Money and Power (2 page)

Goldman Sachs prides itself on being a “mark-to-market” firm, Wall Street argot for being ruthlessly precise about the value of the securities—known as “marks”—on its balance sheet. Goldman believes its precision promotes transparency, allowing the firm and its investors to make better decisions, including the decision to bet the mortgage market would collapse in 2007. “Because we are a mark-to-market firm,” Blankfein once wrote, “we believe the assets on our balance sheet are a true and realistic reflection of book value.” If, for instance, Goldman observed that demand for a certain security or group of like securities was changing or that exogenous events—such as the expected bursting of a housing bubble—could lower the value of its portfolio of housing-related securities, the firm religiously lowered the marks on these securities and took the losses that resulted. These new, lower marks would be communicated throughout Wall Street as traders talked and discussed new trades. Taking losses is never much fun for a Wall Street firm, but the pain can be mitigated by offsetting profits, which Goldman had in abundance in 2007, thanks to the mortgage-trading group that set up “the big short.”

What’s more, the profits Goldman made from “the big short” allowed the firm to put the squeeze on its competitors, including Bear Stearns, Merrill Lynch, and Lehman Brothers, and at least one counterparty, AIG, exacerbating their problems—and fomenting the eventual crisis—because Goldman alone could take the write-downs with
impunity. The rest of Wall Street squirmed, knowing that big losses had to be taken on mortgage-related securities and that they didn’t have nearly enough profits to offset them.

Taking Goldman’s new marks into account would have devastating consequences for other firms, and Goldman braced itself for a backlash. “Sparks and the [mortgage] group are in the process of considering making significant downward adjustments to the marks on their mortgage portfolio esp[ecially] CDOs and CDO squared,” Craig Broderick, Goldman’s chief risk officer, wrote in a May 11, 2007, e-mail, referring to the lower values Sparks was placing on complex mortgage-related securities. “This will potentially have a big P&L impact on us, but also to 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. This is getting lots of 30th floor”—the executive floor at Goldman’s former headquarters at 85 Broad Street—“attention right now.”

Broderick’s e-mail may turn out to be the unofficial “shot heard round the world” of the financial crisis. The shock waves of Goldman’s lower marks quickly began to be felt in the market. The first victims—of their own poor investment strategy as well as of Goldman’s marks—were two Bear Stearns hedge funds that had invested heavily in squirrelly mortgage-related securities, including many packaged and sold by Goldman Sachs. According to U.S. Securities and Exchange Commission (SEC) rules, the Bear Stearns hedge funds were required to average Goldman’s marks with those provided by traders at other firms.

Given the leverage used by the hedge funds, the impact of the new, lower Goldman marks was magnified, causing the hedge funds to report big losses to their investors in May 2007, shortly after Broderick’s e-mail. Unsurprisingly, the hedge funds’ investors ran for the exits. By July 2007, the two funds were liquidated and investors lost much of the $1.5 billion they had invested. The demise of the Bear hedge funds also sent Bear Stearns itself on a path to self-destruction after the firm decided, in June 2007, to become the lender to the hedge funds—taking out other Wall Street firms, including Goldman Sachs, at close to one hundred cents on the dollar—by providing short-term loans to the funds secured by the mortgage securities in the funds.

When the funds were liquidated a month later, Bear Stearns took billions of the toxic collateral onto its books, saving its former counterparties from that fate. While becoming the lender to its own hedge funds was an unexpected gift from Bear Stearns to Goldman and others, nine months later Bear Stearns was all but bankrupt, its creditors rescued
only by the Federal Reserve and by a merger agreement with JPMorgan Chase. Bear’s shareholders ended up with $10 a share in JPMorgan’s stock. As recently as January 2007, Bear’s stock had traded at $172.69 and the firm had a market value of $20 billion. Goldman’s marks had similarly devastating impacts on Merrill Lynch, which was sold to Bank of America days before its own likely bankruptcy filing, and AIG, which the government rescued with $182 billion of taxpayer money before it, too, had to file for bankruptcy.
There is little doubt that Goldman’s dual decisions to establish “the big short” and then to write down the value of its mortgage portfolio exacerbated the misery at other firms.

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U
NDERSTANDABLY
, G
OLDMAN DOES
not like to talk about the role it had in pushing other firms off the edge of the cliff. It prefers to pretend—even in sworn testimony in front of Congress—that there was no “big short” at all, that its marks were not much lower than any other firm’s marks, and that its profits in 2007 from its mortgage trading activities were
de minimis,
something on the order of $500 million, Blankfein later testified, which is chump change in the world of Goldman Sachs. (Goldman officials preferred to talk about their mortgage business as having lost $1.7 billion in 2008, and therefore for the two-year period, Goldman lost $1.2 billion in its mortgage business.) Rather than crow—as would be typical on Wall Street—about its trading prowess in 2007, a prowess that probably saved the firm, Goldman has been taking the opposite tack in public lately of obfuscating and suggesting that it was just as stupid as everyone else. For a firm where Blankfein once said of his job, “
I live ninety-eight percent of my time in the world of two-percent probabilities,” this argument may seem counterintuitive. But in a political and economic environment where the repercussions of the financial crisis are still reverberating and blame is still being apportioned, Goldman’s preference for appearing dumb rather than brilliant may be the best of its poor options.

Consider this exchange, from an April 27, 2010, U.S. Senate hearing, between Senator Carl Levin, D-Michigan, the chairman of the Permanent Subcommittee on Investigations, and Blankfein:

This disconnect with Senator Levin had followed Blankfein’s opening statement, where he denied the firm had made a bet against the housing market in 2007. “Much has been said about the supposedly massive short Goldman Sachs had on the U.S. housing market,” he said. “The fact is, we were not consistently or significantly net-short the market in residential mortgage-related products in 2007 and 2008. Our performance in our residential mortgage-related business confirms this. During the two years of the financial crisis, while profitable overall, Goldman Sachs lost approximately $1.2 billion from our activities in the residential housing market. We didn’t have a massive short against the housing market, and we certainly did not bet against our clients.”

In a separate interview, Blankfein said the decision to mitigate the firm’s risk to the housing market in December 2006 has been “overplayed” and was just a routine decision. “It’s what you do when you’re managing risk, and a huge part of risk management is scouring the P&L every day for aberrations or unpredicted patterns,” he said. “And when you see something like that, you call the people in the business and say, ‘Can you explain that?’ and when they don’t know, you say, ‘Take risk down.’ That’s what happened in our mortgage business, but that meeting wasn’t significant. It was rendered significant by the events that subsequently happened.”

In fact, Goldman’s decision to short the mortgage market, beginning around December 2006, was anything but routine. One former Goldman mortgage trader said he does not understand why Goldman is being so coy. “Their MO is that we made as little money as possible,” he said. “[So,] anything that makes it look like they didn’t make money or they lost money is good for them, right? Because they don’t want to be seen as benefiting during the crisis.”

For his part, Senator Levin said he remains mystified by Blankfein’s denials when the documentary evidence—including e-mails and board presentations—points overwhelmingly to Goldman having profited handsomely from the bet. “
I try to understand why it is that Goldman denies, to this day, making a directional bet against the housing market,” he said in a recent interview. “They don’t give a damn much about appearances, apparently, on a lot of things they did, but at any rate, I don’t get it. Clearly [Goldman] made a directional bet and … they lied. The bottom line: They have lied. They’ve lied about whether or not they made a directional bet.” He said his “anger” about Goldman is “very deep” because “they made a huge amount of money betting against housing and they lied about it, and their greed is incredibly intense.”

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D
ESPITE HAVING
“the big short,” Goldman and Blankfein could not avoid the tsunami-like repercussions of the crisis. On September 21, 2008, a week after Bank of America bought Merrill and Lehman Brothers filed for bankruptcy protection—the largest such filing of all time—both Goldman and Morgan Stanley voluntarily agreed to give up their status as securities firms, which required increasingly unreliable borrowings from the market to finance their daily operations, to become bank holding companies, which allowed them to obtain short-term loans from the Federal Reserve but, in return, required them to be more heavily regulated than they had been in the past. Goldman and Morgan Stanley made the move as a last-ditch, Hail Mary pass to restore the market’s confidence in their firms and stave off their own—once unthinkable—bankruptcy filings. The plan worked. Within days of becoming a bank-holding company, Goldman raised $5 billion in equity from Warren Buffett, considered one of the world’s savviest investors—making Buffett the firm’s largest individual investor—and another $5.75 billion from the public.

Weeks later, on October 14, Treasury Secretary Paulson summoned to Washington Blankfein and eight other CEOs of surviving Wall Street firms, and ordered them to sell a total of $125 billion in preferred stock to the Treasury, the funds for the purchase coming from the $700 billion Troubled Asset Relief Program, or TARP, the bailout program that Congress had passed a few weeks earlier on its second try. Paulson forced Goldman to take $10 billion of TARP money, as a further step to restore investor confidence in the firms at ground zero of American capitalism. Paulson’s evolving thinking, which was shared by both Ben Bernanke, the chairman of the Federal Reserve Board, and Timothy Geithner, then president of the Federal Reserve Bank of New York and now Paulson’s successor at Treasury, was that the economic status quo could not be restored until Wall Street returned to functioning as normally as possible. “We were at a tipping point,” Paulson said in a speech a few weeks later. Paulson’s idea was that the banks receiving the TARP funds would make loans available to borrowers as the economy improved.

Blankfein never believed Goldman needed the TARP funds—and perhaps unwisely said so publicly, earning him Obama’s ire. Exacerbating the concerns of the banks that received the TARP money was the fact that Obama had appointed Kenneth Feinberg as his “pay czar” and gave him the mandate to monitor closely—and limit if need be—the compensation of people who worked at financial institutions that received TARP money. Wall Street bankers and traders like to think their compensation potential is unlimited, and so the idea of having Feinberg as a pay czar
did not sit well. At the earliest opportunity, which turned out to be July 2009, Goldman—as well as Morgan Stanley and JPMorgan Chase—paid back the $10 billion, plus dividends of $318 million, and paid another $1.1 billion to buy back the warrants Paulson extracted from each of the TARP recipients that October day as part of the price of getting the TARP money in the first place.

“
People are angry and understandably ask why their tax dollars have to support large financial institutions,” Blankfein wrote in his April 27 letter. “That’s why we believe strongly that those institutions that are able to repay the public’s investment without adversely affecting their financial profile or curtailing their role and responsibilities in the capital markets are obligated to do so.” He made no mention of pay caps as influencing his decision to repay the TARP money or that the TARP money was supposed to be used to make loans to corporate borrowers. Instead, Goldman likes to boast that for the nine months that it had the TARP money it said it didn’t want or need, American taxpayers received an annualized return of 23.15 percent.

Ironically, no one seemed the slightest bit grateful. Rather, there was an increasing level of resentment directed at the firm and its perceived arrogance. The relative ease with which Goldman navigated the crisis, its ability to rebound in 2009—when it earned profits of $13.2 billion and paid out bonuses of $16.2 billion—and Blankfein’s apparent tone deafness to the magnitude of the public’s anger toward Wall Street generally for having to bail out the industry from a crisis of largely its own making made the firm an irresistible target of politicians looking for a culprit and for regulators looking to prove that they once again had a backbone after decades of laissez-faire enforcement of securities laws. Aiding and abetting the politicians in Congress, and the regulators at the U.S. Securities and Exchange Commission, were scornful and wounded competitors angry that Goldman had rebounded so quickly while they still struggled.

Those who believe, like Obama, that the steps the government took in September and October 2008 helped to resurrect the banking sector, and Goldman with it, point to a chart of the firm’s stock price. Before Thanksgiving 2008, the stock reached an all-time low of $47.41 per share, after trading around $165 per share at the start of September 2008. By October 2009, Goldman’s stock had fully recovered—and more—to around $194 per share. “
[Y]our personally owned shares in Goldman Sachs appreciated $140 million in 2009, and your options appreciated undoubtedly a multiple of that,” John Fullerton, a former managing director at JPMorgan and the founder of the Capital Institute,
wrote to Blankfein on the last day of 2009. “Surely you must acknowledge that this gain, much less the avoidance of a total loss, is attributable directly to the taxpayer bailout of the industry.”