As homeowners were falling behind on their subprime mortgages, wreaking havoc for investors that owned slices of their mortgages in securities peddled by Wall Street, Goldman Sachs was "well positioned," according to internal company emails from top executives.
The firm had "the big short," declared chief financial officer David Viniar -- Goldman Sachs was making money off the souring of the very securities it had peddled to the market.
The internal emails released Saturday by the Senate Permanent Subcommittee on Investigations paint a picture long known by most of the country, yet never before so vividly and explicitly articulated by Goldman officials. (Scroll down to see the full text of the emails.) As early as May 2007, as homeowners were being crushed under the weight of subprime mortgages, the most profitable firm on Wall Street had long taken out a form of insurance on those delinquencies.
The firm made money on the upside -- originating, securitizing and selling subprime mortgage-based securities to investors -- and on the downside, thanks to the insurance.
"Bad news," a May 17, 2007, email began from one Goldman employee to another. A security the firm had underwritten and sold had just lost value, costing Goldman about $2.5 million.
Further down in the email, the employee, Deeb Salem, wrote "Good news...we own 10mm protection...we make $5mm."
The firm made $5 million betting against the very securities it had underwritten and sold.
In a July 25 email that year, Gary Cohn, the firm's chief operating officer, wrote Viniar to update him on the firm's mortgage market activities. The firm lost about $322 million on residential mortgages -- but it made $373 million on its bets against the market, bets that increased in value as the market tanked.
About 25 minutes later, Viniar wrote back, "Tells you what might be happening to people who don't have the big short." The firm made $51 million that day.
"There it is, in their own words: Goldman Sachs taking 'the big short' against the mortgage market," subcommittee chairman Sen. Carl Levin (D-Mich.) said in a statement accompanying the release of the internal emails.
"Investment banks such as Goldman Sachs were not simply market-makers, they were self-interested promoters of risky and complicated financial schemes that helped trigger the crisis," Levin said. "They bundled toxic mortgages into complex financial instruments, got the credit rating agencies to label them as AAA securities, and sold them to investors, magnifying and spreading risk throughout the financial system, and all too often betting against the instruments they sold and profiting at the expense of their clients."
Levin's panel points out that in the firm's 2009 annual report, Goldman Sachs stated that the firm "did not generate enormous net revenues by betting against residential related products."
"These e-mails show that, in fact, Goldman made a lot of money by betting against the mortgage market," Levin said.
Top Goldman Sachs executives will testify before Levin's panel on Tuesday to answer for their subprime activities. The panel is using the firm as a case study to focus on the role played by investment banks in contributing to the worst financial crisis and economic downturn since the Great Depression.
The nearly 18-month-long investigation has already netted impressive results. The panel exposed the subprime shenanigans at failed lender Washington Mutual, and how lax federal supervision allowed it to become the biggest bank failure in U.S. history, and this week it showed how the major credit rating agencies essentially worked with Wall Street in allowing the firms to peddle AAA-rated securities that had no business ever earning top ratings. That lulled investors into buying what they were told was gold but was really just lead.
Goldman Sachs is under a particularly harsh glare, as its profits have engendered the kind of enmity normally reserved for swindlers. The Securities and Exchange Commission filed charges against the firm April 16 for defrauding investors. Goldman vigorously denies that it did anything wrong.
In a Nov. 17, 2007, email, Goldman's chief executive officer, Lloyd Blankfein, wrote to his top lieutenants in response to an upcoming New York Times story about how the firm had profited off the souring subprime market: "Of course we didn't dodge the mortgage mess. We lost money, then made more than we lost because of shorts."
Blankfein is one of the top executives to be questioned Tuesday by Levin.
In an Oct. 11 email that year, one Goldman employee, reacting to news that Moody's Investors Service had downgraded $32 billion in mortgage-related securities, wrote to a colleague: "Sounds like we will make some serious money."
"Yes, we are well positioned," the colleague responded.
Most investors lost money off that downgrade. But Goldman had been shorting the market.
As of November 2007, Goldman had about $2.1 billion worth of long positions in subprime mortgage products, meaning it was betting that those securities would increase in value, according to the firm's 2008 annual filing with the SEC.
But in a cautionary note to investors and regulators, the firm also noted that "At any point in time, we may use cash instruments as well as derivatives to manage our long or short risk position in the subprime mortgage market."
See the full emails: