Panel: Investment Banks Bet Against Mortgage Market, Clients

April 14, 2011 Updated: April 14, 2011

NEW YORK—A scathing report, delivered by a bipartisan U.S. Senate panel this week, claimed that investment bank Goldman Sachs Group Inc. had deceived clients and Congress regarding its proprietary positions on mortgage-backed securities.

The Permanent Subcommittee on Investigations, chaired by Sen. Carl Levin (D-Mich.), said that it concluded that Goldman misled its clients, and placed massive bets against the very securities it peddled to its clients.

The report, likely the last of its kind regarding the causes of the recent financial crisis, began in 2007, which was driven by defaults in subprime mortgages and related securities. The ensuing crisis engulfed the global economy in a severe recession, caused Lehman Brothers to collapse, pushed insurer American International Group Inc. to seek a huge bailout, and forced mortgage finance giants Fannie Mae and Freddie Mac to be nationalized.

More than two years since the start of the financial crisis, no Wall Street executives have been prosecuted for events leading to a $700 billion federal bailout of multiple business sectors. However, Sen. Levin said that he would recommend Goldman executives—who had testified in front of his panel—for possible prosecution. The executives denied that their firm misrepresented to its clients regarding mortgage-related securities.

“When Goldman Sachs realized the mortgage market was in decline, it took actions to profit from that decline at the expense of its clients,” Sen. Levin’s office said in a statement. “New documents detail how, in 2007, Goldman’s Structured Products Group twice amassed and profited from large net short positions in mortgage related securities.”

Goldman, in response to the report, maintained that it was free of any wrongdoing, and said that in its documentation, it disclosed to clients that it may take “short” positions. It also disputed Sen. Levin’s charges that its CEO Lloyd Blankfein misled Congress last year.

The bank was not the only target of the report. The panel outlined a culture on Wall Street where proprietary positions were taken despite certain official recommendations to clients.

The 639-page report detailed how German investment bank Deutsche Bank securitized a $1.1 billion collateralized debt obligation (CDO) called “Gemstone 7,” which was deemed to be “crap” by its bankers in internal memos, was hurriedly sold by the bank “before the market falls off a cliff,” its traders wrote in e-mails.

The report also questioned practices at Washington Mutual, the lender that was taken over by JPMorgan Chase & Co. The reports claims that WaMu President Steve Rotella testified in Congress that he and his bank had moved away from risky subprime lending, however, internal memos paint a different picture.

“I think our focus needs to be on organic growth of home e.q. [equity], and subprime, and greater utilization of [the Home Loans division] as we know it today to facilitate that at lower acquisition costs and greater efficiency,” Rotella wrote in an e-mail in 2005.

Sen. Levin and his team also criticized ratings agencies such as Moody’s Investors Service, as well as various government regulators and agencies.

Goldman, for its part, paid $550 million last year to settle a case with the Securities and Exchange Commission over its sale of Abacus II, a series of CDOs sold in 2007.

It shows without a doubt the lack of ethics in some of our financial institutions," said Sen. Tom Coburn (R-Okla.), the ranking Republican in the committee.