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Banks vs. American People - Can Wall Street Reform Be Done?

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Guest greenzen

Can you say Oligarchy in which power effectively rests with a small elite segment of our country. This oligarchy consists of six megabanks: Goldman Sachs, Morgan Stanley, JPMorgan Chase, Citigroup, Bank of America, and Wells Fargo. These banks control 60 percent of our gross national product. These banks bet against the American Dream.

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Guest Sensible Anger

Wall Street has destroyed the lives of MORE Americans than any enemy in the history of the United States. Those sworn to protect this nation are too busy collecting campaign monies from Wall Street

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Guest LAW

Austan Goolsbee of the Presidents Council of Economic Advisors, answers questions on Wall Street Reform.

 

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Guest Maxwell

If there is a tightening of monetary policy, the public will see higher interest payments, and a larger increase in public debt. And greater debt, in turn, brings forward the time at which "monetizing the debts" will be the only means left to finance the debt. End result, short of outright default on debts: Massive currency depreciation and inflation. Final result, China and Asia administer the dollar's coup de gras.

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Guest Tyrone

Wall Street has destroyed the lives of MORE Americans than any enemy in the history of the United States. Those sworn to protect this nation are too busy collecting campaign monies from Wall Street

 

"Those sworn to protect this nation ..." I agree 100 percent. It's shocking how money has overtaken principles in our political system. A lot of Dems are criminal in their own right but PALE in comparison to the partisanship and money grubbing of the Republicans in power. All the blue-collar working class Republicans are being played like a cheap fiddle but are too blind to the obvious.

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Guest ALWAYSRED

In the weekly GOP address, Texas Senator Kay Bailey Hutchison says her party isn't out to try and block a financial overhaul bill, they just want to make sure there are no more taxpayer bailouts. (April 24)

 

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Guest Hirsch

How about this?

 

Where in gods green earth IS FANNIE MAE and FREDDIE MAC in all of this?

 

It's the Evil banks, but Fannie and Freddie get a free ride in all of this.

 

Pick a town, a city, or a state and our collective neglected infrastructure is falling down around us. Years ago we knew what to do. For some reason we stopped knowing and we stopped doing.

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Guest August Havlicek

John Paulison walked away with a billion dollars. Wonder if he was buddies with Bernie Madoff?

 

John Paulson and predatory lending kingpins Herb & Marion Sandler (who also gave generously to ACORN through the years), the inappropriately named Center for Responsible Lending (CRL) laid the foundation for the current financial crisis.

 

Why is there no media on this?

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Guest CRL

The Center for Responsible Lending (CRL) is proud of its work to halt predatory lending and help Americans build and protect their financial wealth and security. For seven years we have worked successfully to ensure that mortgage loans are fair and affordable, reduce unfair credit card fees and tricks, rein in 400% interest payday loans, and eliminate abusive debit card fees. These changes save American families billions of dollars each year. However, lending abuses still persist, and have led us to today's economic crisis. Now more than ever, we need stronger consumer protections and a fair, transparent financial system.

 

Big-money opponents of these reforms—particularly payday lenders desperate to keep their 400% interest loans—are driving efforts to discredit CRL. Their time-worn tactics are nothing new: They spend millions of dollars to lobby lawmakers. They hide behind big PR firms and an array of fake "front groups" with consumer-friendly names to promote their viewpoints and criticize opponents. And they attack the Center for Responsible Lending and other groups supporting financial reform, using claims they know are false. CRL has repeatedly addressed these charges at the Center for Straight Answers on our website, but the payday lenders can't abandon their tactics because they know that the public opposes their abusive product.

 

Now these foes of financial reform are trying to use the justified anger of many Americans against Wall Street abuses to undermine the prospects of a real fix for our financial system and increased consumer protection. This misdirection is a last-ditch effort of lies, innuendo, and misinformation to try to stop real momentum for reform. And its goal is to help big-money special interests, not American families.

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Guest JK

"[The limits on derivatives] would suck more money out of the American economy than the stimulus injected into it," one Republican staffer close to the negotiations told ABC News. "It would negatively impact jobs, and would increase the cost of just about everything."

 

And if you believe that, I have a bridge I can sell you in Brooklyn...

 

But he's not blatantly lying, he's actually really close, but you must replace the words "American economy" with "very elite hedge-fund managers" in the quote above and then it is just dead-center-on.

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Guest Homey Don't Play That

Whoever votes against this bill has been purchased by bankers and their casino industry.

 

Except, We are the House that is backing all bets.

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Guest ALWAYSRED

On Washington Unplugged, Senator Richard Shelby (R-Ala.) who is part of key negotiations with Senate Banking Chairman Chris Dodd says that an agreement on financial reform will most likely not be reached today and no Republicans will break ranks.

 

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Guest American 4 Reform

U.S Senator Robert Menendez

528 Senate Hart Office Building

Washington, DC 20515

 

April 23, 2010

 

Dear Senator Menendez,

 

The over 200 consumer, employee, investor, community and civil rights groups who are members of Americans for Financial Reform (AFR) write to express our strong support for your amendment to increase transparency in accounting by (1) requiring the most systemically important firms to provide full disclosure in annual reports of their off balance sheet liabilities and (2) requiring issuers to disclose daily average leverage ratios in quarterly and annual reports to prevent companies from continuing to mask debt levels.

 

Your amendment would require systemically important financial firms to provide, as part of their annual filing with the Securities and Exchange Commission, a detailed written disclosure of off balance sheet activities and the justification for failing to put the activities on balance sheet. This will more fairly present to investors and regulators the financial condition of firms. This will also help these institutions to become aware of the overall range of their liabilities and exposures. In addition your amendment would require issuers to disclose, in quarterly and annual reports, average daily liabilities and average daily assets during the period, daily averages for any short term borrowings, including separately presenting securities sold under agreements to repurchase, and a daily average leverage ratio. In addition, the amendment would require the disclosure of information on transactions that were accounted for as sales by the issuer, but have implications for future liquidity.

 

Obtaining comprehensive information on the off-balance sheet holdings and average daily commitments of large firms is long overdue. As early as the late 1980s, partial assessments of information and estimates indicated that contingent liabilities rivaled the actual volume of loans on the books of the largest banks. Thus, it should have come as no surprise to regulators that, during the recent crisis, the inability of investors and counterparties to assess the riskiness of the major financial institutions resulted in a loss of confidence within the financial sector itself as well as by its outside investors. As the scramble for funding in markets for repurchase agreements and commercial paper made clear, off-balance sheet positions were not only inadequately capitalized but were like dry tinder in their potential to exacerbate the crisis when the short-term funding that supported those positions dried up.

 

Equally important, off-balance sheet vehicles and positions allowed firms to hide potential risks and minimize liabilities in ways the misled investors and regulators.

 

For example, the recent report by the bankruptcy examiner revealed that Lehman Brothers through its “Repo 105” transactions, treated $50 billion in repurchase agreement transactions as sales instead of financing transactions on their balance sheets. This month, the Wall Street Journal reported 18 banks “understated the debt levels used to fund securities trades by lowering them an average of 42% at the end of each of the past five quarterly periods.” This included Goldman Sachs, Morgan Stanley, JP Morgan Chase, Bank of America and Citigroup. Like the Repo 105 practice, this provided a quarter end snap shot of a bank’s financial condition that cosmetically made it looked less debt burdened than the bank looked earlier in the quarter or on average. In addition, as noted by experts Frank Partnoy and Lynn Turner, a chief cause of the financial crisis was “abusive off balance sheet accounting.”1 Financial firms did not disclose as liabilities on their balance sheets the amounts owed on swaps or variable-interest-entities (VIEs). For example, Citigroup held over $100 billion in credit derivative payables and $292 billion in VIEs, which do not appear as liabilities on a balance sheet.

 

Failure to address the problems caused by the unreported off-balance sheet accounts of systemically important financial firms will continue to perpetuate the gaps in information that misled investors and regulators before the current crisis and are likely to contribute to risks that may precipitate another. Providing information to market participants and those charged with ensuring fairness and transparency must be included as a critical prong in the reform process. For these reasons we support your efforts to require reports on all off-balance sheet activities of these firms.

 

If you have any questions, please do not hesitate to contact Heather McGhee, Washington Office Director, Demos.

 

Sincerely,

Americans for Financial Reform

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Guest LAW

The Senate Permanent Subcommittee on Investigations, whose chairman is Sen. Carl Levin, D-Mich., and whose Ranking Republican is Sen. Tom Coburn, R-Okla., will hold the fourth in its series of hearings on the causes and consequences of the financial crisis at 10 a.m. Tuesday, April 27, in room 106 of the Dirksen Senate Office Building.

 

Tuesday’s hearing will focus on the role of investment banks in the crisis, using Goldman Sachs as a case study. Previous hearings have examined how reckless mortgage lending, weak-kneed regulatory agencies and misleading credit ratings and the agencies that produced them contributed to the crisis.

 

The Subcommittee’s nearly 18-month investigation found evidence that Goldman Sachs, contrary to the repeated public statements of the firm’s executives, made and held significant bets against the mortgage market – “short positions” in Wall Street terms – and that at times those bets were not just against the mortgage market in general, but against securities that Goldman Sachs had assembled and marketed to its customers.

 

"Goldman Sachs, like all the major Wall Street firms, got a multibillion-dollar lifeline from the taxpayers in 2008,” said Levin. “Goldman Sachs was slicing, dicing, and selling toxic mortgage-related securities on Wall Street like many other investment banks, but its executives continue to downplay the firm’s role in the financial engineering that blew up the financial markets and cost millions of Americans their jobs, homes, and livelihoods. Goldman Sachs made billions of dollars from betting against the housing market, and it placed those bets in some cases at the same time it was selling mortgage related securities to its clients. They have a lot to answer for."

 

Goldman and other investment banks played a crucial role in building and running the conveyor belt that fed toxic mortgages and mortgage-backed securities into the financial system. In Goldman’s case, this activity included underwriting securities backed by or related to mortgages from some of the most notorious subprime mortgage lenders, including Washington Mutual’s Long Beach subprime subsidiary, Fremont Investment & Loan, and New Century Mortgage. Goldman Sachs also designed and sold billions of dollars of collateralized debt obligations (CDOs) that further spread the risks associated with toxic mortgages.

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Guest LAW

Documents the Subcommittee will examine on Tuesday include internal reports and emails that make clear that, as high risk mortgages began to incur record delinquency rates, Goldman Sachs took on a significant "net short" position in the mortgage market throughout 2007, and cashed in shorts that generated substantial income. Those documents contradict repeated company statements to shareholders and the media denying that Goldman Sachs bet against the mortgage market or made substantial profit from doing so.

 

In late 2006, company officials sought to reduce Goldman's exposure to the risk of holding a large inventory of mortgage-related securities on its books. It began to both reduce that inventory and to bet against such securities. It was hedging its risk and moving toward a balanced position. But within months, that neutral position shifted into a large bet against the mortgage market. Company documents show the firm taking every opportunity during early 2007 to take short positions against mortgages. And in reducing its risk, the firm aggressively sold its mortgage holdings to clients. Documents show the firm's sales force raising questions about the quality of securities Goldman was trying to unload, and complaints from clients who posted big losses on products Goldman had sold them.

The bipartisan Subcommittee investigation has resulted in the following findings of fact regarding the role of investment banks in the financial crisis:

 

( 1 ) Securitizing High Risk Mortgages. From 2004 to 2007, in exchange for lucrative fees, Goldman Sachs helped lenders like Long Beach, Fremont, and New Century, securitize high risk, poor quality loans, obtain favorable credit ratings for the resulting residential mortgage backed securities (RMBS), and sell the RMBS securities to investors, pushing billions of dollars of risky mortgages into the financial system.

( 2 ) Magnifying Risk. Goldman Sachs magnified the impact of toxic mortgages on financial markets by re-securitizing RMBS securities in collateralized debt obligations (CDOs), referencing them in synthetic CDOs, selling the CDO securities to investors, and using credit default swaps and index trading to profit from the failure of the same RMBS and CDO securities it sold.

 

( 3 ) Shorting the Mortgage Market. As high risk mortgage delinquencies increased, and RMBS and CDO securities began to lose value, Goldman Sachs took a net short position on the mortgage market, remaining net short throughout 2007, and cashed in very large short positions, generating billions of dollars in gain.

( 4 ) Conflict Between Client and Proprietary Trading. In 2007, Goldman Sachs went beyond its role as market maker for clients seeking to buy or sell mortgage related securities, traded billions of dollars in mortgage related assets for the benefit of the firm without disclosing its proprietary positions to clients, and instructed its sales force to sell mortgage related assets, including high risk RMBS and CDO securities that Goldman Sachs wanted to get off its books, creating a conflict between the firm's proprietary interests and the interests of its clients.

( 5 ) Abacus Transaction. Goldman Sachs structured, underwrote, and sold a synthetic CDO called Abacus 2007-AC1, did not disclose to the Moody's analyst overseeing the rating of the CDO that a hedge fund client taking a short position in the CDO had helped to select the referenced assets, and also did not disclose that fact to other investors.

 

( 6 ) Using unclothed Credit Default Swaps. Goldman Sachs used credit default swaps (CDS) on assets it did not own to bet against the mortgage market through single name and index CDS transactions, generating substantial revenues in the process.

 

Witnesses at Tuesday's hearing will include Goldman Sachs Chief Executive Officer Lloyd Blankfein, Chief Financial Officer David Vinier and executives who were involved in the assembly, marketing, sale, and trading of mortgage-related securities.

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Guest marc

As a Republican, I'm so tired of today's GOP. They are such a hindrance to getting work done. After 8 years of getting absolutely nothing done, they're trying to block efforts to get actual work done.

 

What is the GOP so afraid of? Becoming irrelevant?

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Guest Kelly Teninty

The republicans have been riding the "to much government" train for too long.. They say the more you say the statement, the more people believe it.. Guess they think we are believing their crap... If you really knew what ...

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Guest Denise

Tell it like it is. My home is about to foreclose next week. I wish I could get my hands on that man we refinanced with. He left town.

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Guest Old Yeller

The opportunity for President Barack Obama is to now demonstrate genuine leadership by attacking the corruption that continues to aid and abet the illegal manipulation of markets through excessively large and influential institutions. Corporations can’t go to jail, but their charters can be revoked for cause. If the government of the United States doesn’t act decisively and meaningfully, the people eventually will.

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Guest American 4 Progress

op Republicans have teamed up with banking executives to seek "Wall Street's help" in funding the GOP's mid-term election fight in exchange for watering down or even killing the looming financial overhaul. Republicans argue that they are the "banks' best hope" of preventing a tough Wall Street crackdown. In fact, on the same day the President traveled to New York City to urge Wall Street executives to embrace reform and call off their "battalions of financial industry lobbyists," bank lobbyists hosted a secret fundraiser for GOP senators in Washington, D.C. Sens. Richard Burr (R-NC), John Cornyn (R-TX), and George Lemieux (R-FL) emerged from the meeting but would not talk to reporters. The Progress Report attempted to speak with other fundraiser attendees and all but one -- longtime corporate lobbyist Charlie Black -- refused to even provide their names. At the same time, Wall Street giants "are going grassroots" to lobby against reform. Bank of America, JP Morgan Chase, Master Card, and other industry players are working through "Democracy Data & Communications" -- a firm that specializes in helping corporations activate their employees and customers into grassroots advocates -- to join the U.S. Chamber of Commerce's effort to kill reform. Nelson's vote may have less to do with his ties to Wall Street and more to do with placating big business interests in Nebraska. Banking Committee chair Chris Dodd (D-CT) speculated that Nelson voted to block debate because a provision intended to benefit billionaire Warren Buffett's Omaha-based company Berkshire Hathaway had been stripped from the bill.

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Guest LAW

Nebraska’s Senator Ben Nelson issued this statement after opposing the motion to proceed to a debate and vote on financial reform in the Senate:

 

“I cannot support proceeding on a bill I haven’t seen, but no one should view my vote today as an indication that I won’t support the bill currently being negotiated by the Banking Committee. I look forward to seeing what the Committee develops on a bipartisan basis with Republicans, then I will have something concrete to consider.

 

“We need to regulate Wall Street without doing harm to Main Street, and I’m hearing from Main Street businesses in Nebraska that have concerns about the current bill adversely impacting them.

 

“Clearly, though, Wall Street’s reckless behavior that nearly destroyed our economy must be reined in.

 

“While the national economic crisis has not been as severe in Nebraska, we have not been insulated. We’ve seen the ripple effects of rising unemployment as thousands of Nebraskans have lost their jobs; a decline in our economy that has hurt business activity; a drop in state revenues that will affect nearly every Nebraskan; and furloughs, wage freezes and other belt-tightening squeezing family budgets across our state.

 

“When the economic crisis exploded in September 2008, the last administration came to Congress for funds to bail out banks. The current administration has spent hundreds of billions of dollars in recovery funds to try to help our economy recover.

 

“We must not allow a repeat of the worst economic crisis since the Great Depression, and Congress should bring forward bipartisan Wall Street reforms soon that make sure we do not.”

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Guest Senator Levin's Office

Opening Statement of Senator Carl Levin, U.S. Senate Permanent Subcommittee on Investigations Hearing, Wall Street and the Financial Crisis: The Role of Investment Banks

 

Today the Subcommittee holds the fourth in our series of hearings to explore some of the causes and consequences of the financial crisis. These hearings are the culmination of nearly a year and a half of investigation.

 

The freezing of financial markets and collapse of financial institutions that sparked our investigation are not just a matter of numbers on a balance sheet. Millions of Americans have lost their jobs, their homes and their businesses in the recession that the crisis sparked, the worst economic decline since the Great Depression. Behind every number we cite are American families who are still suffering the effects of a man-made economic catastrophe.

 

Our Subcommittee’s goal is to construct a record of the facts in order to deepen public understanding of what went wrong; to inform the ongoing legislative debate about the need for financial reform; and to provide a foundation for building better defenses to protect Main Street from the excesses of Wall Street.

 

Our first hearing dealt with the impact of high-risk mortgage lending, and focused on a case study of Washington Mutual Bank, known as WaMu, a thrift whose leaders embarked on a reckless strategy to pursue higher profits by emphasizing high-risk exotic loans. WaMu didn’t just make loans that were likely to fail, creating hardship for borrowers and risk for the bank. It also built a conveyor belt that fed those toxic loans into the financial system like a polluter dumping poison into a river. The poison came packaged in mortgage-backed securities that WaMu sold to get the enormous risk of these loans and their growing default rates off its own books, dumping that risk into the financial system.

 

Our second hearing examined how federal regulators saw what was going on, but failed to rein in WaMu’s reckless behavior. Regulation by the Office of Thrift Supervision that should have been conducted at arm’s length was instead done arm in arm with WaMu. OTS failed to act on major shortcomings it observed, and it thwarted other agencies from stepping in.

 

Our third hearing dealt with credit rating agencies, specifically case studies of Standard & Poor’s and Moody’s, the nation’s two largest credit raters. While WaMu and other lenders dumped their bad loans into the river of commerce and regulators failed to stop their behavior, the credit rating agencies assured everyone that the poisoned water was safe to drink, slapping AAA ratings on bottles of high risk financial products. The credit rating agencies operate with an inherent conflict of interest – their revenue comes from the same firms whose products they are supposed to critically analyze, and those firms exert pressure on rating agencies who too often put market share ahead of analytical rigor.

 

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.

 

Our previous hearings have covered some of this ground. The story begins with mortgage lenders such as WaMu, which loaned money to home buyers and then sought to move those loans off its books. That activity spawned an ever more-complex market in mortgage-backed securities, a market that for a while worked pretty well. But then things turned upside down. The fees that banks and Wall Street firms made from their securitization activities were so large that they ceased to be a means to keep capital flowing to housing markets and became ends in themselves. Mortgages and mortgage-backed securities began to be produced for Wall Street instead of Main Street. Wall Street bond traders sought more and more mortgages from lenders in order to create new securities that generated fees for their firms and large bonuses for themselves.

 

Demand for securities prompted lenders to make more and riskier mortgage loans. Making and packaging new loans became so profitable that credit standards plummeted and mortgage lenders began making risky, exotic loans to people with little chance of making the payments. Wall Street designed increasingly complex financial products that produced AAA ratings for high-risk products that flooded the financial system.

As long as home prices kept rising, the high risk mortgages posed few problems. Those who couldn’t pay off their loans could refinance or sell their homes, and the market for mortgage-related financial products flourished.

 

But the party couldn’t last, and we all know what happened. Housing prices stopped rising, and the bubble burst. Investors started having second thoughts about the mortgage backed securities Wall Street was churning out. In July 2007, two Bear Stearns offshore hedge funds specializing in mortgage related securities suddenly collapsed. That same month, the credit rating agencies downgraded hundreds of subprime mortgage backed securities, and the subprime market went cold. Banks, securities firms, hedge funds, mutual funds, and other investors were left holding suddenly unmarketable mortgage backed securities whose value was plummeting. America began feeling the consequences of the economic assault.

 

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.

 

The Securities & Exchange Commission has filed a civil complaint alleging that in another transaction, involving a product called Abacus 2007-AC1, Goldman violated securities law by misleading investors about a mortgage-related financial instrument.

 

The SEC’s complaint alleges that Goldman Sachs in effect helped stack the deck against the buyers of the instrument it sold. The hedge fund that bought the short position in the transaction – in other words, that bet that the product would not perform well – helped select the mortgages that were to be referenced in the product that Goldman sold to investors. The SEC alleges that Goldman Sachs knew of the hedge fund’s selection role and failed to disclose it to the other Abacus investors, who thought the package had been designed to succeed, not fail. We learned in last week’s hearing that Goldman also failed to disclose the hedge fund’s role to the credit rating agency that rated the Abacus deal. Eric Kolchinsky, who oversaw the ratings process at Moody, testified before the Subcommittee, “It just changes the whole dynamic on the structure, where the person who is putting it together, choosing it, wants it to blow up.”

 

The SEC and the courts will resolve the legal question of whether Goldman’s actions broke the law. The question for us is one of ethics and policy: Were Goldman’s actions in 2007 appropriate, and if not, should we act to bar similar actions in the future?

 

Abacus may be the best-known example of conflicts of interest revealed in the Goldman documents, but it is far from the only example. Anderson Mezzanine Funding 2007-1 was a synthetic product assembled by Goldman. According to company documents, a Goldman client had expressed interest in taking a short position in the transaction, but an executive noted that Dan Sparks, the head of Goldman’s mortgage department, might “[want] to preserve that ability for Goldman.” This suggests that not only was Goldman going to bet against the instrument that it was selling, but it wanted to make that bet badly enough that it took the bet for itself instead of letting an interested client have it. It then sold Anderson securities to its clients, without disclosing that it would profit if those securities suffered losses.

Client loyalty fell so far that one Goldman employee cited his refusal to assist Goldman clients facing losses from a Goldman financial product as performance that should be rewarded. Mr. Swenson wrote to his superiors in his performance review: “I said ‘no’ to clients who demanded that GS should ‘support the GSAMP program,” Goldman Sachs’ subprime mortgage-backed security program. Mr. Swenson wrote that saying “no” to clients who asked Goldman to support a security it had sold them were “unpopular positions but they saved the firm hundreds of millions of dollars.”

 

Most investors make the assumption that people selling them securities want those securities to succeed. That’s how our markets ought to work, but they don’t always. The Senators who in the 1930s investigated the causes of the Great Depression stated the principle clearly:

 

“[investors] must believe that their investment banker would not offer them the bonds unless the banker believed them to be safe. This throws a heavy responsibility upon the banker. He may and does make mistakes. There is no way that he can avoid making mistakes because he is human and because in this world, things are only relatively secure. There is no such thing as absolute security. But while the banker may make mistakes, he must never make the mistake of offering investments to his clients which he does not believe to be good.”

 

Goldman documents make clear that in 2007 it was betting heavily against the housing market while it was selling investments in that market to its clients. It sold those clients high-risk mortgage-backed securities and CDOs that it wanted to get off its books in transactions that created a conflict of interest between Goldman’s bottom line and its clients’ interests.

 

These findings are deeply troubling. They show a Wall Street culture that, while it may once have focused on serving clients and promoting commerce, is now all too often simply self-serving. The ultimate harm here is not just to clients poorly served by their investment bank. It’s to all of us. The toxic mortgages and related instruments that these firms injected into our financial system have done incalculable harm to people who had never heard of a mortgage-backed security or a CDO, and who have no defenses against the harm such exotic Wall Street creations can cause.

 

Running through our findings and these hearings is a thread that connects the reckless actions of mortgage brokers at WaMu with market-driven credit rating agencies and the Wall Street executives designing the next synthetic. That thread is unbridled greed, and the absence of a cop on the beat to control it.

 

As we speak, lobbyists fill the halls of Congress, hoping to weaken or kill legislation aimed at reforming these abuses. Wall Street is on the wrong side of this fight. It insists that reining in its excesses would unduly restrict a free market that is the engine of American progress. But this market isn’t free of self-dealing or conflict of interest. It is not free of gambling debts that taxpayers end up paying.

I hope the executives before us today, and their colleagues on Wall Street, will recognize the harm that their actions have caused to so many of their fellow citizens. But whether or not they take responsibility for their role, I hope this Congress will follow the example of another Congress, eight decades ago, and enact the reforms that will put a cop back on the Wall Street beat.

 

I would like to thank my ranking member, Sen. Coburn, who is carrying out a very important responsibility at the White House this morning and who will join us later, for his support and that of his staff, and I recognize the acting ranking member, Sen. Collins, and welcome her remarks.

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Senator Susan Collins, Ranking Member of the Senate Homeland Security and Governmental Affairs Committee, questioned Goldman Sachs executives regarding questionable business practices that critics have said helped lead to the collapse of the U.S. housing market.

 

The firm, charged by the Securities and Exchange Commission with securities fraud, also reportedly sold mortgage-related investment products to clients and then bet that those products would fail by taking what are called short positions in the market a decision that reaped the company billions of dollars when the housing market did indeed collapse.

 

Senator Collins noted that top-tier investment banks such as Goldman Sachs do not have a fiduciary responsibility to their clients, something that financial advisers do have. The results, she said, are conflicts of interest that helped create the economic damage that ensued.

 

The hearing was the latest before the Senate's Permanent Subcommittee on Investigations, headed by Sen. Carl Levin (D-Mich.), which is examining the roles of various industry sectors in the collapse of financial markets. Senator Collins gave an opening statement at the start of Tuesdays hearing. That text is below:

 

Mr. Chairman, thank you for leading this investigation into the root causes of the Great Recession of 2008. You and the Ranking Member, Senator Coburn, have cast a bright light into the dark corners of financial institutions that helped to inflate the housing bubble and then reaped billions of dollars when it burst, leaving millions of Americans in debt and jobless, with destroyed dreams and financial insecurity.

 

This investigation raises two overarching issues. First, we must recognize that the dynamic innovation of our capital markets can have a downside. It can produce pain rather than prosperity. Financial markets require updated and effective regulation to help prevent excesses that can inflict great harm on wholly innocent Americans -- be they workers, retirees, or small business owners.

 

The lack of regulation of the trillions of dollars in credit default swaps is a prime example. That is why it is so important that financial regulatory reform legislation include a council of regulators whose job it will be to assess systemic risk and to identify regulatory gaps.

 

I recognize that even measured regulation may limit the potential benefits that unfettered markets can produce. The question, however, is whether those benefits are outweighed by the terrible harm such markets can cause. Recent history certainly suggests that is the case, that the combination of lax or absent regulation plus unbridled greed can produce devastating results.

 

Second, even legal practices may raise ethical concerns. Assuming Goldman's role as a market maker and its desire to hedge its risk provided legal justification for some of its practices -- a question that must ultimately be decided by the courts -- there is something unseemly about Goldman betting against the housing market at the same time that it is selling to its clients mortgage-backed securities containing toxic loans.

 

And it is unsettling to read emails of Goldman executives celebrating the collapse of the housing market when the reality for millions of Americans is lost homes and disappearing jobs. That is especially the case in light of Goldman's decision to opt for status as a bank holding company to secure benefits effectively underwritten, at least in part, by those same Americans.

 

During its previous hearings on the financial crisis, this Subcommittee revealed the reckless, and at times predatory, lending behavior of some mortgage brokers and banks like Washington Mutual. These banks discarded decades of reliable and pragmatic lending practices. Instead, they opted to offer high-risk loans to borrowers whom they knew could not afford to repay them.

 

Traditionally, such behavior would have exposed the originating banks to high levels of unacceptable risk. In other words, the offending banks would have paid dearly for their own underwriting errors.

But with the advent of securitization during the past decade, lenders have been able to insulate themselves by selling off toxic loans -- pitching them as assets to investment banks. Those investment banks, in turn, bundled the toxic loans inside mortgage-backed securities, which were then bought and sold by investors.

 

The cash that flowed back to the banks from investors buying these securities only made matters worse. The cash was akin to throwing fuel on the hot fire of greed and recklessness. The in-flow of dollars encouraged loan originators to put that money to work again and again and again, turning over loan applications as quickly as possible, applying little scrutiny because they ultimately had no stake in the loan.

 

This cycle was based on a dangerous and false assumption that the housing market would always move upward. It was based on the fantasy, the myth, that what goes up stays up, and never comes crashing down.

 

When it all collapsed, like a house of cards, we realized too late how incredibly fragile and tragically interconnected the system had become. The fallout wasnt limited; the debris field wasnt contained. The damage was widespread, profound, and nearly catastrophic.

 

The architects of this scheme entangled neighborhood banks and large brokerage firms across America; their toxic linkages ensnared borrowers and investors from Main Street to Wall Street. They deluded themselves into believing that the basic principles could be defied and ignored. And when that delusion met reality, the bubble burst.

Today we will look at the top tier of this system a major investment bank and examine how its trading practices amplified the rise and fall of the housing market. Todays witnesses are from Goldman Sachs, which was one of the few Wall Street firms to actually profit from the financial crisis.

 

This hearing is not to celebrate that ignoble feat; rather, it is to examine how the trading practices of Goldman during that time made such profits possible. It is to examine how Goldman sold financial products that were tied to the health of the housing market even while Goldman itself was betting that the housing market would collapse.

 

The SEC case accuses Goldman Sachs of marketing a complex product to its clients while allegedly failing to disclose that the same company that hand-selected the components, the hedge fund Paulson and Company, also planned to bet on its failure. Goldman sold the product to long-time, trusting clients without disclosing this fact. The bet Paulson made earned him $1 billion, while at least one of Goldmans clients a German bank went bankrupt.

 

Although Goldman lost money on that particular deal, it reaped billions of dollars in the mortgage-backed securities market as a whole. While the market was on the verge of collapse, Goldman decided to go short, and earned billions from that strategy. Some have alleged that Goldman did so while continuing to sell clients long investments in the mortgage markets. While such conflicts of interest may not be illegal, they certainly seem ethically questionable. And these conflicts of interest appear to be rooted in the fact that broker/ dealers do not have a fiduciary obligation to their clients. That is an issue we will be considering.

 

The system must be reformed so that Wall Street banks are not seen as unscrupulous operators who seek to profit from the publics misfortune, even as they are pitching toxic investments and even as hard-working, struggling taxpayers are left to pick up the tab.

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