Senate Grills Goldman for MBS Sale Practices

WASHINGTON, DC-As the Senate Governmental Affairs Subcommittee on Investigations grilled Goldman Sachs Tuesday about the sales of residential and commercial mortgage-backed securities, the senators agreed they will amend pending legislation to include conflict-of-interest wording based on the testimony. The company, which earned $500 million in 2007 by balancing long investments on these securities with short sales against the securities' success, has been charged by the SEC with fraud regarding MBS sales.

Through 11 hours of testimony from Goldman executives, the subcommittee accused the company of selling securities to some companies without telling the buyers that Goldman planned to sell short on those securities--basically betting against the product. "You have salespeople saying they think these products are crap, yet they still sell them while your company bets against them," said committee chairman Sen. Carl Levin. "You shouldn't be selling junk, and you shouldn't be betting against your own customer the same time you're selling to him."

Levin was referring to about half a dozen examples of large bad loan packages that the company sold to investors, while Goldman at the same time went short on the same packages. Emails presented as evidence showed that Goldman employees knew the packages were bad, but did not relay this sentiment as it marketed the packages. All of these packages ended up in default, and investors lost millions of dollars.

Levin said he's going to insert regulatory language into an amendment for a financial services regulatory reform bill, now pushed by Sen. Christopher Dodd, to try to prevent conflicts of interest. "We need a financial cop back on the beat, to protect Main Street from the excesses of Wall Street," Levin said.

However, Goldman executives said repeatedly that no fraud was committed, and that they have followed the law and acted ethically in all dealings. Goldman's product salespeople are responsible to show a buyer its due diligence on a product, but they do not have to provide their opinion about the securities, the executives said. Also, Goldman's short coverage of the MBS packages, even after it became clear the housing market was failing, was just a market correction to stem losses, the executives said.

"Nothing I've heard today makes me think anything went wrong," said Lloyd Blankfein, Goldman chairman and CEO, during his testimony. "We didn't know what was going to happen with the housing market. We just wanted to reduce risk."

While a few of the senators tried to liken trading in synthetic collateralized debt obligations to sports betting, Blankfein and the other Goldman executives said they were just providing a service to investors who wanted to assume various levels of risk at a good price. "You could probably even find someone right now who would give you pennies on the dollar for those same bad loans, because that's the risk they want to assume," Blankfein said.

It was clear at various times during the questioning that the senators lack understanding of how a market maker such as Goldman Sachs operates, with separate departments that handle trades and sales. Also, while the senators had trouble with the ethics of the trades, they did not claim that direct fraud was committed.

The SEC filed charges against Goldman Sachs on April 16. The commission alleges that hedge fund Paulson & Co. paid Goldman to structure a transaction in which Paulson could take short positions against mortgage securities chosen by Paulson, based on the belief that the securities would fail. Goldman did not mention Paulson's role in choosing the securities, or Paulson's short bet, in their marketing materials for the product, the SEC alleged in its charges. Goldman Vice President Fabrice Tourre, named in the SEC suit as being the principal behind this deal, said during Tuesday's testimony that investors knew of Paulson's involvement.