That is a good place to start. Banks like Goldman Sachs which exist as investment banks are meant to assist "individuals, corporations and governments in raising capital." That sounds innocuous enough but Goldman Sachs's actions leading up to the financial crisis took on a corrupt character in at least two ways:
One, it helped destroy the integrity of the rating agencies by buying or bribing higher ratings for junk bonds so that investors would be encouraged to buy their products; and Two, they created MBSs that were themselves tainted in quality. Additionally, by GS's buying up sub-prime mortages for its securities, it encouraged mortgage servicing companies to ignore their lending rules so that more mortgages could be obtained, some of them fraudulently. Another bit of putrefaction that Goldman Sachs contributed to.
Compare Blankfein's testimony with Levin's analysis, and you begin to see how sound business practices rotted away; how ethical standards were infected; how the little bit of integrity left at GS was perverted by greed; and how dishonestly and unfaithfully Goldman Sachs behaved throughout.
Let's see what Lloyd Blankfein said about his company in his testimony before the Permanent Senate Subcommittee on Investigations on April 27, 2010, and compare that with what Chairman Carl Levin said about the role of Goldman Sachs during the financial crisis.
First, here is Blankfein:
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I recognize, however, that many Americans are skeptical about the contribution of investment banking to our economy and understandably angry about how Wall Street contributed to the financial crisis. As a firm, we are trying to deal with the implications of the crisis for ourselves and for the system. What we and other banks, rating agencies and regulators failed to do was sound the alarm that there was too much lending and too much leverage in the system -- that credit had become too cheap. One consequence of the growth of the housing market was that instruments that pooled mortgages and their risk became overly complex. That complexity and the fact that some instruments couldn’t be easily bought or sold compounded the effects of the crisis.
While derivatives are an important tool to help companies and financial institutions manage their risk, we need more transparency for the public and regulators as well as safeguards in the system for their use. That is why Goldman Sachs, in supporting financial regulatory reform, has made it clear that it supports clearinghouses for eligible derivatives and higher capital requirements for non-standard instruments.
As you know, ten days ago, the SEC announced a civil action against Goldman Sachs in connection with a specific transaction. It was one of the worst days in my professional life, as I know it was for every person at our firm. We believe deeply in a culture that prizes teamwork, depends on honesty and rewards saying no as much as saying yes. We have been a client centered firm for 140 years and if our clients believe that we don’t deserve their trust, we cannot survive.
While we strongly disagree with the SEC’s complaint, I also recognize how such a complicated transaction may look to many people. To them, it is confirmation of how out of control they believe Wall Street has become, no matter how sophisticated the parties or what disclosures were made. We have to do a better job of striking the balance between what an informed client believes is important to his or her investing goals and what the public believes is overly complex and risky.
Here is Chairman Levin:
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Today we will explore the role of investment banks in the development of the crisis. We focus on the activities during 2007 of Goldman Sachs, one of the oldest and most successful firms on Wall Street. Those activities contributed to the economic collapse that came full-blown the following year.
Goldman Sachs and other investment banks, when acting properly, play an important role in our economy. They help channel the nation’s wealth into productive activities that create jobs and make economic growth possible, bringing together investors and businesses and helping Americans save for retirement or a child’s education.
That’s when investment banks act properly. But in looking at this crisis, it’s hard not to echo the conclusion of another congressional committee, which found, “The results of the unregulated activities of the investment bankers … were disastrous.” That conclusion came in 1934, as the Senate looked into the reasons for the Great Depression. The parallels today are unmistakable.
Goldman Sachs proclaims “a responsibility to our clients, our shareholders, our employees and our communities to support and fund ideas and facilitate growth.” Yet the evidence shows that Goldman repeatedly put its own interests and profits ahead of the interests of its clients and our communities. Its misuse of exotic and complex financial structures helped spread toxic mortgages throughout the financial system. And when the system finally collapsed under the weight of those toxic mortgages, Goldman profited from the collapse. The evidence also shows that repeated public statements by the firm and its executives provide an inaccurate portrayal of Goldman’s actions during 2007, the critical year when the housing bubble burst and the financial crisis took hold. The firm’s own documents show that while it was marketing risky mortgage-related securities, it was placing large bets against the U.S. mortgage market. The firm has repeatedly denied making those large bets, despite overwhelming evidence.
Why does this matter? Surely there is no law, ethical guideline or moral injunction against profit. But Goldman Sachs didn’t just make money. It profited by taking advantage of its clients’ reasonable expectation that it would not sell products that it didn’t want to succeed, and that there was no conflict of economic interest between the firm and the customers it had pledged to serve. Goldman’s actions demonstrate that it often saw its clients not as valuable customers, but as objects for its own profit. This matters because instead of doing well when its clients did well, Goldman Sachs did well when its clients lost money. Its conduct brings into question the whole function of Wall Street, which traditionally has been seen as an engine of growth, betting on America’s successes and not its failures.
To understand how the change in investment banks helped bring on the financial crisis, we need to understand first how Wall Street turned bad mortgage loans into economy-wrecking financial instruments.
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Goldman Sachs was an active player in building this mortgage machinery. During the period leading up to 2008, Goldman made a lot of money packaging mortgages, getting AAA ratings, and selling securities backed by loans from notoriously poor-quality lenders such as WaMu, Fremont and New Century.
Of special concern was Goldman’s marketing of what are known as “synthetic” financial instruments. Ordinarily, the financial risk in a market, and hence the risk to the economy at large, is limited because the assets traded are finite. There are only so many houses, mortgages, shares of stock, bushels of corn or barrels of oil in which to invest. But a synthetic instrument has no real assets. It is simply a bet on the performance of the assets it references. That means the number of synthetic instruments is limitless, and so is the risk they present to the economy. Synthetic structures referencing high-risk mortgages garnered hefty fees for Goldman Sachs and other investment banks. They assumed an ever-larger share of the financial markets, and contributed greatly to the severity of the crisis by magnifying the amount of risk in the system.
Increasingly, synthetics became bets made by people who had no interest in the referenced assets. Synthetics became the chips in a giant casino, one that created no economic growth even when it thrived, and then helped throttle the economy when the casino collapsed.
But Goldman Sachs did more than earn fees from the synthetic instruments it created. Goldman also bet against the mortgage market, and earned billions when that market crashed. In December 2006, Goldman decided to move away from its “long” positions in the mortgage market in what began as prudent hedging against the firm’s large exposure to that market, exposure that sparked concern on the part of the firm’s senior executives. The edict from top management after a Dec. 14, 2006 meeting was “get closer to home,” meaning get to a more neutral risk position. But by early 2007, the company blew right past a neutral position on the mortgage market and began betting heavily on its decline, often using complex financial instruments, including synthetic collateralized debt obligations, or CDOs.
Goldman took large net short positions throughout 2007. This chart, which is based upon data supplied to the Subcommittee by Goldman Sachs, tracks the firm’s ongoing huge net short positions throughout the year. These short positions at one point represented approximately 53% of the firm’s risk as measured by the most relied upon risk measure, “Value at Risk” or “VaR.” And these short positions did more than just avoid big losses for Goldman. They generated a large profit for the firm in 2007.
Goldman says these bets were just a reasonable hedge. But internal documents show it was more than a reasonable hedge – it was what one top executive described as “the big short.”
Listen to a top Goldman mortgage trader, Michael Swenson, who touted his success in 2007, what he called his “proudest year” because of what he called “extraordinary profits” – $3 billion as of September 2007 – that came from bets he recommended the firm take against the housing market. Mr. Swenson told his superiors, “I was able to identify key market dislocations that led to tremendous profits.”
Another Goldman mortgage trader, Joshua Birnbaum, wrote in his performance evaluation about the billions of dollars in profits earned in 2007 betting against the mortgage market. “The prevailing opinion within the department was that we should just ‘get close to home’ and pare down our long,” he wrote. He then touted the fact that he had urged Goldman Sachs “not only to get flat, but get VERY short.” He wrote that after convincing his superiors to do just that, “we implemented the plan by hitting on almost every single name CDO protection buying opportunity in a 2-month period. Much of the plan began working by February as the market dropped 25 points and our very profitable year was under way.” When the mortgage market collapsed in July, he said: “We had a blow-out [profit and loss] month, making over $1Bln that month.”
These facts end the pretense that Goldman’s actions were part of its efforts to operate as a mere “market-maker,” bringing buyers and sellers together. These short positions didn’t represent customer service or necessary hedges against risks that Goldman incurred as it made a market for customers. They represented major bets that the mortgage securities market – a market Goldman helped create – was in for a major decline.
Goldman continues to deny that it shorted the mortgage market for profit, despite the evidence. Why the denial? My best estimate is that it’s because the firm cannot successfully continue to portray itself as working on behalf of its clients if it was selling mortgage related products to those clients while it was betting its own money against those same products or the mortgage market as a whole. The scope of this conflict is reflected in an internal company email sent on May 17, 2007, discussing the collapse of two mortgage-related instruments, tied to WaMu-issued mortgages, that Goldman helped assemble and sell. The “bad news,” a Goldman employee says, is that the firm lost $2.5 million on the collapse. But the “good news,” he reports, is that the company had bet that the securities would collapse, and made $5 million on that bet. They lost money on the mortgage related products they still held, and of course the clients they sold these products to lost big time. But Goldman Sachs also made out big time in its bet against its own products and its own clients. Goldman CEO Lloyd Blankfein summed it up this way: “Of course we didn’t dodge the mortgage mess. We lost money, then made more than we lost because of shorts.” The conflict of interest that lies behind that statement is striking.
Read the rest of the Opening Statement here