WASHINGTON -- Goldman Sachs executives deceived clients in order to profit off the brewing financial crisis and then misled Congress when asked to explain their actions, concluded a top lawmaker who led a two-year investigation into Wall Street's role in the meltdown.
Carl Levin, chair of the Senate Permanent Subcommittee on Investigations, will recommend that Goldman executives who testified before his panel, including chairman and chief executive Lloyd Blankfein, be referred to the Justice Department for possible criminal prosecution, the Michigan Democrat announced Wednesday. Members of the subcommittee will now deliberate Levin's proposal.
A Goldman spokesman said its executives were truthful in their testimony, adding that the firm disagreed with many of the panel's conclusions.
Two and a half years after a historic crisis that has yielded not a single criminal conviction of anyone who played a leading role in causing it, the prosecution of such a high-profile Wall Street executive may satisfy the public's desire to see culprits brought to justice. Last year, the Securities and Exchange Commission settled a lawsuit it had brought against Goldman.
But the firm was just one target of a sweeping, 639-page report by the Senate panel into the causes of the crisis. Hardly a fluke occurrence, the meltdown was the product of a deeply corrupt financial system, one fueled by profit-hungry banks that deceived their clients, and overseen by lax regulators who were complicit in the firms' chronic abuse of the most fundamental rules of the game, the report concludes.
The investigation found a "financial snake pit rife with greed, conflicts of interest, and wrongdoing," Levin said.
More than any other government report produced in the wake of the crisis, this account names names, blaming specific people and institutions: Goldman Sachs, Washington Mutual, Moody's Investors Service, Standard & Poor's, the Office of Thrift Supervision and others. It targets four types of institutions, all of which it says played key roles in causing the crisis: mortgage lenders that offered prospective homeowners booby-trapped loans; regulators that were paid by the institutions they were regulating and cooperated in widespread deception; rating agencies that gave seals of approval to products they knew to be especially risky, all in the pursuit of market share; and Wall Street banks that duped investors into buying securities that only the insiders knew were destined to go bad.
"Blame for this mess lies everywhere from federal regulators who cast a blind eye, Wall Street bankers who let greed run wild, and members of Congress who failed to provide oversight," said the panel's ranking member, Sen. Tom Coburn, an Oklahoma Republican.
Eventually, as the falling housing market helped drag the broader economy into the most punishing recession since the 1930s, this parasitic apparatus began to crumble. At that point, the key players had already pocketed their profits and were poised to pocket more, while legions of investors and homeowners had been set up for ruin.
The forces behind the economic collapse were multiple, with some causes likely originating decades before the crash. But this report exposes the people who, it says, most immediately caused the crisis -- whose behavior, motivated by profit above seemingly anything else, trashed the financial system, and magnified the devastation from which the real economy has yet to recover.
Wall Street banks magnified the crisis and its fallout. The Senate subcommittee singled out Goldman as a particularly representative case.
Investigators pored over millions of pages of internal Goldman documents and correspondence. They found evidence of traders boasting about how they sold their clients "shitty" deals, and discovered documents that detailed how the storied investment bank -- which has long maintained it didn't make a firm-wide bet against American homeowners -- reversed course over a three-month period in late 2006 through 2007, shedding bets that the value of subprime mortgage-linked investments would rise.
Rather, the firm went "short," the report exhaustively documents. In Wall Street parlance, shorting an investment means betting its value will fall.
Levin said his investigators found 3,400 instances of Goldman officials using the phrase "net short" in the documents they reviewed. He intimated that Goldman likely used the phrase many more times in other documents not reviewed by his panel.
As of December 2006, Goldman had $6 billion in bets that the value of its subprime assets would surge, according to the panel's report. By February of the next year, its mortgage traders had $10 billion in bets that such securities would collapse.
By June, the firm was net short on subprime borrowers to the tune of $13.9 billion, according to the report.
As more borrowers fell behind on their payments and as the value of securities linked to their mortgages slid, Goldman stayed "net short." Other banks suffered. But not this one.
"Tells you what might be happening to people without the big short," Goldman's chief financial officer David Viniar wrote in a July 2007 email to the firm's chief operating officer, Gary Cohn.
Even when these documents came to light last year, Goldman maintained it never took the position that housing-linked securities would decline, particularly considering that it was selling its clients investments that were bullish on homeowners. Goldman, too, suffered losses from housing-related investments, the firm pointed out.
But Levin's investigators don't dispute that Goldman took losses during the financial crisis. His team asserts that while Goldman salesmen were peddling investments linked to bonds backed by subprime mortgages, its traders were betting that those securities -- and others like it -- would fail, and that the two teams were in contact. The assertion raises a crucial question about whether the firm violated securities rules prohibiting double-dealing.
Worse, Levin said, Goldman traders attempted to manipulate the market for derivatives linked to such investments, according to the report.
Internal company documents show that in May 2007, Goldman traders tried to artificially drive down the price of certain bets it wanted to make -- bets that borrowers would default on their home loans.
The plan was for one group of Goldman traders to peddle such securities across Wall Street "at lower and lower prices, in order to drive down the market price [of the securities] to artificially low levels," the report notes. Due to Goldman's size and market power, that would have driven down prices across the Street, forcing holders of such securities to record losses.
The firm wanted "to cause maximum pain," Michael Swenson, a head mortgage trader at Goldman, wrote in a May 25, 2007 email documented in the report.
By that point, many Wall Street players were betting on homeowners to default. The price of placing such bets was rising. Goldman wanted a cheaper way in.
As part of the plan, another Goldman unit was to buy those positions at a lower price, enabling them not only to add to their growing bet that the American homeowner would eventually default, but to do so at a lower price.
Goldman initiated this plan "despite the harm that might be caused to Goldman's clients," according to the report. Indeed, clients began to complain of a "sudden mark-down" of their positions.
A Goldman representative who showed Swenson the complaints of one hedge fund client was met with a terse response: "We are ok with that," Swenson wrote in another documented email. "They do not have much more gun powder."
In other words, Goldman didn't have to worry about the client because the client didn't have the resources -- the "gun powder" -- to compete with Goldman, according to the report.
One of the traders Swenson oversaw, Deeb Salem, laid this all out in a self-evaluation of his performance in 2007 that he sent to Goldman's senior management.
"In May, while we were remain[ing] as negative as ever on the fundamentals in sub-prime, the market was trading VERY SHORT, and susceptible to a squeeze," Salem wrote, emphasizing that traders across Wall Street were shorting the market. "We began to encourage this squeeze, with plans of getting very short again, after the short squeezed cause[d] capitulation of these shorts."
"This strategy seemed do-able and brilliant," he wrote.
Interviewed by investigators in October of last year, Salem denied that he had tried to squeeze the market. Investigators reading his self-evaluation put too much emphasis on "words," according to the report.
Goldman abandoned the plan the next month after a rival investment bank's hedge funds collapsed.
"While we disagree with many of the conclusions of the report, we take seriously the issues explored by the subcommittee," Goldman said in a statement. A Goldman spokesman added that the firm recently overhauled its business standards to improve transparency and disclosure and to strengthen its client relationships.
Levin, who briefly described the strategy during a Senate hearing last December, said Wednesday that it was the type of "disgraceful" behavior emblematic of Goldman's attitude at the time: Goldman first, clients last.
Deutsche Bank, Germany's largest lender and one of the biggest in the world, also came under fire for its crisis-era activities.
The panel caught one of its former traders, Greg Lippmann, referring to such securities over email as "crap" and "pigs," according to the report. Lippmann was made semi-famous by author Michael Lewis for his prescient call to short subprime securities.
His unit sold some of the very securities he criticized.
The banker who oversaw Lippman's unit, Michael Lamont, told a colleague at another firm how Deutsche was rushing to sell these financial instruments "before the market falls off a cliff," according to a February 2007 email Lamont sent.
Meanwhile, buyers of the securities were never told.
At one point, Lippman described the creation and selling of such instruments as a "Ponzi scheme." He also said he would "try to dupe someone" into buying a particularly risky mortgage-linked security he himself was being asked to purchase, according to the report.
He later backed off some of those comments when interviewed by Senate investigators.
Levin said the German bank engaged in "disturbing activities."
During this time, the now head of enforcement at the SEC, Robert Khuzami, served as a top lawyer at Deutsche, overseeing litigation and regulatory investigations.
The panel said it didn't find anything incriminating that would implicate Khuzami in the matters under investigation.
Khuzami is now in charge of pursuing financial wrongdoers. He has pledged to recuse himself from investigations involving the German lender.
Goldman, for its part, sold a collection of questionable securities. Levin's investigators uncovered four securities -- complex financial instruments with names like Hudson and Timberwolf -- that Goldman recommended to customers without fully disclosing key information, or saying whether the firm was betting against them.
For example, in the Hudson deal, Goldman told investors its interests were "aligned" with theirs when in reality the firm held "100 percent of the short side" of that security, according to the report. Goldman was betting on Hudson to fail.
Also, Goldman said the assets in Hudson were "sourced from the Street." But investigators said Goldman selected the assets and priced them itself.
Wednesday's disclosures are similar to a case from last year, in which Goldman Sachs allegedly helped set up a mortgage-linked investment for a favored client, designing it to fail, yet selling it anyway to its other clients, reaping the favored client nearly $1 billion. The deal, named Abacus, was also targeted in the Senate report. Goldman settled the accusations with the SEC last year for $550 million.
"Goldman was sticking it to their own clients," Levin told reporters. "Goldman gained at the expense of their clients, and used abusive practices to do it."
Goldman, though, has rejected such characterizations.
"Much has been said about the supposedly massive short Goldman Sachs had on the U.S. housing market," Goldman chief Blankfein said in testimony before Levin's panel last year. "The fact is, we were not consistently or significantly net-short the market in residential mortgage-related products in 2007 and 2008."
"We didn't have a massive short against the housing market, and we certainly did not bet against our clients," he added. Other Goldman executives made similar claims.
"That is simply not true," Levin said Wednesday. "They clearly misled their clients and they misled the Congress," he added, announcing that he will recommend that his panel refer all of the Goldman executives who testified before the committee for possible criminal prosecution by the Justice Department and for sanctions by the SEC for violations of securities laws.
Goldman disputed Levin's characterizations.
"The testimony we gave was truthful and accurate and this is confirmed by the subcommittee's own report," the firm said. "The report references testimony from Goldman Sachs witnesses who repeatedly and consistently acknowledged that we were intermittently net short during 2007. We did not have a massive net short position because our short positions were largely offset by our long positions, and our financial results clearly demonstrate this point."
The investigative panel must deliberate Levin's recommendations before making any referrals to prosecutors or regulators. Coburn, the Republican, would have to agree with Levin in order for the referrals to be made.
Asked about the general lack of prosecutions of high-powered Wall Street executives, Levin replied: "There is still time."
"Hope springs eternal," he added with a smile.