Washington Post

By Zachary A. Goldfarb

Goldman Sachs is preparing its most detailed defense yet to allegations that it misled clients in its mortgage securities business, arguing that the firm was unsure whether housing prices would rise or fall and did not take any action at odds with the interests of its clients.

An internal Goldman document, prepared for senior executives and obtained by The Washington Post, addresses the criticism that the bank invested its own money betting against the housing market while simultaneously urging clients to invest in securities that would increase in value only if the housing market did.

Those concerns over possible double-dealing spiked a week ago as the Securities and Exchange Commission filed a fraud suit against Goldman, alleging that it misled clients by selling them mortgage-related securities secretly designed to fail.

Goldman prepared the 11-page document to serve as the basis for testimony that chief executive Lloyd Blankfein is scheduled to deliver Tuesday before the Senate Permanent Subcommittee on Investigations.

The Goldman paper describes debates among top executives in 2006 and 2007 over whether the firm should make investment decisions based on the belief that the mortgage market would continue to prosper.

The document details meetings and e-mails that ultimately resulted in a decision to reduce the company's exposure to the mortgage market, especially subprime loans, by making new investments that would pay off if housing prices fell.

Subprime risk
Over the past few years, other financial firms and some in the media have complained that Goldman recognized the risks of the subprime mortgage market early on and, without telling clients, developed financial products that would allow the bank to bet against mortgages with its own money. At the same time, Goldman continued to sell mortgage-related investments to clients who expected the subprime loan business to remain vibrant, critics have alleged.

While the firm moved to significantly reduce its losses when the housing market cratered, the impression conveyed by the document is that Goldman was confused, like many other financial firms, over how bad the collapse would be and suffered losses as a result.

The document also reprises Goldman's frequent explanation that it was not investing its own money in financial transactions to make a trading profit but to help investors who wanted to do a deal and could not easily find someone else to trade with. That role, commonly played by investment banks, is known as being a market maker.

A spokesman for the Senate subcommittee declined Friday evening to comment on Goldman's defense.

"Our investigation has found that investment banks such as Goldman Sachs were not market makers helping clients," Sen. Carl M. Levin (D-Mich.), who heads the panel, said Friday. "They were self-interested promoters of risky and complicated financial schemes that were a major part of the 2008 crisis."

In the paper, Goldman argues that it was a relatively small player in the mortgage market, bringing in only $500 million from its residential mortgage business in 2007, less than 1 percent of the firm's overall revenues.

Still, the bank's mortgage investments were large enough that executives began to worry in 2006 that it was betting too heavily on the health of the housing market.

'Getting hit hard'
According to the document, the concerns arose in late 2006, when Dan Sparks, the head of the mortgage unit, wrote to top executives that the "subprime market [was] getting hit hard," with the firm losing $20 million in one day.

On Dec. 14, 2006, financial officer David Viniar called Goldman's mortgage traders and risk managers into a meeting to discuss investing strategy. They concluded that they would reduce the firm's overall exposure to the subprime mortgage market.

But the prevailing view of executives, as described in the paper, was not that the housing market was headed into a prolonged decline. They were not looking to short the market overall. That would have entailed making such large bets against mortgage securities that the firm would turn a profit if the market as a whole collapsed, which in fact it did.