman also exercised complete control over the pricing of those contracts. When Goldman set up the 80 single name CDS contracts, and sold the long side of those contracts to Hudson 1, Goldman decided internally what it would charge the CDO to acquire the long side of those contracts. Goldman decided to price the contracts, not according to the cost of a single name CDS contract on the market, but instead according to the cost of a CDS contract for the long side of the relevant ABX index that day. |2241| By using this pricing method, Goldman enabled Hudson to purchase the single name CDS contracts at the lower ABX prices, which meant it could tell investors that, by purchasing Hudson securities, they would be purchasing the single name CDS contracts at the discount price at which Hudson acquired them. |2242|
The pricing differential also benefitted Goldman's ABS Desk in two ways. First, it created a modest incentive for investors to buy Hudson securities and take the long position needed to offset Goldman's ABX risk. Second, it left Goldman with a short position in the form of CDS single name contracts, which Goldman expected to become more valuable than a short position in CDS contracts that referenced ABX indices. The ABS Desk kept both its long ABX positions and its short single name CDS positions in the same dedicated account. Over time, the short position in single name CDS did gain in value and boosted the overall value of the portfolio of assets held by the ABS Desk by more than $1 million, producing additional profits for Goldman. |2243|
In addition to the $1.2 billion in single name CDS contracts to offset Goldman's ABX risk, Mr. Herrick from the CDO Origination Desk and Deeb Salem from the ABS Desk worked together to select $800 million in additional single name CDS contracts to include in the Hudson CDO. |2244| Mr. Herrick told the Subcommittee that he gave Mr. Salem a specific set of criteria for selecting these CDS contracts, including a list of RMBS names that he wanted to be included, a list of RMBS names that he did not want to be included, and an acceptable price range for each CDS contract. Since Goldman planned to take 100% of the short side of Hudson 1, these lists were presumably used to identify RMBS contracts that Goldman expected to offset Goldman's long positions. Mr. Herrick told the Subcommittee that Mr. Salem responded with an initial list of 60 possible RMBS reference obligations, 52 of which were ultimately included in Hudson 1. |2245|
According to Goldman's contemporaneous records and its responses to Subcommittee questions, 100% of the CDS contracts included in Hudson 1 were supplied by Goldman's Mortgage Department. |2246| Because Hudson 1 contained only CDS contracts, it was entirely "synthetic"; it contained no loan pools or RMBS securities that directed actual cash payments to the CDO. Instead, the only cash payments made to Hudson 1 consisted of the cash paid by investors making initial purchases of the Hudson securities and the premiums that Goldman paid into Hudson 1 as the sole short party. |2247|
Marketing Hudson. After establishing its basic characteristics and selecting the CDS assets to be included in Hudson 1, Goldman began to look for investors. A key development took place early on, when near the end of September 2006, Morgan Stanley's proprietary trading desk committed to entering into a CDS agreement with Goldman referencing the "super senior" portion of Hudson 1, meaning the CDO's lowest risk tranche that would be the first to receive payments to the CDO. |2248| Morgan Stanley agreed to take the long side of a CDS that represented $1.2 billion of the $2 billion CDO, while Goldman took the short side. |2249| As part of its agreement to invest in Hudson 1, Morgan Stanley was permitted to review the $800 million in single name CDS contracts to be included in the CDO and, in fact, vetoed the proposed inclusion of certain CDS contracts referencing commercial mortgage backed securities. |2250|
After getting the commitment from Morgan Stanley, Goldman turned its focus to selling the remaining Hudson securities. On September 27, 2007, Mr. Swenson, the SPG Trading Desk and ABS Desk head, sent an email to set up a meeting, which later became a conference call, on "Marketing Strategy for the ABX CDO Trade." |2251| The invitees included Daniel Sparks, Jon Sobel, Peter Ostrem, Darryl Herrick, and others. Mr. Herrick circulated a draft copy of the Hudson 1 termsheet and transaction overview for review in advance of the call. |2252|
Goldman's CDO marketing strategy typically involved its sales personnel sending clients a marketing booklet outlining different features of a particular CDO. Mr. Herrick drafted the marketing booklet for Hudson 1, and circulated it for review to Mr. Ostrem and other members of the CDO Origination Desk including Benjamin Case and Matthew Bieber. |2253| The executive summary of the marketing booklet described Goldman's Hudson CDO program generally and Hudson 1 in particular:
"Goldman Sachs developed the Hudson CDO program in 2006 to create a consistent, programmatic approach to invest in attractive relative value opportunities in the RMBS and structured product market[.]
-We successfully launched Hudson High Grade in September. This is a continuation of the program using mezzanine Baa2/Baa3 quality RMBS[.]
Hudson CDOs are non-managed and static in nature and provide term non-recourse funding where Goldman Sachs acts as Liquidation Agent on an ongoing basis. The Liquidation Agent will be responsible for efficiently selling credit risk assets ...
Goldman Sachs has aligned incentives with the Hudson program by investing in a portion of equity and playing the ongoing role of Liquidation Agent." |2254|
The marketing booklet also described the Hudson 1 assets, and the selection process for those assets:
"The portfolio composition of Hudson Mezzanine Funding 2006-1 will consist of 100% CDS on RMBS.
- 60% of the RMBS will be single name CDS on all 40 obligors in ABX 2006-1 and ABX 2006-2
- 40% of the RMBS will consist of single name CDS on 2005 and 2006 vintage RMBS ... Goldman Sachs' portfolio selection process:
- Assets sourced from the Street. Hudson Mezzanine Funding is not a Balance Sheet CDO
- Goldman Sachs CDO desk pre-screens and evaluates assets for portfolio suitability
- Goldman Sachs CDO desk reviews individual assets in conjunction with respective mortgage trading desks (Subprime, Midprime, Prime, etc.) and makes decision to add or decline[.]" |2255|
The marketing booklet statement that "Goldman Sachs had aligned incentives with the Hudson program by investing in a portion of equity," was misleading. Goldman did, in fact, purchase approximately $6 million in Hudson equity. |2256| However, that $6 million equity investment was outweighed many times over by Goldman's $2 billion short position, which made Goldman's interest adverse to, rather than aligned with, the Hudson investors. Neither the marketing booklet nor other offering materials disclosed to investors the size or nature of Goldman's short position in Hudson 1.
The marketing booklet also stated that Hudson's assets were "sourced from the Street," and that it was "not a Balance Sheet CDO," even though all of the CDS contracts had been produced and priced internally by Goldman and $1.2 billion of the contracts offset Goldman ABX holdings. The plain meaning of the phrase, "sourced from the Street," is that the Hudson 1 assets were purchased from several broker-dealers on Wall Street. |2257| Indeed, a former Goldman salesperson who sold Hudson 1 securities to investors told the Subcommittee that he thought "sourced from the Street" referred to assets being acquired from a variety of different broker-dealers at the best prices, and was surprised to learn that all of the Hudson assets had been provided by Goldman's ABS Desk. |2258| A Hudson 1 investor told the Subcommittee that it had also interpreted the phrase "sourced from the Street" to mean assets acquired from a variety of different broker-dealers. |2259|
The Subcommittee asked several Goldman traders involved in Hudson 1 to explain their understanding of the phrase, and received inconsistent answers. Darryl Herrick, who drafted the Hudson marketing booklet, stated that "sourced from the Street" meant the assets were "sourced from a street dealer at street prices." His supervisor, CDO Managing Director Peter Ostrem, stated that "sourced from the Street" referred to the fact the underlying RMBS securities were not originated or underwritten by Goldman. |2260| Deeb Salem, a Goldman mortgage trader who selected 40% of the assets in Hudson 1, described "the Street" as simply "short hand for all brokerdealers." |2261| David Lehman, who became the head of the CDO Origination Desk after Mr. Ostrem, and Matthew Bieber, who worked for Mr. Ostrem and later Mr. Lehman, claimed that it was accurate to say the Hudson assets were "sourced from the Street," even though all the assets were acquired from the Goldman ABS Desk, because Goldman was part of "the Street." |2262|
By using the phrase, "sourced from the Street," Goldman may have misled investors into thinking that the referenced assets had been purchased from several broker-dealers and obtained at arms-length prices, rather than simply taken directly from Goldman's inventory and priced by its own personnel. Moreover, this phrase also appears to hide the fact that Goldman had an adverse interest to investors and was seeking to transfer unwanted risk from its own inventory to the clients it was soliciting. By claiming it was "not a Balance Sheet CDO," Goldman may have misled investors into believing that Goldman had little interest in the performance of the referenced assets in Hudson, rather than having selected the assets to offset risks on its own books.
In addition to the Hudson marketing booklet, in December 2006, Goldman issued an Offering Circular which it distributed to potential investors. |2263| The Offering Circular contained the statement that no independent third party had reviewed the prices at which the CDS contracts were sold to Hudson 1. |2264| In addition to lacking third party verification, no external counterparty had participated in any aspect of the CDS contracts – all of the CDS contracts had been produced, signed, and priced internally by two Goldman trading desks which exercised complete control over the Hudson CDO.
Internally, while Hudson 1 was being constructed, Goldman personnel acknowledged that they were using a novel pricing approach. |2265| At one point, Mr. Swenson sent an email to Mr. Birnbaum, raising questions about how they could explain some of the pricing decisions. Mr. Swenson wrote that he was: "concerned that the levels we put on the abx cdo for single-a and triple-bs do not compare favorably with the single-a off of a abx 1 + abx 2 trade," telling Mr. Birnbaum "[w]e need a goo[d] story as to why we think the risk is different." |2266| The prices that Goldman established for the CDS contracts that Hudson "bought" affected the value of the CDO and the Hudson 1 securities Goldman sold to investors, but the Offering Circular failed to disclose the extent to which Goldman had single-handedly controlled the pricing of 100% of the CDO's assets.
Perhaps the most serious omission from the marketing booklet and other offering materials was Goldman's failure to disclose the fact that it would be the sole short party in the entire $2 billion CDO. The Goldman materials told investors that an affiliate, Goldman Sachs International (GSI), would be the "credit protection buyer" or initial short party for the Hudson 1 CDO. |2267| It was common practice for underwriters to act as the initial short party in a CDO, acting as an intermediary between the CDO vehicle and broker-dealers offering competitive bids in order to short the assets referenced in the CDO. |2268| The disclosure provided by Goldman contained boiler plate language suggesting that would be the role played by GSI in the Hudson transaction. Goldman never disclosed that it had provided all of Hudson's assets internally, GSI was not acting as an intermediary, and GSI would not be passing on any portion of the short interest in Hudson to any other party, but would be keeping 100% of the short position. The Hudson disclosures failed to state that, rather than serving as an intermediary, Goldman was making a proprietary investment in the CDO which placed it in a direct, adverse position to the investors to whom it was selling the Hudson securities.
The Offering Circular contained a section entitled, "Certain Conflicts of Interest," which included a subsection entitled, "The Credit Protection Buyer and Senior Swap Counterparty," in which Goldman could have disclosed its short position. Rather than disclose that short position, however, Goldman stated in part:
"GSI and/or any of its affiliates may invest and/or deal, for their own respective accounts for which they have investment discretion, in securities or in other interests in the Reference Entities, in obligations of the Reference Entities or in the obligors in respect of any Reference Obligations or Collateral Securities (the "Investments"), or in credit default swaps (whether as protection buyer or seller), total return swaps or other instruments enabling credit and/or other risks to be traded that are linked to one or more Investments." |2269|
This disclosure indicates that GSI or an affiliate "may invest and/or deal" in securities or other "interests" in the assets underlying the Hudson CDO, and "may invest and/or deal" in securities that are "adverse to" the Hudson "investments." The Offering Circular, however, misrepresented Goldman's investment plans. At the time it was created in December 2006, Goldman had already determined to keep 100% of the short side of the Hudson CDO and act as the sole counterparty to the investors buying Hudson securities, thereby acquiring a $2 billion financial interest that was directly adverse to theirs.
Tracking Hudson. Once it constructed the Hudson CDO, Goldman personnel were focused on completing and selling the Hudson 1 securities as quickly as possible. At least one other CDO was pushed back to facilitate the execution of Hudson 1. |2270|
Goldman senior executives closely followed Hudson's development and sale. Hudson was discussed, for example, at five different Firmwide Risk Committee meetings attended by senior Goldman executives. |2271| Mortgage Department executives also sent progress reports to the senior executives on Hudson 1. On October 25, 2006, for example, Mr. Sobel sent an email to COO Gary Cohn and CFO David Viniar alerting them to Hudson sales efforts and the pricing of its securities. |2272| During discussions over the best price at which to market the CDO's equity tranche, a senior executive emailed Peter Ostrem and others: "keep in mind the overall objective - this is not about one trade - having said that, I agree that [the proposed price] may be too low." |2273| On October 26, 2006, Mr. Jha, a Goldman risk officer, circulated a Mortgage Department Risk Report to a number of Goldman executives, including CEO Lloyd Blankfein and COO Gary Cohn, noting in the forwarding email: "Risk reduction [in the Mortgage Department] is primarily due to pricing of $2bn Hudson Mez synthetic CDO." |2274|
Selling Hudson. Once the Hudson CDO was ready for sale, the Goldman sales force had difficulty selling Hudson securities to investors due to its reliance on BBB and BBB- rated subprime RMBS securities. Allied Irish Bank (AIB), for example, apparently referred to the Hudson securities as "junk." |2275| One Goldman employee emailed the CDO team and asked:
"[D]o we have anything talking about how great the BBB sector of RMBS is at this point in time ... a common response I am hearing on both Hudson & HGS1 is a concern about the housing market and BBB in particular? We need to arm sales with a bit more." |2276|
Another Goldman salesman emailed Mr. Herrick on the CDO Desk, telling him:
"The guy at Schroders looking at this deal has one main issue h[e] has to get over: He is worried about how he is going to convince his boss to invest in a pool of sub prime mortgages with probably their greatest exposures in California and Florida. He is nervous on US house prices. ... Anything else we could offer? He is not a big believer in the Moody's data and rating system. I WANT THIS GUY THERE AND IN SIZE! Please help if you can - just three bullet points would help." |2277|
Mr. Herrick kept the SPG Trading Desk posted on the progress of sales. On October 11, 2006, Mr. Herrick informed the group: "This [sale] clears the team of majority the senior risk Equity and BBs we are hammering away on and hope to get traction tomorrow/Friday." |2278| Mr. Swenson responded: "you are doing an awesome job, keep it up." Mr. Swenson emailed the sales team manager: "I am extremely impressed by darryl [a]nd the rest of your team." |2279|
On October 25, 2006, Mr. Sobel sent a Hudson update to COO Gary Cohn and CFO David Viniar: "$1.6bn of the $2bn sold, with the majority of the unsold bonds being investment grade. Equity more than 85% sold." |2280|
The Goldman sales force sold most of the Hudson securities prior to the CDO's closing in December 2006, and continued its sales efforts after the closing as well. Two months after the closing, in February 2007, Goldman had $296 million in unsold Hudson securities, not including the $6 million equity investment Goldman had announced in the Hudson marketing material that it would purchase and hold. Over the following months, Goldman sold an additional $38 million worth of securities to investors, and received bids on several other securities but decided the bid prices were too low and kept the securities on its books instead. |2281| The unsold Hudson securities were split between the CDO Origination Desk and ABS Trading Desk. |2282|
Overall, Goldman sold Hudson securities to 25 investors. Morgan Stanley made the largest investment, taking $1.2 billion of the super senior portion of the CDO. Other investors included the National Australia Bank, which purchased $80 million worth of the AAA rated securities; Security Benefit Mutual, which bought $10 million of the AA rated securities; and Bear Stearns, which bought $5 million of the equity tranche.
Profiting from Hudson. On October 30, 2006, after Hudson 1 was presented to investors and pre-sold most of its securities, Peter Ostrem, the head of the CDO Origination Desk, sent a celebratory email to the ABS and CDO teams with Hudson highlights. He wrote: "Goldman was the sole buyer of protection on the entire $2.0 billion of assets," meaning Goldman had kept 100% of the short position. By shorting Hudson, Goldman had transferred $1.2 billion worth of risky ABX assets Goldman wanted off its books, and shorted another $800 million in RMBS securities. Mr. Ostrem also listed these "highlights":
- "P&L [Profit and Loss] booked of $8.5mm .... Plus, ongoing P&L to GS for acting as liquidation agent equal to $2.5mm per year for the next 4 years
- Hudson Mezz went long $1.2bln of BBB/BBB- ABX from ABS trading desk at market wides 4 weeks ago
- Fastest execution of a SP [Structured Product] CDO done at Goldman (4 weeks from inception to pricing)
- Over half the Equity was sold by Andy Davilman
- ... Super senior note ($1.2bln in size) was executed in the first week of the transaction and was a key driver of this deal[']s success (covered by Nicole Martin)." |2283|
Over the next year, Goldman pocketed nearly $1.7 billion in gross revenues from Hudson 1, all of which was at the expense of the Hudson investors. |2284| As the value of the RMBS securities referenced in the ABX indices declined, Goldman, as the sole short party in Hudson, collected $1.393 billion in gains directly from the investors to whom it had sold the Hudson securities. Goldman's $1.393 billion gains were, in turn, offset internally at the firm by the ABX losses recorded on the books of its ABS Desk. Goldman made another $304 million in gains due to its short of the other $800 million in single name CDS contracts included in Hudson 1. |2285| That $304 million gain was also at the expense of the investors to whom Goldman had sold the Hudson securities.
Goldman also profited in other ways. It received substantial fees from the roles it played in underwriting and administering Hudson 1, including $31 million in underwriting fees, $3.1 million for serving as the liquidation agent, and $1 million for serving as the collateral put provider. |2286| The ABS Desk warehouse account that contained both the long ABX assets and the 80 offsetting single name CDS contracts reported a gain of approximately $1.2 million due to the higher value of the single name CDS compared to the ABX CDS. |2287|
Goldman also incurred some losses in connection with Hudson 1. Although Goldman sold some additional Hudson securities several months after the CDO closed, it incurred a $267 million loss from the Hudson 1 securities that it was unable to sell at the prices it wanted and instead retained in its inventory. Goldman lost another $111 million from serving as the collateral put provider for Hudson collateral securities which also lost value. |2288| Overall, however, Goldman recorded a profit from Hudson 1 of more than $1.35 billion.
In contrast to Goldman, Hudson 1 investors suffered substantial losses. In March 2007, less than three months after the issuance of the Hudson securities, when asked to analyze how a holder of Hudson securities could hedge against a drop in their value, a Goldman trader wrote: "their likelihood of getting principal back is almost zero." |2289| Six months later, the credit rating downgrades began. In September 2007, Moody's downgraded several Hudson 1 securities and followed with additional downgrades in November 2007. S&P began downgrades of Hudson 1 in December 2007, and by February 2008, had downgraded even the AAA rated securities. |2290|
Morgan Stanley, the largest Hudson investor, lost $930 million. |2291| As other investors incurred increasing losses, they sold their securities back to Goldman at rock bottom prices. In September 2007, for example, nine months after the Hudson securities were first issued, Goldman repurchased $10 million worth of Hudson securities from Greywolf Capital at a price of five cents on the dollar; in October 2007, another hedge fund sold $1 million in Hudson securities back to Goldman at a price of 2.5 cents on the dollar. |2292| In November 2008, Hudson 1 was completely liquidated by Goldman. Today, Hudson securities are worthless.
Analysis. Goldman constructed Hudson 1 as a way to transfer its ABX risk to the investors who bought Hudson securities. When marketing the Hudson securities, Goldman misled investors by claiming its investment interests were aligned with theirs, when it was the sole short party and was betting against the very securities it was recommending. Goldman also implied that Hudson's assets had been purchased from outside sources, and failed to state that it had selected the majority of the assets from its own inventory and priced the assets without any third party participation. By holding 100% of the short position at the same time it solicited clients to buy the Hudson securities, Goldman created a conflict of interest with its clients, concealed the conflict from them, and profited at their expense.
In the summer of 2006, Goldman began work on Anderson Mezzanine Funding 2007-1 (Anderson), a synthetic CDO whose assets were single name CDS contracts referencing subprime RMBS securities with mezzanine credit ratings. |2293| To execute the Anderson CDO, Goldman partnered with GSC Partners ("GSC"), a New York hedge fund. Goldman personnel working on the CDO included Peter Ostrem, head of the CDO Origination Desk, and Matthew Bieber, a CDO Origination Desk employee assigned to be deal captain for the Anderson CDO.
The CDO was originally conceived as part of the Hudson series of non-managed, proprietary CDOs in which Goldman acted as the principal. |2294| But Goldman decided to enlist GSC to take part in structuring the $500 million CDO. |2295|
Partnering on Anderson. GSC Partners was founded by Alfred C. Eckert, III, a former partner and former head of private equity, distressed debt investing, and corporate finance at Goldman. |2296| Goldman had a longstanding relationship with GSC. In addition to Mr. Eckert, at least five other former Goldman Managing Directors were employed by GSC, and at least eight other former and current Managing Directors had invested in one or more of GSC's funds. |2297| In the spring of 2006, GSC circulated information through Goldman about raising money for its Elliot Bridge Fund, a "fixed income arb[itrage] fund focusing primarily on ABS using cash and synthetics, long/short strategies." |2298| When discussing the fund with other Goldman employees, Curtis Willing, the Goldman sales representative responsible for covering GSC wrote: "They are a strategic partner with the Synthetic desk and have handed us multiple CDO/CLO mandates." |2299| After being informed of the internal conversations almost a month later, Mr. Sparks informed Mr. Willing that it was a "[m]istake not to involve me from early on," telling Mr. Willing, "I've run a bunch of traps for [GSC] in the past." |2300|
GSC agreed to partner with Goldman on the Anderson CDO and to share in the associated risk, including by splitting the equity tranche and sharing the risk with Goldman that the Anderson assets would lose value while being warehoused. |2301| GSC also participated in selecting the assets for the CDO. |2302| Later on, Goldman consulted with GSC on whether to liquidate or underwrite Anderson, |2303| and allowed GSC to participate in pricing issues, |2304| while GSC at times assisted in marketing Anderson. |2305|
Goldman offered to let GSC take a short interest in the CDO by offering to "sell protection on BBBs to GSC at market for 0.75% times notional," and agreeing to "source assets via GSC," meaning GSC could propose assets for the CDO that GSC wanted to get rid of or short. |2306| GSC responded by shorting a select group of RMBS securities to hedge its risk while those assets were in the Anderson warehouse account. |2307| For instance, at one point in October 2006, GSC sought to add $56 million in assets to the Anderson CDO, while also taking a short position on $9 million of those assets, which it described as "GSC Hedge Amount." |2308|
Designing Anderson. GSC and Goldman participated together in the selection of assets for Anderson. Anderson was designed to be a synthetic CDO whose assets would consist solely of CDS contracts referencing RMBS securities whose average credit ratings would be BBB or BBB-. GSC proposed some of the referenced RMBS securities, but it is unclear how many were included in Anderson. |2309| GSC and Goldman employees interviewed by the Subcommittee had no specific recollection of the asset selection process, beyond each party selecting some RMBS securities and the other having veto rights. |2310|
Anderson's assets were purchased from 11 different broker-dealers from September 2006 to March 2007. Goldman was the source of 28 of the 61 CDS contracts in Anderson, and Goldman retained the short side. The next largest short party was Lehman Brothers which sold six CDS contracts to Anderson and retained the short side. Goldman also served as the sole credit protection buyer to the Anderson CDO, acting as the intermediary between the CDO and the various brokerdealers selling it assets. |2311|
By February 2007, the Anderson warehouse account contained $305 million out of the intended $500 million worth of single name CDS, many of which referenced mortgage pools originated by New Century, Fremont, and Countrywide, subprime lenders known within the industry for issuing poor quality loans and RMBS securities. Approximately 45% of the referenced RMBS securities contained New Century mortgages. |2312|
Falling Mortgage Market. During the same time period in which the Anderson single name CDS contracts were being accumulated, Goldman was becoming increasingly concerned about the subprime mortgage market, was reacting to bad news from the subprime lenders it did business with, |2313| and was building a large short position against the same types of BBB rated RMBS securities referenced in Anderson. |2314| By February 2007, the value of subprime RMBS securities was falling, and the Goldman CDO Origination Desk was forced to mark down the value of the long single name CDS contracts in its CDO warehouse accounts, including Anderson.
Goldman was also aware that its longtime customer, New Century, was in financial distress. On February 7, 2007, New Century announced publicly it would be restating its 2006 earnings, causing a sharp drop in the company's share price. On February 8, 2007, Goldman's Chief Credit Officer Craig Broderick sent Mr. Sparks and others a press clipping about New Century and warned:
"[T]his is a materially adverse development. The issues involve inadequate [early payment default] provisions and marks on residuals .... [I]n a confidence sensitive industry it will be ugly even if all problems have been identified. ... We have a call with the company in a few minutes (to be led by Dan Sparks)." |2315|
On some occasions, Mr. Sparks addressed negative news about New Century in the same email he discussed liquidating assets in warehouse accounts for upcoming CDOs. On March 8, 2007, for example, Mr. Sparks noted in an email to senior executives: "New Century remains a problem" due to loans experiencing early payment defaults, and informed them that the Mortgage Department had "liquidated a few deals and could liquidate a couple more." |2316|
On February 23, 2007, Mr. Sparks sent an email to senior Goldman executives estimating that Goldman had lost $72 million on the holdings in its CDO warehouse accounts, due to falling prices. |2317| He directed Mortgage Department personnel to liquidate rather than securitize the assets in certain warehouse accounts. Two days later, on February 25, 2007, Mr. Sparks informed senior executives of the possibility of liquidating Anderson:
"[T]he CDO business liquidated 3 warehouses for deals of $530mm (about half risk was subprime related). ... One more CDO warehouse may be liquidated this week - approximately $300mm with GSC as manager." |2318|
Three days later, David Rosenblum, head of Goldman's Collateralized Loan Obligations activities, emailed Mr. Ostrem, head of the CDO Origination Desk, stating: "Dan tells me that SP [Structured Product] CDO desk has reported -77 [million dollars] from retained debt (Hmezz 1+2, etc), and -129 [million dollars] from unrealized and realized CDO WH [warehouse] markdowns." |2319|
On February 24, 2007, a Saturday, several persons from the Mortgage Department worked to analyze the costs of unwinding and liquidating the assets collected for the Anderson CDO. Deeb Salem, a trader on the ABS Desk, estimated that unwinding Anderson would result in a $60 million loss due to the falling value of its single name CDS. |2320| On the same day, Mr. Ostrem sent his colleagues this explanation of why the losses in the CDO warehouse accounts were growing so rapidly:
"Each warehouse is marked by either (a) MTM [mark-to-market] on each asset or (b) mark to model [MTModel] which involves taking the portfolio through the expected CDO execution and calculating Goldman's P&L [profit and loss] given current market yields on debt and equity. MTM is preferred if CDO execution is highly uncertain or portfolio is small. Both the MTM and the MTModel take into account risk sharing arrangements with 3rd parties.
As CDO execution has become more uncertain we have moved a couple warehouses closer to their MTM which has significantly increased our losses. Also, our MTModel results have shown losses as expected liability spreads have widened significantly and the overall strength of the CDO market has waned due to fundamental credit decline in 06/07 in RMBS subprime (90+% of assets) and increased co[r]relation between ABX/TABX levels and mezz debt levels in CDOs. We expect this co[r]relation to increase volatility in our warehouse marks for the [sic] a while (this series of events have happened quickly within the last month and the co[r]relation is getting closer to 1 as global markets get more familiar with fundamentals in subprime and trading levels in ABX/TABX).
Additional losses have also resulted from the liquidation of 3 warehouses. In each case, the realized loss from the sale of assets has been higher than our MTM or MTModel. This is attributable to both volatility in subprime markets and that our competitors are closing their CDO warehouse accounts from buying our subprime or CDO positions. The buyer base has suddenly shrunk significantly. As this continues, we expect this lack of liquidity to further weaken our MTMs and feed into our losses in our remaining warehouse marks." |2321|
At about 11:00 p.m. that Saturday night, February 24, 2007, Mr. Sparks seemed to reach a decision to liquidate Anderson. He sent an email to Mr. Ostrem, Mr. Bieber, and several others stating: "I want to liquidate Anderson Monday - we should begin the discussion with gsc asap." |2322|
After Mr. Sparks relayed this decision, Mr. Ostrem and Mr. Bieber began to strategize ways to convince Mr. Sparks to reverse his decision. |2323| Messrs. Ostrem and Bieber assembled a list of likely buyers of the Anderson securities to present to Mr. Sparks, and brainstormed about other CDOs that could potentially buy Anderson securities for their asset pools. |2324| Mr. Ostrem also proposed allowing a hedge fund to short assets into the deal as an incentive to buy the Anderson securities, but Mr. Bieber thought Mr. Sparks would want to "preserve that ability for Goldman." |2325|
At some point, Mr. Sparks changed his mind and decided to go forward with underwriting the Anderson CDO. None of the Goldman personnel interviewed by the Subcommittee could recall why the final decision was made to go forward with Anderson. In one email on March 2, 2007, Jonathan Egol, head of the Goldman Correlation Trading Desk, suggested adding $195 million more in assets to Anderson, with Goldman selecting the assets internally and shorting them. |2326| Mr.
Sparks rejected any expansion of Anderson, responding: "we are not ramping - execute deal as is." |2327|
The Anderson CDO closed on March 20, 2007. As finally constructed, 100% of its assets were CDS contracts referencing $307 million in mezzanine subprime RMBS securities, meaning RMBS securities carrying BBB or BBB- credit ratings. About 45% of the subprime mortgages in the referenced RMBS securities were issued by New Century. Another 8% were issued by Countrywide, and almost 7% were issued by Fremont. Goldman took about 40% of the short side of the Anderson CDO. Ten other investors held the rest of the short interest in the CDO.
Selling Anderson. During March, selling Anderson securities became a top priority for Goldman. Goldman even put another deal on hold, the Abacus 2007-AC1 deal with the Paulson hedge fund, to promote Anderson. As Mr. Egol advised Goldman personnel: "Given risk priorities, subprime news and market conditions, we need to discuss side-lining [Abacus 2007-AC1] in favor of prioritizing Anderson in the short term." |2328|
On March 13, 2007, Goldman issued internal talking points for its sales force on the Anderson CDO. Among the points highlighted were:
"Portfolio selected by GSC. Goldman is underwriting the equity and expects to hold up to 50%. ... Low fee structure[.] ... No reinvestment risk." |2329|
The talking points described Goldman as holding up to 50% of the equity tranche in the CDO – worth about $21 million, without mentioning that Goldman would also be holding 40% – about $135 million – of the short side of Anderson, placing its investment interests in direct opposition to the investors to whom it was selling Anderson securities.
The large number of poor assets referenced in Anderson raised investor questions and was an impediment to sales. |2330| One potential investor wrote to a Goldman sales representative explaining its decision not to purchase the Anderson securities:
"We're going to pass on this deal for a number of reasons: Two bonds . . . have been downgraded or are on negative watch; Another 12 bonds in the portfolio are negatively impacted by the downgrades lower in the capital structure; 28% of the portfolio is failing delinquency triggers; We show that a lot of these bonds will take principal hits; Not crazy about the deal structure given the quality of the portfolio." |2331|
Other investors expressed concerns that the CDO would be downgraded. |2332| Goldman did not disclose to these investors that it had almost canceled the CDO, due to its assets' falling values.
Of particular concern for investors was the concentration of New Century mortgages in Anderson. |2333| On March 13, 2007, a potential investor, Rabobank, asked Goldman sales representatives: "how did you get comfortable with all the new centu ry [sic] collateral in particular the new century serviced deals - con sidering [sic] you are holding the equity and their servicing may not be around is that concerning for you at all?" |2334| Goldman and GSC prepared a list of talking points with which to respond to the investor:
"- Historically New Century has on average displayed much better performance in terms of delinq[uency] and default data
- Prepayments have tended to be higher lowering the extension risk
- Losses and REO [Real Estate Owned by a lender taking possession of a property] are historically lower than the rest of the market
- Traditionally the structures have strong enhancement/subordination." |2335|
The talking points did not disclose that, in fact, Goldman, too, was uncomfortable with New Century mortgages. On March 8, 2007, five days before receiving the investor's inquiry, Mr. Sparks had reported to senior Goldman executives, including Co-President Gary Cohn and CFO David Viniar, that New Century mortgages "remain[ed] a problem for [early payment default]." |2336| On March 13, the same day as the investor inquiry, Goldman personnel completed a review of New Century mortgages with early payment defaults that were on Goldman's books and found fraud, "material compliance issues," and collateral problems. The review found that "62% of the pool has not made any pmts [payments]" and recommended "putting back 26% of the pool" to New Century for repurchase "if possible." |2337| Goldman also did not disclose to the investor that it was shorting 40% of the Anderson CDO.
Some Goldman clients also had questions about GSC's involvement in Anderson. An Australian sales representative wanted "more color on asset selection process, especially with respect to GSC involvement." |2338| This clarification was necessary, because although GSC's role was mentioned in numerous internal Goldman documents, the official Anderson marketing materials did not mention GSC's role in asset selection. |2339| In previous drafts of the marketing materials, for example, Goldman stated that "Goldman Sachs and GSC Group co-selected the assets"; "GSC pre-screens and evaluates assets for portfolio suitability"; the CDO was "cosponsored by Goldman and GSC Eliot Bridge Fund"; and "Goldman Sachs and GSC ha[ve] aligned incentives with Anderson Funding by investing in a portion of equity." |2340| But all of the references to GSC were removed from the final documents. |2341| Mr. Bieber told the Subcommittee that he did not recall specifically why the references to GSC were removed, but recalled GSC having an issue with disclosing its name in the offering documents. |2342| Edward Steffelin, a Senior Trader at GSC, also did not recall the specifics regarding why the references to GSC were removed, but told the Subcommittee that he felt GSC's role in the Anderson CDO did not rise to the level of "coselecting." |2343| Mr. Steffelin said that although GSC had the ability to suggest assets and veto others, he felt that "co-selecting" implied a level of control over the portfolio that GSC didn't have. |2344|
Despite the poor reception by investors, Goldman continued "pushing the axe" with its sales force to sell Anderson securities. |2345| Mr. Bieber identified and monitored potential investors and attempted to sell Anderson securities to pension funds and place Anderson securities in other Goldman CDOs as collateral securities. |2346| On March 20, 2007, when Mr. Bieber reported selling $20 million in Anderson securities, his supervisor, Mr. Ostrem, responded with the single word: "Profit!" |2347| In a separate email a week later, Mr. Ostrem told Mr. Bieber he did "an excellent job pushing to closure these deals in a period of extreme difficulty." |2348|
After several months of effort, Goldman was able to sell only a third, or about $102 million of the $307 million in Anderson securities. |2349| The nine investors included Beneficial Life, Moneygram, and GSC which purchased the entire $11 million class D portion of the CDO. |2350|
Losing Money from Anderson. Due to its inability to sell two-thirds of the Anderson securities, Goldman lost money overall on the CDO. Goldman's biggest gain came from holding 40% of the short position on certain Anderson assets, which produced a $131 million gain at the direct expense of the investors to whom Goldman had sold the Anderson securities. Goldman was also paid $200,000 for serving as the liquidation agent, |2351| and collected $2 million in CDS premiums while it warehoused Anderson assets. |2352|
Despite those gains, Goldman incurred a $185 million loss from the Anderson securities it was unable to sell and had to keep on its books. It incurred another $122 million loss due to the decreased value of the securities Goldman had purchased as collateral for the CDO.
Anderson's nine investors suffered more substantial losses. Seven months after its issuance, in November 2007, Anderson securities experienced their first ratings downgrades. At that point, 27% of the assets underlying Anderson were downgraded below a B- rating. |2353| GSC then sold back to Goldman a portion of the Anderson securities it had purchased at a price of 3 cents on the dollar. |2354| Within a year, Anderson securities that were originally rated AAA had been downgraded to BB. In the end, the Anderson investors were wiped out and lost virtually their entire investments.
Analysis. Goldman constructed the Anderson CDO using CDS contracts referencing subprime RMBS securities, the majority of which were issued by subprime lenders like New Century who were known for issuing poor quality loans. When potential investors asked how Goldman was able to "get comfortable" with the New Century mortgage pools referenced in Anderson, Goldman attempted to dispel concerns about the New Century loans, withheld information about its own discomfort with New Century, and withheld that it was taking 40% of the short side of the CDO, essentially betting against the very securities it was selling to its clients. Instead, Goldman instructed its sales force to tell potential investors that Goldman was buying up to 50% of the equity tranche. Goldman also did not disclose to potential investors that it had almost cancelled the CDO due to the falling value of its assets.
Timberwolf I was a $1 billion hybrid CDO2 transaction that Goldman constructed, underwrote, and sold. It contained or referenced A rated CDO securities which, in turn, referenced primarily BBB rated RMBS securities. The assets in Timberwolf were selected by Greywolf Capital Management, a registered investment adviser, with the approval of Goldman. Greywolf served as the collateral manager of the CDO. |2355| Goldman effectively served as the collateral put provider. |2356| Timberwolf was initiated in the summer of 2006, and closed in March 2007.
Partnering with Greywolf. Greywolf Capital Management was founded by a team of former employees of Goldman's fixed income trading division. |2357| It had experience in constructing and investing in CDOs. In the summer of 2006, Peter Ostrem, head of Goldman's CDO Origination Desk, approached Greg Mount, a former Goldman trader working for Greywolf, and asked if Greywolf would be interested in managing a CDO2 transaction. |2358| Goldman and Greywolf negotiated a risk sharing agreement, and worked through the profitability of the CDO2 under expected market conditions. Greg Mount, as well as Joseph Marconi, another former Goldman trader, obtained approval from Greywolf's Chief Investment Officer to manage the CDO.
Greywolf agreed to purchase half of the Timberwolf equity tranche, sharing that risk with Goldman. |2359| In addition, Greywolf agreed to share with Goldman the risk of the assets being purchased for the CDO falling in value before the CDO issued its securities. Greywolf also accepted the responsibility of selecting the assets with the approval of Goldman, which would then keep them in a warehouse account for the Timberwolf CDO. Greywolf agreed to provide ongoing surveillance of the performance of the assets in the CDO and liquidate any assets deemed to be impaired.
Constructing Timberwolf. In September 2006, Greywolf began identifying, purchasing, and warehousing CDO securities or single name CDS referencing CDO securities for Timberwolf.
Before selecting an asset for inclusion in Timberwolf, Greywolf did a detailed credit analysis of the relevant CDO security, including examining its underlying mortgage portfolio, the CDO's cashflow structure, and the mortgage servicer. |2360| Once Greywolf finished its credit analysis, it submitted its choices to Goldman's CDO Origination Desk for review by Mr. Ostrem and Matthew Bieber, who was assigned to be the Goldman deal captain for Timberwolf. Goldman had the right to approve each asset going into the Timberwolf warehouse account and thus onto Goldman's warehouse balance sheet.
Once an asset was approved by both Greywolf and Goldman, it was acquired in one of two ways. In most instances, Greywolf circulated a list of the CDO securities or reference CDO securities that it was interested in buying to the broker-dealer community to get bids. To buy a single name CDS, Goldman wrote the CDS contract, taking the long side on behalf of Greywolf, while the broker-dealer who provided the best bid took the short side. The CDS contract would then be held by Goldman in the Timberwolf warehouse account until the CDO was ready to close. |2361| In some instances, after circulating a list for bids, a broker-dealer responded to Greywolf's request with a price for a single name CDS on a similar CDO security, which Greywolf analyzed and sometimes agreed to acquire. |2362|
Timberwolf's single name CDS and CDO securities were acquired from 12 different brokerdealers. |2363| Goldman was the single largest source of assets, providing 36% of the assets by value, including $15 million in single name CDS contracts naming Abacus securities. |2364| As a result, Goldman held 36% of the short interest in Timberwolf. |2365|> Altogether, Timberwolf contained 56 different assets, of which 51 were single name CDS contracts referencing CDO securities and five were cash CDO securities. |2366| The 51 single name CDS contracts referenced both CDO and CDO2 securities, and each CDO or CDO2 security contained or referenced its own RMBS, CMBS, or CDO securities or other assets. In total, Timberwolf had over 4,500 unique underlying securities and a grand total of almost 7,000 securities. |2367| This process was further complicated by the fact that the CDO assets in Timberwolf were privately issued and often had little or no publicly available information on the underlying assets they contained.
By the time Greywolf and Goldman were nearing completion of the acquisition of the Timberwolf assets in the spring of 2007, Goldman was becoming increasingly concerned about the deteriorating subprime mortgage market and the falling value of the assets in its CDO warehouse accounts. In February 2007, Mr. Sparks, the Mortgage Department head, and Goldman senior executive Thomas Montag exchanged emails about the warehouse risk posed by Timberwolf and another pending CDO2 called Point Pleasant. Mr. Montag asked Mr. Sparks: "cdo squared–how big and how dangerous?" |2368| Mr. Sparks responded: "[R]oughly 2bb [billion], and they are the deals to worry about." Mr. Sparks also told Mr. Montag that, due to falling subprime prices, the assets accumulated in the warehouse account for the $1 billion Timberwolf CDO had already incurred significant losses, those losses had eaten through all of Greywolf's portion of the warehouse risk sharing agreement, and any additional drops in value would be Goldman's exclusive obligation. |2369|
In March 2007, due to the falling values of subprime RMBS and CDO securities, Goldman decided against completing several CDOs under construction, and liquidated the assets in their warehouse accounts. Goldman decided, in contrast, to accelerate completion of Timberwolf. |2370|
Timberwolf I closed on March 27, 2007, approximately six weeks ahead of schedule. |2371| The final CDO had $1 billion in cash and synthetic assets, including $960 million in single name CDS referencing CDO securities, and $56 million in cash CDO securities.
Selling Timberwolf. Selling Timberwolf securities became a high priority for Goldman. Mr. Sparks worked with senior sales managers to review ideas, telling them: "I can't over state the importance to the business of selling these positions and new issues." |2372|
During the spring and summer of 2007, the Goldman Syndicate |2373| emailed the CDO sales force a list of "Senior CDO Axes" or sales directives on a weekly and sometimes daily basis, many of which placed a priority on selling Timberwolf securities. |2374| As early as February, the Goldman sales force developed "broader lists" of clients to target for Timberwolf sales. |2375| After exhausting those initial lists, Goldman sales personnel began to target "non-traditional" buyers |2376| as well as clients outside of the United States. |2377| The sales force had some early successes. On March 28, 2007, for example, the Syndicate included a note in one of the axe sheets:
"Great job Cactus Raazi trading us out of our entire Timberwolf Single-A position – $16mm. Sales - Good job over the last two weeks moving over $66mm of risk off the axe sheet. Please stay focused on trading these axes." |2378|
As sales began to flag in April, Mr. Sparks sent emails reminding Goldman sales personnel that Timberwolf "is our priority." |2379| On one occasion, on April 19, 2007, Mr. Sparks suggested to a sales manager offering "ginormous credits" as an incentive to sell Goldman's CDO securities: "for example, let's double the current offering of credits for [T]imberwolf." |2380| Mr. Sparks was informed in response: "[W]e have done that with timberwolf already."
On March 9, 2007, Harvey Schwartz, a senior executive at Goldman Sachs, expressed concern to Mr. Sparks and others about what Goldman sales personnel were telling clients: "Seems to me ... one of our biggest issues is how we communicate our views of the market – consistently with what the desk wants to execute." |2381| Mr. Sparks responded by outlining several concerns and the need for the sales team and traders to work together. |2382| He wrote:
"3 things to keep in mind:
(1) The market is so volatile and dislocated that priorities and relative value situations change dramatically and constantly.
(2) Liquidity is so light that discretion with information is very important to allow execution and avoid getting run over.
(3) The team is working incredibly hard and is stretched."
He concluded: "Priority 1 – sell our new issues and our cash positions."
Pricing Timberwolf Securities. Despite the urgency communicated by Goldman management, Timberwolf sales slowed. By May 11, 2007, only one Timberwolf sale had taken place in the previous several weeks. |2383| Goldman personnel also knew that the value of the Timberwolf securities, and the value of their underlying assets, were falling. |2384|
On May 11, 2007, Mr. Sparks notified Goldman senior executives that marking down the value of the unsold CDO securities so that, internally, the firm understood their current market value had become a "real issue":
"Cdo positions and market liquidity and transparency have seized. I posted senior guys that I felt there is a real issue. ... We are going to have a very large markdown – multiple hundreds. Not good." |2385|
That same evening, Mr. Lehman sent out a "Gameplan" to colleagues in the Mortgage Department announcing that Goldman was going to undertake a detailed valuation of its CDO2 securities using three different valuation methods, and would also take "a more detailed look" at the values of the assets in the CDO warehouse accounts and in Goldman's own inventory. |2386|
Also on May 11, Chief Credit Officer Craig Broderick sent an email to his team to set up a survey of Goldman clients who might encounter financial difficulty if Goldman lowered the value of the CDO securities they had purchased. |2387| As explained earlier, some Goldman clients had purchased their CDO securities with financing supplied by Goldman that required them to post more cash margin if the financed securities lost value. Other clients had invested in the CDO securities by taking the long side of a CDS contract with Goldman and also had to post more cash collateral if the value of the CDO securities declined. All of these clients would also have to record a loss on their books due to the lowered valuations.
With respect to the CDO securities that had yet to be sold, Goldman senior executive Harvey Schwartz raised another issue related to lowering the values of the CDO securities Goldman was selling to clients: "[D]on't think we can trade this with our clients andf [sic] then mark them down dramatically the next day. ... Needs to be a discussion if that risk exists." |2388| In an email to Mr. Sparks, Mr. Montag, and Mr. Schwartz, Goldman senior executive Donald Mullen acknowledged concerns "about the representations we may be making to clients as well as how we will price assets once we sell them to clients." |2389| The executives also agreed, however, not to "slow or delay" efforts to sell Timberwolf securities if they got "strong bids." |2390|
The CDO valuation project generated many comments on how to price the firm's unsold CDO securities, including Timberwolf. One Goldman employee, who was applying Goldman's most common valuation method to Timberwolf, wrote that the price should be dramatically lower:
"Based on current single-A CDO marks, the A2 tranche of Timberwolf would have a price of 72 cents on the dollar." |2391| He also noted:
"Based on a small sample of single-A CDOs for which we have a complete underlier marks, we believe that the risks of the RMBS underliers are frequently not fully reflected in the marks on the CDOs. If the trends in this small sample are extrapolated, the fair spread on the CDOs could even be double where they are marked now; if that were the case, the price of the A2 tranche of Timberwolf would actually be 35-41 cents on the dollar, depending on the correlation." |2392|
Several days later, in preparation for a meeting with senior executives on the valuation issue, the same Goldman employee calculated that, for the A2 tranche of Timberwolf, the "price based on CDO marks" was 66 cents on the dollar, while the "price based on RMBS marks" was 24 cents on the dollar. |2393|
Throughout the valuation process, senior management, including Co-President Gary Cohn, was kept posted on how the Mortgage Department planned to value the firm's CDO assets. |2394| On Sunday, May 20, 2007, the Mortgage Department presented its findings in a 9:00 p.m. conference call with CFO David Viniar and others. |2395| The presentation's executive summary expressed concern about valuing a range of CDO assets, including unsold securities from Goldman-originated CDOs. |2396| The presentation stated: "[T]he desk is most concerned about the CDO^2 positions, comprised of the recent Timberwolf and Point Pleasant transactions. The lack of liquidity in this space and the complexity of the product make these extremely difficult to value." |2397|
The presentation recommended unwinding and selling the assets in the CDO warehouse accounts and using "independent teams" to continue to value the unsold CDO securities from Goldman originations. It also recommended switching to a targeted sales effort for the unsold CDO2 securities, focused on four hedge fund clients: Basis Capital, Fortress, Polygon, and Winchester Capital. |2398| The Goldman sales force apparently felt those four hedge funds were the clients most likely to buy the CDO2 securities, and two of them, Basis Capital and Polygon, did subsequently purchase Timberwolf securities. |2399| An appendix to the presentation identified another 35 clients for targeted sales efforts and provided an assessment of the CDO sales efforts for each. |2400| Several of those clients later purchased Timberwolf securities. |2401|
Despite Goldman's internal analysis that the value of the Timberwolf securities was in rapid decline, the firm did not lower the prices at which it marketed the securities to clients. In a May 14 email, Mr. Sparks explained his Timberwolf pricing strategy to Mr. Mullen and Mr. Montag:
"I think we should take the write-down, but market at much higher levels. I'm a little concerned we are overly negative and ahead of the market, and that we could end up leaving some money on the table – but I'm not saying we shouldn't find and hit some bids." |2402|
As a result of the CDO valuation project, Goldman took substantial writedowns on the value of its CDO inventory on May 25, 2007. |2403| For example, Goldman marked down the AAA rated Timberwolf A2 securities to a value of $80. |2404| At the same time, Goldman continued to market them at inflated prices, selling Timberwolf A2 securities to clients at $87.00 on May 24, at $83.90 on May 30, and at $84.50 on June 11. |2405| On May 25, Goldman also marked the AA rated Timberwolf B securities to an internal value of $65.00. Over a month later, Goldman sold $9 million of those AA rated securities to Bank Hapoalim at a price of $78.25, but by then Goldman's internal valuation had fallen to $55, a difference of more than 30% of the market value. |2406|
In addition to marketing its CDOs at inflated prices compared to its internal valuations, the Mortgage Department told some clients that the mortgage market was strengthening. On May 14, 2007, for example, Edwin Chin, a trader on the Mortgage Department's ABS Desk, sent this upbeat commentary to both Goldman traders and clients:
"Incredible as it may seem, the subprime mortgage slump is already [a] distant memory for some. It's been two months since the ABX market plunged amid worries about a housing meltdown, and already investors (and some dealers) are beginning to get ‘complacent' again. Blame it on the CDO bids, but with subprime production projected down 40-60% from last year's level, appetite for spread products triumphs any risk concern in the marketplace right now. ABX Index is trading higher as dealers short cover their single name positions after a month of range-bound trading. Flows continue to weigh toward better seller of protection - longs outpace shorts by 3 to 1 as CDO demand has been robust the last two weeks. While warehouse activities might be slow, many CDOs are still looking to finish up their ramp post-closing." |2407|
Daniel Sparks responded to Edwin Chin's commentary by asking senior ABS traders, David Lehman, Mike Swenson, and Joshua Birnbaum: "Is this a head fake or does this make you bullish on all spread product?" Mr. Lehman responded: "[G]iven the sizable short interest in ABS/subprime mkt it does not surprise me that short covering is pushing spds [spreads] tighter. Not sure I would enter new longs here." Mr. Swenson responded: "I would characterize this as a great opportunity to be constructive on the market." |2408|
A few weeks later, Mr. Lehman forwarded an email to Goldman executives informing them "the market feels that GS is being more aggressive than other dealers moving CDO^2 paper," and marking down clients more than their competitors. |2409| Don Mullen responded: "Does this give any one pause about our selling prices?" Mr. Swenson responded to Mr. Mullen: "[N]o pause[.] [E]veryone else is afraid to execute at these levels and they will be wishing for these prices by the end of the summer." Mr. Sparks added: "There is real market meltdown potential (although far from certain)." |2410|
Timberwolf Sales to Basis Capital. At the conclusion of the CDO valuation project, which found that Timberwolf and Goldman's other CDO securities had lost significant value, the Mortgage Department resumed its efforts to push Timberwolf sales.
On Sunday, May 20, 2007, the same day the Mortgage Department made its valuation presentation to Mr. Viniar and recommended targeting Basis Capital for CDO sales, George Maltezos, the Goldman sales representative responsible for Basis Capital, emailed Mr. Lehman saying he would contact the Basis Capital principals immediately upon their return from a business trip the following day. |2411|
Mr. Maltezos began pressing Basis Capital to buy the securities. On May 22, Mr. Maltezos urged Basis Capital to consider buying the securities before the end of the quarter:
"I appreciate you are flat chat [busy] at the moment, but pls [please] keep in mind GS is an aggressive seller of risk for QTR [quarter] end purposes (last day of quarter is this Friday). We would certainly appreciate your support, and equally help create something where the return on invested capital for Basis is over 60%." |2412|
At the same time Mr. Maltezos was claiming that a Timberwolf investment could provide over a 60% return on invested capital, Goldman's internal marks were showing that Timberwolf was continuing to fall in value.
Basis Capital indicated that it was interested in the Timberwolf securities, but had several issues it needed to work through. First, Basis Capital indicated that Goldman would have to help it find financing for the purchase price. |2413| Second, Basis Capital was concerned about the value of its existing CDO2 investment with Goldman. On April 19, 2007, Basis Capital had purchased BBB rated Point Pleasant securities at a price of $81.72. |2414| Goldman had provided the financing for this purchase. Two weeks later, Goldman had marked down the value of the securities to $76.72, and asked Basis Capital to post additional cash collateral totaling $700,000. |2415| When Basis Capital asked how the value of the security had fallen $5 in just two weeks, Goldman responded that the price had gone back up to $81.72, and no additional cash was required. |2416|
In May and June 2007, Mr. Maltezos worked to convince Basis Capital to purchase $100 million in Timberwolf securities. At one point Basis Capital pressed for a lower sales price, but was told by Mr. Maltezos: "I don't think the trading desk shares the sentiment with regard to such spread levels [lower prices]." |2417| During the negotiations over the Timberwolf sale, on June 12, 2007, Goldman again marked down the value of the Point Pleasant securities to $75, and again asked Basis to post more cash collateral. |2418| When Basis Capital asked Mr. Maltezos to justify the lower value, Mr. Maltezos wrote:
"[T]here has been further softening in the market since the Point Pleasant trade was put on 8 weeks ago. We have infact [sic] traded some Point Pleasant BBBs at this level in the last 2 weeks." |2419|
In fact, no such sales had taken place, and the lower value could not be justified by any sales transactions. |2420| The lower mark was instead related to Goldman's CDO valuation project in May, which had concluded that its CDO2 securities had lost significant value. |2421|
Stuart Fowler at Basis Capital brought up the valuation issue in the context of the Timberwolf securities, and asked Mr. Maltezos: "I need to be very clear on this and are we going to see a similar problem on [T]imberwolf?" |2422| Mr. Maltezos responded: "Stuart - I assure you no foul here," and offered to set up some "1-on-1 time with the trading desk" to discuss pricing. |2423|
Mr. Sparks was closely monitoring Mr. Maltezos' ongoing effort to sell the Timberwolf securities to Basis Capital and, on June 13, 2007, sent this email to Mr. Maltezos:
"Let me know if you need help tonight - or feel free to wake up [Mr. Lehman and Mr. Egol] in [S]pain. I'd love to tell the senior guys on 30 at risk comm[ittee] Wednesday morning that you moved 100mm [$100 million]." |2424|
In response, Mr. Maltezos coordinated a call between Basis Capital and Mr. Lehman to "clarify any and all questions you have on the marking policy of Goldman, the actual marking of Point Pleasant, and the overall trading that has been seen by the [Goldman] desk in the last 1-6 months." |2425| In that telephone call with Basis Capital, Mr. Lehman apparently corrected Mr. Maltezos' misstatement about recent Timberwolf sales, and Mr. Maltezos followed up with an email to Basis Capital:
"[P]lease accept my sincerest apologies for the mis-information below. As David mentioned, the 75 mark on Pt Pleasant BBB was more reflective of an interpretation of softer AAA-AA rated CDO-sqd paper translating to BBB part of the curve." |2426|
Later that same day, June 13, 2007, Mr. Lehman reported that Goldman had reached agreement on $100 million in Timberwolf sales to Basis Capital. The sale consisted of the hedge fund taking the long side of a CDS contract with Goldman, referencing $50 million in AAA rated Timberwolf securities and $50 million in AA rated Timberwolf securities. |2427| Mr. Lehman told Mr. Montag that the CDS premiums that Basis Capital had agreed to accept implied a cash price of $84 for the AAA securities and $76 for the AA securities. Mr. Montag asked what Goldman's internal mark was for the Timberwolf AA securities, and Mr. Lehman responded: "$65." |2428|
The Timberwolf sale to Basis Capital was finalized on June 18, 2007. |2429| Goldman provided the financing. Just two weeks later, Goldman informed Basis Capital that the Timberwolf securities had lost value and required the hedge fund to post additional cash collateral. |2430| Basis Capital immediately questioned the new value and asked to see a "comparable market data point for the Timberwolf marks." |2431| In response, Mr. Lehman complained internally: "I would like to know what the precedent there is here - does GS need (outside of the client issue) to provide the below info to justify our prices???" |2432| After Goldman provided additional information, Basis Capital appeared to agree to post the additional collateral.
Eight days later, on July 12, Goldman again marked down the value of the Timberwolf securities to prices of $65 and $60, after having sold them to Basis Capital one month earlier at $84 and $76. |2433| This repricing resulted in a $37.5 million movement in the value of the securities, and required Basis Capital to post substantially more cash collateral with the firm. |2434| On July 13, 2007, Basis Capital told Goldman that one of its funds was "in real trouble." |2435| On July 16, Goldman again marked down Basis Capital's securities to prices of $55 for AAA and $45 for AA. |2436| These prices matched Goldman's internal valuations. |2437| By the end of July, Basis Capital was forced to liquidate its hedge fund. |2438| Goldman bought back the Timberwolf securities from Basis Capital on July 31, at prices of $30 and $25. |2439|
Other Timberwolf Sales. Basis Capital was only one of several clients that Goldman contacted in connection with Timberwolf. On May 24, 2007, a Goldman sales associate told Mr. Lehman and Mr. Sparks that he wanted more information to send to a European hedge fund that was "not experts in the space at all but [I] made them a lot of money in correlation dislocation and will do as I suggest. Would like to show stuff today if possible." |2440| Mr. Lehman told the sales associate that he was available to get on the telephone with the clients, and forwarded him the Timberwolf offering circular and marketing materials. |2441|
On June 5, 2007, Goldman trader Benjamin Case emailed Mr. Lehman with a "[g]ameplan for distribution" or sales of Goldman's remaining CDO2 securities. |2442| The plan was to target "institutional buyers that can take larger bite size than traditional CDO buyers ... for example Asian banks and insurance companies." |2443| Mr. Case also noted that Goldman was shorting "51 CDO names in the two portfolios [Timberwolf and Point Pleasant] and we have been aggressively sourcing further protection in the CDS market on names in the two portfolios recently." |2444|
In early June, Goldman targeted a Korean insurance company called Hungkuk Life for Timberwolf sales. According to a Goldman employee in the Japan sales office, Jay Lee, "the largest hurdle from the client perspective is whether or not they can get the mandate to buy something backed by synthetically sourced CDO's [sic], as they have never bought CDO^2 before." |2445| Mr. Lee was also concerned that the value of the securities would drop soon after the office sold the Timberwolf securities to the insurance company. Mr. Lee stated:
"[T]he largest hurdle from a sales' perspective is MTM [mark to market]. It is an important client, and if the mark widens out more than 1pt immediately after selling the asset to them, sales cannot sell it. Understanding that it is a volatile asset, sales wants to know that where we sell it to the client will not be more than 1pt less than where the mark would be, provided no new market information." |2446|
It is unclear how his valuation concern was addressed. Later the same day, on June 1, Mr. Lee reported that Hungkuk Life had purchased $36 million in AAA rated Timberwolf securities. Mr. Sparks responded "good job - keep going." |2447|
Six days later, on June 7, 2007, the head of the Goldman Japan sales office, Omar Chaudhary, contacted Mr. Sparks and Mr. Lehman about a possible additional sale of Timberwolf securities to Hungkuk Life. Mr. Chaudhary wrote that the head of Goldman's Korean sales office was "pushing on our personal relationships" to make the sale and wanted to be assured he'd be paid more if he "got it done":
"Jay and I spoke to the head of Korea Sales today. He said that he feels we can push for H[ungkuk] Life to increase their size from the 36mm of AAA's and wanted to see if we would pay more GC's [sales credits] if he got it done. Told him that if we sell ~45-50mm+ [$45-50 million more] that we would honor the 7.0% even if we trade at the 84.5 dollar px [expected price]. Trust you will support this as we are pushing on our personal relationships to get this done." |2448|
Mr. Lehman and Mr. Sparks told Mr. Chaudhary to "go for it" and "[g]et ‘er done." |2449| The Korean office did get it done, and Goldman sold another $56 million in Timberwolf securities to Hungkuk Life at a price of $84.50. |2450| The sales representative was awarded the 7% sales credit. |2451| Mr. Sparks wrote to the sales office: "you boys are awesome and many people are noticing." |2452| Mr. Montag, a senior Goldman executive monitoring the Timberwolf sales, told the mortgage team it had done an "incredible job – just incredible." |2453|
On June 11, 2007, Mr. Lehman received an email from the Goldman Syndicate asking whether the CDO axe sheet, which included directives to sell Timberwolf securities, could be sent to the Japan sales office for re-distribution to sales representatives across Asia. Mr. Lehman agreed: "let's send to all Japan sales." |2454| Two days later, on June 13, 2007, the Japan sales office reported over $250 million in new sales of Goldman's CDO securities, including Timberwolf. |2455|
Mr. Montag continued to monitor the sales of Timberwolf as well as other CDO securities in Goldman's inventory and warehouse accounts. On June 22, 2007, Mr. Sparks reported to him on the completion of a number of sales of CDO and RMBS securities that Goldman had purchased from the two failed Bear Stearns hedge funds. Mr. Montag asked Mr. Sparks to provide him with a "complete rundown" on "what[']s left." |2456| Mr. Sparks responded that the "main thing left" was $300 million in Timberwolf securities. Mr. Montag responded: "boy that timeberwo[l]f was one shitty deal." |2457|
Despite Mr. Montag's assessment of Timberwolf, he continued to press for the sale of Timberwolf securities to Goldman clients. On June 25, 2007, Mr. Sparks emailed Mr. Montag and others with another update on selling Goldman's remaining CDO assets. |2458| Mr. Sparks informed the group that Goldman would probably have to lower the values of the CDO assets over the next few days, but that the net effect for Goldman would be positive, since its short position was larger than its long. In fact, the Mortgage Department made $42.5 million that day. |2459| Mr. Montag remained focused on Timberwolf, responding: "[h]ow are twolf sales doing?" |2460|
On July 12, 2007, another Goldman sales representative, Leor Ceder, reported selling $9 million in Timberwolf securities to Bank Hapoalim at a price of $78.25. |2461| Goldman trader Mitchell Resnick asked Mr. Lehman "to pay him well on this." |2462| Mr. Ceder was paid an 8% sales credit. |2463| That was Goldman's last Timberwolf sale, even though its Syndicate continued to list the CDO as a top sales priority for months afterward.
Goldman ultimately sold about $853 million of the $1 billion in Timberwolf securities to about 12 investors. The unsold securities, with a face value of about $150 million, remained on Goldman's books.
Limited Disclosures. Despite their aggressive sales efforts, Goldman sales personnel typically did not help potential investors analyze the Timberwolf securities and the 4,500 unique assets underlying the CDO. One Goldman employee told his colleagues: "In terms of telling customers. I prefer to give them the general idea of the trade. Then give them the excel spread sheet with our info on ref obs [reference obligations] and let them draw their own conclusions." |2464| Another Goldman employee, discussing a potential buyer of Timberwolf, warned:
"[H]e is going to want to look at the TWOLF trade on a fundamental basis with a lot of supporting runs to back up any additional mark downs we have - telling him we are busy when it comes to month end and we can't run that analysis because we are resourceconstrained will not be good enough." |2465|
Still another Goldman employee stated with respect to Timberwolf and Point Pleasant: "The trickiest part about sharing this [pricing] analysis with custies [customers] is that it shows just how rudimentary our own understanding of these positions actually is." |2466|
Goldman also in many instances refused to provide investors with its pricing methodology or specific prices or values for the CDO securities it was selling. After its securities began to lose value, Basis Capital emailed George Maltezos, David Lehman, and others asking: "How many times do we have to request data points and scenarios by email. These were read out to us on the call and it was agreed that GS would send them through. I am getting weary of continually hearing about transparency and yet an obvious avoidance of ‘putting things to paper.'" |2467|
Similarly, when Hungkuk Life requested additional information about the underlying Timberwolf assets, Goldman sent an asset report, but only after removing all of its pricing and valuing information related to those assets. |2468| In August 2007, Jay Lee from Goldman's Japan sales office told a sales associate who was seeking information about Goldman's marks for Tokyo Star Bank:
"[U]nder no circumstances are we going to be able to provide materials specific to Timberwolf ... or even use the word ‘mark' in written materials. ... Everything will be described in general terms, and if what we provide is too vague or general, the medium for further clarification must be oral, not written." |2469|
Mr. Lehman added: "[W]e should be clear that the information we are providing is not our pricing methodology but rather some tho[ugh]ts on the current market." |2470|
In an interview with the Subcommittee, Mr. Lehman defended Goldman's aggressive markdowns by noting that Goldman would buy or sell at the prices it quoted to a customer. He explained that if a client thought Goldman's mark was too low, the client could buy more of the securities from Goldman at the low price, then resell them for a profit. Since Goldman's internal valuations were much lower than the price quoted to clients, however, such sales would still produce a profit for the firm. |2471| Furthermore, as Goldman marked down the values in the summer of 2007, it began to decrease the volume of the securities it was willing to buy or sell at the prices it quoted to clients. Goldman was initially willing to buy or sell CDO securities in blocks of $10 million, but by July, it lowered the maximum size to $3 million for some securities and $1 million for others: "Given current market environment, we would like our bid for size for CDO valuations to be MAX $3mm for AAA to AA and $1mm for A and below. No valuations should go out with a bid for $10mm." |2472|
"A Day That Will Live In Infamy." The Timberwolf securities issued by Goldman steadily lost money from the day they were issued. Less than four months after they were issued, on July 16, 2007, Mr. Lehman instructed the Timberwolf deal captain, Mr. Bieber, to "create an ‘unwind' spreadsheet ... where we can input CDS spds [spreads]/prices and liability prices so we can determine if unwinding these deals makes sense." |2473| The analysis appeared to show that it would cost Goldman $140 million to unwind Timberwolf, and the conclusion was to "Hold Off." |2474| Instead of unwinding, Goldman continued its sales push.
In September 2007, Mr. Montag asked for data tracking the drop in prices for a Goldman CDO that experienced a dramatic fall in value, such as Timberwolf. |2475| In response, a Goldman employee provided prices for the A2 tranche of the Timberwolf securities using a combination of Goldman's internal marks and the bids provided to investors, from the issuance of the CDO on March 27, 2007 through September. The data showed that, in six months, prices for Timberwolf's AAA rated A2 security had fallen from $94 per security to $15, a drop of almost 80%:
After receiving this pricing history, Mr. Bieber, the Timberwolf deal captain, described March 27, the Timberwolf issuance date, as "a day that will live in infamy." |2477|
The chart on the next page shows how, between mid-June 2007 and early August 2007, the value of Timberwolf securities dropped precipitously, and that Goldman personnel were aware of its falling value while selling the securities to clients.
[SEE CHART NEXT PAGE: Timberwolf Marks, Axes, and Sales, prepared by the Permanent Subcommittee on Investigations.]
Goldman profited in part from Timberwolf's decline in value due to its 36% short interest in the CDO. In addition, June was the month that Goldman built its $13.9 billion big short, which meant that the decline in most mortgage related assets translated into increasing profits for Goldman. |2478|
Timberwolf experienced its first credit rating downgrades in November 2007, just eight months after the CDO closed and issued its securities. The downgrades included the AAA rated securities. In March 2008, one year after Timberwolf was issued, its AAA securities were downgraded to junk status. In June 2008, a controlling class of debt investors voted to liquidate Timberwolf, and the deal was terminated in October 2008. |2479|
Goldman's 36% short position in Timberwolf produced about $330 million in revenues at the direct expense of the clients to whom Goldman had sold the Timberwolf securities. Goldman also made $3 million in interest while the Timberwolf assets were in Goldman's warehouse account. At the same time, because Goldman was unable to sell about a third of the Timberwolf securities and had to keep the unsold securities on its books, it ended up losing $562 million from them. Goldman also lost $226 million from the decline in the value of the collateral securities securing the CDO. When offset by the profits from its Timberwolf short, Goldman ended up with a total loss of about $455 million. |2480|
Timberwolf's investors lost virtually their entire investments. Basis Capital ended up declaring bankruptcy and has filed suit against Goldman. |2481|>
Analysis. Goldman constructed Timberwolf using CDO assets that began to fall in value almost as soon as the Timberwolf securities were issued, yet solicited clients to buy the securities. Timberwolf contained or referenced CDO assets with more than 4,500 unique mortgage related securities, but Goldman offered potential investors little help in understanding those securities, and targeted clients with limited or no experience in CDO investments. When marketing Timberwolf, Goldman withheld its internal marks showing the securities losing value and did not mention its short position. Senior Goldman executives knew the firm was selling poor quality assets at inflated prices. Within six months of issuance, AAA Timberwolf securities lost almost 80% of their value. Due to its short position, Goldman profited at the expense of the clients to whom it sold the Timberwolf securities, but it lost money overall because Goldman was forced to retain so many of the unsold Timberwolf securities on its books.
Abacus 2007-AC1 was a $2 billion synthetic CDO whose reference obligations were BBB rated mid and subprime RMBS securities issued in 2006 and early 2007. |2482| It was a static CDO, meaning once selected, its reference obligations did not change. |2483| It was the last in a series of 16 Abacus CDOs referencing RMBS securities designed by Goldman. Goldman served as the underwriter or placement agent, |2484| the lead manager, |2485| and the protection buyer, |2486| and also acted in other roles related to the CDO. |2487| Unlike previous Abacus CDOs, Abacus 2007-AC1 used a third party to select its assets, referring to it as the portfolio selection agent. |2488|
Designing Single Tranche CDOs. Abacus CDOs were known as single tranche CDOs, a structure pioneered by Goldman through its Abacus platform. |2489| Goldman used this structure to design customized CDOs for clients interested in assuming a specific type and amount of investment risk. An Abacus CDO could be issued with a single tranche, designed in coordination with a client who could select the assets the client wished to reference, the size of the investment, and the amount of subordination or cushion before the single tranche of securities would be exposed to loss. |2490| Abacus also enabled investors to short a selected group of RMBS or CDO securities at the same time. Goldman used the Abacus CDOs not only to sell short positions to investors, but also to carry out its own shorts. As summarized in one Goldman Mortgage Capital Committee Memorandum, the Abacus design allowed "Goldman to short spreads in our core structured products business in large size." |2491| Between 2004 and 2007, Goldman issued 16 Abacus deals referencing RMBS securities, including Abacus 2007-AC1, which together had an aggregate value of $13 billion. |2492|
Responding to Paulson Inquiry. In mid to late 2006, Goldman was approached by the hedge fund Paulson & Co. Inc. ("Paulson"), and asked to structure a transaction that would enable the hedge fund to short multiple RMBS securities. |2493| Goldman had previously worked with Paulson and was aware that Paulson held strong negative views of the residential mortgage market and was making investments based on that view. The Goldman Mortgage Capital Committee Memorandum seeking approval of Abacus 2007-AC1, for example, stated:
"Paulson is a macro hedge fund that has taken directional views on the subprime RMBS market for the past few months. In 2006 the Desk worked an order for Paulson to buy protection on a supersenior tranche off a portfolio similar to the Reference Portfolio selected by ACA, and the AC1 Transaction is another means for Paulson to accomplish their trading objective: buying protection in tranched format on the subprime RMBS market." |2494|
An email sent to Daniel Sparks, head of the Mortgage Department, by Fabrice Tourre, a Correlation Trading Desk employee who led the effort on the Abacus CDO for Paulson, was even more blunt:
"Gerstie and I are finishing up engagement letters ... for the large RMBS CDO Abacus trade that will help Paulson short senior tranches off a reference portfolio of Baa2 subprime RMBS risk selected by ACA." |2495|
These documents make it clear that Goldman knew Paulson's investment strategy was to identify a reference portfolio of assets for the Abacus CDO that Paulson believed would perform poorly or fail, so that its short position would profit at the expense of the long investors. |2496| In addition, during his Subcommittee interview, Mr. Tourre made it clear that he was aware of the Paulson investment strategy. |2497|
In response to the inquiry from Paulson, Goldman proposed structuring an Abacus CDO. |2498| Fabrice Tourre was given lead responsibility for organizing and structuring the Abacus transaction. Goldman's primary role was to act as an agent and administrator of the CDO, obtaining its profit from the fees it charged for the services rendered, rather than from any investment in the CDO itself. In effect, Goldman "rented" the Abacus platform to the Paulson hedge fund and served as Paulson's agent in carrying out the hedge fund's investment objectives. Mr. Tourre had been suggesting that Goldman employ such an approach and supported the arrangement. |2499|
Finding a Portfolio Selection Agent. According to Mr. Tourre, Paulson suggested that Goldman employ an outside portfolio selection agent for the CDO. |2500| However, Paolo Pellegrini, Paulson's Managing Director who led Paulson's selection of the reference assets for the Abacus 2007-AC1 transaction, told the SEC that it was Goldman's idea to have a portfolio selection agent. |2501| At the same time, Goldman internal communications made it clear that the objective was to select a portfolio selection agent that would comply with Paulson's suggestions for the assets to be referenced in the CDO. In an email to colleagues discussing the matter, Mr. Tourre suggested finding a manager that:
"will be flexible w.r.t. [with respect to] portfolio selection (i.e. ideally we will send them a list of 200 Baa2-rated 2006-vintage RMBS bonds that fit certain criteria, and the portfolio selection agent will select 100 out of the 200 bonds)." |2502|
In the early part of January 2007, Mr. Tourre sent an email to prospective selection agents describing their anticipated role in the CDO. One of his points was the following:
"Reference Portfolio: static, fully identified upfront, and consisting of approx 100 equallysized mezzanine subprime RMBS names issued between Q4 [the fourth quarter of] 2005 and today. Starting portfolio would be ideally what the Transaction Sponsor shared, but there is flexibility around the names." |2503|
Goldman's internal communications also suggest that Goldman was, in fact, more interested in identifying cooperative portfolio selection agents for its own transactions, rather than locating one for the Paulson CDO. In an email chain discussing a portfolio selection agent for Abacus 2007- AC1, a Goldman employee wrote to a colleague that Mr. Tourre "suggested Faxtor was a potential portfolio selection agent [for Paulson] since they are relatively inexpensive and easy to work with." The colleague responded: "We already have a portfolio in front of Faxtor; they probably will be willing to structure a short that I believe we would want to keep for ourselves ... not sure if this is the best fit." |2504|
Jonathan Egol, chief architect of the Abacus structure and head of the Correlation Trading Desk, suggested that Goldman approach GSC Partners, a New York hedge fund that Goldman had worked with on other CDOs, including Anderson. Mr. Tourre sent an email to colleagues asking:
"Do you think gsc is easier to work with than faxtor? They will never agree to the type of names paulson wants to use, I don't think steffelin [a senior trader at GSC] will be willing to put gsc's name at risk for small economics on a weak quality portfolio whose bonds are distributed globally." |2505|
A colleague replied:
"There are more managers out there than just GSC / Faxtor. The way I look at it, the easiest managers to work with should be used for our own axes. Managers that are a bit more difficult should be used for trades like Paulson given how axed Paulson seems to be (i.e. I'm betting they can give on certain terms and overall portfolio increase)." |2506|
On January 4, 2007, on behalf of Paulson, Goldman approached GSC Partners as well as two other companies to act as the portfolio selection agent for the Abacus CDO. |2507| Following a meeting among representatives of Goldman, Paulson, and GSC, Mr. Tourre sent an email to his colleagues summarizing the meeting and indicating that Paulson was also looking for a portfolio selection agent that would be willing to accept many of the reference assets it identified:
"At the end of the meeting, the Paulson team told us that they were happy to have met GSC and assuming that (1) GSC could get comfortable with a sufficient number of obligations that Paulson is looking to buy protection on in ABACUS format, (2) GSC could get comfortable being in the market as early as end of January with a transaction under which Gsc is disclosed as Portfolio Selection Agent (without any credit risk removal rights), and (3) Paulson, Goldman, and GSC agree on GSC's required compensation for a transaction like this, then Paulson will want to proceed with gsc as soon as possible and be in the market as soon as possible." |2508|
Subsequently, Mr. Tourre reported to his colleagues that GSC had declined the offer to act as the Abacus portfolio selection agent due to its negative views of the assets Paulson wanted to include in the CDO:
"As you know, a couple of weeks ago we had approached GSC to ask them to act as portfolio selection agent for that Paulson-sponsored trade, and GSC declined given their negative views on most of the credits that Paulson had selected." |2509|
Later, when Goldman began to market Abacus 2007-AC1 securities, Edward Steffelin, a senior trader at GSC, sent an email to Peter Ostrem, head of Goldman's CDO Origination Desk saying: "I do not have to say how bad it is that you guys are pushing this thing." |2510| When asked by the Subcommittee what he meant, Mr. Steffelin responded that he believed that particular Abacus CDO created "reputational risk" for GSC as the collateral manager and for the whole market. |2511|
Goldman and Paulson eventually settled on ACA Capital Management, LLC, a company with experience in selecting assets for CDOs. Goldman employees expressed the hope that ACA's involvement would improve the sales of the Abacus securities. In an internal memorandum seeking approval of the CDO, for example, Goldman personnel wrote: "We expect to leverage ACA's credibility and franchise to help distribute this Transaction." |2512|
Selecting Assets. During January, February, and March 2007, the Abacus reference assets were selected. The Paulson hedge fund initiated the asset selection process by providing Goldman with criteria for choosing RMBS securities for the CDO. |2513| According to Mr. Tourre, Goldman's subsequent identification of candidate assets was essentially ministerial, as Paulson's specified criteria had restricted the scope of the RMBS securities that could be proposed. |2514| For example, Paulson wanted RMBS securities that had adjustable rate mortgages, low borrower FICO scores, and mortgages in states with slowing home price appreciation, like Arizona, California, Florida, and Nevada. |2515| Paulson specifically required 2006-vintage or 2007-vintage subprime RMBS that were rated BBB by S&P or Baa2 by Moody's. |2516| Goldman sent Paulson a database and spreadsheet listing the securities that met Paulson's criteria. |2517| Paulson used that database to select 123 securities, and Goldman forwarded the resulting list to ACA. |2518| Over the next two months, a series of negotiations and meetings took place to finalize selection of the reference assets and the structure of the CDO.
On March 22, 2007, ACA and Paulson agreed on the final $2 billion reference portfolio for Abacus 2007-AC1. |2519| The assets consisted of 90 Baa2 rated mid and subprime RMBS securities issued after January 1, 2006. |2520| The RMBS securities were "equally-sized," each with a $22.22 million notional value. |2521| Each asset in the final reference portfolio was approved by both Paulson and ACA. Of the final 90 RMBS securities, 49 had been initially proposed by Paulson, and 41 had been initially proposed by ACA. |2522|
Goldman characterized Paulson's participation in the asset selection process as one in which the hedge fund merely "express[ed] [its] views" about the reference portfolio, |2523| which often happens in synthetic CDO transactions. |2524| The evidence indicates, however, that Paulson did more than express its views; it played an active and determinative role in the asset selection process. Paulson established the criteria used to identify the initial list of RMBS securities, proposed a majority of the reference assets in the final portfolio, and approved 100% of the reference assets. Moreover, the "views" expressed by Paulson directly conflicted with the interests of the investors to whom Goldman was marketing the Abacus 2007-AC1 deal. Mr. Pellegrini was quite clear about Paulson's intentions in a deposition with the SEC:
Question: Your portfolio analysis was designed in large part to identify bonds that weren't going to perform, right?
Question: Because you wanted to short those bonds?
Answer: Right. |2525|
Goldman documents reviewed by the Subcommittee contain conflicting information on exactly who was involved in the asset selection process. Goldman's Mortgage Capital Committee Memorandum on the Abacus CDO, the key internal Goldman document describing the new CDO, stated: "The Reference portfolio has been selected and mutually agreed upon by ACA and Goldman." |2526| In an email to a colleague, however, Mr. Tourre wrote that the portfolio had been selected by "ACA/Paulson." |2527| The Abacus Marketing book identified ACA as the portfolio selection agent for the CDO, and stated that the portfolio selection agent had selected the reference assets. |2528| The Abacus Offering Memorandum stated: "The Initial Reference Portfolio will be selected by ACA Management, L.L.C." |2529|
Another email exchange, between Mr. Tourre and his colleague Mr. Egol, demonstrates the strong influence Paulson had in the selection process. IKB, a German bank that was a frequent investor in past Abacus CDOs and was considering purchasing securities issued by Abacus 2007- AC1, apparently asked to have certain RMBS securities removed from the portfolio and sent the following email to a Goldman sales representative:
"[D]id you hear something on my request to remove Fremont and New Century serviced bonds? I would like to try to [sic] the advisory com[m]it[t]ee this week and would need consent on it." |2530|
The IKB email was forwarded to Mr. Tourre, who sent it to Mr. Egol with the following message: "Paulson will likely not agree to this unless we tell them that nobody will buy these bonds if we don't make that change." |2531| Mr. Tourre expressed concern, not about what ACA, the portfolio selection agent, might or might not agree to, but only about what the Paulson hedge fund might agree to.
Failing to Disclose Key Information. Evidence obtained by the Subcommittee indicates that Paulson's role in the Abacus asset selection process and its investment objectives for the CDO were not fully or accurately disclosed to key parties or investors at the time the CDO was being structured and sold.
Moody's, one of the credit rating agencies asked to rate the Abacus securities, was not informed of Paulson's role or investment objectives. At a Subcommittee hearing on the role of the credit rating agencies in the financial crisis, Eric Kolchinsky, a former Moody's managing director who oversaw its CDO ratings and was familiar with Abacus 2007-AC1, provided sworn testimony that he had not known of Paulson's involvement with the CDO at the time it was rated, did not know of Paulson's role in selecting the referenced assets, and believed his staff did not know either. He testified that allowing an entity that wants a CDO to "blow up" to pick its assets "changes the whole dynamic," and was information that he would have wanted to know when rating the securities:
Senator Levin: And were you or your staff aware at the time that Moody's was working on the ABACUS rating that Paulson was shorting the assets in ABACUS and playing a role in selecting referenced assets expected to perform poorly?
Mr. Kolchinsky: I did not know, and I suspect, I am fairly sure, that my staff did not know either.
Senator Levin: And are these facts that you or your staff would have wanted to know before rating ABACUS?
Mr. Kolchinsky: From my personal perspective, it is something that I would have wanted to know because it is more of a qualitative not a quantitative assessment if someone who intends the deal to blow up is picking the portfolio. But, yes, that is something that I would have personally wanted to know. It changes the incentives in the structure.
Senator Levin: Are people usually putting deals together that want the deal to succeed? Isn't that the usual assumption?
Mr. Kolchinsky: That is the basic assumption, yes.
Senator Levin: And if the person wanting the deal to blow up is picking the assets, that would run counter to what the usual assumption is?
Mr. Kolchinsky: It just changes the whole dynamic of the structure where the person who is putting it together, choosing it, wants it to blow up. |2532|
Moody's assigned AAA ratings to two tranches of the Abacus CDO. |2533|
ACA told the Subcommittee that, throughout the asset selection process, it was not informed and remained unaware of Paulson's true investment objective, which was to identify and short a set of assets that it believed would not perform and would lose value. |2534| According to ACA, it believed that Paulson was going to be a long investor in the CDO through its purchase of the equity share that would incur the first losses in the CDO. Contemporaneous ACA documents support that position. An internal ACA Commitments Committee Memorandum on Abacus 2007-AC1 dated February 12, 2007, for example, stated: "The hedge fund is taking the 0-9% equity tranche." |2535| Ten days later, on February 23, 2007, the ACA Managing Director who worked on the Abacus transaction spoke with a Goldman representative, and took notes of the conversation which stated in part: "Paulson taking 0-10%." |2536| In April 2007, the same ACA Managing Director sent an email to the CEO and President of ACA's parent company, ACA Capital Holdings Inc., which was considering buying Abacus securities for itself. Her email stated: "We did price $192 million in total of Class A1 and A2 today to settle April 26th. Paulson took down a proportionate amount of equity (0-10% tranche)." |2537|
In addition, on January 10, 2007, a few days after ACA was first approached by Goldman about working on the Abacus CDO, Mr. Tourre sent ACA a "Transaction Summary" describing the proposed transaction. The Transaction Summary identified the Paulson hedge fund as the "Transaction Sponsor," described the "Contemplated Capital Structure" of the CDO, and indicated that the lowest tranche, "%-%," was "pre-committed first loss." |2538| The ACA Managing Director told the Subcommittee that the "%-%" tranche identified in the Transaction Summary matched the general description of an equity tranche, and the wording suggested that someone had already committed to buy it. |2539| She explained that it was typical for a CDO sponsor to purchase the equity tranche, and she believed that Paulson, as the Abacus "sponsor," had committed to buy that tranche. |2540| The Abacus Marketing book also specified that the "First Loss" tranche of the CDO, of a "[+10%]" size, was "Not Offered" for sale. |2541| The ACA Managing Director declared in a statement to the SEC that she had interpreted the phrase, "Not Offered," to indicate the equity tranche had been "pre-placed" and "ha[d] already been committed to purchase by an investor and [would] not be marketed." |2542| She thought that investor was the Paulson hedge fund.
When asked about the Transaction Summary description of the lowest tranche in the Abacus CDO, Mr. Tourre told the Subcommittee that the phrase "pre-committed first loss" normally indicated that the tranche had been sold. He stated that he actually meant to communicate that the tranche had not been sold, and that portion of the Transaction Summary was poorly worded. |2543|
In his prepared statement at the Subcommittee hearing, Mr. Tourre testified that he never told ACA that the Paulson hedge fund would be a long investor in the Abacus CDO:
"I never told ACA, the portfolio selection agent, that Paulson and Company would be an equity investor in the AC-1 transaction or would take any long position in the deal. Although I don't recall the exact words that I used, I recall informing ACA that Paulson's fund was expected to buy credit protection on some of the senior tranches in this deal. This necessarily meant that Paulson was expected to take some short position in the transaction." |2544|
In addition, Mr. Tourre testified that he informed ACA that the Paulson hedge fund was going to invest only on the short side of the transaction:
Senator Levin: You did not disclose to ACA that Paulson was on the short side of this deal. Is that correct?
Mr. Tourre: I did mention to ACA that the expectation was that Paulson was going to buy protection on senior layers of risk in the transaction.
Senator Levin: That they were going to be only on the short side.
Mr. Tourre: Yes. |2545|
ACA has since filed a civil lawsuit against Goldman asserting that Goldman did not inform ACA that "Paulson intended to take an enormous short position" in Abacus and is seeking to recover $30 million in compensatory damages and $90 million in punitive damages for fraudulent inducement, fraudulent concealment, and unjust enrichment. |2546|
Regardless of the communications between Goldman and ACA, it is clear that the Abacus marketing material and offering documents provided by Goldman to investors contained no mention of Paulson's short position in the CDO nor the significant role it played in the selection of the CDO's reference assets. This was confirmed by Mr. Tourre at the Subcommittee hearing:
Senator Levin: And was it reflected in the Goldman Sachs security offering to investors that Paulson had been part of the selection process? Was that represented in that document?
Mr. Tourre: Paulson was not disclosed in the Abacus 07 AC-1 transaction, Mr. Chairman.
Senator Levin: It was not?
Mr. Tourre: No, it was not. |2547|
Still another troubling omission was Goldman's failure to advise potential Abacus investors that the firm's own economic interests were aligned with those of the Paulson hedge fund. As part of the Abacus CDO arrangement, Paulson agreed to pay Goldman a higher fee if Goldman could provide Paulson with CDS contracts containing premium payments below a certain level. |2548| The problem with the fee incentive offer was that, while lower premiums would result in lower costs to Paulson, it would also result in lower premium payments to the CDO, directly reducing the amount of cash available to the long investors. The Paulson-Goldman compensation arrangement, thus, created a direct conflict of interest between Goldman and the investors to whom it was selling the Abacus securities.
Selling Abacus Securities. Abacus 2007-AC1 closed, and its securities were issued on April 26, 2007. They were issued later than the securities from the Hudson, Anderson, and Timberwolf CDOs and hit the market as subprime mortgages were hitting record delinquency and default rates. Goldman sold the Abacus 2007-AC1 securities to just three investors: IKB, the German bank; ACA, the portfolio selection agent; and ACA Financial Guaranty Corp., the owner of ACA and a wholly owned subsidiary of ACA Capital Holdings Inc. |2549| IKB bought $150 million of the AAA rated Abacus securities. ACA bought about $42 million in the AAA securities for placement in another CDO it was managing. |2550| ACA Financial Guaranty Corp. was by far the largest investor, taking the long side of a $909 million CDS contract referencing the super senior portion of the CDO. |2551| Goldman took the short side of the CDS contract, which it then transferred to Paulson. |2552|
Within months, the high risk subprime mortgages underlying the RMBS securities referenced in the Abacus portfolio incurred steep rates of default, and the Abacus securities began to lose value. According to the SEC, by October 2007, six months after the securities were issued, 83% of the underlying assets had received a credit rating downgrade and 17% of the underlying assets had been placed on a negative credit watch. |2553| On October 26, 2007, a Goldman employee sent an email about Abacus 2007-AC1 with an assessment even more negative than that of the SEC:
"This deal was number 1 in the universe of CDO's that were downgraded by Moody's and S&P. 99.89% of the underlying assets were downgraded." |2554|
The three long investors in Abacus 2007-AC1 together lost more than $1 billion. As the sole short investor, Paulson recorded a corresponding profit of about $1 billion. |2555|
On April 16, 2010, the SEC filed a complaint against Goldman and Mr. Tourre, alleging their actions constituted securities fraud. |2556| The SEC specifically alleged violations of Section 17(a) of the Securities Act of 1933, as well as Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934. |2557| The SEC contended that Goldman had failed to disclose to potential investors materially adverse information, that the party shorting the reference assets was the same party that had played a significant role in selecting those assets. |2558| On July 14, 2010, Goldman reached a $550 million settlement with the SEC. |2559| In connection with the settlement, Goldman acknowledged:
"[T]he marketing materials for the ABACUS 2007-AC1 transaction contained incomplete information. In particular, it was a mistake for the Goldman marketing materials to state that the reference portfolio was ‘selected by' ACA Management LLC without disclosing the role of Paulson & Co. Inc. in the portfolio selection process and that Paulson's economic interests were adverse to CDO investors." |2560|
Analysis. Goldman constructed Abacus 2007-AC1 to help a hedge fund short multiple RMBS securities. Goldman allowed the hedge fund to play a significant role in the selection of the CDO's referenced assets, while employing an outside portfolio agent to give the impression that the CDO assets were selected by a disinterested third party. Goldman failed to disclose the hedge fund's investment objective and asset selection role to a credit rating agency that assigned AAA ratings to two tranches of the Abacus securities. Goldman also failed to provide full disclosure to the long investors to whom it sold the Abacus securities. In addition, Goldman failed to disclose to the investors a compensation arrangement that provided incentives for Goldman to minimize the premium payments into the CDO. Within six months, the Abacus securities began incurring losses and ratings downgrades. Goldman watched the long investors to whom it had sold the securities lose virtually all the funds they had invested, while the hedge fund it had assisted walked away with a profit of approximately $1 billion.
In addition to creating and failing to manage conflicts of interest arising from its design and sale of CDO securities, Goldman at times allowed conflicts of interest to affect how it carried out key roles in the administration of its CDOs. |2561| Two examples, in which Goldman acted as the liquidation agent in Hudson 1 and the collateral put provider in Timberwolf, illustrate the problems. In both cases, Goldman used its administrative roles to promote and enhance its own financial interests at the expense of the clients to whom it had sold the CDO securities.
In 2006 and 2007, several Goldman CDOs included provisions establishing a "liquidation agent" to sell any poorly performing assets in the CDO. This feature appeared in Hudson Mezzanine 2006-1, which is examined in this Report, as well as Hout Bay 2006-1, Hudson High Grade 2006-1, Hudson Mezzanine 2006-2, and Anderson Mezzanine 2007-1. |2562| In each instance, Goldman served as the initial liquidation agent, although in several CDOs, it later transferred the role to a third party. In Hudson 1, Goldman's dual roles as liquidation agent and sole short party in the CDO created a direct conflict of interest between Goldman and the clients to whom it sold the Hudson securities, which Goldman exploited by placing its own financial interests ahead of those of its clients.
Designing the Liquidation Agent Role. According to Goldman, appointing a CDO liquidation agent was a "fairly novel idea" that was first implemented in the 2006 Hout Bay CDO. |2563| Peter Ostrem, then head of the CDO Origination Desk, oversaw the drafting of the liquidation agent feature. |2564| He told the Subcommittee that Goldman wanted to issue static portfolio CDOs, meaning CDOs whose assets did not change over time, but also wanted to protect investors from poorly performing assets. He explained that the liquidation agent feature was intended to be triggered by a specified event and provided the liquidation agent with "no discretion" other than to sell the poorly performing asset, which was referred to as a "Credit Risk Asset." He explained that, without such a feature, poorly performing assets would "just stay there" in a CDO, further harming investors. |2565| The CDO Origination Desk also favored the approach, because it could be performed by Goldman itself at a lower cost than retaining a traditional collateral manager. |2566|
The liquidation agent provisions established criteria for identifying "Credit Risk Assets" and removing them from the CDO. In a July 2006 memorandum to the Goldman Mortgage Capital Committee, the CDO Origination Desk described the liquidation agent role as follows:
"As Liquidation Agent, Goldman will liquidate assets determined by the Trustee to be ‘Credit Risk Assets' based on specific guidelines. Goldman will have 12 months to sell these assets. Sales will be made under a competitive bidding process, whereby we will solicit three outside bids and select the highest. Prior to executing Hout Bay 1, in which we also played the Liquidation Agent role, we spoke to multiple counterparties as to our role as Liquidation Agent. We received approval for our role in this transaction from legal and accounting. ... Finally, we spoke with outside counsel, Wilmer Cutler, about potential issues related to the Investment Advisor Act. They are of the opinion that our role of Liquidation Agent does not cause us to be deemed an Investment Advisor based on the exception to the Advisors Act for a ‘limited grant of discretion.'" |2567|
One key issue discussed in the memorandum was whether, by assuming the role of liquidation agent, Goldman would trigger registration and disclosure obligations under the Investment Advisers Act of 1940. The CDO Origination Desk wrote:
"We have discussed Goldman's role as Liquidation Agent internally with Tim Saunders [counsel in Goldman's legal department] and externally with outside counsel, Wilmer Cutler. One concern about that role was whether Goldman would be viewed as an Investment Advisor. We specifically crafted Goldman's role in Hout Bay 1 and in this case to eliminate both internal and external counsel's concern about Goldman being treated as an Investment Advisor. The main factors that made Tim Saunders and Wilmer Cutler comfortable that Goldman will not be treated as an Investment Advisor were:
- Goldman's role is Liquidation Agent and not Collateral Manager. Goldman is engaged by the CDO to liquidate Credit Risk Assets and will receive an ongoing Liquidation Agent Fee for such services;
- Goldman does not determine whether an asset is a Credit Risk Asset. Such determination is made by the CDO based on specific rules . . . ;
- Goldman must liquidate such Credit Risk Assets within 12 months of such determination and the price received on such liquidation must be in the context of a three-bid process;
- Goldman does not receive additional compensation and or control of the CDO for acting as a Liquidation Agent. ...
We will build a provision in the deal documents to allow Goldman to resign as Liquidation Agent if appropriate notice is given and a replacement Liquidation Agent is in place." |2568|
This memorandum indicates that, from its inception, the liquidation agent function was designed as a narrow, ministerial role, in part to avoid the legal obligations applicable under federal law to investment advisers. The memorandum also indicated that "Credit Risk Assets" would be identified through objective criteria. For example, in the CDO under review, the memorandum stated that Credit Risk Assets would be defined as "[a]ny asset that is downgraded by Moody's or S&P below Ba2" and "[a]ny asset that is defaulted." |2569|
Credit Rating Downgrades. One year later, on July 19, 2007, after Mr. Ostrem had left Goldman and Mr. Lehman had assumed responsibility for all Goldman-originated CDOs, he held a conference call with members of the CDO team and Goldman in-house legal counsel Tim Saunders, to discuss how to carry out Goldman's CDO liquidation agent responsibilities. The prior week, Moody's and S&P had suddenly downgraded hundreds of RMBS and CDO securities in the first of many mass downgrades. Those downgrades suddenly caused a number of assets in Goldman's CDOs to qualify as Credit Risk Assets that had to be liquidated.
In advance of the conference call, Mr. Lehman's staff prepared a two-page summary of Goldman's liquidation agent duties, the liquidation procedures specified in the CDO documents, the CDOs affected, and the assets that Goldman anticipated would be affected by the downgrades. |2570|
Four days after the conference call, on July 23, 2007, Benjamin Case, who had been assigned lead responsibility for carrying out Goldman's liquidation agent functions, circulated a draft document describing Goldman's role. It stated that Goldman's goal as liquidation agent was:
"to attempt to maximize proceeds on the unwind of credit risk assets pursuant to the liquidation process governed by the CDO documents, rather than to liquidate at an arbitrary pre-specified time without regard to market conditions." |2571|
It identified the assets that had been classified as Credit Risk Assets and provided Goldman's "Current Strategy" for handling them:
"– wait and continue to evaluate market conditions, rather than liquidating now.
- upside is that continued short-covering by hedge funds anxious to monetize profits could cause minor rally (5-10 points)[.]
- downside is that speed up of foreclosure process vs. current timeline expected by market could decrease IO value, or significant forced selling of similar names by CDO vehicles could push levels wider [lower prices]."
Hudson Liquidation Agent. Although the liquidation agent role was originally designed for use in Goldman's "high grade" CDOs, where "there is substantially less credit risk in the assets vs. a mezzanine structured product CDO portfolio," the feature was also added to some of its riskier mezzanine CDOs, including Hudson Mezzanine 2007-1 (Hudson 1). |2572| Hudson 1 was a synthetic CDO whose assets consisted entirely of CDS contracts referencing subprime RMBS or ABX assets with BBB or BBB- ratings. Goldman had selected 100% of the reference assets and held 100% of the short side of the CDO.
Hudson 1's marketing materials outlined Goldman's liquidation agent role. The Hudson marketing booklet, for example, told potential investors:
"Hudson CDOs are non-managed and static in nature and provide term non-recourse funding where Goldman Sachs acts as Liquidation Agent on an ongoing basis. The Liquidation Agent will be responsible for efficiently selling credit risk assets." |2573|
The Hudson term sheet provided additional information about the liquidation agent role and the "Credit Risk Assets" that would have to be liquidated:
"Goldman as Liquidation Agent, will liquidate any asset determined to be a ‘credit risk' within 12 months of said determination. Credit Risk assets will include: any asset downgraded by Moody's or S&P below Ba3 or BB-, any asset that is defaulted or would be experiencing a credit event as defined by the PAUG [Pay As You Go] confirm. There will be no reinvestment, substitution, discretionary trading or discretionary sales. After closing, assets that are determined to be ‘credit risk' securities will be sold by the Liquidation Agent within one year of such determination." |2574|
The Hudson Offering Circular repeated that information and added:
"The Liquidation Agent will not have the right, or the obligation, to exercise any discretion with respect to the method or the price of any assignment, termination or disposition of a CDS Transaction; the sole obligation of the Liquidation Agent will be to execute such assignment or termination of a CDS Transaction in accordance with the terms of the Liquidation Agency Agreement. ... [T]he Liquidation Agent shall have no responsibility for, or liability relating to, the performance of the Issuer or any CDS Transaction, Reference Obligation, Collateral Security or Eligible Investment." |2575|
Goldman charged a 10 basis point ongoing fee for serving as the Hudson Liquidation Agent, |2576| which resulted in its being paid a total fee of approximately $3.1 million. |2577|
While Goldman was marketing Hudson in 2007, a client asked why the liquidation agent was "afforded up to 12 months to sell a credit risk asset." |2578| The Subcommittee was unable to find Goldman's contemporaneous response, but when asked the same question, Darryl Herrick, the Hudson deal captain, told the Subcommittee that there was "headline risk" associated with the downgrade of an asset, and twelve months gave Goldman "flexibility to try to get a better price later." |2579| When asked whether the "flexibility" to delay a sale violated Hudson's prohibition against discretionary trading by the liquidation agent, Mr. Herrick said that Goldman had "discretion based on a rule," and that the liquidation agent provisions had been vetted with the credit rating agencies which "probably wanted the deal to avoid forced sales." |2580|
Failure to Liquidate. In July 2007, after the credit rating agencies began the mass downgrades of RMBS securities, the first RMBS securities underlying the Hudson CDO lost their investment grade ratings, and the CDS contracts referencing those assets qualified as Credit Risk Assets requiring liquidation. |2581| Within three months, by October 15, 2007, over 28% of the Hudson assets qualified as Credit Risk Assets. |2582| As liquidation agent, Goldman should have begun issuing bids to sell the assets at the best possible price and remove them from the Hudson CDO, but it did not.
In October 2007, Goldman began to contact Hudson investors to discuss transferring its liquidation agent responsibilities to a third party. That transfer required investor consent. Benjamin Case took notes of two telephone conversations he had with a Hudson investor, National Australia Bank (NAB), discussing the issues. |2583| In the calls, Mr. Case explained why Goldman had yet to liquidate any of the Credit Risk Assets, explaining that Goldman was waiting for asset prices to improve. |2584| He also reported that Goldman was considering an amendment to the Hudson transaction that would extend the maximum liquidation period, as well as make other structural changes to the Hudson deal. |2585|
According to his notes, Mr. Case informed NAB that Goldman was seeking to transfer its liquidation role to a third party with more liquidation experience, because that change:
"will be in the best interest of investors - the credit obligation term was originally written with the expectation that was unlikely to happen. ...
Good for several reasons:
1. Large institutional assets manager will be able to access more liquidity b/c [because] they can access other broker dealers and get good pricing[.]
2. Even keeping the deal the way it is, the decision of when in the 12 month period to liquidate could be better handled by an experienced manager[.]
3. Potential amendment could be made to benefit the deal by giving more flexibility to agent." |2586|
These notes indicate that, although Goldman was the architect of the Hudson CDO and selected itself to serve as liquidation agent at a fee of $3.1 million, when Goldman was called upon to execute its role, it believed the decision of when to liquidate the impaired assets "could be better handled by an experienced manager."
According to Mr. Case's notes, NAB sent Mr. Case an email asking if Goldman held any of the Hudson investments: "does GS hold any of this?" Mr. Case responded:
"def own equity and different pieces of various tranches no [sic] exactly, but decent size and numbers of cl[a]sses on our books." |2587|
Mr. Case apparently did not disclose that, in addition to its $6 million equity tranche, Goldman also held 100% of the short position in the $2 billion CDO, and that its short investment would increase in value as the Hudson assets lost value.
According to Mr. Case's notes, NAB replied by asking Goldman to provide more specific information about Goldman's holdings in the transaction: "Could you please follow up with what Goldman holds?" |2588| When Mr. Case asked why NAB wanted that information, NAB responded: "Want to make sure you [Goldman] are making restructuring decisions for the right reasons - make sure serving the right interests." According to his notes, Mr. Case replied: "Our intended goal of liquidation agent is to serve the best interests of the CDO - that is the duty of the liquidation agent - it is a policy and process." |2589|
In November 2007, Goldman took initial steps to transfer its liquidation agent responsibilities to a third party. |2590| At that point, Goldman had yet to liquidate any of the Hudson Credit Risk Assets. |2591| The nine assets that had become Credit Risks in July had already dropped significantly in value. One asset which, on July 16, had a value of 61% of its face (par) value, had fallen by November 1 to 16% of par. |2592| Another asset that, on July 16, had a value of 43% of par, had fallen in value by November 1 to 7% of par. |2593|
At the end of November, Goldman reached an agreement with Trust Company of the West (TCW), subject to investor approval, in which Goldman would assign its liquidation agent duties to TCW, and TCW would "share back" 30% of the fees with Goldman. |2594| Mr. Lehman told the Subcommittee that Goldman's decision to assign the liquidation agent rights to a third party was because liquidation was a non core business for Goldman, and TCW was better suited to liquidate the Credit Risk Assets. |2595| On December 18, 2007, while Goldman was still seeking investor approval to assign the liquidation agent role to TCW, a Goldman representative explained to an investor the firm's thinking:
"GS [Goldman Sachs] is soliciting consent to assign GS role as liquidation agent to TCW bec[ause] when liquidation agent role was designed, it was very ‘out of the money'; now when the risk is very real, it is much more efficient to have a sophisticated collateral manager bec[ause]
(i) TCW can access better liquidity than GS, ie get bids from the entire street
(ii) real asset manager can pursue further amendments to the doc to make liquidation more efficient bec[ause] is not an asset [manager] under the investment act in 1940 and cannot act [sic] investment advisory services and can't act with optimal discretion." |2596|
On December 19, 2007, Morgan Stanley, the largest Hudson long investor with a $1.2 billion interest encompassing the entire super-senior tranche, |2597| was presented with a consent form to assign the liquidation agent rights to TCW. |2598| Morgan Stanley told the Subcommittee that it had declined to consent to the transfer, because the liquidation agent role was ministerial, had no discretionary authority, and could quickly and easily be accomplished by Goldman. |2599| Morgan Stanley told the Subcommittee that it instead asked Goldman to begin liquidating the $596.5 million in Credit Risk Assets immediately, some of which had been designated as Credit Risks for five months, and all of which had declined in value. |2600|
On January 3, 2008, Daniel Sparks, the Mortgage Department head, was given a spreadsheet listing the Credit Risk Assets in each of the CDOs in which Goldman was serving as the liquidation agent, including Hudson 1. The spreadsheet showed that, in Hudson, 44 assets were Credit Risks with a face value of $635 million, totaling about 30% of the asset pool. |2601|
[SEE CHART NEXT PAGE: Credit Risk Assets, prepared by Goldman Sachs.]
The spreadsheet also showed that the weighted average values of the Hudson assets had fallen dramatically, causing losses that could have been avoided had Goldman liquidated them sooner. The weighted average values had fallen from 45% of face (par) value in July, to a low of 15% on November 1, 2007, and were about 20% of par value on January 2, 2008. |2602|
[SEE CHART NEXT PAGE: Weighted Average Levels, prepared by Goldman Sachs.]
Hudson Conflict of Interest. Despite the falling values and Morgan Stanley's ongoing request to initiate liquidation of the Credit Risk Assets as set out in the Hudson 1 agreement, Goldman still did not begin liquidating.
During January and February 2008, Morgan Stanley engaged in frequent communications with Goldman personnel, including Mr. Lehman who oversaw Goldman's CDOs, and Mr. Case who oversaw the liquidation agent function, to initiate liquidation of the Hudson assets. |2603| The falling value of the Hudson assets caused sharp losses in Morgan Stanley's $1.2 billion investment, leading Morgan Stanley to press for the Credit Risk Assets to be liquidated and removed from the CDO as soon as possible. In contrast, as the Hudson assets fell in value, Goldman, as the CDO's sole short party, saw its short position become increasingly profitable. Goldman had little financial incentive to liquidate the Credit Risk Assets, because the more they fell in value, the more Goldman was able to maximize the profits from its short position in the CDO. Goldman's dual roles as liquidation agent and short party, thus, created a conflict of interest that disadvantaged the long investors in the Hudson CDO, such as Morgan Stanley. |2604|
Morgan Stanley personnel expressed increasing frustration with Goldman's failure to liquidate the Hudson Credit Risk Assets, in both internal communications and with Goldman representatives. On January 16, 2008, for example, the key trader on Morgan Stanley's Proprietary Trading Desk dealing with Hudson wrote to a colleague: "Had another call with [Goldman's] sr. trader about GS's liquidation agent role in the $1.2bn HUDSON deal. They insist they are NOT acting as a fiduciary per the docs in this deal." |2605| On February 5, he sent Mr. Lehman an email: "[P]lease call when possible - $969mm now eligible to be liquidated post S&P do[w]ngrades." |2606|
On February 6, the Morgan Stanley trader wrote to a colleague:
"[W]ent down the road with Goldman on liquidation agent assets (now ~$1bb of eligible assets post downgrades). They told me they will ‘continue to take my opinion under advisement' but provided no course of action. I broke my phone. Will talk to [Morgan Stanley legal counsel] tomorrow but don't think there is any probable way for us to force them to liquidate assets." |2607|
On February 7, the Morgan Stanley trader sent another email to Mr. Lehman:
"Spoke with Ben [Case] re: Hudson today.
Goes without saying I remain very frustrated by the way GS is handling the liquidation agent role. There is almost $1bb of eligible assets in that deal now, every one of which has lost value since it was downgraded.
No good reason to wait other th[a]n to devalue our position. It's a shame .... [O]ne day I hope I get the real reason why you are doing this to me." |2608|
According to Morgan Stanley, Goldman continued to explain its seven-month delay in liquidating the Credit Risk Assets by asserting that the market would rebound during a rally to cover shorts, and it should wait to liquidate until asset prices rose. In a February 13, 2008 telephone call between Morgan Stanley and Goldman, for example, which was recorded and transcribed, Mr. Case stated:
"So I think, as we see the short covering wave kind of continue to proceed ... it's gonna get to the point where it's in the best interest of the deal to start liquidating then. ... I know we've talked about this twelve month period ... it doesn't seem like it's gonna take till late in the twelve month process for the majority of these assets to get to that point." |2609|
Morgan Stanley asked if there was anything beyond the "technical nature of the markets," such as government intervention, to produce "any kind of real pop" that would improve the underlying fundamentals in the mortgage market. Mr. Case responded: "The chance that it could move in that direction, at least in the next few months . . . is de minimis I'd say." |2610| During the call, Morgan Stanley's representative again urged Goldman to begin the liquidation process: "Just so you know, my opinion stays the same, I'd like to see a bid list before three o'clock today." |2611|
Morgan Stanley told the Subcommittee that the Hudson assets had been in near continuous decline, and Goldman's refusal to liquidate assets shortly after they became Credit Risk Assets allowed them to decline further, rather than limiting losses for bondholders. By February 21, 2008, Morgan Stanley had calculated that the liquidation delay had cost it $130.5 million; the next week it calculated the losses had increased to $150 million. |2612|
Morgan Stanley told Goldman that by delaying the liquidation of the Credit Risk Assets, Goldman was in violation of the terms in the Hudson 1 offering circular, in particular the provision: "The Liquidation Agent will not have the right, or the obligation, to exercise any discretion with respect to the method or the price of any assignment, termination or disposition of a ... Credit Risk Obligation." |2613| On February 29, 2008, Morgan Stanley sent Goldman a letter demanding that it immediately initiate liquidation of $1 billion in Hudson Credit Risk Assets:
"As Liquidation Agent, [Goldman] is currently responsible for liquidating approximately $1,000,000,000 of Credit Risk Obligations. The transaction documents clearly state that [Goldman] would not exercise investment discretion in its role as Liquidation Agent. [Goldman] has not yet liquidated a single Credit Risk Obligation, notwithstanding that some date back to August of 2007. The [Goldman] employee handling the liquidation has explained this by stating that he believes the price for these obligations will increase in the future and it is better for the deal to liquidate these obligations at a later date. ...
The Liquidation Agency Agreement states that "the Liquidation Agent ... shall not provide investment advisory services to the Issuer or act as the "collateral manager" for the Pledged Assets. ...
While the Liquidation Agency Agreement provides that the Liquidation Agent must complete the process of liquidating the relevant assets within twelve months, it does not provide the Liquidation Agent with any right to delay the liquidation process based on the exercise of Investment discretion. To the contrary, the Liquidation Agency Agreement and the [Offering Circular] clearly state that no discretion or investment advisory services are ever to be provided by the Liquidation Agent." |2614|
Morgan Stanley concluded by "demanding only that [Goldman] fulfill its contractual duties as required by the Liquidation Agency Agreement and assign, terminate or otherwise dispose of the relevant CDS transaction forthwith."
On March 10, 2008, Goldman responded:
"[Y]our letter is entirely mistaken in its suggestion that Goldman Sachs has somehow breached its obligations under the Liquidation Agency Agreement. As [Morgan Stanley's] letter recognizes, Section 2(b) of the Liquidation Agency Agreement specifically provides that Goldman, acting as Liquidation Agent, has up to twelve months in which to assign, terminate or otherwise dispose of Credit Risk Obligations assigned to it for that purpose. Obviously, establishment of a liquidation period of that duration contemplates - and, indeed, embodies Hudson's informed consent - that the Liquidation Agent will necessarily exercise judgement in determining when and how to dispose of Credit Risk Obligations assigned to it for that purpose. ...
Nor does this expressly intended contractual latitude transform Goldman Sachs into a de facto ‘investment adviser' to Hudson, as you suggest. The Agreement ... in fact categorically disclaims that Goldman Sachs or its affiliates will be providing investment advisory services or otherwise acting as an adviser or fiduciary to Hudson by virtue of its liquidation services. That disclaimer is perfectly consistent with discretion routinely accorded to securities brokers in seeking to fulfill their obligation to obtain the best execution possible for their clients without making them ‘investment advisors.'" |2615|
Several days before Goldman's response letter was sent to Morgan Stanley, however, Goldman began liquidating the Credit Risk Assets in Hudson 1. On March 7, 2008, Goldman liquidated eight assets, followed by more on March 20 and 28, liquidating nearly one third of the eligible assets over the course of the month. |2616| In its role as liquidation agent, Goldman was required to solicit bids from at least three independent dealers for the Credit Risk Assets, and Morgan Stanley was given an opportunity to bid on many of the liquidated assets. |2617| Liquidation proceeded over the next two months, from April through June. |2618| On July 22, 2008, Hudson's realized losses exceeded $800 million, and Hudson 1 went into default. Hudson's remaining assets were liquidated in November 2008. Morgan Stanley's losses from its Hudson investment exceeded $930 million. |2619|
Analysis. In several of the CDOs it constructed, Goldman established a new position of liquidation agent and appointed itself to play that role for a substantial fee. In the case of Hudson 1, by taking on the role of liquidation agent at the same time it was the sole short party in the CDO, Goldman created a conflict of interest. When the Hudson 1 assets began falling in value, the long investors wanted the poorly performing assets liquidated as soon as possible; Goldman, on the other hand, benefitted financially the farther the assets fell in value since that allowed Goldman to maximize the value of its short position.
Goldman delayed liquidating the Credit Risk Assets, despite urgent requests from the largest Hudson investor, Morgan Stanley, placing its own financial interests ahead of the client to whom it had sold a $1.2 billion Hudson investment.
The second example of a conflict of interest affecting how Goldman carried out a CDO administrative function involves Goldman's role as the collateral put provider in Timberwolf I. Synthetic CDOs like Timberwolf collected cash from the long investors that purchased its securities as well as from the short parties that paid CDS premiums to the CDO. A portion of the cash collected from the long investors was placed by the CDO into a "default swap collateral account" to be used if the CDO performed poorly and payments had to be made to the short parties. |2620| At one time, many CDOs used the cash in the default swap collateral account to purchase Guaranteed Investment Contracts (GICs), which guaranteed repayment of the principal and a fixed or floating interest rate for a fixed period of time. But in the years leading up to the financial crisis, CDO issuers sought to use the cash in the default swap collateral account to make investments that generated higher returns, in order to improve financial performance, obtain better credit ratings, and attract investors. To obtain those higher returns, CDO issuers began to invest the incoming cash in "default swap collateral securities."
Goldman's synthetic CDOs generally invested in default swap collateral securities, and its CDO agreements typically set out parameters for the types of default swap collateral securities that could be purchased with investor funds, often requiring them to be high quality, low risk, liquid investments. |2621| If the CDO had a collateral manager, the manager often selected the CDO's default swap collateral securities. The returns earned by the default swap collateral securities often became an important component of the CDO's income. The principal proceeds of the default swap collateral securities were typically re-invested in similar securities until the CDO matured or the proceeds were needed to make payments to short parties.
Goldman's Dual Roles. In its synthetic CDOs, Goldman often took on two roles that affected the default swap collateral securities, acting as both the CDO's primary CDS counterparty |2622| and its collateral put provider. Goldman's synthetic CDOs typically followed industry practice by making one entity the sole counterparty for all of the CDS contracts issued by the CDO. In Goldman CDOs, that party was generally Goldman Sachs International (GSI), a United Kingdom subsidiary that was wholly owned by Goldman. Typically, GSI was the sole party that entered into a CDS contract directly with the domestic and offshore companies that served as the issuers of the CDO's securities (hereinafter collectively referred to as the "Issuer"). |2623| GSI then acted as an intermediary for the Issuer by entering into a corresponding CDS contract with each party seeking to take a short position in the CDO. By inserting itself into the middle of the CDS transactions, GSI put Goldman's financial standing behind the CDS contracts issued by the Issuer and improved the credit ratings assigned to and investor confidence in the CDO. If a credit event later took place, the Issuer was responsible for making payments to GSI, and GSI, whether or not it received sufficient payments from the Issuer, was responsible for making the payments owed to the short parties in the corresponding CDS contracts. Sometimes, instead of contracting with a third party, GSI kept some or all of the short positions in the CDO on behalf of Goldman itself.
By acting as the primary CDS counterparty, GSI necessarily took the short side of each CDS contract it entered into with the Issuer. Those CDS contracts typically provided that, in the event of a specified credit event that required payment to GSI, GSI could collect a specified amount of funds from the Issuer. The Issuer paid its obligations to GSI by first drawing down any available cash in the default swap collateral account. If that cash was insufficient, GSI also had the right to identify one or more of the default swap collateral securities that together had a face (par) value equal to the amount owed to GSI. Those securities could then be sold and the sale proceeds used to satisfy the amount owed to GSI under the CDS contracts. |2624| GSI would then use the cash it received from the sale proceeds to pay off the short parties in the corresponding CDS contracts. Since GSI's financial obligations under the CDS contracts were dependent in part upon the quality of the default swap collateral securities, Goldman provided in the CDO agreement that those securities could be purchased only with the prior "consent" of GSI. This arrangement enabled Goldman to exert control over the selection of the default swap collateral securities.
In addition to acting as the primary CDS counterparty in the CDOs it constructed, Goldman often acted as the CDO's default swap collateral put provider (hereinafter "collateral put provider"). The collateral put provider essentially guarantees the face (par) value of the CDO's default swap collateral securities. |2625|
Since GSI was already acting as the primary CDS counterparty, the CDO indenture agreement typically provided that, if the market value of any default collateral security selected by GSI to satisfy an amount owed to GSI fell below its face (par) value, then GSI suffered the market risk, and could not recover additional funds from the Issuer to make up for the security's loss in value. GSI was still responsible, however, for making full payments to the short parties in the corresponding CDS contracts. This arrangement functioned effectively as a "put" agreement that guaranteed the face (par) value of the default swap collateral securities, and Goldman treated the arrangement as a put agreement.
Due to the dual roles played by GSI in its CDOs, many of Goldman's CDO indenture agreements did not contain an explicit put agreement, but simply constructed GSI's CDS contracts to include the provisions that achieved the same result. For example, the Timberwolf Indenture agreement specified that the primary CDS counterparty in its CDS contract – GSI – bore the market risk associated with any default swap collateral sold to satisfy an obligation to that counterparty. |2626| In exchange for bearing the risk of not receiving the full payment owed to it from the sale of the default swap collateral securities, GSI received a discount – typically equal to 5 basis points – on the premiums GSI paid to the Issuer under the primary CDS contract. In a CDO deal of $1 billion, the premium discount would yield a "fee" of approximately $500,000. |2627| In most cases, however, the CDO indenture agreements did not specifically cite the connection between GSI's bearing the market risk of the default swap collateral sales and receiving a CDS premium discount. The CDO agreements simply included a reduced premium payment by GSI under the primary CDS contract with the Issuer. |2628|
Timberwolf Conflict of Interest. In the Timberwolf CDO, GSI acted as both the primary CDS counterparty and the collateral put provider. Documents provided to the Subcommittee show how these dual roles created a conflict between Goldman and the Timberwolf long investors, and how Goldman reacted by placing its interests before those of the clients to whom it had sold the Timberwolf securities.
In 2007, as the mortgage market deteriorated, the value of many types of default swap collateral securities also declined. Goldman became concerned that if the market value of the securities fell below par and a credit event occurred, those securities would provide insufficient funds to pay the amounts owed to GSI under its primary CDS contract with the Issuer. In addition, Goldman knew that the more the default swap collateral securities fell in value, the more of a shortfall Goldman would have to make up if GSI had to make payments to other short parties. Goldman wanted to maximize the value of the default swap collateral and what would be available to make all of the payments needed pursuant to Goldman's own short positions as well as any payments it would need to make to other short parties.
In the late spring of 2007, Goldman began to closely monitor the value of the default swap collateral securities in its synthetic CDOs. |2629| On June 20, 2007, Matthew Bieber, a Goldman employee on the CDO Origination Desk and the deal captain of the Timberwolf CDO, sent an email to his colleagues requesting information on CDOs that Goldman had "significant exposure to in terms of default swap collateral." |2630| Mr. Bieber identified 17 possible CDOs where the default swap collateral securities may have lost value and stated: "we need to get Dan [Sparks, the Mortgage Department head,] a list this morning." |2631| When asked about this email, Mr. Bieber told the Subcommittee that he did not recall why he had sent it or why he had to deliver the list to Mr. Sparks that same day, but he said he did recall that the decline in the value of the default swap securities was an issue. |2632| In response to the email, Goldman employees associated with the various CDOs submitted lists of the existing default swap collateral securities with their par and market values.
As the mortgage market worsened, Goldman's attention to the value of the default collateral securities increased. On July 18, 2007, the Goldman Credit Department sent an email to Mr. Bieber indicating that Goldman had large, valuable short positions in six of the CDOs it had originated, but that the department needed to monitor the value of the default swap collateral securities in each CDO to understand Goldman's "exposure" under the CDS contracts:
"From our discussion earlier today, we were able to verify the MTM [mark to market] exposures on the below CDOs against what we have in our credit systems (they are in fact as large as we mentioned). Our next step is understanding how the collateral pools are performing in each of the deals. Would you be able to give us a summary of the current marks and default writedowns for the below deals? This would help us in monitoring the collateralization in relation to our exposure from CDS." |2633|
The next day, July 19, 2007, Mr. Bieber informed David Lehman, who then oversaw Goldman's CDOs, that the Credit Department had asked the ABS Desk in the Mortgage Department to "mark" the value of all of the default swap collateral securities in the Goldman-originated CDOs to "get a sense of the MV [market value] supporting the deals['] obligation to pay us, if necessary." |2634|
Later that same day, another Credit Department official sent an email message to Mr. Lehman similar to the one that had been sent to Mr. Bieber:
"We understand that you are responsible for marking the collateral in relation to the below CDOs. Is that true? If so, can you please put us on your distribution list for these. We have some sizeable in the money swap positions (i.e. cdo owes GS) and Credit needs to monitor these positions vs. collateral market value." |2635|
With respect to Timberwolf, on July 25, 2007, Fabrice Tourre, a Goldman employee on the Mortgage Department's Correlation Trading Desk, circulated an internal Goldman analysis showing that the weighted average value or "mark" of Timberwolf's default swap collateral securities had declined over 3%. |2636| During the same period, the value of Goldman's short position had increased. Mr. Tourre suggested to his colleagues that as Timberwolf's default swap collateral securities matured, the resulting cash proceeds should not be re-invested in new securities, but instead be retained as cash:
"We need to start monitoring MtM [mark to market value] of the CDS collateral for the Wolf, given how much in the money the CDS are - right now, average bid side for the AAA cash bonds is approx 96.89 - per Mahesh analysis below. Matt/Mehesh - maybe we should look at the collateral reinvestment provisions in this deal - ideally principal proceeds on the CDS collateral should not be reinvested but I guess Greywolfe [sic] has discretion on this, right?" |2637|
In response, Mr. Bieber noted that the same situation applied to all of Goldman's CDOs; the declining value of the default swap collateral securities was increasing Goldman's exposure, and a weekly monitoring program was being set up. He also noted that it would be difficult for Goldman to oppose re-investment of the cash proceeds from maturing securities across the board:
"CDS across all of our transactions are in the money. We've had conversations at length with credit regarding our exposure to the default swap collateral and are setting ourselves up for weekly monitoring/pricing of the default swap collateral across the cdo business.
"We have discretionary approval over default swap collateral, however, it will be difficult for us to take the non-reinvestment approach." |2638|
The next day, on July 26, 2007, the collateral manager of one of Goldman's CDOs sought approval to purchase some new default swap collateral securities. A Goldman employee responded: "We are going to pass on this bond. Given current market conditions, we'd like to keep some cash in the default swap collateral." |2639| A few days later, after receiving more requests to approve the purchase of new default swap collateral securities, Mr. Bieber asked Mr. Lehman for a meeting to discuss how to proceed:
"Have gotten several requests today for reinvestment (Greywolf on TWOLF and TCW on DS7 [Davis Square 7]). Would like to sit down this evening to discuss how we're going to respond as this comes up." |2640|
In early August, Goldman conducted an internal analysis to assess the decrease in the return to the CDOs if the default swap collateral was kept in cash rather than re-invested in securities. |2641| As expected, that analysis showed that using the cash in the default swap collateral account to buy new securities would yield a larger return and more money for the CDO investors. |2642| But buying new securities also meant that Goldman, as the primary CDS counterparty and collateral put provider, would bear the risk if those securities later declined in market value. If the securities' market value fell below their par value, but had to be sold to make payments to the CDOs' short parties, Goldman would have to absorb any shortfall in the course of making the required payments to the short parties. Goldman's risk would be mitigated, however, if the default swap collateral was kept in cash, since cash is not subject to the same market fluctuation. The result was that Goldman benefitted more if the CDO default swap collateral was kept in cash, but the CDO investors benefitted more if the collateral was kept in securities. In short, what was best for Goldman clashed with what was best for the investors to whom Goldman had sold the Timberwolf securities.
Subsequent documents show that Goldman placed its financial interests before those of the CDO investors by taking actions to keep the CDO default swap collateral in cash, rather than securities. On August 21, 2007, Mr. Bieber sent an email to Mr. Lehman asking about what Goldman had decided regarding re-investment of the cash collateral: "Was there any further discussion over the past few days on what were going to be doing? With the 25th coming up, I suspect a bunch of managers are going to be looking to put cash to work." |2643| Mr. Lehman responded: "Nothing further - I think our gameplan remains to build cash for now." Mr. Bieber replied: "Ok. I think we should be proactive in letting managers know, then, rather than waiting for them to come to us for approval and then denying." Mr. Lehman agreed.
Greywolf Objections. Over the next three or four weeks, Goldman continued to refuse to consent to the purchase of new default swap collateral securities by the collateral managers of its CDOs. |2644|
At first, Goldman delayed telling Greywolf, Timberwolf's collateral manager, what it had decided. In late August and early September, Joseph Marconi, a Greywolf executive, former Goldman employee, and key member of the Greywolf team managing Timberwolf, sent Goldman several requests to buy new default swap collateral securities, without receiving a response. On September 6, 2007, a Goldman employee on the CDO Origination Desk forwarded one of the requests to Mr. Bieber with the comment: "Guess we can't delay talking to him anymore." |2645| Mr. Bieber informed Mr. Marconi that Goldman would no longer approve the purchase of additional default swap collateral securities for Timberwolf. When informed of Goldman's decision, Mr. Marconi protested in an email to Mr. Lehman, who was Mr. Bieber's supervisor:
"David: I would like to have a call with you to discuss the purchase of Default Swap Collateral into Timberwolf. I understand you are traveling this week. Let me know when you will have some time to talk. In response to the attached message, Matt [Bieber] told me that GS will not approve the purchase of any additional Default Swap Collateral into Timberwolf. While GS does have consent rights regarding the purchase of Default Swap Collateral, a blanket refusal to approve any assets is inappropriate, inconsistent with the parties' original expectations and will negatively impact the performance of both the debt and equity issued by Timberwolf. Give me a call when you can." |2646|
When asked by Subcommittee what he meant when he wrote that "a blanket refusal to approve any assets is inappropriate, inconsistent with the parties' original expectations and will negatively impact the performance of both the debt and equity issued by Timberwolf," Mr. Marconi explained that if Goldman wouldn't approve any new purchases as the default swap collateral securities matured, the CDO would have an increasing amount of cash on hand that would produce less income for Timberwolf than if that cash were invested in new securities. |2647|
Later on September 6, 2007, Mr. Lehman telephoned and spoke with Mr. Marconi. Neither he nor Mr. Marconi recalled exactly what was discussed, but the following day Mr. Marconi sent Mr. Lehman an email that repeated Greywolf's objections to Goldman's decision not to consent to the purchase of new default swap collateral securities:
"David: As we discussed yesterday, I believe that your refusal to approve the purchase of any additional Default Swap Collateral into Timberwolf is unreasonable and inconsistent with the way the transaction structure was originally presented to us. We were told that the purpose of the approval rights was to permit GS to review specific assets and approve or disapprove specific assets based on their relative credit merits. If we thought for a second that you had the right to prohibit all new purchases indefinitely, we would have implemented the much simpler GIC [Guaranteed Investment Contract] structure that is used in most other synthetic CDOs and CDO^2 transactions and thereby locked in a fixed spread to LlBOR for the term of our transaction. Also, the Timberwolf CDS economics include an ongoing fee to GS for the put swap component of the trade; we would not have agreed to those terms if we thought you had this option. Finally, I believe that if anyone on the deal team thought you had this option, it would have been clearly disclosed in the OM [Offering Memorandum]. Especially given current market conditions, I am surprised that you are taking a position that will directly result in less cash flow being available to debt and equity investors. As I said yesterday, we recognize the impact of current market conditions and, even before I spoke with Matt, I was suggesting we collectively focus on shorter average life AAA RMBS for the deal and I specifically solicited feedback on securities where GS would be comfortable. I continue to be surprised by your response." |2648|
When asked by the Subcommittee why he sent such a strongly worded email to Goldman regarding its refusal to approve the reinvestment of Timberwolf's cash collateral, Mr. Marconi responded: "We felt strongly about this. We had an obligation to investors to do the right thing." |2649|
Mr. Marconi told the Subcommittee that Goldman had rationalized its decision by contending that it was less risky to have more cash and fewer securities. Mr. Marconi also told the Subcommittee that Greywolf felt Goldman's blanket refusal to approve the purchase of additional securities was inconsistent with the terms of the CDO, and if anyone at Greywolf had believed that Goldman possessed that authority, Greywolf would have structured the deal differently. |2650| In addition, Mr. Marconi's September 6 email pointed out that Goldman was receiving an "ongoing fee" to serve as the collateral put provider and undertake the risk of guaranteeing the par value of the default swap collateral securities. The email stated that Greywolf would not have agreed to pay that fee to Goldman if it had thought Goldman could use its approval authority to stop the purchase of all default swap collateral securities and mitigate the risk it was being paid to bear.
The exchanges between Greywolf and Goldman brought into question the proper interpretation of Section 12.5 of the Timberwolf Indenture agreement which required the CDO to purchase default swap collateral which satisfied certain criteria and which received the "consent" of and was not "objected to" by Goldman as the "Synthetic Security Counterparty." |2651| The issue was whether that authority allowed Goldman to block the purchase of all default swap collateral securities and essentially limit the default swap collateral to cash. In a July 2007 email, Mr. Bieber wrote: "We have discretionary approval over default swap collateral, however, it will be difficult for us to take the non-reinvestment approach." |2652| But when the Subcommittee asked about the matter, Goldman's legal counsel sent a written statement indicating the Indenture agreement authorized Goldman's actions:
"Section 12.5 of the Indenture for the Timberwolf CDO confers on the Secured Party the right to consent to the selection and reinvestment of default swap collateral. It is the position of Goldman Sachs that neither Section 12.5 of the Indenture nor any other relevant deal documents impose any obligation on the Secured Party to consent to reinvestment of default swap collateral, either on a case-by-case basis or generally." |2653|
Goldman's internal documents show that on September 7, 2007, the day after the email exchange between Mr. Marconi and Mr. Lehman, Mr. Bieber scheduled a meeting with Goldman's legal counsel and a key compliance officer to discuss the issue. His email stated:
"Pls see email we received below - - wanted to get your take on what response (if any) we should craft. This is related to the default swap collateral account in Timberwolf used to collateralize the exposure we have to the CDO on the CDS contracts that are the assets in TWOLF." |2654|
The meeting was scheduled for 1:15 p.m. that same day, |2655| and one of the counsels requested a copy of the Offering Memorandum and "the operative documents that contain our rights/obligations with respect to the Collateral." |2656|
The Subcommittee did not locate any documents recounting exactly what was discussed at the meeting. The default swap collateral issue involved a significant number of Goldman CDOs, affected Goldman's relationships with investors and other financial firms serving as collateral managers of its CDOs, and entailed substantial financial risk for Goldman. Yet, when asked about it, the key participants said they could not recall whether the meeting took place, what was discussed at the meeting if it did take place, or what determinations were reached regarding Goldman's authority or actions. The participants who could not recall the meeting included Mr. Bieber, the Timberwolf deal captain; Tim Saunders, counsel from Goldman's legal department; Susan Helfrick, another legal counsel; and Jordan Horvath, the compliance officer. Mr. Saunders, the lead Goldman legal counsel on the matter, informed the Subcommittee that he had "no present recollection of the circumstances surrounding any disagreement between Goldman Sachs and Greywolf Capital Management LP regarding Goldman Sachs' right to consent to reinvestment of default swap collateral in Timberwolf." |2657| Mr. Bieber, the Timberwolf deal captain, told the Subcommittee that he did not recall whether Goldman developed any specific strategy limiting the type of default swap collateral securities that could be purchased for its CDOs. |2658|
However, documents obtained by the Subcommittee indicate that the meeting did take place, and Goldman did develop a strategy to respond to Greywolf's concerns. On September 7, 2007, the same day as the meeting, Mr. Lehman sent a email to Mr. Bieber stating:
"U spoke w[ith] [Jonathan] egol? What ab[ou]t legal/compliance[?] Just make sure Dan [Sparks] is ok w[ith] it[.] Also I do th[in]k we sh[oul]d be consistent across deals . . . so if slmas and credit cards are ‘ok' I th[in]k we tell our mgrs [managers] that . . . maybe 2 y[ea]rs and shorter." |2659|
Mr. Bieber responded: "Spoke with legal/compliance. Not doing anything w/o [without] discussing with dan [Sparks] first. Agree with the point on consistency." |2660|
Also on September 7, 2007, Jonathan Egol, head of the Mortgage Department's Correlation Trading Desk, sent an email to Mr. Lehman and others suggesting that Goldman identify a narrow set of very safe asset backed securities that it could propose to Greywolf as possible default swap collateral securities, such as AAA rated securities backed by credit card receivables or student loans. |2661| Mr. Bieber sent an email the same day indicating he supported that approach, but wanted to speak first with Mr. Sparks, head of the Mortgage Department. |2662|
Subsequent documents indicate that Goldman reversed its initial position and decided to consent to the purchase of more default swap collateral securities. However, Goldman appeared to narrow the class of asset backed securities that it would consent to be acquired as default swap collateral. On September 10, 2007, Mr. Bieber sent an email to Mr. Lehman reporting:
"Managed to catch up with Dan [Sparks] just now. . .we're going to put together a list of SLMA floaters in our inventory to show Joe [Marconi at Greywolf]. Going over w/ Dan tomorrow before sending anything externally." |2663|
Goldman also sent a short list of commercial mortgage backed securities (CMBS) in its inventory that it would consent to be acquired for Timberwolf. |2664|
Over the next two weeks, Goldman sent a list of acceptable securities to two more collateral managers of its CDOs. |2665| On October 15, 2007, Mr. Bieber provided virtually the same list to a Goldman colleague together with a short explanation of some of the criteria used to identify the securities:
"Here are the shelves we'd like to use for default swap collateral reinvestment.
RMBS: CBASS, GSAA, GSAMP, JPMAC, WFHET
ARDS: AMXCA, BACCT, BOIT, MBNAS, CCCIT,CHAIT, DCMT
AUTOS: COPAR, DCMOT, FORDO, HAROT, HDMOT, NALT, USAOT
STUDENT LOANS: ACCSS, GCOE, KSLT, NCSLT, SLMA (FFELP)
In addition to the default swap collateral constraints in the docs for each transaction, also looking to securities that are (a) floating rate (b) monthly pay (c) senior-most bond in capital structure (d) avg life of less than or equal to 2 years (e) currently amortizing. Please let me know if you have any questions." |2666|
All of the listed securities consisted of AAA rated securities backed by residential mortgages, credit card receivables, automobile loans, or student loans, and had an expected maturity of two years or less. It appears as if Goldman was restricting the selection of default swap collateral securities to a limited list of assets that it believed were likely to maintain their par value in order to minimize its financial exposure.
After indicating it would allow these new purchases, Goldman maintained tight control over the actual purchases made by the collateral managers. A September 27, 2007 email exchange between Mr. Marconi of Greywolf and Mr. Bieber of Goldman, for example, demonstrates Goldman's intense monitoring effort:
Mr. Marconi: "Matt: I am seeing this list from another dealer. Can I assume that I can buy any name on your approved list?" ...
Mr. Bieber: "No-we need to give approval on a security by security basis." |2667|
When asked about these matters, both Mr. Sparks and Mr. Lehman characterized the default swap collateral securities issue as a minor issue. Mr. Lehman informed the Subcommittee that he did not recall significant debate with collateral managers on the matter. |2668| Mr. Sparks said the yield difference between keeping the collateral in cash and investing in securities was minimal and characterized the whole issue as "structured finance gymnastics." |2669| But information supplied by Goldman to the Subcommittee on seven Goldman-originated CDOs shows that, due to its duties as collateral put provider and the declining value of the CDOs' default swap collateral securities, Goldman eventually lost over $1 billion. |2670|
Analysis. In its synthetic CDOs, Goldman arranged for its subsidiary, GSI, to act as both the primary CDS counterparty and the collateral put provider. Goldman also arranged for GSI to receive a fee for serving as the collateral put provider, through paying reduced premiums in connection with the CDS contracts it entered into with the CDOs. Despite this fee, Goldman took actions to evade its responsibilities as the collateral put provider, including by refusing to approve the purchase of new default swap collateral securities whose values might decline below par value. Instead, Goldman tried to force the CDOs to keep their collateral in cash. While this effort provided more protection for Goldman's financial interest as the short party, it worked to the disadvantage of the CDO investors because it produced lower returns for the CDOs than the purchase of default swap collateral securities.
When the Timberwolf collateral manager objected, Goldman backed down and allowed the purchase of a narrow range of very safe, short term asset backed securities as collateral for Timberwolf and other CDOs. Goldman's conduct in the Timberwolf CDO demonstrates how a financial institution that plays multiple roles in a CDO can develop conflicts of interest and attempt to manipulate the CDO to place its own financial interests before those of the investors to whom it sold the CDO securities.
2006. The 27 CDOs securitized about $28 billion in assets. 2006 See undated chart prepared for Subcommittee by Goldman Sachs, GS MBS 0000004276. The 93 RMBS securitized about $72 billion in home loans. See undated chart prepared for Subcommittee by Goldman Sachs, GS-PSI-00172. [Back]
2007. See Goldman Sachs 2007 response to Subcommittee QFR at PSI_QFR_GS0252, at 0262. [Back]
2008. For a detailed discussion of these obligations under federal securities laws, see Section (6)(a), below. [Back]
2009. See 12/7/2006 email from Daniel Sparks to Tom Montag, "Subprime Volatility," 2009 GS MBS-E-010931233. [Back]
2010. 12/13/2006 Firmwide Risk Committee December 13 Minutes, GS MBS-E-009582963-64. [Back]
2011. For more information about this December 14 meeting, see discussion in Section C(4)(b), above. [Back]
2012. 2/8/2007 email from Daniel Sparks, 2012 "Post," Hearing Exhibit 4/27-7. [Back]
2013. 2/14/2007 email from Daniel Sparks to himself, "Risk," GS MBS-E-002203268. [Back]
2014. 2/21/2007 email exchange between Daniel Sparks and Jon Winkelried, "Mortgages today," GS MBS-E- 010381094, Hearing Exhibit 4/27-10. [Back]
2015. 2/26/2007 emails between Tom Montag and Daniel Sparks, "Questions you had asked," GS MBS-E-019164799. [Back]
2016. 3/3/2007 email from Daniel Sparks, 2016 "Call," Hearing Exhibit 4/27-14. [Back]
2017. 3/12/2007 Goldman Firmwide Risk Committee, "March 7th FWR Minutes," GS MBS-E-00221171, Hearing Exhibit 4/27-19; see also 3/7/2007 email from Daniel Sparks to himself, "Risk Comm," GS MBS-E-002212223. [Back]
2018. 3/8/2007 email from Daniel Sparks, "Mortgage risk," Hearing Exhibit 4/27-75. [Back]
2019. 1/29/2007 email from Jon Egol to Fabrice Tourre, GS MBS-E-002620292. Mr. Tourre responded: "‘The market is dead'??? Ouahhh, what do you mean by that? Do you have any insight I don't?" Mr. Egol replied: "LDL [let's discuss live] tomorrow." Id. Mr. Egol later wrote: "This is not my personal opinion – just a synopsis of the views of the customers we have seen today." 1/29/2007 email from Jon Egol to Daniel Sparks, GS MBS-E- 003249991. [Back]
2020. 2/11/2007 email from Jon Egol, "Index Tranche Pricing Study - 08Feb07.xls," GS MBS-E-002640951. See also 2/20/2007 email from Fabrice Tourre to Jon Egol, GS MBS-E-009332408 (Mr. Tourre: "By the way, quote from an ABS correlation trader (non-GS): "the mezz ABS CDO business is dead." Mr. Egol responded: "who." Mr. Tourre replied: "LDL." "LDL," which means "let's discuss live," is an abbreviation that appears throughout the Goldman documents produced to the Subcommittee.); 3/27/2007 email from a Goldman analyst, GS MBS-E- 009685430 ("The housing slowdown has the risk now not be[ing] offsetting [sic] by stronger capital spending. Both growth and the market are DEAD if that's the case.") [emphasis in original]. [Back]
2021. 3/8/2007 email from Daniel Sparks, "Mortgage 2021 risk," Hearing Exhibit 4/27-75. [Back]
2022. See also emails expressing concerns about the CDO market in particular. 6/27/2007 email from Jonathan Sobel, "Citi feedback on debt mkts," GS MBS-E-010807091 (reporting a conversation with the head of the mortgage desk at Citibank: "He is very nervous. ... Some Citi people think the CDO market is dead - a potential result of [subprime] contagion."); 8/30/2007 email from Daniel Sparks, "RAIT," GS MBS-E-010626401 ("the business model pursued by these guys (taking junior parts of the . . . capital structure and obtaining further leverage via the CDO market) is dead for the foreseeable future."). [Back]
2023. See also Section C(4)(b) of this chapter, above. [Back]
2024. 12/14/2007 email from Kevin Gasvoda, "Retained bonds," GS MBS-E-010935323, Hearing Exhibit 4/27-72. See also 2/8/2007 email from Kevin Gasvoda to Tom Montag, "Mortgage risk – credit residential," at 2, GS MBS-E- 010372233, Hearing Exhibit 4/27-74 (seven weeks later, Mr. Gasvoda reported transferring the remaining Goldmanoriginated RMBS securities to the mortgage trading desk to sell: "moving retained bonds out of primary desk hands and into 2ndry desk."). [Back]
2025. 2/9/2007 email exchange between Kevin G 2025 asvoda and sales syndicate, "GS Syndicate RMBS Axes (INTERNAL)," GS MBS-E-010370495, Hearing Exhibit 4/27-73. [Back]
2026. 2/23/2007 "Significant Cash Inventory Change (Q1'07 vs. Q4'06)," datasheet prepared by Goldman, GS MBSE- 010037311, Hearing Exhibit 4/27-12. [Back]
2027. See, e.g., 3/8/2007 email from Daniel Sparks, "Mortgage risk," GS MBS-E-002206279, Hearing Exhibit 4/27- 75 ("[f]or residential loans, we have not bought much lately"); 3/26/2007 Goldman presentation to Board of Directors, "Subprime Mortgage Business," GS MBS-E-005565527, Hearing Exhibit 4/27-22 (reporting that Mortgage Department is using "conservative bids" on loans); 3/14/2007 Goldman Presentation to SEC, "Subprime Mortgage Business 14-Mar-2007," at 7, GS MBS-E-010022328; 3/2/2007 email to Craig Broderick, "Audit Committee Package_Feb 21_Draft_Mortgage_Page.ppt," GS MBS-E-009986805, Hearing Exhibit 4/27-63 (we are "lowballing" bids on loans). [Back]
2028. 2/8/2007 email from Kevin Gasvoda to Daniel Sparks,"Post," GS MBS-E-002201668, Hearing Exhibit 4/27-7 ("monthly performance analysis completed this morning on what can be securitized vs will be foreclosed tells us we should mark down around $22mm"). See also 2/2/2007 email from Daniel Sparks, "Second lien deal performance and write-down," GS MBS-E-002201050, Hearing Exhibit 4/27-92 ("Gasvoda alerted me last night that we will take a write-down to some retained positions next week as the loan performance data from a few second lien sub-prime deals just came in (comes in monthly) and it is horrible."); 2/8/2007 email from Kevin Gasvoda to Tom Montag, "Mortgage risk – credit residential," at 2, GS MBS-E-010372233, Hearing Exhibit 4/27-74. Mr. Gasvoda summarized the other write-downs as follows:
"– 2nd lien residual – took $20-25mm write-downs over last 3 months (could lose $5-15 mm more)
– 2nd lien retained bonds–took $18mm write-down this week (could lose $5-15 more)
– Subperforming loan book – taking $28mm write-down this week (could lose $20-40mm more) What do all these areas have in common? – most HPA [housing price appreciation] sensitive sectors. They've crumbled under HPA slowdown as these are the most levered borrowers. What have we done to mitigate?
– we stopped buying subprime 2nd liens in the summer of ‘06 and have focused on alt-a and prime." [Back]
2029. 2/9/2007 email from Daniel Sparks, "Scratch & dent loan write down $30mm," GS MBS-E-009760380. [Back]
2030. Id. [Back]
2031. 2/13/2007 email from Richard Ruzika to Gary Cohn, "Catch Up," G 2031 S MBS-E-019794071. Mr. Cohn forwarded Mr. Ruzika's report to Messrs. Blankfein and Winkelried. Id. See also 6/8/2007 email from Kevin Gasvoda, "Project Omega - Mortgages MTM of Resids," GS MBS-E-013411815 (working on potential deal to sell markeddown mortgage residuals). [Back]
2032. See Goldman Sachs response to Subcommittee QFR at PSI_QFR_GS0039. [Back]
2033. Id. [Back]
2034. Using loan data, the U.S. mortgage industry had developed anticipated default rates, including EPDs, for different mortgage classes, such as subprime, Alt A, and prime loans. These default rates, however, were based in large part on past loan underwriting practices and loan types that bore little resemblance to the loans issued in the years leading up to the financial crisis, as explained in Chapter V of this Report. In 2006, subprime loans began to experience higher than anticipated EPD rates, and lenders were hit by unanticipated repurchase demands they could not afford to pay. The first EPD-related mortgage lender failures occurred in late 2006, and bankruptcies continued throughout 2007. [Back]
2035. See, e.g., 3/26/2007 "Subprime Mortgage Business," Goldman presentation to Board of Directors, at 3-5, GS MBS-E-005565527 at 532, Hearing Exhibit 4/27-22 (timeline showing Ownit, a subprime lender, filed for bankruptcy on December 28, 2006, and list of subprime related businesses bankrupted, suspended, closed, sold, or put up for sale). [Back]
2036. Goldman or a third party due diligence firm it hired typically 2036 examined a sample of the loans. Based on the number of problem loans found in the sample, Goldman or the due diligence firm extrapolated the total percentage of problem loans likely to be contained in the pool. This information was then factored into the price Goldman paid for the pool. Any specific loans identified in the sampling process as deficient were generally returned to the lender for repurchase, but it was rare for an investment bank to review 100% of a pool to identify all of the deficient loans and return them. Subcommittee interview of Clayton Holdings (11/9/2010). [Back]
2037. See, e.g., 1/8/2007 email from Daniel Sparks, "Color on the Sub Prime Market," GS MBS-E-002195434 (after receiving a report on potential EPD problems, Mr. Sparks wrote: "I just can't see how any originator in the industry is worth a premium. I'm also a bit scared of accredited and new century, and I'm not sure about taking on a bunch of new exposures."); 2/8/2007 email from FICC analyst to Mr. Sparks, Mr. Gasvoda, and others, "2006 Subprime 2nds Deals Continue to Underperform," GS MBS-E-003775340, Hearing Exhibit 4/27-167d ("2006 vintage Subprime closed-end seconds (CES) issuance has continued to deteriorate. ... [N]on-GS Subprime CES deals are categorically experiencing similar negative behavior across shelves, originators, and servicers. ... Outlook: 2006 vintage ... could eventually reach 4-5+ times that of 2004/early 2005 vintages (more than double that of RA expected losses)."). [Back]
2038. 2/2/2007 email from Daniel Sparks to Messrs. Montag, Ruzika, and Viniar, GS MBS-E-002201050, Hearing Exhibit 4/27-92. See also 2/2/2007 email from Michelle Gill, "Warehouse policy," GS MBS-E-005556331 (discussing proposal to charge higher warehouse fees to mortgage originators with higher EPD and "drop-out" rates, including Fremont and New Century). [Back]
2039. 2/27/2007 email from Christopher Gething, "Our Expansion," GS MBS-E 2039 -010387242 (expansion of St. Petersburg office to accommodate staff for loan repurchase effort). [Back]
2040. See, e.g. 3/2007 Goldman email chain, "RE: NC Visit," GS MBS-E-002048050 (mentioning four different third party "vendors" conducting loan reviews for the loan repurchase effort and stating: "We're off to other vendors at this point."). [Back]
2041. See 3/9/2007 email from Kevin Gasvoda, "priorities," GS MBS-E-002211055 (listing priority mortgage originators as Accredited, Fremont, New Century, and Novastar); 3/14/2007 Goldman email, "NC Visit," GS MBSE- 002048050 (identifying New Century, Fremont and Long Beach); 6/29/2007 email from Ed Chavez, "Countrywide Investigation Review Update," GS MBS-E-002134411. [Back]
2042. 3/2/2007 email to Craig Broderick, "Audit Committee Package_Feb 21_Draft_Page.ppt," GS MBS-E- 009986805, Hearing Exhibit 4/27-63. [Back]
2043. 3/7/2007 email from Daniel Sparks, "Originator exposures," GS MBS-E-002206279, Hearing Exhibit 4/27-75. [Back]
2044. 3/12/2007 email from Daniel Sparks, "Subprime Opportunities," GS MBS-E-004641002. See also 4/15/2007 email, "March 2007 Counterparty Surveillance," GS MBS-E-002135667 (forwarding report to loan repurchase team, "Please find attached the March counterparty surveillance report (and boy, is it a doozy)."); 3/26/2007 "Subprime Mortgage Business," Goldman presentation to Board of Directors, at 5, GS MBS-E-005565527, Hearing Exhibit 4/27-22 (list of subprime related businesses bankrupted, suspended, closed, sold, or put up for sale). [Back]
2045. 3/13/2007 email from Manisha Nanik, "New Century EPDs," GS MBS-E-002146861, Hearing Exhibit 4/27-77. The review of the New Century loan pool found:
"– approx 7% of the pool has material occupancy misrepresentation where borrowers took out anywhere from 4 to 14 loans at a time and defaulted on all. ...
– approx 20% of the pool has material compliance issues. These are mainly missing HUDs. ...
– approx 10% of the pool is flagged as potential REO [Real Estate Owned by lender] or potential unsecured (if 2nd liens). ...
– approx 5% of the pool was possibly originated fraudulently based on the dd [due diligence] results. Main findings: possible ID theft, broker misrepresentations, straw buyer, and falsification of information in origination docs. ...
"approx 62% of the pool has not made any payments (4% were reversed pymts/nsf [non-sufficient funds]) ...
"approx 38% of the loans are out of [loan to value] tolerance." [Back]
2046. See Goldman Sachs response to Subcommittee QFR at PSI_QFR_GS0040. [Back]
2047. 3/14/2007 Goldman email, "NC Visit," GS-MBS-E-002048050. See also 3/21/2007 email from Daniel Sparks to Tom Montag, GS MBS-E-002207114 (noting progress in cutting down funding commitments to mortgage originators to $300 million, including closeout of all funding to New Century in exchange for loans). [Back]
2048. See Goldman Sachs response to Subcommittee QFR at PSI_QFR_GS0040. [Back]
2049. 3/14/2007 Goldman email, "NC Visit," GS-MBS-E-002048050; see also 8/10/2007 email from Michelle Gill, "Fremont - Incremental Information," GS MBS-E-009860358 (Goldman's repurchase claims against Fremont would have amounted to a 9% ownership stake in Fremont after a proposed buyout by investor group; Goldman was not the largest purchaser of Fremont loans but its repurchase claims were 3-4 times larger than the claims of the nearest counterparty). [Back]
2050. 6/29/2007 email from Ed Chavez, "Countrywide Investigation 2050 Review Update," GS MBS-E-002134411. [Back]
2051. See Goldman Sachs response to Subcommittee QFR at PSI_QFR_GS0040. The five mortgage originators to which Goldman directed the most repurchase requests were First Franklin, New Century, Fremont, Greenpoint, and Long Beach. Id. [Back]
2052. 2/15/2007 email from Loren Morris of Goldman Sachs to David Schneider of WaMu and others, GS MBS-E- 002142424, Hearing Exhibit 4/13-69b. [Back]
2053. See, e.g., Goldman response to Subcommittee QFR at PSI_QFR_GS0040; 3/8/2007 email from Daniel Sparks to Jon Winkelried and others, "Mortgage risk," GS_MBS-E-002206279, Hearing Exhibit 4/27-75 ("Accredited ... plan to send us $21mm"); 6/25/2007 email from Deana Knox, "Option One," GS MBS-E-019645932 ("Option One has agreed to settle the entire claim, paying $2.5M (repurchase and monitor) and $3M will be rescinded."). [Back]
2054. New Century, for example, declared bankruptcy in April 2007. In re New Century TRS Holdings, Inc., Case No. 07-10416 (KJC) (US Bankruptcy Court, District of Delaware). See also 6/7/2007 email from Loren Morris, "WFALT 05-2 Repurchase demand," GS MBS-E-002131857. [Back]
2055. See, e.g., 1/3/2011 Bank of America press release, "Bank of America Announces Fourth-Quarter Actions," bankofamerica.com (announcing agreements to pay $3 billion to Freddie Mac and Fannie Mae to resolve residential mortgage repurchase claims related to loans originated by Countrywide). [Back]
2056. See 2/2/2007 Goldman memorandum to the Mortgage Capital Committee, "Agenda for Monday, February 5, 2007," GS MBS-E-002201064; 2/5/2007 Mortgage Capital Committee Memorandum regarding GSAMP Trust 2007-FM2, GS MBS-E-002201055-58. [Back]
2057. See discussion of Goldman's loan repurchase effort, 2057 above. In addition, in the prior month, a Goldman employee in the mortgage credit trading department sent senior Mortgage Department officials a lengthy email on the deteriorating subprime mortgage market and observed: "Subprime originators, large and small, ha[ve] exhibited a notable increase in delinquencies and defaults, however, deals backed by Fremont and Long Beach collateral have generally underperformed the most." 2/8/2007 email from Fabrice Tourre, "FW: 2006 Subprime 2nds Deals Continue to Underperform **INTERNAL ONLY**," at GS MBS-E-003775340, Hearing Exhibit 4/27-167d. [Back]
2058. In re Fremont Investment & Loan, Docket No. FDIC-07-035b, Order to Cease and Desist (March 7, 2007). [Back]
2059. See Standard & Poor's www.globalcreditportal.com. [Back]
2060. 3/23/2007 Goldman memorandum to members of the Mortgage Capital Committee, "Agenda for Monday, March 26, 2007," Hearing Exhibit 4/27-79 ("GSAMP 2007-HE2 – Goldman to securitize $960 million of subprime mortgage loans purchased by Goldman Sachs from New Century (71.9%)" and other mortgage originators. "The securitization is scheduled to be completed by April 12, 2007."). [Back]
2061. See discussion of Goldman's loan repurchase effort, above. Earlier in March, a Goldman review of a different New Century loan pool had found that 26% of the loans were deficient and ought to be returned to New Century for a refund. 3/13/2007 email from Manisha Nanik, "New Century EPDs," GS MBS-E-002146861, Hearing Exhibit 4/27-77. In addition, New Century had already informed Goldman that it had insufficient cash to pay any loan repurchase requests. 3/14/2007 Goldman email, "NC Visit," GS-MBS-E-002048050. [Back]
2062. In re New Century TRS Holdings, Inc., Case No. 07-10416 (KJC) (US Bankruptcy Court, District of Delaware). [Back]
2063. See Standard & Poor's www.globalcreditportal.com. [Back]
2064. 4/11/2007 email to Jon Egol, "GSAMP 2006-S3 – Computational Materials for 2064 Wachovia (external)," GS MBSE- 003322028 [emphasis in original]. [Back]
2065. 11/7/2007 letter from Sarah Smith, Controller and Chief Accounting 2065 Officer to SEC, at 5, GS MBS-E- 015713460, Hearing Exhibit 4/27-50. Goldman issued its final RMBS securitization for the year in August 2007. [Back]
2066. 4/2010 "Goldman Sachs Long Cash Subprime Mortgage Exposure, Investments in Subprime Mortgage Loans, and Investments in Subprime Mortgage Backed Securities November 24, 2006 vs. August 21, 2007 in $ Billions," chart prepared by the Subcommittee, Hearing Exhibit 4/27-163. [Back]
2067. 1/31/2007 email from Daniel Sparks to Tom Montag, 2067 "MTModel," Hearing Exhibit 4/27-91. [Back]
2068. See, e.g., 2/25/2007 emails between Daniel Sparks and Tom Montag, "Questions you had asked," GS MBS-E- 019164799. [Back]
2069. See 2/23/2007 email from Daniel Sparks, "Mortgages today," GS MBS-E-009759477 ("We liquidated 3 CDO warehouses today and started the liquidation of another."); 2/26/2007 emails between Daniel Sparks and Tom Montag, "Questions you had asked," GS MBS-E-019164799; 2/22/2007 email from Peter Ostrem to David Rosenblum, "League Tables," GS MBS-E-001800683 ("FYI Liquidating 3 warehouses tomorrow. And Dan [Sparks] wants to liquidate Greywolf."). [Back]
2070. 2/25/2007 emails between Daniel Sparks and Tom Montag, "Questions you had asked," GS MBS-E-019164799. [Back]
2071. See, e.g., 3/8/2007 email from Daniel Sparks to Mr. Winkelried and others, GS MBS-E-002206279, Hearing Exhibit 4/27-75 (Mortgage Department is "rushing to get deals rated"). See also discussions of Anderson and Timberwolf CDOs, below. [Back]
2072. See 6/1/2007 email from David Lehman, "CDO Update," GS MBS-E-001866889 (referring to "liquidated warehouses"); 5/30/2007 email from David Lehman, "ABX hedges – Buy order," GS MBS-E-011106690 (directing trading desk to unwind hedges for CDO warehouse accounts). Some of the assets were accounted for in a separate "CDO Transition book," but the sale of the assets became the responsibility of the SPG trading desk. [Back]
2073. 6/22/2007 email from David Lehman, "Few trade posts," GS MBS-E-010848985. [Back]
2074. Between the fall of 2006 and mid-2007, Goldman o 2074 riginated 14 CDOs, which included or referenced many assets that were from or similar to Goldman's own inventory. The Subcommittee examined seven of those CDOs, and found that 57% of the CDO assets had come from Goldman, including over $3 billion in synthetic assets in which Goldman was the short party, and therefore stood to profit from a decline in the value of the underlying assets. Goldman had unsold securities from a number of these CDOs on its books. [Back]
2075. 3/9/2007 email exchange between Daniel Sparks and sales managers, "help," GS MBS-E-010643213, Hearing Exhibit 4/27-76. [Back]
2076. Id. [Back]
2077. Id. [Back]
2078. Id. [Back]
2079. 3/12/2007 email from David Lehman, "**Internal** Three focus axes for SP CDOs/SPG Trading," GS MBS-E- 021895601. [Back]
2080. Id. [Back]
2081. 3/21/2007 email from syndicate, "Non-traditional 2081 Buyer Base for CDO AXES," GS MBS-E-003296460, Hearing Exhibit 4/27-78. [Back]
2082. 3/30/2007 email from Fabrice Tourre to Daniel Sparks, David Lehman, and others, GS MBS-E-002678071, Hearing Exhibit 4/27-80. [Back]
2083. 4/11/2007 email from syndicate, "GS Syndicate Structured Product CDO Axes (INTERNAL)," GS MBS-E- 010533482, Hearing Exhibit 4/27-101. Mr. Sparks forwarded the directive to global senior sales executives with a note: "Your focus on this ax would be very helpful – we are trying to clean up deals and this is our priority." [Back]
2084. 4/19/2007 email from Daniel Sparks to Bunty Bohra, GS MBS-E-010539324, Hearing Exhibit 4/27-102. Mr. Sparks authorized large sales credits on at least one other occasion as well – for sales to cover the Department's $9 million AAA ABX net short position in September 2007. See 9/27/2007 email from Tom Montag to Daniel Sparks, GS MBS-E-010703744 (Mr. Montag asked: "Did we really pay sixty million in gcs [gross credits] on the aaa short covering? Why so high?" Mr. Sparks responded: "It was a very big ax, but sales credits have become such a contentious point that trading team doesn't debate it anymore. The politics around sales credits had become unbelievable and were a hinderance [sic] to business." Mr. Montag replied: "so you overpay?"). [Back]
2085. See, e.g., 5/11/2007 email from Tom Montag to Daniel S 2085 parks, GS MBS-E-019648100. [Back]
2086. 5/11/2007 email from Daniel Sparks to Richard Ruzika, "You okay?," GS MBS-E-019659221. [Back]
2087. Id. ("We had a meeting today with viniar, don [Mullen], mcmahon, my team, controllers, gary [Cohn] on the phone to walk through situation. The market has seized up so much that levels are very hard to determine for the complex products – which also are difficult to model for value due to market changes."); 5/14/2007 email from David Lehman, "Gameplan – asset model analysis," GS MBS-E-001865782 (last email in a longer email chain). [Back]
2088. 5/14/2007 email from David Lehman, "Gameplan – asset model analysis," GS MBS-E-001865782 (last email in a longer email chain) ("Following up from this afternoon's meeting. We are going to better evaluate the CDO^2 risk using three distinct frameworks: 1) Blended scenario analysis using HPA [housing price appreciation;] ... 2) Risk neutral/correlation framework, consistent with our current synthetic ABS CDOs[;] 3) Simplistic loss assumptions on the underlyings / Market Value Coverage"); 5/14/2007 email from Elisha Weisel, "Modelling Approaches for Cash ABS CDO/CDO^2," GS MBS-E-001863618. See also 3/6/2007 email from Elisha Weisel to Daniel Sparks, "Property Derivs," GS MBS-E-010649734 (discussing lack of model or models to consistently value subprime assets). [Back]
2089. 5/14/2007 email from Tom Montag to Daniel Sparks, GS MBS-E-019642797. [Back]
2090. 5/20/2007 email from Lee Alexander to Daniel Sparks, Donald Mullen, Lester Brafman, and Michael Kaprelian, "Viniar Presentation - Updated," GS MBS-E-010965211 (attached file "Mortgages V4.ppt," "Mortgages Department, May 2007," GS MBS-E-010965212). This document is identified in the relevant correspondence as "v.4," and appears to be the final version of a draft presentation prepared earlier that day, "Mortgages Department, May 2007," GS MBS-E-001863651, which bears a time and date stamp of May 20, 2007, 2:58 p.m. See also 5/20/2007 Goldman document, "Mortgage Presentation to David Viniar – Dial In Information," GS MBS-E-010787603. The final document, "Mortgages V4.ppt" was emailed to Mr. Sparks and Mr. Mullen, and also messengered to Mr. Mullen's home, at 8:31 p.m. on May 20, immediately before the scheduled call. 5/20/2007 email to Daniel Sparks and Donald Mullen, "Viniar Presentation – Updated," GS MBS-E-010971156.
Goldman also produced a similar document prepared the day before, which may have been an earlier draft of the final presentation. 5/19/2007 Goldman presentation, "Mortgages CDO Origination – Retained Positions & Warehouse Collateral, May 2007," GS MBS-E-010951926. This document is identified in the relevant correspondence as "Mortgages CDO Origination," and the file name is "Mortgages V3.ppt." This presentation was forwarded to Mr. Sparks for comment on May 19, 2007 at 12:32 a.m., and Mr. Sparks replied with comments at 5:57 p.m. Mr. Sparks forwarded the file "Mortgages V3.ppt" to himself at home on Sunday, May 20, 2007 at 8:07 a.m. [Back]
2091. The writedowns were required, in part, because the assets 2091 in the CDO warehouses had generally been marked at cost when purchased or at a value related to the final securitized structure, called "mark-to-securitization-exit." Those valuation methods generally resulted in values well above what the assets would bring if sold individually in a declining mortgage market. [Back]
2092. Id. [Back]
2093. 5/20/2007 email from Lee Alexander to Daniel Sparks, Donald Mullen, Lester Brafman, Michael Kaprelian, "Viniar Presentation - Updated," GS MBS-E-010965211 (attached file "Mortgages V4.ppt," "Mortgages Department, May 2007," GS MBS-E-010965212). By May 2007, Goldman had ceased originating any new CDO securitizations. [Back]
2094. Id. The four identified customers appear to be ones which the sales force felt it had the greatest likelihood of success in selling the CDO assets. Two of the customers, Basis Capital and Polygon, had already made recent purchases of Point Pleasant and Timberwolf securities, respectively, from Goldman. See Goldman Sachs response to Subcommittee QFR at PSI_QFR_GS0226. [Back]
2095. The client list drawn up pursuant to the Gameplan was a stark example of actions taken by Goldman to target specific clients for CDO sales, but different Mortgage Department desks maintained their own "target lists" that focused on specific types of products, specific transactions, and specific types of cross-selling opportunities with other Goldman departments. See, e.g., 3/1/2007 email from Michael Swenson, "names," GS MBS-E-012504595 (SPG Trading target list tiered according to likelihood of purchasing); 2/14/2007 email to Matthew Bieber, "Timberwolf I, Ltd. – Target Account List," GS MBS-E-001996121 (list of U.S. accounts "we should be directly targeting" for Timberwolf sales); 3/2/2007 email from David Lehman, "ABX/Mtg Credit Accts," GS MBS-E-011057632 (mortgage credit business shared with SPG Trading Desk "a fairly lengthy list of accounts that are considered to be ‘key'"). In December 2006, the Correlation Trading Desk drew up a list of target customers for 2007: the "proposed top 20 correlation customer list." 12/29/2006 email from Fabrice Tourre, "Last call–any other comments on the proposed top 20 correlation customer list," GS MBS-E-002527843, Hearing Exhibit 4/27-61. Mr. Tourre issued a "last call" for comments on the list and suggested focusing on "buy-and-hold rating-base buyers" who might be more profitable for the desk than more sophisticated and demanding hedge fund customers:
"[T]his list might be a little skewed towards sophisticated hedge funds with which we should not expect to make too much money since (a) most of the time they will be on the same side of the trade as we will, and (b) they know exactly how things work and will not let us work for too much $$$, vs. buy-and-hold ratingbased buyers who we should be focused on a lot more to make incremental $$$ next year."
The proposed top 20 list identified a number of European accounts, as well as customers who had purchased asset backed security products from Goldman in the past.
The reference to "buy and hold, ratings-based buyers" was to conservative financial institutions, often insurance companies or pension funds, that tended to hold their investments indefinitely or until maturity, some of which were limited to holding investments with AAA or other investment grade credit ratings. Many of these buyers tended to rely on the AAA rating as a "seal of approval" signaling that the rated instrument offered predictable, safe returns. Many viewed the AAA rating as, in effect, all these buyers thought they needed to know about the CDO securities they were purchasing. See, e.g.,11/13/2007 Goldman email, GS MBS-E-010023525 (attachment, 11/14/2007 "Tri-Lateral Combined Comments," GS MBS-E-010135693-715 at 713) ("Investors in subprime related securities, especially higher rated bonds, have historically relied significantly on bond ratings particularly when securities are purchased by structured investing vehicles."). But as one press article explained: "CDO ratings may mislead investors because they can obscure the risk of default, especially compared with similar ratings for bonds, says Darrell Duffie, a professor of finance at Stanford Graduate School of Business in California, who's paid by Moody's to advise the company on credit risk. ‘You can't compare these CDO ratings with corporate bond ratings,' Duffie says. ‘These ratings mean something else – entirely.'" See 5/31/2007 email to David Lehman and others, "CDO Boom Masks Subprime Losses," GS MBS-E-001865723 at 733. The article pointed out that the lowest grade of corporate bonds rated by Moody's had a default rate of 2.2%, while the default rate for CDOs with the same rating was 24%. Id. [Back]
2096. 5/19/2007 Goldman presentation, "Mortgages CDO Origination – Retained 2096 Positions & Warehouse Collateral, May 2007," GS MBS-E-010951926. [Back]
2097. 5/19/2007 email from Daniel Sparks, "Mortgages CDO Origination Presentation," GS MBS-E-010973174 (Mr. Sparks: "p. 5 again ‘marked to securitization exit' [re marked to model language]. . . some A and BBB were sold on the deals [re demand only for the supersenior tranche language]"). [Back]
2098. See 5/19/2007 email from Dan Sparks to Lee Alexander, others, GS 2098 MBS-E-010973174 (attached file "Mortgages V3.ppt," GS MBS-E-010973175); and 5/20/2007 9:52 a.m. draft "Mortgages V4.ppt," GS MBS-E- 010952331; compared to final version, 5/20/2007 email from Lee Alexander to Daniel Sparks, Donald Mullen, Lester Brafman, and Michael Kaprelian, "Viniar Presentation - Updated," GS MBS-E-010965211 (attached file "Mortgages V4.ppt," "Mortgages Department, May 2007," GS MBS-E-010965212). [Back]
2099. 5/17/2007 email from Daniel Sparks to Tom Montag, "Ostrem is resigning," GS MBS-E-019654926. [Back]
2100. 5/11/2007 email from Daniel Sparks, "You okay?," GS MBS-E-019659221 ("I'm going to make a change in the responsibility of the business away from Ostrem to david lehman (with Swenson helping)."). [Back]
2101. 5/19/2007 email to David Lehman, "congratulations, but seems like you have a lot of work ahead of you," GS MBS-E-018921924. [Back]
2102. Id. [Back]
2103. 5/19/2007 email from Jon Egol to Daniel Sparks, GS MBS-E-018921924. [Back]
2104. 5/20/2007 email from David Lehman, "ABX hedges – Buy order," GS M 2104 BS-E-011106690 ("begin unwinding certain ABX hedges vs. the CDO WH [warehouse] and transition book"); 6/1/2007 email from Mr. Lehman, "CDO Update," GS MBS-E-001866889 ("liquidated warehouses and the trading books"). [Back]
2105. Subcommittee interview of David Lehman (9/27/2010). [Back]
2106. 5/24/2007 email from Yusuf Aliredha to Mr. Sparks, Mr. Lehman, and others, "Priority Axes," GS MBS-E- 001934732. [Back]
2107. Id. [Back]
2108. 4/27/2007 email from George Maltezos, Goldman Australia sales, to Jon Egol, "utopia," GS MBS-E- 003305101. [Back]
2109. 5/20/2007 email from George Maltezos to David Lehman, "T/wolf and Basis," GS MBS-E-001863555. [Back]
2110. See Goldman Sachs response to Subcommittee QFR at PSI_QFR_GS0226. [Back]
2111. 5/30/2007 email from David Lehman, "Timberwolf – Order from Tokyo Star Bank," GS MBS-E-001934058. Tokyo Star Bank was not on the list of "targeted" customers, but had been solicited previously by the Japan sales team pursuant to an earlier sales directive listing Timberwolf as a priority. [Back]
2112. 6/11/2007 email from syndicate, "GS Syndicate Structured Product 2112 CDO Axes (INTERNAL USE ONLY)," GS MBS-E-001914921-24. [Back]
2113. Id. [Back]
2114. Id. See also "New Investors Board the Asian CDO Train," Creditflux (6/1/2007) (noting that while non bank investors had previously been barred from buying CDO assets in most Asian countries, regulators increasingly allowed life insurance companies and other financial firms to buy them within prescribed limits). [Back]
2115. 6/13/2007 email from Goldman Sachs Japan sales, "**GS SP CDO Axes** – Asia Trade Update (INTERNAL USE ONLY)," GS MBS-E-010803888 [emphasis in original]. [Back]
2116. 6/13/2007 email from Goldman Sachs Japan sales, "**GS SP CDO Axes** – Asia Trade Update (INTERNAL USE ONLY)," GS MBS-E-011212260. [Back]
2117. 6/18/2007 email from David Lehman, "$20mm Point Pleasant trade w/ TK Star Bank," GS MBS-E-011136832. [Back]
2118. Id. [Back]
2119. 6/18/2007 email from Goldman Sachs Japan sales, "Point Pleasant 07-A1 // Tokyo Star Bank (internal use only)," GS MBS-E-001920459 [emphasis in original]. [Back]
2120. See Goldman Sachs response to Subcommittee QFR at PSI_QFR_GS0226; 7/24/2007 email from [Taiwan], "7/23 CDO/RMBS requests from Taiwan," GS MBS-E-011198375, Hearing Exhibit 4/27-67. [Back]
2121. Id. [Back]
2122. 8/15/2007 email from Donald Mullen, "Post," GS MBS-E-009740784, Hearing Exhibit 4/27-32. [Back]
2123. 8/17/2007 email from Michael Swenson, "Twolf super seniors," GS MBS-E-001927791. [Back]
2124. 8/23/2007 email from Jon Egol, "*** SP CDO/Correlation Desk Super Senior Axes *** (INTERNAL USE ONLY), GS MBS-E-011310717. [Back]
2125. Id. Around the same time, a Goldman managing director who 2125 ran Corporate / PWM [Private Wealth Management] Sales in Japan and sold investments to wealthy individuals, inquired: "Do you have any cdo secondary inventory." 8/21/2007 email from PWM Managing Director, GS MBS-E-010619382. He was advised by the SPG Trading Desk that Goldman was "prohibited from offering cdo paper to all pw [private wealth] clients, even [qualified institutional] pw clients. ... To change this, we would have to petition the committee that oversees such things [the Structured Investment Product Committee]." Id. Mr. Lehman added: "Spoke with Sparks about this. Given the complexity of the product, we would like to handle this on a client by client basis." Id. After receiving information that potential clients had previously purchased ABS CDOs from other firms, Mr. Lehman asked Goldman compliance: "What do we need to do on our end to get this approved." 8/28/2007 email from David Lehman, "Japan PWM Client Interest in ABS CDO (internal use only)," GS MBS-E-011090928. One of Mr. Lehman's team members in the Mortgage Department replied: "Ldl [let's discuss live]. Have info on this." Id. Mr. Lehman replied "xoxo." Id. [Back]
2126. 9/5/2007 email from Michael Swenson, "Refresh of Axe Priorities," GS MBS-E-010684858. [Back]
2127. Id. [Back]
2128. Id. [Back]
2129. 9/6/2007 email from Daniel Sparks to syndicate desk, "Refresh of Axes Priorities," GS MBS-E-010685200. [Back]
2130. 3/1/2010 letter from Goldman Sachs to the Financial Crisis 2130 Inquiry Commission, GS-PSI-01310 at 16. [Back]
2131. 4/19/2007 email from Daniel Sparks, "*UPDATE* GS Syndicate Structured Product CDO Axes," GS MBS-E- 010539324, Hearing Exhibit 4/27-102. [Back]
2132. Subcommittee interview of David Viniar (4/13/2010) and Craig Broderick (4/9/2010). [Back]
2133. See, e.g., 2/2007 Goldman email chain, "FYIs," GS MBS-E-002339552 (regarding residential credit scratch & dent loan book: "Has the biz agreed with controllers about how frequently each book is to be marked? Daily? Weekly? Monthly?"; Mr. Sparks' response: "For this book I think monthly is the right way as the data comes monthly on performance. Dramatic mkt moves could change things."). CDOs were often marked monthly, as hedge fund clients generally needed month-end valuations of CDOs in their portfolios to enable them to report hedge fund Net Asset Values (NAVs) to clients. See, e.g., 6/28/2007 email from Bear Stearns, "Missing Marks (15).xls," GS MBS-E-001965860 (portfolio manager requesting month-end marks: "I need the 4 bonds marked for 5/31/07 we still need to report an NAV."); 6/19/2007 email from Lester Brafman to Jon Egol, GS MBS-E-003373736 (regarding Abacus CDO securities, Mr. Egol wrote: "We mark them monthly"). [Back]
2134. See, e.g., 2/12/2007 email from Daniel Sparks, "Post today," GS MBS-E-009763506 (New Century "claim[s] we are the only ones being harsh. C-Bass claims we are the only one margin calling. Our marks are appropriate for moves in the market. More margin calls going out today."). [Back]
2135. Subcommittee interview of David Lehman (4/12/2010). [Back]
2136. Mr. Broderick explained in his interview with the Subcommittee that because of the 2136 volatility in the subprime market, Goldman had an unusually large number of disputes with customers over marks or collateral valuation during 2007. Subcommittee interview of Craig Broderick (4/9/2010). See also 8/2/2007 email from Stacy Bash- Polley, "Marks Summary," GS MBS-E-013349723 (transmitting complaints from eight clients that Goldman's marks were far lower than those of other dealers); 2/12/2007 email from Daniel Sparks, "Post today," GS MBS-E- 009763506 (New Century "claim[s] we are the only ones being harsh. C-Bass claims we are the only one margin calling."); 8/10/2007 Goldman memorandum, "Summary of German Bank US Sub Prime Exposure," GS MBS-E-009994305. This memorandum was generated by Goldman's European Investment Banking Division, FICC Sales and Credit. It highlighted losses incurred by many German banks due to markdowns in the value of U.S. subprime assets, necessitating several European Central Bank bailouts. The memorandum stated: "We understand from clients that valuation marks provided by Goldman Sachs on ABS are substantially lower than the competition's valuations. As a result, clients are irritated by the valuation difference."
Goldman's dispute with AIG FP is another example. The two companies disagreed over both the marks and the amount of collateral and margin that AIG had to post with Goldman in connection with various mortgage products. At one point in the dispute, Co-President Jon Winkelried wrote to his colleagues: "[O]ne thing we're not going to do is compromise on what we think the right marks are and our margin process." 8/2/2007 email from Jon Winkelried, "Aig collateral call," GS MBS-E-010055302. Goldman's dispute with AIG continued for over a year until the Federal Reserve, through the Maiden Lane III transaction, ultimately ensured that Goldman and its customers received 100 cents on the dollar on the bulk of their disputed claims against AIG. Subcommittee interview of David Viniar (4/13/2010). Goldman later told regulators that it had more collateral disputes than anticipated during the financial crisis. 11/13/2007 Goldman email, GS MBS-E-010023525 (attachment, 11/14/2007 "Tri-Lateral Combined Comments," GS MBS-E-010135693-715 at 695). According to Goldman documents, as late as October 30, 2007, its Mortgage Department generated approximately 66% of all derivative collateral disputes by Goldman customers. 10/30/2007 Goldman presentation, "Derivative Collateral Dispute Summary," GS MBS-E- 009882064. [Back]
2137. See, e.g., 8/10/2007 Goldman memorandum, "Summary of German Bank US Sub Prime Exposure," GS MBS-E-009994305 (highlighting losses incurred by many German banks due to markdowns in the value of U.S. subprime assets, necessitating several European Central Bank bailouts). [Back]
2138. 5/11/2007 email from Craig Broderick, "CDOs - Mortgages," 2138 Hearing Exhibit 4/27-84. [Back]
2139. Id. The reference to the "30th floor" was the floor on which Goldman's most senior executives had office space in its New York headquarters. [Back]
2140. 5/11/2007 email from Harvey Schwartz to Daniel Sparks, Tom Montag, and others, GS MBS-E-010780864. As explained earlier, some clients were affected by Goldman's marks even after completing purchase of CDO securities, due to repo financing margin requirements, CDS collateral requirements, or other arrangements. [Back]
2141. 5/11/2007 chain of email exchanges among Messrs. Mullen, Schwartz, Montag, and Sparks, GS-MBS-E- 010780849, Hearing Exhibit 4/27-103. [Back]
2142. Id. [Back]
2143. See, e.g., discussion of Timberwolf CDO, below. [Back]
2144. See Section (3)(a), above. [Back]
2145. 4/2010 "Goldman Sachs Mortgage Department Total Net Short Position, February - December 2007 in $ Billions (including All Synthetic and Cash Positions in Mortgage Related Products)," Hearing Exhibit 4/27-162. [Back]
2146. See 7/25/2007 email from Arbind Jha to Kevin Kao, "Cash bonds," GS MBS-E-011128623 ("huge changes in marks today"). [Back]
2147. 7/29/2007 email from Daniel Sparks to Tom Montag, "Problem," GS MBS-E-010876595 ("[w]e probably should have taken more time to put through the CDO monster remark"). [Back]
2148. 7/29/2007 email from Daniel Sparks to Mr. Mullen, "Problem," GS MBS-E-010876565. [Back]
2149. 7/29/2007 email from Daniel Sparks to Tom Montag, "Problem," GS MBS-E-010876595 ("we rushed it because of Basis and a desire to protect ourselves against counter-parties"). See also 7/13/2007 email from John McHugh to Michael Swenson and David Lehman, "Talking Points Needed for Gary Cohn," GS MBS-E-010853931 ("BSAM [Bear Stearns Asset Management] & other hedge fund managers (most recently Basis Capital) announced they were halting fund redemptions and/or liquidating holdings, with some likely to fail."). [Back]
2150. See 7/31/2007 email chain between Tom Montag and Lloyd Blankfein, "Mortgage Derivative Collateral Disputes – 7/31 Update (COB 7/27 marks)," GS MBS-E-009691545. [Back]
2151. Id. [Back]
2152. Id. By late August, Goldman had instituted a system that required senior management pre-approval for large markdowns. On August 28, 2007, Mr. Lehman sent Mr. Sparks a list of "Mark changes which are greater than 5% / greater than 10%" for his approval. 8/28/2007 email from David Lehman to Daniel Sparks, GS MBS-E-010623779. Mr. Lehman asked whether he should ask Mr. Mullen for approval of the changes greater than 10%, and Mr. Sparks told him to do so. Id. [Back]
2153. Id. [Back]
2154. 8/16/2007 email from Daniel Sparks, "Mort P&L explanation," GS MBS-E-010680327. Since Goldman took the entire net short side in many of its Abacus CDOs, the customers' losses translated directly into gains for Goldman. [Back]
2155. Id. The Correlation Trading Desk reported $145 million in total profits, which were then offset by losses on other mortgage desks. [Back]
2156. 8/16/2007 email from Jon Egol to Michael Swenson, "Projected Corr Customers winners/losers from singlename mark changes," GS MBS-E-011092473, Hearing Exhibit 4/27-33. [Back]
2157. See, e.g., 5/11/2007 email from Craig Broderick, "CDOs - Mortgages," GS MBS-E 2157 -009976918, Hearing Exhibit 4/27-84; see also 8/10/2007 Goldman internal memorandum, "Summary of German Bank US Sub Prime Exposure," GS MBS-E-009994305. [Back]
2158. 10/12/2007 email to Daniel Sparks, "US ABS SS Intermediation Trades," GS MBS-E-013706095, Hearing Exhibit 4/27-70. [Back]
2159. Id. [Back]
2160. 7/24/2007 email from [Taiwan], "7/23 CDO/RMBS requests from Taiwan," GS MBS-E-011198375, Hearing Exhibit 4/27-67. [Back]
2161. 8/2/2007 email from Stacy Bash-Polley to Messrs. Montag, Mullen, Schwartz, and Sparks, "Marks Summary," GS MBS-E-013349723. [Back]
2162. Id. [Back]
2163. 6/21/2007 email from Mr. Sparks to Lester Brafman, "Repo," GS MBS-E-010847490. [Back]
2164. The Subcommittee did identify at least one instance of a mark change. Goldman's China sales representative contacted the ABS Desk to request an increase in a mark on an RMBS security:
"[C]an we try our best to show ‘better' indicative prices for [client]? ... [C]lient is under pressure of being questioned that they bought something looks really bad. ... [W]e showed a price of LBMLT 06 A A1 as of 95-00 . . . this is something hard for client to believe .... [W]e need them to think of GS as the best firm, and we need them to be our best client when next biz boom comes. ... We would highly appreciate if a slightly aggressive price can be showed from trading desk."
5/21/2007 email from China sales representative to Edwin Chin and others, "Mark to market prices," GS MBS-E- 011068490. Mr. Chin moved the mark in question from 95 to 98, and wrote:
"After much discussion internally, we will improve our bid to 98-00 given the market color we have observed in the past two days. The markdown was mostly a reaction to rating agency downgrade and partly reflected the illiquidity of the position, but upon further analysis we have gotten more comfortable with the risk position and agree it should be marked at a higher price."
2165. 8/6/2007 email from David Lehman to Japan 2165 sales, "RE: Tokyo Star," GS MBS-E-001927891. [Back]
2166. Id. [Back]
2167. 6/6/2007 email from David Lehman to Japan sales, "Point Pleasant Marks – request from Tokyo Star Bank," GS MBS-E-001912408-10 at 9. [Back]
2168. 9/26/2007 Goldman Sachs 2007 Performance Review for Michael Swenson, "Reviewee's Feedback," GS-PSI- 02399, Hearing Exhibit 4/27-55b. [Back]
2169. 11/20/2007 email from Thomson IFR - ABS, "ABS: Market Tense as Goldman Predicts RMBS CDO Problems to Drag On," GS MBS-E-013782989. [Back]
2170. Id. [Back]
2171. Id. [Back]
2172. See 9/17/2007 Goldman presentation to Board of Directors, "Residential Mortgage Business, Global Impact of the Mortgage Crisis," at 2, GS MBS-E-001793840, Hearing Exhibit 4/27-41 (noting bankruptcies of Goldman clients IKB and Basis Capital). See also 8/10/2007 Goldman internal memorandum, "Summary of German Bank US Sub Prime Exposure," GS MBS-E-009994305; 11/27/2007 email from David Lehman to Daniel Sparks, "ACA," GS MBS-E-013746511 (discussing "what would happen upon an ACA bankruptcy (which is the most likely scenario in our opinion)."). [Back]
2173. See 6/21/2007 email from Fabrice Tourre, "Post on ACA," GS M 2173 BS-E-002562148. See also ACA Financial Guaranty Corp. v. Goldman, Sachs & Co., Complaint (filed 1/6/2011, Sup. Ct. N.Y) at ¶ 7 (ACA now "operates as a run-off insurance company."), available at http://www.aca.com/press/pdfs/2011/20110106-GoldmanComplaint.pdf. [Back]
2174. April 27, 2010 Subcommittee Hearing at 66. [Back]
2175. Id. [Back]
2176. Id. [Back]
2177. Id. Mr. Sparks went on to say: "I 2177 mentioned we made some bad business decisions. These deals performed horribly. That is bad. ... [T]hat said, just because one person in my business unit or a few people might have had one view, I can tell you there were a lot of people in my business unit that had a very different view, and there were a lot of investors that had a very different view." Id. [Back]
2178. See 5/19/2007 draft Goldman presentation, "Mortgages CDO Origination – Retained Positions & Warehouse Collateral, May 2007," GS MBS-E-010951926. [Back]
2179. 2/8/2007 email from Mr. Sparks, "Post," Hearing Exhibit 4/27-7. [Back]
2180. 3/3/2007 email from Mr. Sparks, "Call," Hearing Exhibit 4/27-14. [Back]
2181. 3/8/2007 email from Mr. Sparks, Mortgage risk," Hearing Exhibit 4/27-75. [Back]
2182. 3/12/2007 Goldman memorandum to Firmwide Risk Committee, "March 7th FWR Minutes," GS MBS-E- 00221171, Hearing Exhibit 4/27-19. [Back]
2183. 2/21/2007 email from Daniel Sparks to Jon Winkelried, "Mortgages today," GS MBS-E-010381094, Hearing Exhibit 4/27-10. [Back]
2184. April 27, 2010 Subcommittee Hearing at 66. The Anderson, Timberwolf, and Abacus 2007-AC1 CDOs were issued in March and April 2007. [Back]
2185. 4/27/2007 email from Deeb Salem to Michael Swenson, GS MBS-E-012432706 (6 of 20 deals in ABX Index put on watch or downgraded). [Back]
2186. 7/10/2007 email to George Maltezos, "GS Cashflow/ABACUS CDOs Mentioned in S&P Report on CDO Exposure to Subprime RMBS," GS MBS-E-001837256; 7/10/2007 email from Goldman Sachs analyst to Goldman Sachs Japan salesman, "GS Cashflow/ABACUS CDOs Mentioned in S&P Report on CDO Exposure to Subprime RMBS," GS MBS-E-001990255 (updating percentage exposure from 25% to 35%). [Back]
2187. Id. [Back]
2188. 10/26/2007 email from Goldman salesman to Michael Swenson, "ABACUS 2188 2007-AC1 – Marketing Points (INTERNAL ONLY) [T-Mail]," GS MBS-E-016034495. [Back]
2189. See "List of WaMu-Goldman Loans Sales and Securitizations," Hearing Exhibit 4/13-47b. [Back]
2190. 2/13/2006 Goldman chart, "Current Warehouse Facilities and Funded Balances," GS MBS-E-001157934. [Back]
2191. See Chapters III and IV, above. [Back]
2192. See, e.g., 4/14/2005 OTS email, "Fitch," OTSWME05-2192 012 0000806, Hearing Exhibit 4/13-8a. [Back]
2193. 2/8/2007 email from Goldman analyst to Mr. Sparks, Mr. Gasvoda, and others, "2006 Subprime 2nds Deals Continue to Underperform **INTERNAL ONLY**," GS MBS-E-003775340, Hearing Exhibit 4/27-167d. [Back]
2194. 5/17/2007 email from Deeb Salem to Michael Swenson, "FW: LBML 06A," GS MBS-E-012550973, Hearing Exhibit 4/27-65. [Back]
2195. See wamusecurities.com. [Back]
2196. For more information about Fremont, see Chapter IV, Section D(2)(d). [Back]
2197. 3/7/2007 Fremont General Corporation 8-K filing with the SEC. [Back]
2198. 11/16/2006 Goldman internal email, "ACA and Freemont [sic] deal," Hearing Exhibit 4/27- 173. [Back]
2199. 3/14/2007 Goldman email, "NC Visit," GS-MBS-E-002048050. [Back]
2200. Id.; see also 8/10/2007 email from Michelle Gill, "Fremont - Incremental Information," GS MBS-E-009860358 (Goldman's repurchase claims against Fremont would have amounted to a 9% ownership stake in Fremont after a proposed buyout by investor group; Goldman was not the largest purchaser of Fremont loans but its repurchase claims were 3-4 times larger than the claims of the nearest counterparty). [Back]
2201. See Goldman Sachs response to Subcommittee QFR at PSI_QFR_GS0040. [Back]
2202. 2/20/2007 Goldman memorandum to Mortgage Capital Committee, "Request for renewal of the existing $1 billion ... 1-year revolving warehouse facility," GS MBS-E-001157942. Goldman wrote the Fremont produced "revenues totaling $13.38 million in 2006 of which $620,000 came in the form of warehouse usage and commitment fees." [Back]
2203. See 2/2/2007 Goldman memorandum to the Mortgage Capital Committee, 2203 "Agenda for Monday, February 5, 2007," GS MBS-E-002201064; 2/5/2007 Mortgage Capital Committee Memorandum regarding GSAMP Trust 2007-FM2, GS MBS-E-002201055 - 58. [Back]
2204. 1/24/2007 S&P internal email, "Quick Question: Fremont," Hearing Exhibit 4/23-93b. See also 2/1/2007 S&P internal email, "Defaults cause Fremont to end ties to 8,000 brokers," Hearing Exhibit 4/23-93d (S&P analysts circulated an article about how Fremont had stopped using 8,000 brokers due to loans with some of the highest delinquency rates in the country). [Back]
2205. 1/24/2007 S&P internal email, "RE: Quick Question: Fremont," Hearing Exhibit 4/23-93c. [Back]
2206. 4/17/2010 S&P downgrade of GSAMP Trust 2007-FM2 containing Fremont mortgages, Hearing Exhibit 4/23- 93f. [Back]
2207. See 3/21/2007 Goldman spreadsheet, "RMBS CDS Trade History 19Jan06 - 19Mar07 v3," GS MBS-E- 013648130. [Back]
2208. See Standard & Poor's www.globalcreditportal.com. [Back]
2209. In some cases, Goldman used assets from its own inventory or warehouse accounts, so that it could transfer assets with falling value to the CDO and the investors who purchased the CDO securities. The Subcommittee examined seven of those CDOs, and of those, 57% of the CDOs' assets were sourced from Goldman, including over $3 billion in synthetic assets in which Goldman was the short party, and therefore stood to profit from a decline in the value of the underlying assets. [Back]
2210. Mezzanine subprime RMBS assets are RMBS securities that carry a credit 2210 rating of BBB or BBB- or CDS contracts that reference those types of RMBS securities. Mezzanine RMBS assets are riskier than AAA, AA, and A rated RMBS securities, but less risky than those that carry, for example, BB, B, or CCC ratings. [Back]
2211. The ABX Index tracks the performance of a designated basket of 20 subprime RMBS securitizations. It consists of five separate indices, each of which tracks a different subset of the RMBS basket, divided according to credit ratings. The indices that track the mezzanine RMBS securities, for example, track the 20 RMBS securities that carry BBB and BBB- credit ratings. In ABX assets, investors enter into CDS contracts in which one party takes the long side, essentially betting that the ABX indices tracking the mezzanine RMBS securities will increase in value, while the other party takes the short side, essentially betting that the indices will fall in value. Prior to establishing the Hudson CDO, Goldman had taken the long side in a number of CDS contracts linked to the ABX indices tracking mezzanine RMBS securities. [Back]
2212. 10/2006 Goldman document, "Hudson Mezzanine Funding 2006-1, Ltd.," Hearing Exhibit 4/27-87. The first Hudson CDO, Hudson High Grade, was issued in September 2006. The second, discussed here, was Hudson Mezzanine 2006-1, issued in October 2006. The third was Hudson Mezzanine 2006-2, issued in February 2007. [Back]
2213. Id. For more information about Goldman's role as the liquidation agent in Hudson, see Section C(5)(b)(iii)AA, below. [Back]
2214. In synthetic CDOs, the cash proceeds from the sales of the CDO securities were used to purchase "collateral debt securities." Later, when cash was needed to make payments to a long or short party, those collateral securities were sold, and the cash was used to make the payments. In the event the collateral securities could not be sold for face (par) value, the collateral put provider paid the difference to the CDO. For more information about the role of collateral put providers, see Section C(5)(b)(iii)BB, below. [Back]
2215. See 2/18/2008 Goldman document, "CDO Transactions (July 1, 2006 - December 31, 2007) in which Goldman Sachs acted as underwriter," GS MBS 0000004337 at 4338. Acting as the "senior swap counterparty" meant that Goldman served as an intermediary between the Hudson CDO and the super senior investor. Acting as "credit protection buyer" meant that Goldman initially took the short side of the CDO and, in the case of Hudson 1, kept 100% of the short side during the life of the CDO. [Back]
2216. See Goldman 2216 response to Subcommittee QFR at PSI_QFR_GS0239. [Back]
2217. 9/20/2006 email from Arbind Jha to Josh Birnbaum, GS MBS-E-012685289. See also 9/20/2006 Firmwide Risk Committee Minutes, GS MBS 0000004472. [Back]
2218. See 10/24/2006 email from Jonathan Sobel to Tom Montag, Dan Sparks, and others, GS MBS-E-010919930 ("CDO should price tomorrow and is in good shape. ... We also are starting to see some short covering, which we will sell into to further reduce our risk toward your 50% goal."). [Back]
2219. Subcommittee interview of Michael Swenson (4/16/2010). Mr. Swenson told the Subcommittee that Goldman had been long "several billion" in ABX in September 2006. [Back]
2220. 8/9/2006 Firmwide Risk Committee Minutes, GS MBS-E-009682590; Subcommittee interview of Joshua Birnbaum (10/1/2010). Mr. Birnbaum recalled a "directive" to reduce ABX exposure in the summer of 2006. [Back]
2221. See, e.g., 9/21/2006 email from Jonathan Sobel to Tom Montag, "ABX wider again today," GS MBS-E- 009739145 ("Down about $10mm."); 9/12/2006 email from Jonathan Sobel to Michael Swenson and Daniel Sparks, "ABX," GS MBS-E-012681410 ("The last post you gave me was this morning when you thought things were ‘firm'. Now I find out that we're down $6mm on the day. I understand things move, but you need to post me. Also, I want to reduce this position."); 9/9/2006 Firmwide Risk Committee Minutes, GS MBS 0000004468 ("Business continuing to reduce volatile ABX position."); 8/23/2006 Firmwide Risk Committee Minutes, GS MBS-E-009615593 ("Mortgages sold down another net 15% of their large ABX position."). [Back]
2222. 9/19/2006 email from Jonathan Sobel to Daniel Sparks, Michael Swenson, and Josh Birnbaum, GS MBS-E- 012683946. [Back]
2223. 9/19/2006 email from Josh Birnbaum to Michael Swenson, GS M 2223 BS-E-012683946. Mr. Sobel also informed Mr. Swenson later that day: "We need to reach a conclusion on the viability of a structured exit." 9/19/2006 email from Jonathan Sobel to Michael Swenson, GS MBS-E-012328199. [Back]
2224. Subcommittee interview of Peter Ostrem (10/5/2010). [Back]
2225. Id.; Subcommittee interview of Darryl Herrick (10/13/2010). [Back]
2226. 9/19/2006 calendar invite from Michael Swenson, GS MBS-E-012328194. [Back]
2227. 9/19/2006 email from Peter Ostrem, GS MBS-E-01818608, Hearing Exhibit 4/27-86. Goldman later told the Subcommittee that Hudson actually offset $1.39 billion in ABX assets on its books. Goldman response to Subcommittee QFR, PSI_QFR_GS0239. [Back]
2228. 9/20/2006 email from Michael Swenson to Jonathan Sobel, GS MBS-E-012328203. See discussion of selection of 60 single names by Mr. Herrick and Mr. Salem, below. [Back]
2229. 9/20/2006 Firmwide Risk Committee Minutes, GS MBS 0000004472; 9/20/2006 email from Arbind Jha to Josh Birnbaum, GS MBS-E-012685289. [Back]
2230. 9/21/2006 email from Jonathan Sobel to Tom Montag, G 2230 S MBS-E-009739145. [Back]
2231. See, e.g., 10/16/2006 email from John Li to Darryl Herrick, "Call Arbind Jha," GS MBS-E-018209595 ("Regarding Hudson Mezz Risk issue"). [Back]
2232. 9/20/2006 email from Arbind Jha to Josh Birnbaum, GS MBS-E-012685289. When asked about this email and Hudson 1 in general, Mr. Birnbaum told the Subcommittee that he had no specific recollection of any involvement with the Hudson 1 CDO. Subcommittee interview of Joshua Birnbaum (10/1/2010). [Back]
2233. 10/12/2006 email from Arbind Jha, "Re: Risk Issue," Hearing Exhibit 4/27-88. [Back]
2234. 9/20/2006 Firmwide Risk Committee Minutes, GS MBS 0000004472. [Back]
2235. See, e.g., 3/23/2007 "CDO Rating Factors: Inclusion of Tranched ABX Indices in ABS CDOs," Moody's, Document No. SF95049. [Back]
2236. The ABX 06-1 Index and the ABX 06-2 Index each tracked a completely different set of 20 RMBS securitizations. Each Index also had its own subset of five indices tracking individual securities issued by those 20 securitizations, divided by credit rating. For example, one of the RMBS securitizations tracked by the ABX 06-2 Index was called CWL 2006-8. One of the sub-indices within the ABX 06-2 Index tracked BBB rated securities that were issued as part of the 20 securitizations, including the M8 tranche of CWL 2006-8 which carried a BBB rating. Another of the five indices tracked the securities carrying a BBB- rating, including the M9 tranche of CWL 2006-8 which carried that credit rating. The CWL 2006-8 M8 and CWL 2006-M9 securities were just two of the 40 BBB and BBB- rated securities issued by the 20 RMBS securitizations in the ABX 06-2 Index. The ABX 06-1 Index functioned the same way; its sub-indices tracked another 40 mezzanine RMBS securities from the 20 RMBS securitizations that composed that Index. [Back]
2237. A "single name CDS" contract uses a single security as its reference obligation, 2237 such as a specific RMBS security. [Back]
2238. For simplicity, all 20 assets in each of the ABX baskets were given the same weighted price in Hudson 1. [Back]
2239. See, e.g., 4/27/2007 email from Fabrice Tourre to Michael Swenson, Deeb Salem, and Edwin Chin, GS MBS-E- 012432742. [Back]
2240. Mr. Swenson described this situation in his testimony before the Subcommittee: "Throughout 2006, numerous clients wanted to sell the ABX in order to express a negative view on the U.S. residential housing market. As a result of these trades, we took on long positions. In order to hedge those positions, we began to increase our short position in single-names. By November 2006, volatility in the ABX increased, pushing prices down. Because our positions in single names did not match identically the basket of securities that comprised the ABX, the positions moved at different rates and even different directions, resulting in losses for the ABS desk." Prepared statement of Michael Swenson, April 27, 2010 Subcommittee Hearing, at 208-09. [Back]
2241. Goldman decided to price the single name assets at one point below the median ABX trading price. See 9/21/2006 email from Darryl Herrick to Deeb Salem, Michael Swenson, Joshua Birnbaum, Peter Ostrem, and Edwin Chin, GS MBS-E-012685645. [Back]
2242. See 10/2/2006 email from Darryl Herrick to Michael Swenson, Joshua Birnbaum, 2242 Deeb Salem, Peter Ostrem, and Daniel Sparks, GS MBS-E-010913416 ("We plan to announce Hudson Mezzanine Funding tomorrow in the am for Europe, Asia and the US[.] I'm circulating around to everyone the CDO portfolio and spreads we will be showing investors and agencies, based on our agreed upon amounts and levels from last week."). Mr. Swenson responded: "Darryl we should use the 265 and 245 spread for the ABX2 and ABX1 triple-B minus spreads and 145 and 130 for triple-B ABX2 and ABX1 triple-B spreads." Id. [Back]
2243. The gain generated by the CDS single name contracts was retained on the books of the ABS Desk, and created a favorable "basis" compared to the cost of the ABX long position held by the desk. See 4/27/2007 email from Fabrice Tourre to Michael Swenson, Deeb Salem, and Edwin Chin, GS MBS-E-012432742; Goldman response to Subcommittee QFR at PSI_QFR_GS0239. See also 9/19/2006 email from Michael Swenson to Thomas Cornacchia and Joshua Birnbaum, GS MBS-E-012684557 ("[ABX] Index to single-name basis is at the wides[t] (ie 40 bp at BBB- level). Index to cash is even more extreme at 70bp. Bids for cash deals remain strong and have barely widened."); Performance Review for Michael Swenson, GS-PSI-02396, Hearing Exhibit 4/27-55b (describing the mortgage trading desk's strategy of shorting single-name RMBS to offset long ABX positions: "[D]uring the early summer of 2006 it was clear that the market fundamentals in subprime and the highly levered nature of CDOs was going to have a very unhappy ending. The beauty of the CDO short was that it allowed for a very efficient method for capturing the value in the ABX to single-name basis from the short side."). [Back]
2244. Subcommittee interview of Darryl Herrick (10/13/2010). See also 10/8/2006 email from Darryl Herrick to a Goldman salesperson, GS MBS-E-017502983 (discussing Hudson 1: "Omar, I realize lack of manager may be tough hurdle for them [investors]. May be helpful to let Deeb and I get on a call with the investor and discuss our asset selection criteria and I can go through asset sale criteria."). [Back]
2245. See 9/19/2006 email from Darryl Herrick to Deeb Salem, Peter Osterm, others, GS MBS-E-011402123, with attachment GS MBS-E-011403442 (Mr. Salem wrote to Mr. Herrick: "Attached are 60 RMBS Ref Obs ... for the CDO we're discussing. On the RMBS side, we chose 30 Baa2 and 30 Baa3 CUSIPs evenly split btw 2005 and 2006 vintage. We can add a few alt-a names as well. How many of those would you like?"). When interviewed by the Subcommittee, Mr. Salem had no specific recollection of how assets were selected for Hudson 1 and little specific recollection about Hudson 1 as a whole. Subcommittee interview of Deeb Salem (10/6/10). [Back]
2246. See, e.g., 2246 Goldman response to Subcommittee QFR, PSI_QFR_GS0192. [Back]
2247. Goldman used the cash paid into Hudson 1 to purchase "collateral securities," as discussed further below. [Back]
2248. See 10/30/2006 email from Peter Ostrem, GS MBS-E-0000057886, Hearing Exhibit 4/27-90 ("Super senior note ($1.2bln in size) was executed in the first week of the transaction and was a key driver of this deal[']s success."). [Back]
2249. The $1.2 billion investment made by Morgan Stanley did not correspond to the CDO's $1.2 billion in CDS contracts referencing RMBS securities in the two ABX indices. Rather, Morgan Stanley was investing in the top tier of the CDO as a whole, which included CDS contracts referencing both the ABX and other RMBS securities. [Back]
2250. Subcommittee interview of Darryl Herrick (10/13/2010). See further discussion of Morgan Stanley investment in Section C(5)(b)(iii)AA, below. [Back]
2251. 9/27/2006 email from Michael Swenson to Crystal Young, GS MBS-E-012328848. Mr. Swenson told the Subcommittee that he had no recollection of this conference call, and that it would have been unusual for him to be involved in the marketing efforts of a CDO. Subcommittee interview of Michael Swenson (10/8/2010). [Back]
2252. 9/28/2006 email from Darryl Herrick, GS MBS-E-014042217, with attachments GS MBS-E-014042218 and GS MBS-E-014042220. [Back]
2253. 9/30/2006 email from Darryl Herrick to Peter Ostrem, Benjamin Case, 2253 and Matthew Bieber, GS MBS-E- 014367160, with attachment GS MBS-E-014367161; 9/30/2006 Goldman internal email chain among Darryl Herrick, Peter Ostrem, Benjamin Case, and Matthew Bieber, GS MBS-E-017504075. [Back]
2254. 10/2006 Hudson Mezzanine Funding 2006-1, LTD., GS MBS-E-009546963, at 966, Hearing Exhibit 4/27-87. [Back]
2255. Id. at 966, 978. [Back]
2256. See Goldman 2256 response to Subcommittee QFR, at PSI_QFR_GS0223. [Back]
2257. Barron's Dictionary of Finance and Investment Terms defines "the Street" as "referring to the financial community in New York City and elsewhere. It is common to hear ‘The Street likes XYZ.' This means there is a national consensus among securities analysts that XYZ's prospects are favorable." [Back]
2258. Subcommittee interview of Andrew Davilman (9/30/2010). [Back]
2259. Subcommittee interview of Morgan Stanley (6/24/2010). [Back]
2260. The Subcommittee asked Mr. Ostrem whether he considered the Hudson 1 assets to be the RMBS securities or the credit default swaps referencing those securities, and Mr. Ostrem responded that the assets in the CDO were the RMBS securities which had been originated by a variety of financial institutions on Wall Street. When asked why it would be important to indicate to investors that not all the underlying RMBS securities were underwritten by Goldman, given that this information would be clear to a professional reviewing the names of the reference assets in Hudson 1, Mr. Ostrem replied that he didn't know. Subcommittee interview of Peter Ostrem (10/5/2010). [Back]
2261. Subcommittee interview of Deeb Salem (10/6/2010). [Back]
2262. Subcommittee interview of David Lehman (9/27/2010); Subcommittee interview of Matthew Bieber (10/21/2010). [Back]
2263. 12/3/2006 Hudson Mezzanine 2006-1, LTD. 2263 Offering Circular, GS MBS-E-021821196. [Back]
2264. Id. at 021821241. [Back]
2265. See, e.g., 9/19/2006 email from Michael Swenson to Thomas Cornacchia and Joshua Birnbaum, GS MBS-E- 012684557 ("we are going to price an innovative full capital structure $1+bb CDO deal with 60% of the risk in ABX (no one has done this before)."); 9/21/2006 email from Darryl Herrick to Deeb Salem, Michael Swenson, Joshua Birnbaum, Peter Ostrem, and Edwin Chin, GS MBS-E-012685645. [Back]
2266. 9/27/2006 email from Michael Swenson to Joshua Birnbaum, GS MBS-E-012689798. [Back]
2267. 12/3/2006 Hudson Mezzanine 2006-1, LTD. Offering Circular, GS MBS-E-021821196, at 021821229. This disclosure related to the master credit default swap, where Goldman Sachs International served as the credit protection buyer facing the Hudson Mezzanine 2006-1, Ltd., the legal entity that issued the Hudson 1 securities. See 12/1/2006 ISDA Master Agreement, GS MBS-E-021822056. In this role, Goldman was serving as an intermediary, and was protecting the CDO from credit risk by placing the Goldman Sachs name on the transaction and assuring investors that a single credit-worthy entity would be making all required payments to the Hudson 1 trust. Having one broker-dealer intermediate between the market and a CDO vehicle was desirable to credit rating agencies in order to minimize risk in the CDO, and Goldman clearly disclosed this role to investors. [Back]
2268. Goldman intermediated between other broker-2268 dealers and the CDO vehicle in Anderson Mezzanine Funding 2007-1, Camber 7, Hudson Mezzanine 2006-1, Hudson Mezzanine 2006-2, and Timberwolf I, among several other CDOs. See Goldman response to Subcommittee QFR, at PSI_QFR_GS0192. [Back]
2269. 12/3/2006 Hudson Mezzanine 2006-1, LTD. Offering Circular, GS MBS- E-021821196, at 021821251. [Back]
2270. 10/16/2006 email exchange between Daniel Sparks and Peter Ostrem, GS MBS-E-010916991 ("Cambridge is upset that we are delaying their deal. They know that Hudson Mezz (GS prop deal) is pushing their deal back."). [Back]
2271. Firmwide Risk Committee meetings were often chaired by David 2271 Viniar and frequently attended by Lloyd Blankfein and Gary Cohn. See 9/20/2006 Firmwide Risk Committee Minutes, GS MBS 0000004472; 9/27/2006 Firmwide Risk Committee Minutes, GS MBS 0000004474; 10/4/2006 Firmwide Risk Committee Minutes, GS MBS 0000004476; 10/11/2006 Firmwide Risk Committee Minutes, GS MBS 0000004478; 11/1/2010 Firmwide Risk Committee Minutes, GS MBS 0000004484. See also 10/11/2006 email from Arbind Jha to Joshua Birnbaum, GS MBS-E-012695030 ("Sobel this morning in the firmwide risk committee mentioned that we have circled up the junior and some of the equity tranches"). [Back]
2272. 10/25/2006 email from Jonathan Sobel to David Viniar and Gary Cohn, GS MBS-E-009757821. [Back]
2273. 10/12/2006 email from Thomas Cornacchia to Peter Ostrem and others, GS MBS-E-0000066413. [Back]
2274. 10/26/2006 email from Arbind Jha, "MarketRisk: Mortgage Risk Report (cob 10/25/2006)," GS MBS-E- 0000056041, Hearing Exhibit 4/27-89. That same day, October 26, 2006, Mr. Swenson also described the risk transfer to Goldman executive Bill McMahon when updating him on the trading desk's ABX position: "In addition to $2bb of risk that was placed into the CDO, we have sold to retail since 4pm yesterday $2bb of BBB- risk." 10/26/2006 email from Michael Swenson to Bill McMahon, others, GS MBS-E-0000054856. [Back]
2275. 10/11/2006 Goldman internal email, "FW: Hudson Mezz," GS MBS-E-017502610, Hearing Exhibit 4/27-170c. (A Goldman employee asked a sales associate: "what specifically did AIB say was ‘junk' about the hudson mezz deal?" The employee then forwarded the email to Mr. Herrick saying: "You may want to ask [the sales associate] about this when she's there tomorrow and Friday. ... She said ‘AIB are too smart to buy this kind of junk.'"). [Back]
2276. 10/19/2006 email from Mitchell Resnick to Jonathan Egol, Darryl Herrick, and David Rosenblum, GS MBS-E- 009557391. "HGS1" refers to Abacus HGS1, a CDO2 where Goldman, as in Hudson 1, held 100% of the short interest. [Back]
2277. 10/20/2006 email from Paul Carrett to Darryl Herrick, GS MBS-E 2277 -018321286 [emphasis in original]. [Back]
2278. 10/11/2006 email from Darryl Herrick to Michael Swenson, David Lehman, and Josh Birnbaum, GS MBS-E- 0000030518. Mr. Swenson told the Subcommittee he had no recollection of being involved in the marketing of Hudson 1. Mr. Swenson said he did not work on CDOs and would not typically be involved in the marketing of CDOs. Subcommittee interview of Michael Swenson (10/8/2010). [Back]
2279. 10/12/2006 email from Michael Swenson to David Rosenblum and Peter Ostrem, GS MBS-E-0000030518. [Back]
2280. 10/25/2006 email from Jonathan Sobel to David Viniar and Gary Cohn, GS MBS-E-009757821. [Back]
2281. Subcommittee interview of Darryl Herrick (10/13/2010). [Back]
2282. Subcommittee interview of Darryl Herrick (10/13/2010). When asked if it was common to divide unsold securities between the CDO Desk and the ABS Desk, Mr. Herrick said unsold securities were usually split with the sponsor of a CDO. His response suggests that Goldman viewed the ABS Desk as the sponsor of Hudson 1, since it was designed to offset the risk associated with the ABS Desk's ABX assets. See also 2/28/2007 email from David Rosenblum to Peter Ostrem, GS MBS-E-001800707 ("are we still sharing 50pct of ups and downs on [Hudson]."). [Back]
2283. 10/30/2006 email from Peter Ostrem, "Great Job on Hudson Mezz," GS MBS-E-0 2283 000057866, Hearing Exhibit 4/27-90. [Back]
2284. Goldman told the Subcommittee that Hudson experienced a gross gain of $1.697 billion offset by a loss of $1.39 billion (rather than $1.2 billion) in ABX assets on its balance sheet. 8/4/2010 email from Goldman to the Subcommittee, PSI_QFR_GS0243. [Back]
2285. See Goldman response to Subcommittee QFR at PSI_QFR_GS0239. [Back]
2286. Id. [Back]
2287. Id. [Back]
2288. Id., at PSI_QFR_GS_0280. [Back]
2289. 3/4/2006 email from Fabrice Tourre to George Maltezos, others, GS MBS-E-006638833. [Back]
2290. See Goldman response to Subcommittee QFR, at PSI_QFR_GS0211. [Back]
2291. 11/21/2008 letter from Goldman to Morgan Stanley, HUD-CDO-00005125. [Back]
2292. See Goldman response to Subcommittee QFR, at PSI_QFR_GS0223 and PSI_QFR_GS0235. [Back]
2293. "Mezzanine" CDS assets reference securities t 2293 hat carry a credit rating of BBB or BBB-. Mezzanine assets are riskier than AAA, AA, and A rated assets, but less risky than those that carry, for example, BB, B, or CCC ratings. [Back]
2294. Some documents indicate the CDO was slated to be Hudson Mezzanine 2006-2. But in December 2006, Goldman delayed Anderson in favor of issuing an ABX based CDO named Hudson Mezzanine 2006-2. Several of the documents cited in this section use the terms "Hudson" or "Hudson Mezz" when in fact they refer to Anderson. None of the Goldman employees interviewed by the Subcommittee could recall the reason for changing the name of the CDO to Anderson. [Back]
2295. 9/25/2006 Goldman memorandum to the Mortgage Capital Committee, GS MBS-E-013475756-62 (hereinafter "9/25/2006 MCC Memorandum"). The MCC Memorandum states that Goldman was approached by GSC, but may be using standard language reused in many MCC Memoranda. In an interview with the Subcommittee, Edward Steffelin, a Senior Trader at GSC, stated that Goldman approached GSC about partnering in the transaction, and the memorandum language was "probably backward." Subcommittee interview of Edward Steffelin (12/10/2010). [Back]
2296. 9/25/2006 MCC Memorandum, GS MBS-E-013475756-62. [Back]
2297. See Goldman response to Subcommittee QFR at PSI_QFR_GS0434. Goldman noted in its QFR response that the information used for its response had been voluntarily provided by Goldman employees. [Back]
2298. 5/10/2006 email from Curtis Willing to David Solomon and Dan Holland, GS MBS-E-013870906-7. The Elliot Bridge Fund eventually invested in Anderson. [Back]
2299. 4/17/2006 email from Curtis Willing to David Solomon and Dan Holland, GS MBS-E-013870906-7. [Back]
2300. 5/14/2006 and 5/10/2006 emails from Dan Sparks to Curtis Willing, GS MBS-E-013870906-7. [Back]
2301. 9/25/2006 MCC Memorandum, G 2301 S MBS-E-013475756-62. [Back]
2032. 8/8/2006 email from Edward Steffelin to Peter Ostrem and others, "GS/GSC EB Prop deal," GS MBS-E- 000904603. 8/8/2006 email from Peter Ostrem to Edward Steffelin, Joshua Bissu and others, GS MBS-E- 000904603 (Mr. Ostrem writes: "Happy to source assets via GSC."). See e.g., 9/26/2006 email from Mr. Bissu to Matthew Bieber, "Names for tomorrow," GS MBS-E-014335388. [Back]
2303. Subcommittee interview of Edward Steffelin (12/10/2010). [Back]
2304. See 3/5/2007 emails between Matthew Bieber and Joshua Bissu, GS MBS-E-014605918. [Back]
2305. See 3/6/2007 email from Joshua Bissu to Matthew Bieber and Peter Ostrem, GS MBS-E-014597705. [Back]
2306. 8/8/2006 email from Edward Steffelin to Peter Ostrem and others, "GS/GSC EB Prop deal," GS MBS-E- 000904603. GSC frequently executed trades with Goldman's Correlation Trading Desk, and was known to have a "long/short strategy" in which it shorted assets it considered expensive and went long assets it thought were undervalued. See 9/15/2006 email from Geoffrey Williams to Correlation Trading Desk, GS MBS-E-009471708. See e.g., 10/31/2006 email from Shelly Lin to Joshua Bissu, and Matthew Bieber, GS MBS-E-016473768. [Back]
2307. 10/31/2006 email from Curtis Willing, GSC Trades, GSC-CDO-FCIC-0029698; 10/31/2006 email from Deeb Salem, "Re: GSC-Hudson Mezz 2," GS MBS-E-000905571. A former GSC employee interviewed by the Subcommittee also indicated that the short positions were taken on Anderson assets in an effort to hedge GSC's warehouse risk. Subcommittee interview of Edward Steffelin (12/10/2010). [Back]
2308. 10/31/2006 email from Shelly Lin to Joshua Bissu and Matthew Bieber, GS MBS-E-016473768. See also 10/31/2006 email from Shelly Lin to Deeb Salem, Edwin Chin, and Matthew Bieber, GS MBS-E-000905571 ("GSC wants to short into the deal the amounts listed below. They'd like to trade the ones they want to hedge with your desk as well. I think they also did this with your desk a few weeks ago."). When Mr. Bieber was shown this document during his 10/21/2010 interview with the Subcommittee he stated he didn't know if GSC had shorted assets and that he didn't know what Ms. Lin meant by her statement. Subcommittee interview of Matthew Bieber (10/21/2010). [Back]
2309. Subcommittee interview of Matthew Bieber (10/20/2010); Subcommittee interview of Edward Steffelin (12/10/2010). [Back]
2310. Id. [Back]
2311. See Goldman response to Subcommittee QFR at PSI_QFR_GS0192. [Back]
2312. This number was compiled using a list of referenced securities supplied by Goldman at QFR_PSI_GS0192 and registration statements available at www.sec.gov. When looking at all mortgages underlying each reference security, New Century originated 48% by value of the underlying mortgages. However, each mortgage may have a different weight in the Anderson CDO based on the size of the reference security it is held in. Therefore, the economic effect of the New Century mortgages could be greater than or less than 48%. The next largest mortgage originator by value was Countrywide at 8%. [Back]
2313. See, e.g., 1/4/2007 Goldman presentation, "Sub-Prime Mortgage Lenders - Update," GS MBS-E-009978840-59, Hearing Exhibit 4/27-169. [Back]
2314. See discussion of Goldman's net short position, Section C(4), above. [Back]
2315. 2/8/2007 email from Craig Broderick to Daniel Sparks, 2315 David Viniar, others, GS MBS-E-002201486. [Back]
2316. 3/8/2007 email from Daniel Sparks to senior executives, GS MBS-E-002206279, Hearing Exhibit 4/27-75. [Back]
2317. 2/23/2007 email from Daniel Sparks to senior executives, GS MBS-E-009759477. [Back]
2318. 2/25/2007 email from Daniel Sparks to Tom Montag, GS MBS-E-019164799. See also 2/23/2007 email from Daniel Sparks to senior executives, GS MBS-E-009759477 ("We liquidated 3 CDO warehouses today and started the liquidation of another. We may liquidate one more next week."). [Back]
2319. 2/28/2007 email from David Rosenblum to Peter Ostrem, GS MBS-E-001800707. [Back]
2320. 2/24/2007 email from Deeb Salem to Michael Swenson, Edwin Chin, and Josh Birnbaum, GS MBS-E- 018936137-38. [Back]
2321. 2/24/2007 email from Peter Ostrem 2321 to colleagues, GS MBS-E-010383828-29. [Back]
2322. 2/24/2007 email from Daniel Sparks to Peter Ostrem, others, GS MBS-E-001996601, Hearing Exhibit 4/27-95. [Back]
2323. 2/25/2007 Goldman internal email chain, GS MBS-E-001996601, Hearing Exhibit 4/27-97. [Back]
2324. Id. [Back]
2325. Id. [Back]
2326. 3/2/2007 email from Jon Egol to Daniel Sparks and others, GS MBS-E-010637566, Hearing Exhibit 4/27-97. [Back]
2327. 3/2/2007 email from Daniel Sparks to Jon Egol and others, 2327 GS MBS-E-010637566, Hearing Exhibit 4/27-97. [Back]
2328. 3/2/2007 email from Jon Egol to colleagues, "Re: Abacus AC1," GS MBS-E-002676413, Hearing Exhibit 4/27- 64. [Back]
2329. 3/13/2007 email from Peter Ostrem to Scott Wisenbaker and Matthew Bieber, GS MBS-E-000898410, Hearing Exhibit 4/27-172. [Back]
2330. In mid-March, Mr. Ostrem informed the GSI Risk Committee that Goldman's estimated losses on the assets in the Anderson warehouse account had reached $22.9 million. 3/16/2007 Goldman Sachs International Risk Committee memorandum, "GSI Warehousing for Structured Product CDOs," GS MBS-E-001806010-16. [Back]
2331. 5/31/2007 email from Goldman client to Andrew Davilman, 2331 GS MBS-E-015550857-58. Andrew Davilman relayed the message to Matthew Bieber, who suggested the client might be interested in higher rated securities. Mr. Davilman responded: "I'll check, but given the portfolio I suspect he's looking for a cleaner start." [Back]
2332. 3/16/2007 email from Russell Brocato to Scott Wisenbaker, GS MBS-E-000902498, Hearing Exhibit 4/27-172. Mr. Bieber and Mr. Ostrem were also informed by a salesperson that the client was "out on Anderson - they feel like the deal will be dow[n]graded and have interest coverage issues." Mr. Ostrem instructed the Goldman salesperson to "[f]ix the miscommunication so the probability [of sale] goes up." [Back]
2333. 3/14/2007 email from Matthew Bieber to Scott Wisenbaker and others, GS MBS-E-000908336, Hearing Exhibit 4/27-172 ("Looking like both dcp and terwin out. New Century issues."). [Back]
2334. 3/13/2007 email from Wendy Rosenfeld at Rabobank to Olivia Ha at Goldman, GS MBS-E-000898417, Hearing Exhibit 4/27-172. [Back]
2335. 3/6/2007 email from Joshua Bissu to Matthew Bieber and Peter Ostrem, GS MBS-E-014597705. [Back]
2336. 3/8/2007 email from Daniel Sparks to senior executives, GS MBS-E-002206279, Hearing Exhibit 4/27-75. [Back]
2337. 3/13/2007 email from Manisha Nanik to Loren Morris, 2337 "New Century EPDs," at GS MBS-E-002146861, Hearing Exhibit 4/27-77. See also 2/2/2007 email from Matthew Nichols to Kevin Gasvoda and others, GS MBS-E- 005556331 ("NC is running a 10% drop rate [due diligence drop] at ~6 points / drop and 4% EPD rate at close to 20 points."); 2/8/2007 email from John Cassidy to Joseph Ozment, others, GS MBS-E-002045021 ("Given the current state of the company I am no longer comfortable with the practice of taking loans with trailing docs . . . that we need in order to conduct compliance testing."). [Back]
2338. 3/1/2007 email from Scott Wisenbaker to Peter Ostrem and Matthew Bieber, GS MBS-E-000893661, Hearing Exhibit 4/27-172. [Back]
2339. 2/2007 Anderson Mezzanine Funding 2007-1, Ltd. Debt Marketing Book, GS MBS-E-000855351. [Back]
2340. 2/2007 Anderson Mezzanine Funding 2007-1, Ltd. Equity Marketing Book, GS MBS-E-000892557-598 at 560, 569. [Back]
2341. 2/2007 Anderson Mezzanine Funding 2007-1, Ltd. Debt Marketing Book, GS MBS-E-000855351. Anderson Mezzanine Funding 2007-1, Ltd. Debt Marketing Book, GSC-CDO-FCIC-0031712 at 726. Around the time Goldman was deciding whether to underwrite Anderson, Fred Horton, head of CDOs at GSC, left the firm. While discussing whether to issue or underwrite the CDO with Matthew Bieber, Mr. Ostrem commented: "Will need disclosure on Horton. This looks bad." 2/25/2007 email from Peter Ostrem to Matthew Bieber, GS MBS-E- 001996601, Hearing Exhibit 4/27-95. [Back]
2342. Subcommittee interview of Matthew Bieber (10/21/2010). [Back]
2343. Subcommittee interview of Edward Steffelin (12/10/2010). The marketing materials also stated that the Anderson assets were "sourced from the Street." Mr. Steffelin described this as a "weird phrase," but felt it implied "it would be open, sourced from all over." See discussion of the phrase, "sourced from the Street," in the prior section on Hudson 1. [Back]
2344. Id. Despite GSC's not being listed as having helped select the Anderson assets, some investors appeared to be aware of its involvement, perhaps from talking to Goldman personnel. See 3/28/2007 email from Matthew Bieber to Edward Steffelin, "ACA Meeting," GS MBS-E-014419176 ("Questions on [Anderson] - but also want to do manager due diligence. They've heard the GSC team shows well - so want to meet you in person."). [Back]
2345. 3/12/2007 email from Robert Black to Matthew 2345 Bieber, others, GS MBS-E-000898037. [Back]
2346. Id. [Back]
2347. 3/20/2007 email from Peter Ostrem to Matthew Bieber and others, GS MBS-E-000906269, Hearing Exhibit 4/27-172. [Back]
2348. 3/27/2007 email from Peter Ostrem to Matthew Bieber, GS MBS-E-000907935, Hearing Exhibit 4/27-172. [Back]
2349. See Goldman response to Subcommittee QFR at PSI_QFR_GS0223 and PSI_QFR_GS0235. [Back]
2350. GSC paid a price of 108.21% for the securities. See Goldman response to Subcommittee QFR at PSI_QFR_GS0223 and PSI_QFR_GS0235. [Back]
2351. See Goldman response to Subcommittee QFR at PSI_QFR_GS0223 and PSI_QFR_GS0235. [Back]
2352. See Goldman response to Subcommittee QFR at PSI_QFR_GS0239. [Back]
2353. 1/3/2008 email from Shelly Lin to Mr. Sparks, GS MBS-E-021880171 (attached file, "Deal Summary," Excel Spreadsheet showing credit ratings for Anderson). [Back]
2354. See Goldman response to Subcommittee QFR at PSI_QFR_GS0223 and PSI_QFR_GS0235. [Back]
2355. 2/2007 Timberwolf I, Ltd. Marketing Book, GS MBS-E-2355 000676809, Hearing Exhibit 4/27-99a. [Back]
2356. For more information about Goldman's actions as the collateral put provider for Timberwolf, see Section (iii)(BB), below. [Back]
2357. 2/2007 Timberwolf I, Ltd. Marketing Book, GS MBS-E-000676809, Hearing Exhibit 4/27-99a. [Back]
2358. Subcommittee interview of Joseph Marconi (10/19/2010). [Back]
2359. Greywolf eventually purchased the entire equity tranche in Timberwolf. See Goldman response to Subcommittee QFR at PSI_QFR_GS0223 and PSI_QFR_GS0235. [Back]
2360. Subcommittee interview of Joseph Marconi (10/19/2010). [Back]
2361. In some cases, Goldman was permitted to "top-up" the deal, taking the short side on an additional $5 million in the same CDO security at the same price paid by the auction winner. Greywolf's goal was for each reference asset to be $20 million in size, but often asked for bids on only $10-15 million worth of CDS protection in order to get a better spread. Goldman would then have the option of providing the remaining $5-10 million in CDS protection at the transaction price, resulting in a total position size of $20 million on the Timberwolf balance sheet. [Back]
2362. Joseph Marconi told the Subcommittee that well over half the assets were obtained through auctions, while just a few were negotiated. Subcommittee interview of Joseph Marconi (10/19/2010). [Back]
2363. See Goldman response to Subcommittee QFR at PSI_QFR_GS0192. [Back]
2364. The Abacus securities were cash assets. However, due to the synthetic nature of the Abacus CDOs, Goldman retained a short interest in $15 million in Abacus securities. [Back]
2365. Timberwolf had about one dozen short parties of which Goldman was the largest. See Goldman response to Subcommittee QFR at PSI_QFR_GS0223 and PSI_QFR_GS0235. [Back]
2366. A total of 84 CDS contracts produced the 51 unique reference assets. See Goldman response to Subcommittee QFR at PSI_QFR_GS0192. [Back]
2367. 8/23/2007 email from Jay Lee to Matthew Bieber, David Lehman, and others, GS MBS-E-001927784. [Back]
2368. 2/26/2007 email exchange between Tom Montag and Daniel S 2368 parks, GS MBS-E-019164799. [Back]
2369. 2/26/2007 email exchange between Tom Montag and Daniel Sparks, GS MBS-E-010989241. [Back]
2370. 3/7/2007 email from Gaelyn Sharp, GS MBS-E-001800634. [Back]
2371. 3/2007 email chain, "Timberwolf I, Ltd. Preliminary Offering Circular," GS MBS-E-001800634. [Back]
2372. 3/9/2007 email from Daniel Sparks, "Re: Help," GS MBS-E-010643213, Hearing Exhibit 4/27-76. [Back]
2373. According to Goldman personnel interviewed by the Subcommittee, the Syndicate coordinated sales efforts between the CDO Origination Desk and the CDO sales force. [Back]
2374. See, e.g., 4/11/2007 Goldman internal email, "GS Syndicate Structured Product CDO Axes (INTERNAL)," Hearing Exhibit 4/27-101; 4/19/2007 Goldman internal email, Hearing Exhibit 4/27-102; 6/22/2007 Goldman internal email, Hearing Exhibit 4/27-166. These "axe sheets" contained directives for selling Goldman issued securities and other financial products, as well as congratulatory and motivational notes. Some Goldman traders had a negative view of the axe sheets. One trader wrote, for example, that he was "guessing sales people view the syndicate ‘axe' email we have used in the past as a way to distribute junk that nobody was dumb enough to take first time around." 10/24/2006 Goldman internal email, GS MBS-E-009557699, Hearing Exhibit 4/27-170d. [Back]
2375. 2/14/2007 email from Robert Black to Matthew Bieber and others, GS MBS-E-001996121. [Back]
2376. 3/21/2007 email from Robert Black, "Non-tradition 2376 Buyer Base for CDO AXES," GS MBS-E-003296460, Hearing Exhibit 4/27-78. [Back]
2377. 3/2007 Goldman internal email chain, GS MBS-E-010643213, Hearing Exhibit 4/27-76. [Back]
2378. 3/28/2007 Goldman email from the Syndicate, GS-MBS-E-000740958, Hearing Exhibit 4/27-100. [Back]
2379. See, e.g., 4/11/2007 email from Daniel Sparks, GS MBS-E-010533482, Hearing Exhibit 4/27-101. [Back]
2380. 4/19/2007 email from Daniel Sparks to Bunty Bohra, GS MBS-E-010539324, Hearing Exhibit 4/27-102. [Back]
2381. 3/8/2007 email from Harvey Schwartz, GS MBS-E-010643213, Hearing Exhibit 4/27-76. [Back]
2382. 3/9/2007 email from Daniel Sparks, GS MBS-E-010643213, Hearing Exhibit 4/27-76. [Back]
2383. See Goldman response to Subcommittee QFR at PSI_QFR_GS0223 and PSI_QFR_GS0235. [Back]
2384. In fact, the decline had begun within a month after Timberwolf closed in late March. 9/17/2007 email from Christopher Creed, "RE: Timberwolf," GS MBS-E-000766370, Hearing Exhibit 4/27-106 (showing price for Timberwolf securities carrying an AAA credit rating had fallen from $94 on 3/31/2007 to $87 on 4/30/2007). [Back]
2385. 5/11/2007 email from Daniel Sparks to Richard Ruzika, GS MBS-E-019659221. 2385 Mr. Sparks also noted that he had a meeting with David Viniar, Don Mullen, and Gary Cohn to discuss the issue. [Back]
2386. 5/11/2007 email from David Lehman, GS MBS-E-003361238. For more information on this CDO valuation project, see Section C(5)(a)(iii)BB, above. [Back]
2387. 5/11/2007 email from Craig Broderick, "CDO's - Mortgages," GS MBS-E-009976918, Hearing Exhibit 4/27- 84. [Back]
2388. 5/11/2007 email from Harvey Schwartz to Daniel Sparks, Tom Montag, and others, GS MBS-E-010780864. [Back]
2389. 5/11/2007 email from Donald Mullen to Daniel Sparks, GS MBS-E-010780849, Hearing Exhibit 4/27-103. [Back]
2390. Id. at GS MBS-E-010780848-49. [Back]
2391. 5/13/2007 email from Paul Bouchard to David Lehman, Daniel 2391 Sparks, and others, GS MBS-E-003361238. [Back]
2392. Id. [Back]
2393. 5/20/2007 email from Paul Bouchard, "Materials for Meeting," GS MBS-E-001863725. [Back]
2394. 5/14/2007 email from Elisha Weisel, "Modeling Approaches for Cash ABS CDO/CDO^2," GS MBS-E- 001863618. [Back]
2395. 5/20/2007 email from Lee Alexander to Daniel Sparks, Donald Mullen, Lester Brafman, and Michael Kaprelian, "Viniar Presentation - Updated," GS MBS-E-010965211 (attached file "Mortgages V4.ppt," "Mortgages Department, May 2007," GS MBS-E-010965212). [Back]
2396. Id. At least two drafts of the presentation also stated about Timberwolf and Point Pleasant that "the complexity of the CDO^2 product and the poor demand for CDOs in general has made this risk difficult to sell and the desk expects it to underperform." This assessment was removed from the final version provided to senior executives. See 5/19/2007 email from Dan Sparks to Lee Alexander, and others, GS MBS-E-010973174 (attached file "Mortgages V3.ppt," GS MBS-E-010973175); 5/20/2007 9:52 a.m. draft presentation, "Mortgages V4.ppt," GS MBS-E- 010952331; 5/20/2007 email from Lee Alexander to Daniel Sparks, Donald Mullen, Lester Brafman, and Michael Kaprelian, "Viniar Presentation - Updated," GS MBS-E-010965211 (final version) (attached file, "Mortgages Department," GS MBS-E-010965212). [Back]
2397. 5/20/2007 email from Lee Alexander to Daniel Sparks, Donald Mullen, Lester Brafman, and Michael Kaprelian, "Viniar Presentation - Updated," GS MBS-E-010965211 (attached file "Mortgages V4.ppt," "Mortgages Department, May 2007," GS MBS-E-010965212 at 14). [Back]
2398. Id. at 24. [Back]
2399. Polygon had already purchased Timberwolf securities prior to the drafting of the presentation, and was apparently targeted for additional Timberwolf or Point Pleasant sales. See Goldman response to Subcommittee QFR at PSI_QFR_GS0223 and PSI_QFR_GS0235. Goldman had an existing relationship with Basis Capital. Goldman had engaged Basis Capital several months earlier as a collateral manager of a CDO Goldman was underwriting called Fort Denison. Mr. Ostrem, head of the CDO Origination Desk, apparently had a low opinion of the firm, describing the firm in an email to Mr. Bieber as "paranoid" and "not very sharp." He told Mr. Bieber that Goldman should "be nice and just sell them stuff going forward." 1/15/2007 email from Peter Ostrem to Matthew Bieber, GS MBS-E-001125549. [Back]
2400. 5/20/2007 email from Lee Alexander to Daniel Sparks, Donald Mullen, Lester Brafman, and Michael Kaprelian, "Viniar Presentation - Updated," GS MBS-E-010965211 (attached file "Mortgages V4.ppt," "Mortgages Department, May 2007," GS MBS-E-010965212 at 31). [Back]
2401. See Goldman response to Subcommittee QFR at PSI_QFR_GS0223 and PSI_QFR_GS0235. [Back]
2402. 5/14/2007 email from Daniel Sparks to Tom Montag and Donald Mullen, GS MBS-E-019642797. [Back]
2403. 5/26/2007 email from Michael Swenson to others, GS MBS-E-012443166 (attached file, "ABS Sec_0525," GS MBS-E-012443167). [Back]
2404. These prices indicate a percentage of security's face (par) value. A price of $80 would be 80% of par or 80 cents on the dollar. [Back]
2405. See Goldman response to Subcommittee QFR at PSI_QFR_GS0223 and PSI_QFR_GS0235; 6/1/2007 email from David Lehman to Daniel Sparks, GS MBS-E-001866889 (indicating Goldman sold Timberwolf securities to Tokyo Star Bank for $83.90, when Goldman's own mark was 80). Goldman took similar action with respect to its other CDO2, Point Pleasant, marking down the internal value of its A2 securities to $82.50 on May 25, 2007, while on May 24, 2007, selling $40 million of the A2 securities to a client at a price of $91.00, a difference in market value of $3.4 million. See 5/26/2007 email from Michael Swenson to others, GS MBS-E-012443166 (attached file, "ABS Sec_0525," GS MBS-012443167). [Back]
2406. See 7/12/2007 "Goldman Warehouse SP CDO positions and hedges_7-12-07," GS 2406 MBS-E-001866482; See also Goldman response to Subcommittee QFR at PSI_QFR_GS0223 and PSI_QFR_GS0235. In an interview with the Subcommittee, David Lehman explained that the bid/offer spread (the difference between the price at which a security is offered for sale ["offer price"] and the price at which a bank would buy the same security ["bid price"]) was the reason for the difference between Goldman's internal valuation of the price of the AA rated securities and price at which it sold them to Bank Hapoalim. However, in many instances during this period, it appeared as if Goldman's internal valuation price had no relationship to the bid and offer prices quoted to clients. For example, at the end of June 2007, Goldman provided Timberwolf investor Moneygram with an offer price of $86 for Timberwolf A2 securities and bid price of $83, indicating a bid/offer spread of 3 points. Meanwhile, Goldman had an internal valuation of $75 for the same securities, far different from $83 and $86 quoted to Moneygram. See Moneygram valuation, 7/5/2007 email from Goldman Sachs Operations, "MoneyGram Marks from GS as of 06/29/07," GS MBS-E-022023387; Goldman internal evaluations see "Warehouse SP CDO positions and hedges_6-29-07," GS MBS-E-010809241. See also 6/6/2007 email from Sheara Fredman, GS MBS-E-010795808 and attachment GS MBS-E-010795809. Goldman's pricing in such situations seemed consistent with the strategy articulated earlier by Mr. Sparks, the head of the Mortgage Department, that Goldman should write down the value of the assets, "but market [the CDO securities] at much higher levels," because he was concerned that Goldman was "overly negative and ahead of the market, and that [Goldman] could end up leaving some money on the table." 5/14/2007 email from Tom Montag to Daniel Sparks, GS MBS-E-019642797. [Back]
2407. 5/14/2007 email from Edwin Chin, GS MBS-E-012553986. [Back]
2408. Mr. Birnbaum responded directly to Mr. Swenson: "what a beautiful quote." Id. [Back]
2409. 6/6/2007 email from David Lehman, GS MBS-E-001936955. [Back]
2410. 6/6/2007 email from Daniel Sparks, GS MBS-E-001922156. Mr. Lehman further responded: "thk abt this - if we establish a defined + healthy supply/demand dynamic in this product we can always create more CDO^2 at a significant profit vs current levels," meaning that since Goldman's internal marks were so much lower than the bids it was providing clients, if a client chose to buy additional securities at Goldman's bid price, Goldman could sell the securities by taking a short position on a CDS facing the client, and make money on the trade. 6/6/2007 email from David Lehman, GS MBS-E-001936955. [Back]
2411. 5/20/2007 email from George Maltezos, Goldman Australia sales, to David Lehman, "T/wolf and Basis," GS MBS-E-001863555 ("FYI – basis are back from their 2 week business trip on Monday. My focus will go to timberwolf 100mm AAA and AA block trade with them. . . . Pls confirm you are willing to trade this at [then-current marks] and that you are not marking these bonds any wider at moment for month end May."). [Back]
2412. 5/22/2007 email from George Maltezos to John Murphy of Basis Capital Management, JUL 000685. [Back]
2413. See. e.g., 5/30/2007 email from George Maltezos to John Murphy a 2413 nd Stuart Fowler, JUL 002032. [Back]
2414. See Goldman response to Subcommittee QFR at PSI_QFR_GS0223 and PSI_QFR_GS0235. [Back]
2415. See 5/1/2007 email from Macdara Molloy to Phillipa Chen, GS MBS-E-002003102. [Back]
2416. Id. [Back]
2417. 5/30/2007 email from George Maltezos to John Murphy and Stuart Fowler at Basis Capital, JUL 002032. "From a pricing perspective, we have been trading Timberwolf AAA and AA bonds. 550 dm on AAAs and north of 700dm on AAs is considered too wide for Timberwolf. . . . To be constructive, however, I know the desk is entertaining block size trades at the moment from real money accounts in the US and Asia at wide levels (much wider than what they have traded before). To give you a sense, I think these represent 400-450dm and 650-700dm respectively (for size) at the widest level of such enquiries." The notation "dm" refers to "discount margin." Higher discount margins correspond to greater markdowns from par prices. See e.g. Timberwolf I, Price-DM Table 05-16- 2007.xls, GS MBS-E-001810225. Basis Capital eventually accepted the 450 and 650 prices suggested by Mr. Maltezos. See 6/13/2007 email from David Lehman to Tom Montag, GS MBS-E-001914580. [Back]
2418. 6/12/2007 email from Sahil Sachdev to George Maltezos, GS MBS-E-001912398. [Back]
2419. 6/12/2007 email from George Maltezos, PSI-Basis_Capital_Group-03-0001. Mr. Maltezos emailed Mr. Lehman and Mr. Egol about Point Pleasant pricing, asking them "does the 75 mark reflect actual trading or overall softness in the market? I know you had indicated 70 was more like the number." 6/12/2007 email from George Maltezos to David Lehman, Jonathan Egol, and Omar Chaudhary, GS MBS-E-002002522. The Subcommittee was unable to locate Goldman's response to his question. [Back]
2420. The most recent Point Pleasant sale had been $40 million worth of the AAA 2420 rated A2 securities, which sold on May 24, 2007, for a price of $91. The next most recent sale had been $20 million worth of the A2 securities on April 24, 2007, for a price of $91.30. See Goldman response to Subcommittee QFR at PSI_QFR_GS0223 and PSI_QFR_GS0235. [Back]
2421. Internally, Goldman had marked down the value of the Point Pleasant securities to $50.00. The much higher bid provided to Basis appears consistent with Goldman's strategy to "market at much higher levels." Goldman consistently offered investors bid prices that were much higher than its internal marks during the months of May and June as it attempted to sell its CDO inventory. See 5/26/2007 email from Michael Swenson to others, GS MBS-E- 012443166 (attached file, "ABS Sec_0525," GS MBS-012443167). [Back]
2422. 6/12/2007 email from Stuart Fowler to George Maltezos, GS MBS-E-001912398. [Back]
2423. Id. [Back]
2424. 6/13/2007 email from Daniel Sparks to George Maltezos, David Lehman, and Jon Egol, GS MBS-E-002006149. The reference to the "senior guys on 30" is to Goldman's senior executives who had offices on the 30th floor of the Goldman headquarters in New York. [Back]
2425. 6/13/2007 email from George Maltezos to Stuart Fowler and John Murphy at Basis Capital and others, GS MBS-E-001918603. [Back]
2426. 6/13/2007 email from George Maltezos, PSI-Basis_Capital_Group-02-0001. [Back]
2427. 6/13/2007 email from D 2427 avid Lehman to Tom Montag, GS MBS-E-001914580. [Back]
2428. Id. [Back]
2429. Goldman response to Subcommittee QFR at PSI_QFR_GS0223 and PSI_QFR_GS0235. [Back]
2430. 7/4/2007 email exchange among David Lehman, George Maltezos, and others, GS MBS-E-001990127. [Back]
2431. Id. [Back]
2432. 7/4/2007 email from David Lehman, GS MBS-E-001990127. [Back]
2433. 7/12/2007 email from Jon Egol, GS MBS-E-001866391. On the same day, Goldman's internal marks for the securities were even lower, at $60 for the AAA securities and $55 for the AA securities. As Basis Capital's financial situation became worse, Goldman responded by marking Basis Capital's securities to levels that were closer to Goldman's own internal evaluations. [Back]
2434. 7/13/2007 email from David Lehman, "Re: Basis," GS MBS-E-001866391 at 93. [Back]
2435. Id. at 91. [Back]
2436. 7/16/2007 email from Jon Egol, "Re: Basis," GS MBS-E-010169281. Goldman also marked down Basis Capital's Point Pleasant securities to $10, from an initial purchase price of $81.72. [Back]
2437. 7/12/2007 Goldman datasheet, "Warehouse SP CDO positions and hedges_7-12-07," GS MBS-E-001866482. [Back]
2438. 7/24/2007 email from David Lehman to others, GS MBS-E-013449641. [Back]
2439. 7/31/2007 letter from Goldman Sachs International to Basis Capital, "Event of Default Under ISDA Master Agreement," JUL 003958. [Back]
2440. 5/24/2007 email from Yusuf Aliredha to Mr. Sparks, Mr. Lehman, and others, 2440 "Priority Axes," GS MBS-E- 001934732. [Back]
2441. Id. [Back]
2442. 6/5/2007 email from Benjamin Case to David Lehman, GS MBS-E-001919861. [Back]
2443. Id. [Back]
2444. Id. [Back]
2445. 6/1/2007 email from Jay Lee to David Lehman, Matthew Bieber, and others, GS MBS-E-010958182. [Back]
2446. Id. [Back]
2447. Id. [Back]
2448. 6/7/2007 email from Omar Chaudhary to Daniel Sparks, David Lehman, 2448 and Bunty Bohra, GS MBS-E- 001866450, Hearing Exhibit 4/27-104. [Back]
2449. 6/7/2007 emails from Daniel Sparks and David Lehman, GS MBS-E-001866450, Hearing Exhibit 4/27-104. [Back]
2450. See Goldman response to Subcommittee QFR at PSI_QFR_GS0223 and PSI_QFR_GS0235. [Back]
2451. See Goldman response to Subcommittee QFR at PSI_QFR_GS0223. [Back]
2452. 6/10/2007 email from Daniel Sparks to Omar Chaudary and Bunty Bohra, GS MBS-E-010971809. [Back]
2453. 6/11/2007 email from Tom Montag, GS MBS-E-001866144. [Back]
2454. 6/11/2007 email exchange between Syndicate and David Lehman, GS MBS-E-001914921-24. [Back]
2455. 6/13/2007 email from Japan sales office, GS MBS-E-011212260. [Back]
2456. 6/22/2007 email exchange between Tom Montag and Daniel Sparks, "Few Trade posts," Hearing Exhibit 4/27- 105. [Back]
2457. Id. [Back]
2458. 6/25/2007 email from Daniel Sparks to Tom Montag, and others, GS MBS-E-010952698. [Back]
2459. 6/26/2007 email from Deeb Sa 2459 lem to Michael Swenson, GS MBS-E-012371112. [Back]
2460. Id. [Back]
2461. Goldman's internal price was then $55, 23% less. See 7/12/2007 Goldman datasheet, "Warehouse SP CDO positions and hedges_7-12-07," GS MBS-E-001866482; see Goldman response to Subcommittee QFR at PSI_QFR_GS0223 and PSI_QFR_GS0235. [Back]
2462. 7/6/2007 email from Mitchell Resnick to David Lehman, GS MBS-E-001866752. [Back]
2463. See Goldman response to Subcommittee QFR at PSI_QFR_GS0223 and PSI_QFR_GS0235. [Back]
2464. 5/7/2007 Goldman email chain between Elisha Wiesel and others, "RE: Timeberwolf Analysis," GS MBS-E-003334218. Elisha Wiesel worked with Goldman's legal department on issues related to disseminating information to potential investors. On May 20, 2007, the same day the Mortgage Department presented the conclusions of its CDO valuation project to Mr. Viniar and others, Mr. Wiesel sent an email to Mr. Bieber underscoring concerns about its valuation process: "[G]iven how complex the data is for a CDO^2, there's little chance we'll ever get fully ‘comfortable' beyond a shadow of a doubt that there's nothing materially misleading in the data cuts we provide. Is best outcome in this situation to just get a big-boy letter drafted?" 5/20/2007 email from Elisha Wiesel, GS MBS-E-001980637. [Back]
2465. 7/16/2007 email to David Lehman, "Carlyle," GS MBS-E-011050254. [Back]
2466. 5/7/2007 email from Elisha 2466 Wiesel, GS MBS-E-004735378. [Back]
2467. 7/7/2007 email from Stuart Fowler, GS MBS-E-011183045. [Back]
2468. 7/31/2007 email from Matthew Bieber to David Lehman, "FW: Requesting Compliance Approval," GS MBS-E- 001920215. [Back]
2469. 8/7/2007 email from Jay Lee to others, GS MBS-E-001927858. [Back]
2470. 8/7/2007 email from David Lehman to others, GS MBS-E-001927858. [Back]
2471. See 6/6/2007 email from David Lehman, GS MBS-E-001936955. Mr. Lehman stated: "thk abt this - if we establish a defined + healthy supply/demand dynamic in this product we can always create more CDO^2 at a significant profit vs current levels." [Back]
2472. 7/11/2007 email from David Lehman, "CDO Marks," GS MBS-E 2472 -013427046 [emphasis in original]. [Back]
2473. 7/16/2007 email from David Lehman to Matthew Bieber, GS MBS-E-001913775. [Back]
2474. See 7/17/2007 email from David Lehman to Daniel Sparks, GS MBS-E-010857643 (with attachment GS MBSE- 010857644). [Back]
2475. 9/17/2007 email from Tom Montag, GS MBS-E-000766371, Hearing Exhibit 4/27-106. [Back]
2476. 9/17/2007 email from Christopher Creed, GS MBS-E-000766370, Hearing Exhibit 4/27-106. [Back]
2477. Id. [Back]
2478. Performance Review for Joshua Birnbaum, GS-PSI-01972, Hearing Exhibit 4/27-5 2478 5c. See also 6/26/2007 email from Deeb Salem to Michael Swenson, GS MBS-E-012371112. [Back]
2479. See Goldman response to Subcommittee QFR at PSI_QFR_GS0030. [Back]
2480. Id. at PSI_QFR_GS0239. [Back]
2481. Id. at PSI_QFR_GS0030. [Back]
2482. See 3/23/2007 Goldman document, "Abacus 2007-AC1," at 2482 11, GS MBS-E-002807082, Hearing Exhibit 4/27- 120; Securities and Exchange Commission v. Goldman Sachs, Case No. 10-CV-3229 (S.D.N.Y.), Complaint (April 16, 2010), at 1, 6 (hereinafter "SEC Complaint against Goldman Sachs"). [Back]
2483. 4/2/2007 email from Fabrice Tourre, "ABACUS 07-AC1," GS MBS-E-002011152 (Abacus 2007-AC1 assets are "fully-identified, with no reinvestment, removals, substitutions or discretionary trading"). [Back]
2484. Goldman internal documents sometimes describe it as the underwriter for Abacus 2007-AC1, and sometimes as the placement agent. Compare 2/18/2008 Goldman document, "CDO Transactions (July 1, 2006 - December 31, 2007) in which Goldman Sachs acted as underwriter," GS MBS 0000004337, to 3/12/2007 Goldman memorandum to Mortgage Capital Committee, "ABACUS Transaction sponsored by ACA," at 2, GS MBS-E-002406025, Hearing Exhibit 4/27-118 ("Goldman is solely working as agent but retains the option to underwrite the risk as principal."). [Back]
2485. 2/27/2007 email from Curtis Willing, "ABACUS 2007 AC1, Ltd. -- New Issue Announcement (144a/RegS)," GS MBS-E-009209654. [Back]
2486. 3/12/2007 Goldman memorandum to Mortgage Capital Committee, "ABACUS Transaction sponsored by ACA," at 6, GS MBS-E-002406025, Hearing Exhibit 4/27-118 ("Goldman is acting as principal as a protection buyer . . . as well as taking other principal roles."). [Back]
2487. Goldman's additional roles included acting as the basis swap counterparty, the basis swap calculation agent, the collateral put provider, the collateral put calculation agent, the collateral disposal agent, the credit default swap calculation agent, and the initial purchaser. 2/18/2008 Goldman document, "CDO Transactions (July 1, 2006 - December 31, 2007) in which Goldman Sachs acted as underwriter," GS MBS 0000004337; 3/12/2007 Goldman Sachs memorandum to Mortgage Capital Committee, "ABACUS Transaction sponsored by ACA," GS MBS-E- 002406025, Hearing Exhibit 4/27-118. [Back]
2488. 3/12/2007 Goldman memorandum to Mortgage Capital Committee, "ABACUS Transaction sponsored by ACA," GS MBS-E-002406025, Hearing Exhibit 4/27-118; April 27, 2010 Subcommittee Hearing at 421. [Back]
2489. Goldman considered its Abacus platform, which commenced in 2004, to be "market-leading." 4/2/2007 email from Fabrice Tourre, "ABACUS 07-AC1," GS MBS-E-002011152; 2/27/2007 Goldman email, "ABACUS-2007- AC1 – Marketing Points (INTERNAL ONLY) [T-Mail]," GS MBS-E-008042545, Hearing Exhibit 4/27-116. See also 6/2007 Goldman document, "CDO Platform Overview," at 31, GS MBS-E-001918722 ("ABACUS is the Goldman brand name for single-tranche CLN [credit linked note] issuances referencing portfolios comprised entirely of structured products."); 4/2006 Goldman presentation "Overview of Structured Products," GS MBS-E-016067482. [Back]
2490. "Subordination" is "[t]he measure of losses that must occur within a portfolio bef 2490 ore a tranche is at risk to loss." Tranche size "[r]eflects the notional (value-at-risk) of a structured credit investment" and "is also a measure of leverage." 7/2006 Goldman presentation, "Structured Credit Investments," at 54, GS MBS-E-002055378; 4/2006 Goldman presentation, "Overview of Structured Products," GS MBS-E-016067482. Goldman contended that, in a single-tranche CDO, investors could customize the tranche risk/return profile by specifying the tranche subordination and tranche size, and that investors could create "credit enhanced" credit exposure through the use of subordination. 4/2006 Goldman presentation, "Overview of Structured Products," at 52, GS MBS-E-016067482. "Combined with tranche size, varying levels of subordination enable investors to tailor both the structural leverage and the risk/return profile of their investment." "Investors are "[n]ot limited by new issuance calendar and bond allocations," are "[n]ot limited by cash bonds in dealer inventory," can "customize by sector (e.g. RMBS, CMBS, ABS), rating, vintage, servicer, etc.," and can "meet various investment objectives via structure." 7/2006 Goldman presentation, "Structured Credit Investments," at 54, GS MBS-E-002055378. [Back]
2491. 3/12/2007 Goldman memorandum to Mortgage Capital Committee, "ABACUS Transaction sponsored by ACA," GS MBS-E-002406025, Hearing Exhibit 4/27-118. [Back]
2492. Goldman trading datasheet, GS MBS 0000004276 (showing closing dates and trade details on various CDOs, including Abacus). [Back]
2493. 3/12/2007 Goldman memorandum to Mortgage Capital Committee, "ABACUS Transaction sponsored by ACA," GS MBS-E-002406025, Hearing Exhibit 4/27-118. [Back]
2494. Id. [Back]
2495. 2/7/2007 email from Fabrice Tourre, 2495 GS MBS-E-003277939, Hearing Exhibit 4/27-114. [Back]
2496. See also 12/18/2006 email from Fabrice Tourre, "Re: Paulson," GS MBS-E-003246145 (a series of email communications regarding the Abacus 2007-AC1 CDO in which Mr. Tourre referred to the asset portfolio that Paulson was proposing for the CDO as "a weak quality portfolio."). [Back]
2497. Subcommittee interview of Fabrice Tourre (4/24/2010). Mr. Tourre also told the SEC that he believed Paulson's selection criteria, such as interest-only mortgages and high loan-to-value ratios, were based on Paulson's view that securities meeting those criteria were "weaker from the credit quality standpoint than other obligations that did not have those characteristics." SEC deposition of Fabrice Tourre (3/3/2009), GS MBS 0000022785, at 813-14. [Back]
2498. Subcommittee interview of Fabrice Tourre (4/24/2010). [Back]
2499. See, e.g., 12/10/2006 email from Fabrice Tourre to David Lehman, GS MBS-E-003453843, Hearing Exhibit 4/27-142. [Back]
2500. Subcommittee interview of Fabrice Tourre (4/24/2010); 2/21/2007 email from Fabrice Tourre to David Lehman, GS MBS-E-011359460-61, Hearing Exhibit 4/27-115. [Back]
2501. SEC deposition of Paolo Pellegrini (12/3/2008), PSI-Paulson-04 (Pellegrini Depo)-0001, at 82-85, 175. [Back]
2502. 12/18/2006 email from Fabrice Tourre, "Paulson," GS MBS-2502 E-003246145; 12/20/2006 email from Fabrice Tourre, GS MBS-E-002534649. [Back]
2503. 1/10/2007 Goldman internal email, GS MBS-E-002480520, Hearing Exhibit 4/27-108; 1/9/2007 email from Fabrice Tourre, "For ACA," GS MBS-E-002480516. [Back]
2504. 12/18/2006 Goldman internal email, GS MBS-E-003246145-46. [Back]
2505. Mr. Egol also suggested HBK as a possible portfolio selection agent. 12/18/2006 email from Fabrice Tourre, "Re: Paulson," GS MBS-E-003246145. [Back]
2506. Id. An email indicates that, in late December 2006, Mr. Tourre was c 2506 ontemplating several possible portfolio selection agents, including "Aladdin, DRCM, Greywolf, and . . . GSC." He also suggested Investec and TCW as possible candidates. 12/18/2006 email from Fabrice Tourre, "Re: Paulson," GS MBS-E-003246145. [Back]
2507. See, e.g., 1/4/2007 email from Fabrice Tourre to Daniel Sparks, "Paulson post," GS MBS-E-002526707 (On January 4, 2007, Goldman "reached out [to] GSC, Greywolf and ACA today re: acting as portfolio selection agent for a Paulson-sponsored trade."). [Back]
2508. 1/6/2007 Goldman email, GS MBS-E-003445985, Hearing Exhibit 4/27-152. [Back]
2509. 1/29/2007 email from Fabrice Tourre, GS MBS-E-003248998, Hearing Exhibit 4/27-112. [Back]
2510. 2/27/2007 email from Ed Steffelin to Peter Ostrem, "FW: ABACUS 2007-AC1, Ltd. -- New Issue Announcement (144a/RegS)," GS MBS-E-009209654. [Back]
2511. Subcommittee interview of Edward Steffelin (12/10/2010). [Back]
2512. 3/12/2007 Goldman memorandum to Mortgage Capital Committee, 2512 "ABACUS Transaction sponsored by ACA," GS MBS-E-002406025, Hearing Exhibit 4/27-118 (The memorandum also stated: "We expect the strong brand-name of ACA as well as our market-leading position in synthetic CDOs of structured products to result in a successful offering." "Partnering with ACA on this innovative, franchise-building transaction will enhance our leadership in the market for structured product synthetic CDOs. We expect that the role of ACA as Portfolio Selection Agent will broaden the investor base for this and future ABACUS offerings." "We intend to target suitable structured product investors who have previously participated in ACA-managed cashflow CDO transactions or who have previously participated in prior ABACUS transactions."). See also SEC Complaint against Goldman at 8. When asked to confirm that Mr. Tourre "suggested that it would be easier to market or to find sort of a counterparty to [Paulson's] short trade if there was a portfolio selection agent involved," Mr. Pellegrini responded, "Right." SEC deposition of Paolo Pellegrini (12/3/2008), PSI-Paulson-04 (Pellegrini Depo)-0001, at 113. Mr. Tourre told the Subcommittee that having an agent gives comfort to potential investors. Subcommittee interview of Fabrice Tourre (4/24/2010). [Back]
2513. At the Subcommittee hearing, Mr. Tourre testified that Paulson produced the portfolio selection criteria. Senator Levin then asked Mr. Tourre, "And did those criteria which Paulson gave to you, were they plugged into your model? Did they generate a list of possible reference securities for that portfolio?" Mr. Tourre responded: "Yes." They "were used to actually trim down the universe of RMBS." April 27, 2010 Subcommittee Hearing at 82. [Back]
2514. Subcommittee interview of Fabrice Tourre (4/24/2010). [Back]
2515. Paolo Pellegrini told the SEC that Paulson's selection criteria for Abacus 2007-AC1 included RMBS with a maximum weighted average FICO score of 640 and a minimum percentage (80%) of adjustable rate mortgages. Paulson also sought a minimum portfolio size of $750 million. SEC deposition of Paolo Pellegrini (12/3/2008), PSIPaulson- 04 (Pellegrini Depo)-0001, at 140-142. Sihan Shu, an analyst working for Paulson on the Abacus 2007- AC1 reference asset selection, told the Subcommittee that Paulson's selection criteria generally included large percentages of adjustable rate mortgages; high concentrations of mortgages in areas such as California and Florida, where Paulson believed the housing bubble was greater than in other areas; and limited due diligence. Subcommittee interview of Sihan Shu (2/24/2010). See also SEC deposition of Sihan Shu (12/4/2008), PSI-Paulson-04 (Shu Depo)-0001, at 26-28. Similarly, the SEC Complaint listed Paulson's selection criteria as favoring "RMBS that included a high percentage of adjustable rate mortgages, relatively low borrower FICO scores, and a high concentration of mortgages in states like Arizona, California, Florida and Nevada that had recently experienced high rates of home price appreciation." SEC Complaint against Goldman Sachs at 9. However, Goldman's initial submission to the SEC listed Paulson's criteria as only 2006-vintage subprime RMBS rated Baa2 by Moody's. In the Matter of Abacus 2007-AC1 CDO, File No. HO-10911 (SEC), Submission on behalf of Goldman Sachs (September 10, 2009), at 11 (hereinafter "Goldman Sachs Submission"). Goldman's supplemental submission disclosed that Goldman did use additional criteria listed in draft engagement letters between Goldman and Paulson "to guide Goldman Sachs' preliminary search for potential reference securities" that complied with Paulson's criteria, which confirms what Mr. Tourre told the Subcommittee in his testimony at the April 27, 2010 Subcommittee Hearing. In the Matter of ABACUS CDO, File No. HO-10911 (SEC), Supplemental Submission on behalf of Goldman Sachs (September 25, 2009), at 3, 4 (hereinafter "Goldman Supp. Submission"). A January 3, 2007 draft engagement letter listed the following portfolio selection criteria: Baa2 ratings; RMBS issued after March 1, 2006; weighted average FICO scores between 600 and 675; and at least 80% adjustable rate mortgages underlying the RMBS. 1/3/2007 draft engagement letter, PAULSON-ABACUS 0252736, at 40. See also 1/6/2007 email from Fabrice Tourre to Ed Steffelin and others, GS MBS-E-002754054 (listing criteria for the Abacus portfolio as 2006 vintage bonds underwritten after March 1, 2006; Baa2 rated bonds; average FICO score between 600 and 675; RMBS transaction size greater than $500 million; and percentage of adjustable rate mortgages greater than 80%). [Back]
2516. 1/29/2007 email from Fabrice Tourre to Peter Ostrem and others, 2516 GS MBS-E-003248998, Hearing Exhibit 4/27- 112; Goldman Sachs Submission at 12 (citing Gerst Tr. 13-14). [Back]
2517. See 1/9/2007 email from Gail Kreitman to Laura Schwartz, GS MBS-E-007974381. [Back]
2518. Id. [Back]
2519. See 3/22/2007 email from Sihan Shu to Fabrice Tourre and David Gerst, GS MBS-E-003010587. [Back]
2520. 3/12/2007 Goldman memorandum to Mortgage Capital Committee, "ABACUS Transaction sponsored by ACA," GS MBS-E-002406025, Hearing Exhibit 4/27-118; 3/23/2007 Goldman presentation, "ABACUS 2007- AC1," GS MBS-E-002807082, Hearing Exhibit 4/27-120; SEC Complaint against Goldman Sachs at 11; Goldman Sachs Submission at 13. [Back]
2521. 3/12/2007 Goldman internal memorandum to Mortgage Capital Committee, "ABACUS Transaction sponsored by ACA," GS MBS-E-002406025, Hearing Exhibit 4/27-118. [Back]
2522. See "Abacus 2007-AC1 Reference Portfolio," chart prepared by Subcommittee. See also 1/5/2007 email from Sihan Shu to Ed Steffelin, Fabrice Tourre, and others, GS MBS-E-002483408; 1/6/2007 email from Fabrice Tourre to Ed Steffelin and others, GS MBS-E-002754054; 1/9/2007 email from Gail Kreitman to Laura Schwartz, GS MBS-E-007974381; 1/22/2007 email from Laura Schwartz to Fabrice Tourre and others, GS MBS-E-002522389; 1/22/2007 email from David Gerst to Paolo Pellegrini and Sihan Shu, GS MBS-E-002480574; 1/28/2007 email from Fabrice Tourre to Gail Kreitman and David Gerst, GS MBS-E-002444359; 1/31/2007 email from David Gerst to Laura Schwartz, GS MBS-E-002620419; 2/1/2007 email from Laura Schwartz to David Gerst, GS MBS-E- 003026086; 2/2/2007 email from Paolo Pellegrini to Laura Schwartz and Sihan Shu, GS MBS-E-002483499; 2/2/2007 email from Laura Schwartz to Paolo Pellegrini and Sihan Shu, GS MBS-E-002483496; 2/5/2007 email from Paolo Pellegrini to Laura Schwartz, GS MBS-E-003062009; 2/5/2007 email from Laura Schwartz to Paolo Pellegrini and others, GS MBS-E-002856966; 2/5/2007 email from David Gerst to Paolo Pellegrini and Sihan Shu, PAULSON-ABACUS 0253248; 2/26/2007 email from Fabrice Tourre to Keith Gorman, GS MBS-E-002444961; 3/22/2007 email from Sihan Shu to Fabrice Tourre and David Gerst, GS MBS-E-003010587; 3/23/2007 Goldman document, "ABACUS 2007-AC1," GS MBS-E-002807082, Hearing Exhibit 4/27-120. Goldman asserted: "The record in this investigation is clear that the overwhelming majority of the securities were identified by ACA." Goldman Supp. Submission at 13. However, the Goldman and Paulson documents reviewed by the Subcommittee show otherwise. [Back]
2523. Goldman 2523 Supp. Submission at 10, 13. [Back]
2524. Id. at 10. [Back]
2525. SEC deposition of Paolo Pellegrini (12/3/2008), PSI-Paulson-04 (Pellegrini Depo)-0001, at 175-76. [Back]
2526. 3/12/2007 Goldman memorandum to Mortgage Capital Committee, "ABACUS Transaction sponsored by ACA," at 3, GS MBS-E-002406025, Hearing Exhibit 4/27-118. [Back]
2527. 5/8/2007 email from Fabrice Tourre to Josh Birnbaum, GS MBS-E-003611826, Hearing Exhibit 4/27-123. [Back]
2528. 3/23/2007 Goldman document, "Abacus 2007-AC1," at 11-12, GS MBS-E-002807082, Hearing Exhibit 4/27- 120. [Back]
2529. 4/26/2007 Goldman Sachs Offering Circular, "Abacus 2007-AC1, Ltd.," at 2, GS MBS-E-001918034. [Back]
2530. 3/12/2007 email from Jorg Zimmerman (IKB) 2530 to Michael Nartey, GS MBS-E-002683134. [Back]
2531. 3/12/2007 email from Fabrice Tourre to Jonathan Egol, GS MBS-E-002648826. [Back]
2532. April 23, 2010 Subcommittee Hearing at 63-64. [Back]
2533. See 3/23/2007 Goldman document, "Abacus 2007-AC1," at 14, GS MBS-E-002807082, Hearing Exhibit 4/27- 120. Moody's rating of Aaa is equivalent to a AAA rating. Standard and Poor's also rated the Abacus Class A-1 notes and the Class A-2 notes as AAA. [Back]
2534. Subcommittee interview of Laura Schwartz (ACA) (4/23/2010). [Back]
2535. 2/12/2007 "CDO Asset ‘Management' Proposal for Abacus 2007-AC1," submitted to ACA Commitments Committee, at 2, ACA-ABACUS-0000121560-66. [Back]
2536. 2/23/2007 handwritten notes of Laura Schwartz, ACA Managing Director of CDO asset management, ACA ABACUS 00004171 at 173. [Back]
2537. 4/10/2007 email from ACA Managing Director Laura Schwartz, ACA-ABACUS-0000006327. [Back]
2538. 1/10/2007 email from Fabrice Tourre to Laura Schwartz, GS MBS-E-002480520, Hearing Exhibit 4/27-108. [Back]
2539. Subcommittee interview of Laura Schwartz (4/23/2010). See also Statement of Laura Schwartz, ACA ABACUS 00004406 at 408. [Back]
2540. Id. See also 1/10/2007 email from Fabrice Tourre to Laura Schwartz, "Transaction Summary," GS MBS-E- 002480520, Hearing Exhibit 4/27-108; SEC Complaint against Goldman Sachs at 14, 15; Goldman Sachs Submission at 32 (citing 1/10/2007 email from Fabrice Tourre to Laura Schwartz, "Transaction Summary," GS MBS-E-003504901). [Back]
2541. 3/23/2007 ACA/Goldman document, "Abacus 2007-AC1," ACA-ABACUS-002807082, Hearing Exhibit 4/27- 120; Statement of Laura Schwartz, ACA ABACUS 00004406 at 408. [Back]
2542. Statement of Laura Schwartz, ACA ABACUS 00004406 at 408. [Back]
2543. Subcommittee interview of Fabrice Tourre (4/24/2010). [Back]
2544. April 27, 2010 Subcommittee Hearing at 44. [Back]
2545. Id. at 86. [Back]
2546. ACA Financial Guaranty Corp. v. Goldman Sachs & Co., Index No. 650027/2011 (N.Y. Sup.), Complaint (January 6, 2011), at 1, 23 (hereinafter "ACA Complaint against Goldman Sachs). [Back]
2547. April 27, 2010 Subcommittee Hearing at 86. [Back]
2548. See 3/12/2007 Goldman memorandum to Mortgage Capital Committee, "ABACUS Transaction sponsored by ACA," GS MBS-E-002406025, Hearing Exhibit 4/27-118 ("Goldman will receive an upfront premium from Paulson for distributing risk at or within specified strike spreads." "If Goldman succeeds in placing a given Targeted Tranche inside the related Strike Spread, Goldman will receive from Paulson a fee on the notional amount of such Targeted Tranche distributed. Such fee will have a floor component (the ‘Minimum Fee Rate') and an upside sharing component, under which Goldman will share with Paulson any execution delivered at levels tighter than the Strike Spreads."). See also 1/18/2007 email from Fabrice Tourre to David Lehman and others, GS MBS-E-002483446 (detailing the additional fees Goldman could earn by executing trades within the strike spread of each tranche); 3/14/2007 email from Paolo Pellegrini to Sihan Shu with "ACA ABACUS Paulson Fee Illustration" spreadsheet attached (the spreadsheet provides details of the incentive-based fees paid to Goldman, including for Goldman's pricing of spreads), PAULSON-ABACUS 0250401. Mr. Pellegrini told the SEC that Goldman and Paulson had discussions regarding Goldman's compensation, resulting in "a formula that tied their compensation to sort of kind of the spread that they sort of presented to or that they would present to us." SEC deposition of Paolo Pellegrini (12/3/2008), PSI-Paulson-04 (Pellegrini Depo)-0001, at 118-19. Mr. Tourre described the compensation agreement in an email to Mr. Sparks, writing that if Goldman could place super senior risk inside a certain spread, Paulson would pay Goldman an upfront fee and periodic fees reflecting the money Goldman saved Paulson. 9/8/2006 email from Fabrice Tourre to Dan Sparks, GS MBS-E-009516671. Mr. Tourre told the SEC that Paulson was "comfortable buying protection only to the extent that the spreads they were paying were less than a certain level." SEC deposition of Fabrice Tourre (3/3/2009), GS MBS 0000022785, at 899-900. [Back]
2549. SEC Complaint against Goldman Sachs at 18. See Credit Default Swap Insurance 2549 Policy, ACA ABACUS 00001593. ACA complaint against Goldman Sachs at 15, 16. [Back]
2550. See Goldman trading datasheet, GS MBS 0000004276 (showing closing dates and details on various deals, including Abacus). [Back]
2551. 5/8/2007 email exchange between Joshua Birnbaum and Fabrice Tourre, "Post on Paulson and ABACUS 07- AC1," GS MBS-E-003352815; 4/13/2007 email exchange between Fabrice Tourre and Charlie Remnant, "ABACUS 07-AC1," GS MBS-E-002485172; 5/9/2007 email to Fabrice Tourre, "ABN Amro," GS MBS-E-002461503. ABN AMRO Bank N.V. (ABN), a large European bank, intermediated the swap between Goldman and ACA Financial Guaranty Corp. [Back]
2552. The CDS contracts were executed between Goldman Sachs International and Paulson Credit Opportunities Master II Ltd., one of the Paulson hedge funds. 4/9/2007 email from Nicholas Friedman to Fabrice Tourre and others, "Re: ABACUS 07-AC1," GS MBS-E-002449178.
Shortly before the Abacus 2007-AC1 transaction closed, Goldman agreed to take the long side of a CDS contract on the performance of a small portion of Abacus' underlying assets when Paulson wanted to increase its short position at the last minute. Although Goldman ended up retaining this long investment, it did so only because it could not find an investor who would buy it. Mr. Tourre admitted this fact in the April 27, 2010 Subcommittee Hearing.
Senator Levin: Did Goldman intend to keep a long stake in that transaction when the deal was structured? I know it ended up with a piece. Was it intended that it end up with a piece of that deal?
Mr. Tourre: We tried to hedge our risk by selling that piece as well, but were not successful in doing so.
Senator Levin: So it was intended to sell that piece?
Mr. Tourre: For prudent risk management reasons, we were trying –
Senator Levin: Oh, I am sure for all the right reasons. But it was intended that Goldman not have any long stake on that piece. Is that correct?
Mr. Tourre: Yes.
See also 6/5/2007 email from David Gerst to Jonathan Egol, GS MBS-E-002469912, Hearing Exhibit 4/27-126. [Back]
2553. SEC Complaint against Goldman Sachs at 3. [Back]
2554. 10/26/2007 email from Goldman salesman to Michael Swenson, "ABACUS 2007-AC1 – Marketing Points (INTERNAL ONLY) [T-Mail]," GS MBS-E-016034495. [Back]
2555. SEC Complaint against Goldman Sachs at 3. [Back]
2556. See SEC Complaint against Goldman Sachs. [Back]
2557. Pursuant to 15 U.S.C. §78j(b) and 17 C.F.R. §240.10b-5, the SEC alleged that Goldman and Mr. Tourre, "in connection with the purchase or sale of securities or securities-based swap agreements, by the use of means or instrumentalities of interstate commerce or of the mails, directly or indirectly (a) employed devices, schemes or artifices to defraud; (b) made untrue statements of material facts or omissions of material facts necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading; or (c) engaged in transactions, practices or courses of business which operated or would operate as a fraud or deceit upon persons." SEC Complaint against Goldman Sachs at 20-21. The SEC alleged that Goldman and Mr. Tourre "knowingly or recklessly misrepresented in the term sheet, flip book and offering memorandum for ABACUS 2007- AC1 that the reference portfolio was selected by ACA without disclosing the significant role in the portfolio selection process played by Paulson, a hedge fund with financial interests in the transaction adverse to IKB, ACA Capital and ABN. Goldman&Co and Tourre also knowingly or recklessly misled ACA into believing that Paulson invested in the equity of ABACUS 2007-AC1 and, accordingly, that Paulson's interests in the collateral section process were closely aligned with ACA's when in reality their interests were sharply conflicting." SEC Complaint against Goldman Sachs at 21. Similar charged were filed pursuant to 15 U.S.C. § 77q(a)(1), (2) and (3). See SEC Complaint against Goldman Sachs at 19. [Back]
2558. SEC Complaint against Goldman Sachs at 2, 20, 21. [Back]
2559. Securities and Exchange Commission v. Goldman, Sachs & Co. and Fabrice Tourre, Case No. 10-CV-3229, (S.D.N.Y.), Consent of Goldman Sachs, (July 14, 2010), at 1, 2, 10 (hereinafter "Consent of Goldman Sachs"). [Back]
2560. Consent of Goldman Sachs at 2. Despite this acknowledgment by 2560 Goldman as part of the settlement, when asked during the Subcommittee hearing if "a non-biased person [could] look at the facts [of Abacus 2007-AC1] as you see them and say there is a question of unethical behavior here," David Viniar, the executive vice present and chief financial officer for Goldman, stated he "didn't believe so." April 27, 2010 Subcommittee Hearing at 125. [Back]
2561. Some of the administrative roles that Goldman filled in its CDOs, as described in its CDO agreements, included: Initial Purchaser, Synthetic Security Counterparty, Senior Swap Counterparty, Credit Protection Buyer, Liquidation Agent, Calculation Agent under U.S. Dollar Cash Flow Swap Transaction, Collateral Put Provider, CP Note Placement Agent, Portfolio CDS Counterparty, Hedge Counterparty - Cashflow Swap, Collateral Disposal Agent, Credit Default Swap Calculation Agent, Basis Swap Counterparty, and Basis Swap Calculation Agent. 2/18/2008 document prepared by Goldman Sachs, outlining the parties serving each role in Goldman underwritten CDOs, GS MBS 0000004337. [Back]
2562. 2/18/2008 Goldman presentation, "CDO Transactions 2562 (July 1, 2006 - December 31, 2007) in which Goldman Sachs acted as underwriter," GS MBS 0000004337, at 4340; 7/19/2007 Goldman document, "GS Liquidation Agent Role in ABS CDOs," GS MBS-E-014055117. [Back]
2563. Subcommittee interview of Darryl Herrick (10/13/2010). [Back]
2564. Subcommittee interview of Peter Ostrem (10/5/2010). [Back]
2565. Id. Although Mr. Ostrem helped design the liquidation agent feature, he was not employed by Goldman when its CDO assets were downgraded and triggered its liquidation agent duties. [Back]
2566. See 7/17/2006 Goldman memorandum to the Mortgage Capital Committee, "Placing debt and equity on a static high grade structured product CDO Squared with Investec (UK) Limited," GS MBS-E-013458155. [Back]
2567. Id. [Back]
2568. Id. [Back]
2569. Id. [Back]
2570. 7/19/2007 Goldman document, "GS Liquidation Agent Role in ABS 2570 CDOs," GS MBS-E-014055117. [Back]
2571. 7/23/2007 email from Mr. Case to Mr. Bieber, "CDO Liquidation Agent Role - Draft Talking Points - INTERNAL USE ONLY," GS MBS-E-015240358. [Back]
2572. 7/17/2006 Goldman memorandum to Mortgage Capital Committee, GS MBS-E-013458155, at 57. A "mezzanine" CDO is one in which the underlying assets carry credit ratings such as BBB or BBB-. [Back]
2573. 10/2006 "Hudson Mezzanine 2006-1 Flipbook," GS MBS-E-009546963, H 2573 earing Exhibit 4/27-87. [Back]
2574. Goldman Sachs Hudson Mezzanine Funding 2006-1, LTD Preliminary Termsheet, GS MBS-E-001557869. [Back]
2575. 12/3/2006 Hudson Mezzanine 2006-1, LTD. Offering Circular, GS MBS-E-021821196 at 234. [Back]
2576. 10/2006 "Hudson Mezzanine 2006-1 Flipbook," GS MBS-E-009546963, Hearing Exhibit 4/27-87. [Back]
2577. See Goldman Sachs response to Subcommittee QFR at PSI_QFR_GS0239. [Back]
2578. 10/6/2006 email from Michael Halevi to Olivia Ha, GS MBS-E-014338525. [Back]
2579. Subcommittee interview of Darryl Herrick (10/13/2010). [Back]
2580. Id. Mr. Herrick was not employed by Goldman when its CDO assets were 2580 downgraded and triggered its liquidation agent duties. [Back]
2581. 1/3/2008 email from Shelly Lin to Mr. Sparks, GS MBS-E-021880171 (attached file, "Deal Summary," GS MBS-E-021880172). [Back]
2582. Id. [Back]
2583. 10/15/2007 email from Naina Kalavar, "NAB/Hudson Mezz Update 2," GS MBS-E-015738973. Mr. Case used this email to circulate his notes of the two telephone conversations. [Back]
2584. Id. at 2. The notes included the following: "[C]urrent distressed nature of the assets has been fully priced in and has not moved over the past 2 months - if unwound those cds would be at 80-90 points, that is % points to be paid up front to unwind swap - equiv of 20 cents to dollar in cash bond terms ... Across entire universe of loans already in liquidation - been generally se[e]n 50-60-70 % recovery rates. Rates are not coming back high enough to make the market opt[i]mistic that bonds will come back to recover princi[pal]. ... Our view that there is upside in waiting an[d] evaluating mtkt conditions before liquidating. ... We think that the shorts may get impatient – minor rallies from short covering – domino effect/momentum creates a rally b/c shorts get nervous at little rally – this provides potential upside to waiting to liquidate." [Back]
2585. Id. at 3. Such an amendment would require investor consent. [Back]
2586. 10/15/2007 email from Naina Kalavar, "NAB/2586 Hudson Mezz Update 2," GS MBS-E-015738973. [Back]
2587. Id. at 75. [Back]
2588. Id. at 76. [Back]
2589. Id. [Back]
2590. 11/9/2007 email from Mr. Case to Mr. Lehman, GS MBS-E-021876334. [Back]
2591. 2/29/2008 letter from Morgan Stanley to Goldman, HUD-CDO-00006877. [Back]
2592. Reference asset OOMLT 2006-2 M8. See 1/3/2008 email from Shelly Lin to Mr. Sparks, GS MBS-E- 021880171 (attached file, "Deal Summary," GS MBS-E-021880172). [Back]
2593. Reference asset MSAC 2006-WMC2 B3. See 1/3/2008 email from Shelly Lin to Mr. Sparks, GS MBS-E- 021880171 (attached file, "Deal Summary," GS MBS-E-021880172). [Back]
2594. See 11/29/2007 email from Mr. Case to Mr. Sparks, 2594 Mr. Lehman, and others, GS MBS-E-021876502. [Back]
2595. Subcommittee interview of David Lehman (9/27/2010). [Back]
2596. 12/18/2007 email from Lira Lee to [investor], GS MBS-E-021878556. [Back]
2597. See discussion of Hudson 1, above. [Back]
2598. 12/19/2007 email from Mr. Case to Nicole Martin of Morgan Stanley, GS MBS-E-021876172. [Back]
2599. Subcommittee interview of Morgan Stanley (8/6/2009). [Back]
2600. Id. [Back]
2601. 1/3/2008 email from Shelly Lin to Mr. Sparks, GS MBS-E-021880171 (attached file, "Deal Summary," GS MBS-E-021880172). [Back]
2602. Id. [Back]
2603. See, e.g., 1/16/2008 email from Nicole Martin to Mr. Lehman, GS MBS-E-022164848. [Back]
2604. Due to the extensive losses experienced by Hudson 1, by January 2008, Morgan Stanley was likely the only long investor whose investment was not completely extinguished. [Back]
2605. 1/16/2008 email from John Pearce of Morgan Stanley 2605 to Michael Petrick, HUD-CDO-00004851. [Back]
2606. 2/5/2008 email from Mr. Pearce to Mr. Lehman and Nicole Martin, HUD-CDO-00004852. [Back]
2607. 2/6/2008 email from Mr. Pearce to Michael Petrick, HUD-CDO-00005146. [Back]
2608. 2/7/2008 email from Mr. Pearce to Mr. Lehman, HUD-CDO-00005147. [Back]
2609. Transcript of 2/13/2008 telephone call between Morgan Stanley and Goldman, HUD-CDO-00006894. See also 2/28/2008 email from Sue Fertel-Kramer to Mr. Case and others, GS MBS-E-021881029. [Back]
2610. Transcript of 2/13/2008 telephone call between Morgan Stanley and Goldman, H 2610 UD-CDO-00006894. [Back]
2611. Id. [Back]
2612. 2/21/2008 email from Vanessa Vanacker to Mr. Pearce, HUD-CDO-00004882. 2/29/2008 letter from Morgan Stanley to Goldman, HUD-CDO-00006877. [Back]
2613. 12/3/2006 Hudson Mezzanine 2006-1, LTD. Offering Circular, section entitled, "Disposition of CDS Transactions by the Liquidation Agent Under Certain Circumstances," GS MBS- E-021821196 at 241. See 2/29/2008 letter from Morgan Stanley to Goldman, HUD-CDO-00006877. [Back]
2614. 2/29/2008 letter from Morgan Stanley to Goldman, HUD-CDO-00006877 [emphasis in original]. [Back]
2615. 3/10/2008 letter from Goldman to Morgan Stanley, HUD-CDO-00006881. 2615 The letter also states: "Morgan Stanley's lack of standing even to advance many positions that are within the exclusive province of Hudson, and the preclusive effect on Morgan Stanley's contentions of the Agreement's broad exculpation and conflict waiver provisions provide sufficient response." [Back]
2616. See 3/27/2008 email from Morgan Stanley to Goldman, HUD-CDO-00004378. On March 24, 2008, Goldman offered to unwind the Hudson 1 trade with Morgan Stanley by paying it 9% of the face (par) value of the Hudson securities. 3/24/2008 email from Goldman to Morgan Stanley, GS MBS-E-022012805. [Back]
2617. See, e.g., 3/27/2008 email from Morgan Stanley to Goldman, HUD-CDO-00004378. See also 3/20/2008 email from Mr. Case, GS MBS-E-021880596. [Back]
2618. See 6/6/2008 letter from Goldman as liquidation agent, "Hudson Mezzanine Funding 2006-1, Ltd. - Certain Dispositions of Assets," HUD-CDO-00003155. [Back]
2619. See 11/21/2008 letter from Goldman to Morgan 2619 Stanley, HUD-CDO-00005125. [Back]
2620. The amount of assets in the default swap collateral account was required to equal the total face ("notional") value of the CDS entered into by the CDO. This arrangement provided assurance to the short parties that funds would be available if and when payments were due to them under the CDS. CDO agreements often required that the cash placed in the default swap collateral account be kept in very secure, short term, cash-like instruments such as Treasury notes or Certificates of Deposit (called "Eligible Investments") until the cash was used to acquire default swap collateral or make payments to a short party. If any credit event resulted in payments from the default swap collateral account to the short parties under the CDS contracts, the long parties might not receive all of their principal investment at the maturity of the deal. [Back]
2621. The parameters governing the type of default swap collateral securities that 2621 could be purchased with investor funds were generally outlined in the CDO agreement documents and offering memorandum. Typical criteria included: a AAA credit rating; a yield slightly greater than LIBOR; limitations on the maturation dates of the securities; and limited exposure to a single counterparty. Generally, the CDO agreement required that some of the default swap collateral be retained in Eligible Investments in order be able to fulfill any obligations or payments due in the short term. In CDOs reviewed by the Subcommittee, the default collateral securities were sometimes RMBS or CDO securities bearing AAA ratings. These securities often lost substantial value which the collateral put provider then had to absorb. [Back]
2622. The Timberwolf Indenture agreement referred to this role as the "Synthetic Security Counterparty." See 3/27/2007 Timberwolf I, LTD. Indenture Agreement, at § 12.5(b), GS MBS-E-021825583 at 711. [Back]
2623. Typically a shell company incorporated in a foreign jurisdiction (often the Cayman Islands) and a shell company incorporated in the United States (often Delaware) served as the "Issuer" and "Co-Issuer," respectively of the CDO. Generally, the financial institution that was underwriting the CDO, in this case Goldman, would arrange for the establishment of those entities. For simplicity, this section will refer to both companies as the "Issuer" of the CDO securities. [Back]
2624. Another option was for Goldman 2624 to take physical possession of the security. [Back]
2625. In a typical put agreement, the put provider guarantees to pay to the put purchaser the face (par) value of a specified security upon delivery of the security, or pay to the put purchaser the difference between the security's par value and actual market price when sold. In exchange for that protection, the put purchaser typically pays a fee to the put provider. In many of the CDS contracts associated with synthetic CDOs, as described above, GSI fulfilled the role of a put provider, by absorbing any shortfall between the face (par) value and market price of any default swap collateral securities sold to pay amounts owing to the short party in the CDS contract. [Back]
2626. See 3/27/2007 Timberwolf I, LTD. Indenture Agreement, at § 12.5(b), GS MBS-E-021825583 at 712. For accounting purposes, Goldman established a CDO Put Reserve, to account for potential losses that might result from its role as a collateral put provider in CDOs. [Back]
2627. Any subsequent losses resulting from Goldman's role as the collateral put provider would reduce the profit resulting from that fee. In responses to Subcommittee questions for the record regarding 7 CDOs (Fort Denison, Camber 7, Timberwolf, Anderson Mezzanine, Point Pleasant, Hudson Mezzanine 2006-1, and Hudson Mezzanine 2006-2), Goldman reported that for most of the CDOs, the net profit was less than $500,000. One exception was Hudson Mezzanine 2006-1, which yielded a profit of approximately $1 million. See Goldman response to Subcommittee QFR at PSI_QFR_GS0249. For another CDO, Broadwick, Goldman also projected that the premium discount would yield a profit of more than $1 million, less any costs it might have to absorb in its role as put provider. See 4/12/2006 email from Peter Ostrem to John Little and Robert Leventhal, GS MBS-E-010808964 at 66-67 ("Can we agree on how we want to treat P&L [profit and loss] on Peloton relative to the put swap? We expect P&L of over $1mm [million] for the 5bp [basis point] reduction in the CDS premiums. ... I propose we separately book the put swap at close to zero (contingent MTM risk on 2 yr AAA diversified portfolio where Goldman retains selection optionality seems low), but we are open to booking 1bp in negative put cost (i.e., -$200k)."). In some other CDOs, the projected put fee was about $500,000. [Back]
2628. Timberwolf used this reduced premium approach, but in a few other instances, 2628 such as Hudson Mezzanine 2006- 1 and Point Pleasant, Goldman received a direct fee for acting as the collateral put provider. Goldman representatives told the Subcommittee that, because the put fee was "embedded" in the CDS agreement in some of the CDOs, Goldman's operations group sometimes overlooked and failed to "book" the profit and loss associated with those put arrangements. When this oversight was discovered in 2007, Goldman identified 18 CDO put arrangements that had not been identified and accounted for in Goldman's books. See 6/28/2007 email from Carly Scales to Phil Armstrong and Steve Schultz, GS MBS-E-015192547:
- "Current Put Option Booking State: 22 Deals with the Put Option Feature
- 4 Deals that do have a Put Option Booked:
- For these trades, Ops [the operations group] knew about the Put as there was a confirmation and a trade booked. ...
- 18 Deals that do not have a Put option Booked:
- For these deals, there was no mention of a Put at all at the time of closing. ...
- The Put option was embedded into the deal documents (Indenture, Offering Circular, etc – both of which are reviewed by outside counsel and GS legal as a normal course of business – but are not reviewed by Operations.)
- For these trades, an intermediation fee was being taken on the CDS trades, but no specific Put was booked in our systems.
- The original explanation from the desk was the intermediation fee was being taken for the risks associated with standing in between the Street and the deal with no mention of the Put."
2629. One reason Goldman was so concerned about the value of the 2629 default swap collateral securities was because those securities included AAA rated RMBS securities whose values were declining in line with the entire mortgage market. [Back]
2630. 6/20/2007 email from Matthew Bieber to Goldman colleagues, GS MBS-E-001912772 ("Below are the deals I recall us having significant exposure to in terms of default swap collateral. Who is responsible for each of the deals? We need to get Dan a list this morning. If there are any missing, please let me know."). [Back]
2631. Id. Mr. Bieber listed the following CDOs: Adirondack 1; Adirondack 2; Coolidge Funding; Broadwick; Hudson High Grade; Hudson Mezzanine 1; Hudson Mezzanine 2; Fortius I; Fortius II; Camber 7; Hout Bay; Point Pleasant; Timberwolf; Anderson Mezzanine; Altius I; Altius III; and Altius IV. [Back]
2632. Subcommittee interview of Matthew Bieber (10/21/2010). [Back]
2633. 7/18/2007 email from Alfa Kiflu, GS MBS-E-001866507. The six CDOs in which Goldman had large short positions were: Hudson Mezzanine 1; Timberwolf; Camber 7; Hudson Mezzanine 2; GSC ABS Funding 2006-3G; and Anderson Mezzanine. [Back]
2634. 7/19/2007 email from Matthew Bieber to David Lehman, G 2634 S MBS-E-011178225. [Back]
2635. 7/19/2007 email from Patrick Welch, GS MBS-E-001866507. [Back]
2636. 7/25/2007 email from Fabrice Tourre, GS MBS-E-001989091. [Back]
2637. Id. Greywolf Capital was the collateral manager of the Timberwolf CDO. [Back]
2638. 7/25/2007 email from Matthew Bieber, GS MBS-E-001989091. [Back]
2639. 7/26/2007 email from Shelly Lin, GS MBS-E-015232129. [Back]
2640. 7/30/2007 email from Matthew Bieber to David Lehman, GS MBS-E-001867239. [Back]
2641. See 8/6/2007 email from Connie Kang to David Lehman, GS MBS-E-001992556; 8/9/2007 email from Mahesh Ganapathy to David Lehman, Matthew Bieber, and Jonathan Egol, GS MBS-E-001930307; 8/12/2007 email from Mahesh Ganapathy to David Lehman and Matthew Bieber, GS MBS-E-001930343; 8/13/2007 email from Mahesh Ganapathy to Matthew Bieber, David Lehman, and Jonathan Egol, GS MBS-E-001930571. [Back]
2642. In addition, since the yield of most default swap collateral securities was linked to their "face (par) value," when the same securities could be obtained at a price lower than their par value, their yield (return on investment) increased as long as they continued to meet their scheduled principal and interest payments. This was another potential benefit to the long investors which conflicted with the interest of Goldman, the short party. [Back]
2643. 8/21/2007 email from Matthew Bieber to David Lehman, GS MBS-E-011273913. [Back]
2644. See 9/21/2007 email from Marty Devote of Aladdin Capital Management t 2644 o Benjamin Case, GS MBS-E 022138816 ("We, at the direction of Connie and Roman [Goldman employees], have not been reinvesting CDS collateral as it matures. We've brought the topic up a few times over the past few months with your team. Last I heard, you were re-evaluating the market, and would come back to us with a breakdown of acceptable replacements. As the cash balances continue to grow, I'd like to address this issue, as the amount of cash drag is beginning to become meaningful."). [Back]
2645. 9/6/2007 email from Roman Shimonov to Matthew Bieber, GS MBS-E-000765873. [Back]
2646. 9/6/2007 email from Joe Marconi to David Lehman, GW 107909. [Back]
2647. Subcommittee interview of Joseph Marconi (Greywolf Capital) (10/19/2010). [Back]
2648. 9/7/2007 email 2648 from Joe Marconi to David Lehman, GW 107909. [Back]
2649. Subcommittee interview of Joseph Marconi (Greywolf Capital) (10/19/2010). [Back]
2650. Id. [Back]
2651. Section 12.5(b) of the Timberwolf Indenture agreement stated: "The Synthetic Securities shall be structured as ‘pay-as-you-go' credit default swaps. As part of the purchase of each Synthetic Security on or before the Closing Date, the Issuer will be required to purchase Default Swap Collateral which satisfies the Default Swap Collateral Eligibility Criteria set forth in the related Synthetic Security and the inclusion of which has been consented to by the Synthetic Security Counterparty in the amount required to secure the obligations of the Issuer in accordance with the terms of the related Synthetic Security which shall be in at least an amount equal to the Aggregate Reference Obligation Notional Amount. The Synthetic Security Counterparty shall have consent rights with respect to the Default Swap Collateral and no Default Swap Collateral objected to by the Synthetic Security Counterparty may be purchased by the Issuer. Default Swap Collateral shall be credited to the Default Swap Collateral Account. The amount payable by the Issuer to the Synthetic Security Counterparty under a Synthetic Security shall not exceed the Default Swap Collateral." 3/27/2007 Timberwolf I, LTD. Indenture Agreement, GS MBS-E-021825583 at 711. [Back]
2652. 7/25/2007 email from Matthew 2652 Bieber, GS MBS-E-001989091. [Back]
2653. 1/7/2011 email from Goldman counsel to the Subcommittee. [Back]
2654. 9/7/2007 email from Matthew Bieber to Tim Saunders, Susan Helfrick, and Jordan Horvath, GS MBS-E- 021881077. [Back]
2655. Id. [Back]
2656. 9/7/2007 email from Susan Helfrick to Matthew Bieber, Tim Saunders, and Jordan Horvath, GS MBS-E- 021881084. [Back]
2657. Mr. Saunders, Ms. Helfrick, and Mr. Horvath provided signed statements 2657 to the Subcommittee to the same effect. See written statements submitted to the Subcommittee by Timothy Saunders (12/22/2010), Susan Helfrick (1/7/2011), and Jordan Horvath (1/7/2011). Although Mr. Lehman was not invited to the meeting, he told the Subcommittee that he generally recalled having discussions with his colleagues, including Goldman's legal department, about the general issue of default swap collateral, but did not recall his conversation with Mr. Marconi. He also submitted a statement to the Subcommittee saying he had no recollection of whether the meeting took place or, if a meeting was held, what was discussed or decided. Written statement of Mr. Lehman (1/26/2011). Mr. Sparks, the head of the Mortgage Department, told the Subcommittee that while he had a general knowledge of the issue regarding default swap collateral securities, he had no recollection of any meeting or decisions made. Subcommittee interview of Daniel Sparks (1/13/2011). [Back]
2658. Subcommittee interview of Matthew Bieber (10/21/2010). [Back]
2659. 9/7/2007 email exchange between David Lehman and Matthew Bieber, GS MBS-E-000766414. The reference to "slmas" is to asset backed securities that were issued by Sallie Mae and backed by pools of student loans. [Back]
2660. Id. [Back]
2661. 9/7/2007 email from Jonathan Egol to Michael Swenson and David Lehman, G 2661 S MBS-E-000765854. [Back]
2662. See 9/7/2007 email from Matthew Bieber to David Lehman, GS MBS-E-000766414 ("I need to speak with dan... we're thinking about offering some 1-3 year SLMAs."). [Back]
2663. 9/10/2007 email from Matthew Bieber to David Lehman, GS MBS-E-000765316. "SLMA" refers to asset backed securities that were issued by Sallie Mae and backed by pools of student loans. [Back]
2664. 9/25/2007 email from Matthew Bieber to Joe Marconi, GS MBS-E-000766338. The action taken by Goldman to stop the purchase of new default swap collateral securities was not the only instance in which it attempted to exert control over the collateral in the CDOs it constructed. In the case of the Broadwick CDO, for example, when some investors were entitled to the return of some collateral, Goldman attempted to have the CDO pay them with securities rather than cash, so that the CDO would preserve the cash in its collateral account. The Broadwick collateral manager objected and complained in an email sent to Mr. Sparks, stating in part:
"In case I wasn't clear on the call, our three main points would be:
1. The aim of the collateral account was to provide LIBOR and not add additional risk to the deal.
2. GS said they would take market risk and clearly represented that to us and to the ratings agencies.
3. The only way the deal works, and the way the deal was marketed and explained to us, is that paydowns are equivalent to partial terminations. We do not believe you have any right to refuse to release excess cash that is no longer needed as collateral, and we do not believe you have the right to release bonds into the waterfall ever, and certainly not when cash exists. Perhaps the way you did these deals changed over time and you are comparing our deal to ones which you marketed or structured later/differently? I look forward to hearing from you."
11/20/2007 email from Ron Beller to Matthew Bieber, GS MBS-E-013746516. [Back]
2665. Documents show that a list of assets was sent to Aladdin Capital Management and Trust Company of the West. See 9/24/2007 email from Benjamin Case to Marty Devote of Aladdin Capital Management, GS MBS-E 022138816; 9/20/2007 email from Matthew Bieber to Vincent Fiorillo of Trust Company of the West, GS MBS-E-022141026- 27. [Back]
2666. 10/15/2007 email from Matthew Bieber to Matthew Verrochi, GS MBS-E-2666 015732147. The list had one more RMBS security than the lists sent to the collateral managers. [Back]
2667. 9/27/2007 email from Joe Marconi to Matthew Bieber, GW 108645. [Back]
2668. Written statement of David Lehman (1/26/2011). [Back]
2669. Subcommittee interview of Daniel Sparks (1/13/2011). [Back]
2670. The seven CDOs were Fort Denison, Camber 7, Timberwolf, Anderson Mezzanine, Point Pleasant, Hudson Mezzanine 2006-1, and Hudson Mezzanine 2006-2. Goldman lost $1.018 billion from acting as the collateral put provider for their default swap collateral securities. See Goldman response to Subcommittee QFR at PSI_QFR_GS0280. [Back]
Back to Contents (4) How Goldman Shorted the Subprime Mortgage Market (6) Analysis of Goldman's Conflicts of Interest
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