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According to the Collins English Dictionary 10th Edition fraud can be defined as: "deceit, trickery, sharp practice, or breach of confidence, perpetrated for profit or to gain some unfair or dishonest advantage".[1] In the broadest sense, a fraud is an intentional deception made for personal gain or to damage another individual; the related adjective is fraudulent. The specific legal definition varies by legal jurisdiction. Fraud is a crime, and also a civil law violation. Defrauding people or entities of money or valuables is a common purpose of fraud, but there have also been fraudulent "discoveries", e.g. in science, to gain prestige rather than immediate monetary gain
*As defined in Wikipedia

Friday, March 25, 2011

Goldman Sachs and Mortgage Securitization

On April 26, 2010, Senator Carl Levin, Subcommittee Chairman, and Senator Tom Coburn, Ranking Member, sent a memorandum to the Members of the Permanent Subcommittee on Investigations in which they explained very clearly the role played by investment banks in "the causes and consequences of the recent financial crisis" using Goldman Sachs as a case study. They had recently held their fourth hearing that dealt with investment banks.

The memo is exemplary in explaining Conflict Between Proprietary and Client Trading, in explaining Goldman Sachs Shorting the Mortgage Market and in explaining their role in Mortgage Securitizations. There is every reason to believe that everyone and anyone can understand the role that Goldman Sachs played in bringing the financial system to its knees.

It is difficult, however, to believe that none of the actions that Goldman Sachs took to make billions of dollars at the expense of others is criminal or illegal. You can judge for yourself by reading the memo here.

This is part of what the memo had to say about Goldman Sachs:
. . . .

Goldman Sachs. Goldman Sachs was first established in 1869. Originally a private partnership, in 1999, it became a publicly traded corporation. In 2008, it converted to a bank holding company, in part to gain access to Federal Reserve lending programs. Its headquarters are located in New York City’s Wall Street and the firm manages about $870 billion in assets. Goldman employs about 14,000 employees in the United States, and 32,500 worldwide. In 2007, it paid about $68 million in compensation to its CEO Lloyd Blankfein.

Goldman Sachs’ mortgage department had several trading desks responsible for purchasing and selling virtually all of the firm’s mortgage related assets, including RMBS and CDO securities. Goldman Sachs maintained an inventory of RMBS and CDO securities to carry out activities for its clients and proprietary trading for the firm. In 2006 and 2007, it underwrote approximately 86 RMBS and 27 CDOs referencing RMBS assets. Of the 27 CDOs, 84 percent were hybrid CDOs, 15 percent were synthetic, and only about 1 percent were cash CDOs with physical assets.

Mortgage Securitizations. From 2004 through 2007, Goldman Sachs was an active participant in the mortgage market, particularly in the area of securitization. On multiple occasions, it helped lenders like Long Beach Mortgage Company, Fremont Loan & Investment, and New Century Mortgage, securitize billions of dollars in poor quality, high risk mortgages and sold them to investors. In doing so, Goldman Sachs provided these lenders with additional liquidity to make even more bad loans, many of which were included in risky securities. Two examples illustrate Goldman Sachs’ role in the securitization process.

The first example involves Washington Mutual (“WaMu”) and its subprime lender Long Beach. An exhibit from the Subcommittee’s first hearing shows that WaMu, Long Beach, and Goldman Sachs collaborated on at least $14 billion in loan sales and securitizations, even though Long Beach originated some of the worst performing subprime mortgages in the country. In 2003, WaMu halted all Long Beach securitizations and sent a legal team for three months to clean up the company’s problems, before allowing securitizations to resume in 2004. In 2005, Long Beach saw a surge of early payment defaults on its loans and had to repurchase over $875 million of nonperforming loans from investors, as well as book a $107 million loss.Internal audits of Long Beach and examinations by the Office of Thrift Supervision repeatedly identified lax lending standards, poor controls over loan officers ignoring credit requirements, and loans subject to fraud, appraisal problems, and errors. Long Beach securitizations had among the worst credit losses in the industry from 1999-2003, and in 2005 and 2006 Long Beach securities were among the worst performing in the market.

Nevertheless, in May 2006 Goldman Sachs acted as co-lead underwriter with WaMu to securitize about $532 million in subprime second lien, fixed rate mortgages originated by Long Beach. Long Beach Mortgage Loan Trust 2006-A (“LBMLT 2006-A”) issued about $495 million in RMBS securities backed by the Long Beach high risk mortgages. The top three tranches, representing 66 percent of the principal loan balance, received AAA ratings from S&P, even though the pool contained high risk, subprime second lien mortgages—loans for which there was little prospect of recovering collateral in the event of a housing downturn—issued by one of the nation’s worst mortgage lenders. In this instance, Goldman Sachs was able, with the help of the ratings agencies, to turn two-thirds of that extremely risky debt into AAA-rated securities. Goldman Sachs then sold the Long Beach securities to investors.

In less than a year, the Long Beach loans started to become delinquent. By May 2007, the cumulative net loss on the underlying mortgage pool jumped to over 12 percent, wiping out a significant amount of the deal’s loss protection and causing S&P to downgrade 6 out of 7 of the mezzanine tranches of the securitization. The Long Beach securities plummeted in value. Goldman Sachs owned some of the mezzanine securities, but had also placed a bet against them by purchasing a credit default swap that paid off if the securities incurred loss. One Goldman employee, upon learning of the Long Beach losses, wrote in an email to management: “bad news… [the loss] wipes out the m6s and makes a wipeout of the m5 imminent… costs us about 2.5[million dollars]… good news… we own 10[million dollars] protection at the m6… we make$5[million].” Ultimately, in this transaction, Goldman Sachs profited from the decline of the very security it had earlier sold to clients. By May 2008—only two years later—even the AAA securities in LBMLT 2006-A had been downgraded to default status. By March 2010, the securities recorded a cumulative net loss of over 66 percent.

A second example involves Fremont, another poor performing subprime lender. In the first calendar quarter of 2007, Goldman Sachs helped Fremont securitize over $1 billion in high risk loans by creating GSAMP Trust 2007-FM1 and GSAMP Trust 2007-FM2. In March, 2007, Fremont reported in an 8-K filing with the SEC that the California Court of Appeals had found sufficient evidence in a lawsuit filed by the California Insurance Commissioner that Fremont was“[m]arketing and extending adjustable–rate mortgage products to subprime borrowers in an unsafe and unsound manner that greatly increases the risk that borrowers will default on the loans or otherwise causes losses.” That same month, Fremont received a public cease and desist order from the Federal Deposit Insurance Corporation (“FDIC”) due to fraud and lax underwriting standards affecting its mortgage loans. Fremont halted all subprime originations by March 2007. Moody’s and S&P rated the Fremont securities, even though analysts at both firms expressed concern about the quality of Fremont loans. Both agencies gave AAA ratings to the top 5 tranches of the securitization. Goldman Sachs sold the Fremont securities to investors, while at the same time purchasing $15 million in credit default swaps referencing some of the Fremont securities. A little over a year later, every tranche in the security was downgraded to junk status. It is unclear what recovery Goldman Sachs received from its credit default swap.

Goldman Sachs has stated that it had a process for evaluating lenders and, as a result of its process, terminated relationships with “dozens of originators.” It has also stated that it employed internal and third party due diligence reviews of individual loans in mortgage pools backing Goldman Sachs RMBS securities to ensure it did not accept loans with “potentially significant legal regulatory compliance or other issues.”

In addition to RMBS securities, Goldman Sachs was active in the CDO market. A September 2007 internal presentation to its Board of Directors listed Goldman Sachs as the fourth largest CDO underwriter in the country, with 14 CDO transactions in 2006 involving $16 billion, and 12 deals in the first half of 2007, involving $8.3 billion. These transactions included about 16 CDOs on the Abacus platform, involving over $10 billion in referenced assets; Hudson CDO involving $2 billion, a $300 million Anderson CDO, and a $1 billion Timberwolf CDO. (p. 5, 6 & 7 of memo)

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Read the entire document here


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