Wall street and the financial crisis; anatomy of a financial collapse (u s senate, 2013)

SENATOR CARL LEVIN Chairman SENATOR TOM COBURN, M.D Ranking Minority Member PERMANENT SUBCOMMITTEE ON INVESTIGATIONS ELISE J BEAN Staff Director and Chief Counsel ROBERT L ROACH Counsel and Chief Investigator LAURA E STUBER Counsel ZACHARY I SCHRAM Counsel DANIEL J GOSHORN Counsel DAVID H KATZ Counsel ALLISON F MURPHY Counsel ADAM C HENDERSON Professional Staff Member PAULINE E CALANDE SEC Detailee MICHAEL J MARTINEAU DOJ Detailee CHRISTOPHER J BARKLEY Staff Director to the Minority ANTHONY G COTTO Counsel to the Minority KEITH B ASHDOWN Chief Investigator to the Minority JUSTIN J ROOD Senior Investigator to the Minority VANESSA CAREIRO Law Clerk BRITTANY CLEMENT Law Clerk DAVID DeBARROS Law Clerk ERIN HELLING Law Clerk HELENA MAN Law Clerk JOSHUA NIMMO Intern ROBERT PECKERMAN Intern TANVI ZAVERI Law Clerk MARY D ROBERTSON Chief Clerk Permanent Subcommittee on Investigations 199 Russell Senate Office Building – Washington, D.C 20510 Main Number: 202/224-9505 Web Address: www.hsgac.senate.gov [Follow Link to “Subcommittees,” to “Investigations”] Contents I EXECUTIVE SUMMARY A Subcommittee Investigation B Overview (1) High Risk Lending: Case Study of Washington Mutual Bank (2) Regulatory Failures: Case Study of the Office of Thrift Supervision (3) Inflated Credit Ratings: Case Study of Moody’s and Standard & Poor’s (4) Investment Bank Abuses: Case Study of Goldman Sachs and Deutsche Bank C Recommendations II BACKGROUND A Rise of Too-Big-To-Fail U.S Financial Institutions B High Risk Mortgage Lending C Credit Ratings and Structured Finance D Investment Banks E Market Oversight F Government Sponsored Enterprises G Administrative and Legislative Actions H Financial Crisis Timeline III HIGH RISK LENDING: CASE STUDY OF WASHINGTON MUTUAL BANK A Subcommittee Investigation and Findings of Fact B Background (1) Major Business Lines and Key Personnel (2) Loan Origination Channels (3) Long Beach (4) Securitization (5) Overview of WaMu’s Rise and Fall C High Risk Lending Strategy (1) Strategic Direction (2) Approval of Strategy (3) Definition of High Risk Lending (4) Gain on Sale (5) Acknowledging Unsustainable Housing Price Increases (6) Execution of the High Risk Lending Strategy D Shoddy Lending Practices (1) Long Beach (2) WaMu Retail Lending (a) Inadequate Systems and Weak Oversight (b) Risk Layering (c) Loan Fraud (d) Steering Borrowers to High Risk Option ARMs (e) Marginalization of WaMu Risk Managers E Polluting the Financial System (1) Long Beach and WaMu Securitizations (2) Deficient Securitization Practices (3) Securitizing Delinquency-Prone Loans (4) WaMu Loan Sales to Fannie Mae and Freddie Mac F Destructive Compensation Practices (1) Sales Culture (2) Paying for Speed and Volume (a) Long Beach Account Executives (b) WaMu Loan Consultants (c) Loan Processors and Quality Assurance Controllers (3) WaMu Executive Compensation G Preventing High Risk Lending (1) New Developments (2) Recommendations Ensure “Qualified Mortgages” Are Low Risk Require Meaningful Risk Retention Safeguard Against High Risk Products Require Greater Reserves for Negative Amortization Loans Safeguard Bank Investment Portfolios IV REGULATORY FAILURE: CASE STUDY OF THE OFFICE OF THRIFT SUPERVISION A Subcommittee Investigation and Findings of Fact B Background (1) Office of Thrift Supervision (2) Federal Deposit Insurance Corporation (3) Examination Process C Washington Mutual Examination History (1) Regulatory Challenges Related to Washington Mutual (2) Overview of Washington Mutual’s Ratings History and Closure (3) OTS Identification of WaMu Deficiencies (a) Deficiencies in Lending Standards (b) Deficiencies in Risk Management (c) Deficiencies in Home Appraisals (d) Deficiencies Related to Long Beach (e) Over 500 Deficiencies in Years (4) OTS Turf War Against the FDIC D Regulatory Failures (1) OTS’ Failed Oversight of WaMu (a) Deference to Management (b) Demoralized Examiners (c) Narrow Regulatory Focus (d) Inflated CAMELS Ratings (e) Fee Issues (2) Other Regulatory Failures (a) Countrywide (b) IndyMac (c) New Century (d) Fremont E Preventing Regulatory Failures (1) New Developments (2) Recommendations Complete OTS Dismantling Strengthen Enforcement Strengthen CAMELS Ratings Evaluate Impacts of High Risk Lending V INFLATED CREDIT RATINGS: CASE STUDY OF MOODY’S AND STANDARD & POOR’S A Subcommittee Investigation and Findings of Fact B Background (1) Credit Ratings Generally (2) The Rating Process (3) Record Revenues C Mass Credit Rating Downgrades (1) Increasing High Risk Loans and Unaffordable Housing (2) Mass Downgrades D Ratings Deficiencies (1) Awareness of Increasing Credit Risks (2) CRA Conflicts of Interest (a) Drive for Market Share (b) Investment Bank Pressure (3) Inaccurate Models (a) Inadequate Data (b) Unclear and Subjective Ratings Process (4) Failure to Retest After Model Changes (5) Inadequate Resources (6) Mortgage Fraud E Preventing Inflated Credit Ratings (1) Past Credit Rating Agency Oversight (2) New Developments (3) Recommendations Rank Credit Rating Agencies by Accuracy Help Investors Hold CRAs Accountable Strengthen CRA Operations Ensure CRAs Recognize Risk Strengthen Disclosure Reduce Ratings Reliance VI INVESTMENT BANK ABUSES: CASE STUDY OF GOLDMAN SACHS AND DEUTSCHE BANK A Background (1) Investment Banks In General (2) Roles and Duties of an Investment Bank: Market Maker, Underwriter, Placement Agent, Broker-Dealer (3) Structured Finance Products B Running the CDO Machine: Case Study of Deutsche Bank (1) Subcommittee Investigation and Findings of Fact (2) Deutsche Bank Background (3) Deutsche Bank’s $5 Billion Short (a) Lippmann’s Negative Views of Mortgage Related Assets (b) Building and Cashing in the $5 Billion Short (4) The “CDO Machine” (5) Gemstone (a) Background on Gemstone (b) Gemstone Asset Selection (c) Gemstone Risks and Poor Quality Assets (d) Gemstone Sales Effort (e) Gemstone Losses (6) Other Deutsche Bank CDOs (7) Analysis C Failing to Manage Conflicts of Interest: Case Study of Goldman Sachs (1) Subcommittee Investigation and Findings of Fact (2) Goldman Sachs Background (3) Overview of Goldman Sachs Case Study (a) Overview of How Goldman Shorted the Subprime Mortgage Market (b) Overview of Goldman’s CDO Activities (4) How Goldman Shorted the Subprime Mortgage Market (a) Starting $6 Billion Net Long (b) Going Past Home: Goldman’s First Net Short (c) Attempted Short Squeeze (d) Building the Big Short Point Pleasant, Hudson Mezzanine 2006-1, and Hudson Mezzanine 2006-2), Goldman reported that for most of the CDOs, the net profit was less than $500,000 One exception was Hudson Mezzanine 2006-1, which yielded a profit of approximately $1 million See Goldman response to 2628 Timberwolf used this reduced premium approach, but in a few other instances, such as Hudson Mezzanine 2006- and Point Pleasant, Goldman received a direct fee for acting as the collateral put provider Goldman representatives told the Subcommittee that, because the put fee was “embedded” in the CDS agreement in some of the CDOs, Goldman’s operations group sometimes overlooked and failed to “book” the profit and loss associated with those put arrangements When this oversight was discovered in 20 07, Goldman identified 18 CDO put arrangements that had no t been identified and accounted for in Goldman’s books See 6/28/2007 email from Carly Scales to Phil Arm strong and Steve Schultz, GS MBS-E-015192547: • “Current Put Option Booking State: 22 Deals with the Put Option Feature C Deals that have a Put Option Booked: - For these trades, Ops [the operations group] knew about the Put as there was a confirmation and a trade booked … • 18 Deals that not have a Put option Booked: - For these deals, there was no mention of a Put at all at the time of closing … - The Put option was embedded into the deal documents (Indenture, Offering Circular, etc – both of which are reviewed by outside counsel and GS legal as a normal course of business – but are not reviewed by Operations.) - For these trades, an intermediation fee was being taken on the CDS trades, but no specific Put was booked in our systems - The original explanation from the desk was the intermediation fee was being taken for the risks associated with standing in between the Street and the deal with no mention of the Put.” 2629 One reason Goldman was so concerned about the value of the default swap collateral securities was because those securities included AAA rated RMBS securities whose values were declining in line with the entire mortgage market 26306/20/2007 email from Matthew Bieber to Goldman colleagues, GS MBS-E -001912772 (“Below are the deals I recall us having significant exposure to in terms of default swap collateral Who is responsible for each of the deals? We need to get Dan a list this morning If there are any missing, please let me know.”) 2631 Id Mr Bieber listed the following CDOs: Adirondack 1; Adirondack 2; Coolidge Funding; Broad wick; Hudson High Grade; Hudson Mezzanine 1; Hudson Mezzanine 2; Fortius I; Fortius II; C amber 7; Hout Bay; Point Pleasant; Timberwolf; Anderson Mezzanine; Altius I; Altius III; and Altius IV 2632Subcommittee interview of Matthew Bieber (10/21/2010) 26337/18/2007 email from Alfa Kiflu, GS MBS-E-001866507 The six CDOs in which Goldman had large short positions were: Hudson Mezzanine 1; Timberwolf; Camber 7; Hudson Mezzanine 2; GSC ABS Funding 2006-3G; and Anderson Mezzanine 26347/19/2007 email from Matthew Bieber to David Lehman, GS MBS-E -011178225 7/19/2007 email from Patrick Welch, GS MBS-E -001866507 7/25/2007 email from Fabrice Tourre, GS MBS-E -001989091 2635Id Greywolf Capital was the collateral manager of the Timberwolf C DO 7/25/2007 email from Matthew Bieber, GS MBS-E001989091 26367/26/2007 email from Shelly Lin, GS MBS-E-015232129 26377/30/2007 email from Matthew Bieber to David Lehman, GS MBS-E -001867239 2638See /6/2007 email from Connie Kang to David Lehman, GS MBS-E -001992556; 8/9/2007 email from Mahesh Ganapathy to David Lehman, Matthew Bieber, and Jonathan Egol, GS MBS-E-001930307; 8/12/2007 email from Mahesh Ganapathy to David Lehman and Matthew Bieber, GS MBS-E -001930343; 8/13/2007 email from Mahesh Ganapathy to Matthew Bieber, David Lehman, and Jonathan Egol, GS MBS-E-001930571 2639 7/26/2007 email from Shelly Lin, GS MBS-2639 E-015232129 2640Subcommittee interview of Joseph Marconi (Greywolf Capital) (10/19/2010) 2641 See 8/6/2007 email from Connie Kang to David Lehman, GS MBS-E-001992556; 8/9/2007 email from Mahesh Ganapathy to David Lehman, Matthew Bieber, and Jonathan Egol, GS MBS-E-001930307; 8/12/2007 email from Mahesh Ganapathy to David Lehman and Matthew Bieber, GS MBS-E-001930343; 8/13/2007 email from Mahesh Ganapathy to Matthew Bieber, David Lehman, and Jonathan Egol, GS MBS-E-001930571 2642 In addition, since the yield of most default swap collateral securities was linked to their “face (par) value,” when the same securities could be obtained at a p rice lower than their par value, their yield (return on investment) increased as long as they continued to meet their scheduled principal and interest payments This was another potential benefit to the long investors which conflicted with the interest of Goldman, the short party 2643 8/21/2007 email from Matthew Bieber to David Lehman, GS MBS-E-011273913 2644 See 9/21/2007 email from Marty Devote of Aladdin Capital Management to Benjamin Case, GS MBS-E 022138816 (“We, at the direction of Connie and Roman [Goldman employees], have not been reinvesting CDS collateral as it matures We’ve brought the topic up a few times over the past few months with your team Last I heard , you were re-evaluating the market, and would come back to us with a breakdown of acceptable replacements As the cash balances continue to grow, I’d like to address this issue, as the amount of cash drag is beginning to become meaningful.”) 26459/6/2007 email from Roman Shimonov to Matthew Bieber, GS MBS-E-000765873 26469/6/2007 email from Joe Marconi to David Lehman, G W 107909 2647Subcommittee interview of Joseph Marconi (Greywolf Capital) (10/19/2010) 26489/7/2007 email from Joe Marconi to David Lehman, G W 107909 2649 Subcommittee interview of Joseph Marconi (Greywolf Capital) (10/19/2010) 2650Id 2651Section 12.5(b) of the Timberwolf Indenture agreement stated: “The Synthetic Securities shall be structured as ‘pay-as-you-go’ credit default swap s As part of the purchase of each Synthetic Security on o r before the Closing Date, the Issuer will be required to purchase Default Swap Collateral which satisfies the Default Swap Collateral 26527/25/2007 email from Matthew Bieber, GS MBS-E -001989091 26531/7/20 11 email from Goldman counsel to the Subcommittee 26549/7/2007 email from Matthew Bieber to Tim Saunders, Susan Helfrick, and Jordan Horvath, GS M BS-E-021881077 2655Id 26569/7/2007 email from Susan Helfrick to Matthew Bieber, Tim Saunders, and Jordan Horvath, GS M BS-E- 021881084 2657 Mr Saunders, Ms Helfrick, and Mr Horvath provided signed statements to the Subcommittee to the same effect See written statements submitted to the Subcommittee by Timothy Saunders (12 /22 /20 10 ), Susan Helfrick (1/7/2011), and Jordan Horvath (1/7/2011) Although Mr Lehman was not invited to the meeting, he told the Subcommittee that he generally recalled having discussions with his colleagues, including Goldman’s legal department, about the general issue of default swap collateral, but did no t recall his conversation with Mr Marconi He also submitted a statement to the Subcommittee saying he had no recollection of whether the meeting took place or, if a meeting was held, what was discussed or decided Written statement of Mr Lehman (1/26/2011) Mr Sparks, the head of the Mortgage Department, told the Subcommittee that while he had a general knowledge of the issue regarding default swap collateral securities, he had no recollection of any meeting or decisions made Subcommittee interview of Daniel Sparks (1 /13/2011) 2658Subcommittee interview of Matthew Bieber (10/21/2010) 26599/7/20 07 email exchange between David Lehman and Matthew Bieber, GS MBS-E-000766414 The reference to “slmas” is to asset backed securities that were issued by Sallie Mae and backed by pools of student loans 2660 Id 26619/7/2007 email from Jonathan Egol to Michael Swenson and David Lehman, GS MBS-E-000765854 2662See 9/7/2007 email from Matthew Bieber to David Lehman, GS MBS-E -000766414 (“I need to speak with dan we’re thinking about offering some 1-3 year SLMAs.”) 2663 9/10 /20 07 email from Matthew Bieber to David Lehman, GS MBS-E-000765316 “SLMA ” refers to asset backed securities that were issued by Sallie Mae and backed by pools of student loans 2664 9/25 /20 07 email from Matthew Bieber to Joe Marconi, GS MBS-E-000766338 The action taken by Goldman to stop the purchase of new default swap collateral securities was not the only instance in which it attempted to exert control over the collateral in the CDOs it constructed In the case of the Broadwick CDO , for example, when some investors were entitled to the return of some collateral, Goldman attempted to have the CDO pay them with securities rather than cash, so that the CDO would preserve the cash in its collateral account The Broadwick collateral manager objected and complained in an email sent to Mr Sparks, stating in part: “In case I wasn’t clear on the call, our three main points would be: The aim of the collateral account was to provide LIBOR and not add additional risk to the deal GS said they would take market risk and clearly rep resented that to us and to the ratings agencies The only way the deal works, and the way the deal was marketed and explained to us, is that paydowns are equivalent to partial terminations We not believe you have any right to refuse to release excess cash that is no longer needed as collateral, and we not believe you have the right to release bonds into the waterfall ever, and certainly not when cash exists Perhaps the way you did these deals changed over time and you are com paring our deal to ones which you marketed or structured later/differently? I look forward to hearing from you ” 11/20/2007 email from Ron Beller to Matthew Bieber, GS MBS-E-013746516 2665 Documents show that a list of assets was sent to Aladdin Capital Management and Trust Company of the West See 9/24/2007 email from Benjamin Case to Marty Devote of Aladdin Capital Management, GS MBS-E 022138816; 9/20/2007 email from Matthew Bieber to Vincent Fiorillo of Trust Company of the West, GS MBS-E-022141026- 27 2666 10 /15/2007 email from Matthew Bieber to Matthew Verrochi, GS MBS-E-015732147 The list had one more RMBS security than the lists sent to the collateral managers 26679/27/2007 email from Joe Marconi to Matthew Bieber, GW 108645 2668Written statement of David Lehman (1 /26/2011) 2669Subcommittee interview of Daniel Sparks (1/13/2011) 2670The seven CDOs were Fort Denison, Camber 7, Timberwolf, Anderson Mezzanine, Point Pleasant, Hudson Mezzanine 2006-1, and Hudson Mezzanine 2006-2 Goldman lost $1 018 billion from acting as the collateral put provider for their default swap collateral securities See Goldman response to Subcommittee QFR at PSI_QFR_GS0280 2671 Section 3(a)(38) of the Securities Exchange Act of 1934 (“The term ‘market maker’ means any specialist permitted to act as a dealer, any dealer acting in the capacity of block positioner, and any dealer who, with respect to a security, holds himself out (by entering quotations in an inter-dealer communications system or otherwise) as being willing to buy and sell such security for his own account on a regular or continuous basis.”); see also SEC website, http://www.sec.gov/answers/mktmaker.htm; see also FINRA website, FAQs, “What Does a Market Maker Do?” http://finra.atgnow.com/finra/categoryBrowse.do 2672 SEC website, http://www.sec.gov/answers/mktmaker.htm 2673 1/2011 “Study on Investment Advisers and Broker-Dealers,” study conducted by the U.S Securities and Exchange Commission, at 55, http://www.sec.gov/news/studies/2011/913studyfinal.pdf, (hereinafter “SEC Study on Investment Advisers and Broker-Dealers”) 2674 See Goldman response to Subcommittee QFR at PSI_QFR_GS0046 2675 FINRA is the largest independent self-regulatory organization for securities firms doing business in the United States FINRA has been delegated authority by the SEC and a number of securities exchanges to regulate the broker-dealer industry Its stated mission is “to protect America’s investors by making sure the securities industry operates fairly and honestly.” See FINRA website, http://www.finra.org 2676 See, e.g., SEC v Capital Gains Research Bureau, Inc., 375 U.S 180, 201 (1963) (“Experience has shown that disclosure in such situations, while not onerous to the advisor, is needed to preserve the climate of fair dealing which is so essential to maintain public confidence in the securities industry and to preserve the economic health of the country ”) See also SEC Study on Investment Advisers and Broker-Dealers at 51 [citations omitted] (“Under the so-called ‘shingle ’ theory a broker-dealer makes an implicit representation to those persons with whom it transacts business that it will deal fairly with them, consistent with the standards of the profession Actions taken by the broker-dealer that are not fair to the customer must be disclosed in order to make this implied representation of fairness not misleading.”) 2677 See Sections 11 and 12 of Securities Act of 1933 See also Rule 10b-5 of the Securities Exchange Act of 1934 See also SEC v Capital Gains Research Bureau, Inc., 375 U.S at 200 (“Failure to disclose material facts must be deemed fraud or deceit within its intended meaning, for, as the experience of the 1920’s and 1930’s amply reveals, the darkness and ignorance of commercial secrecy are the conditions upon which predatory practices best thrive.”) See also Goldman response to Subcommittee QFR, at PSI_QFR_GS0046 2678 Basic v Levinson, 485 U.S 224, 231-32 (1988) (quoting TSC Industries, Inc v Northway, Inc., 426 U.S 438, 449 (1976)) 2679 In the Matter of David Henry Disraeli and Lifeplan Associates, Securities Exchange Act Rel No 34-2686 (December 21, 2007) at 10-11 [citations omitted] 2680 SEC v Tambone, 550 F.3d 106, 135 (1st Cir 2008) [citations omitted] 2681 In the Matter of Richmark Capital Corporation , Securities Exchange Act Rel No 48757 (Nov 7, 2003) (citing Chasins v Smith Barney & Co., Inc , 438 F.3d 1167, 1172 (2d Cir 1970) (“The investor must be permitted to evaluate overlapping motivations through appropriate disclosures, especially where one motivation is economic self-interest”) See also SEC Study on Investment Advisers and Broker-Dealers at 55 In this recent study examining the disclosure obligations of broker-dealers and investment advisers, the SEC has explained: “Generally, under the anti-fraud provisions, a broker-dealer’s duty to disclose material information to its customer is based upon the scope of the relationship with the customer, which is fact intensive.” According to the SEC, when a broker-dealer acts as an order taker or market maker in effecting a transaction for a customer, the broker- dealer generally does not have a duty to disclose information regarding the security or the broker-dealer’s economic interest The duty to disclose this information is triggered, however, when the broker-dealer recommends a security Id 2682 SEC Study on Investment Advisers and Broker-Dealers at 56, n.252 2683 FINRA Notice to Members 96-60 2684 See 2/1/2001 Goldman document, “United States Policies for the Preparation, Supervision, Distribution and Retention of Written and Electronic Communications,” at 9, GS MBS 0000035799 2685 See ,e.g., In the Matter of Arleen Hughes, Securities Exchange Act Rel No 4048 (Feb 1948) (holding a broker-dealer, who is also a registered investment adviser, violated the anti-fraud provisions of the federal securities laws by failing to at minimum disclose the “nature and extent” of its adverse interest); In the Matter of Edward D Jones & Co., L.P., Exchange Act Rel No 50910 (Dec 22, 2004) (settled order), at 21(broker-dealer consents to an order finding that disclosure to its customers was inadequate, because it failed to disclose the full nature and extent of its agreement, including “information about the source and the amount of the revenue sharing payments to [the broker-dealer] and the dimensions of the resulting potential conflicts of interest”) 2686 See, e.g., SEC v Czuczko, Case No CV06-4792 (USDC CD Calif.), Order Granting Plaintiff’s Unopposed Motion for Summary Judgment (Dec 5, 2007) In Czuczko, the defendant, who offered online investment advice, included a disclaimer on his website advising that officers, directors, employees and members of their families “ may, from time to time , trade in these securities for their own accounts” [emphasis in original] Id at Relying on SEC v Blavin, 760 F.2d 706 (6th Cir 1985), the court held such an assertion “is itself a material misstatement because the Defendant knew he, his father, and his business partner did trade in the stocks and had a biased interest in the recommended stocks” [emphasis in original] Czuczko, at 2687 See FINRA Rules 2210(d)(1)(A) and 2211(a)(3) and (d)(1) (by rule all institutional sales material and correspondence may not “omit any material fact or qualification if the omission, in the light of the context of the material presented, would cause the communications to be misleading.”); and FINRA Rule 2310 and IM-2310-3 (suitability obligation to institutional customers) See also Hanly v SEC, 415 F.2d 589, 596 (2d Cir 1969) (holding that sophistication and knowledge of a broker’s customers not warrant a less stringent standard of conduct under federal securities laws); Spatz v Borenstein, 513 F Supp 571, 580 (N.D Ill 1981) (finding investors’ experience does not mitigate a broker’s duty to fully and truthfully disclose material facts, nor does the potential for investors to discover information not disclosed by a prospectus vitiate any legal liability stemming from a failure to disclose material facts); Department of Enforcement v Kesner, FINRA Complaint No 2005001729501 (February 26, 2010) (finding sophistication of investors does not relieve a securities representative from disclosing material facts to investors) 2688 SEC Study on Investment Advisers and Broker-Dealers at 61 2689 Id 2690 FINRA Rule 2010 See also Study on Investment Advisers and Broker-Dealers at 55 (broker-dealers also have an obligation under the federal securities laws and FINRA rules to deal fairly with their customers) 2691 F.J Kaufman and Co., Securities Exchange Act Rel No 27535 at (December 13, 1989) 2692 SEC Study on Investment Advisers and Broker-Dealers at 63 [citations omitted] The suitability rule also requires the broker to determine that the specific security recommended is appropriate based on the customer’s financial situation and needs FINRA Rule 2310 The suitability obligation clearly applies to institutional customers, FINRA IM-2310-3 (suitability obligations to institutional customers require members have a reasonable basis for recommending a particular security or strategy), but may not apply when a broker-dealer solicits another broker-dealer to buy an investment since, under FINRA Rules, the term “customer” does not include a broker or dealer FINRA Manual, 0120 Definition On the other hand, the term “customer” has been given a broad definition under the securities case law See, e.g., Department of Enforcement v Zayed, FINRA Complaint No 2006003834901 (August 19, 2010) (“Cases interpreting the term ‘customer’ in the securities context have viewed the term broadly to encompass individuals or entities that have some brokerage or investment relationship with the broker-dealer Specifically, courts have rejected the argument that an account is necessary to establish an investor’s status as a customer.” [citations omitted]) When the Subcommittee asked Mr Blankfein whether he believed there was a difference between a “customer” and a “client,” Mr Blankfein said he had “never distinguished” between the two terms Subcommittee deposition of Lloyd Blankfein (12/15/2009), Hearing Exhibit 4/27-176 [Sealed Exhibit] 2693 6/16/1934 “Stock Exchange Practices,” Report of the Senate Committee on Banking and Currency, S Rep 73- 1455, at 88 (quoting “Who Buys Foreign Bonds,” Foreign Affairs (1/1927)) 2694 SEC Study on Investment Advisers and Broker-Dealers at 15-16 2695 Id 2696 Id 2697 The Subcommittee did not examine the extent to which Goldman was acting as an investment adviser within the meaning of the Investment Advisers Act when recommending that various customers buy its RMBS and CDO securities 2698 See, e.g., 3/1/2010 letter from Goldman’s legal counsel to the Financial Crisis Inquiry Commission, GS-PSI-01310 (discussing Goldman Sachs’ “Role as a market maker” in detail and distinguishing it, in a much shorter description, from its underwriting and placement roles) Although the letter acknowledged that Goldman acted as an underwriter and placement agent for RMBS and CDO transactions, it also suggested that those transactions were commonly designed in response to client inquiries and did not discuss efforts by the firm to solicit customers to buy the securities: “Goldman Sachs’ CDOs were initially created in response to the request of a sophisticated institutional investor that approached the firm specifically seeking that particular exposure Reverse inquiries from clients were a common feature of this market.” 2699 April 27, 2010 Subcommittee Hearing Transcript at 26-27 2700 Prepared statement of Fabrice Tourre, April 27, 2010 Subcommittee Hearing at 2701 April 27, 2010 Subcommittee Hearing at 137-138 2702 Id at 53 2703 Goldman response to Subcommittee QFR at PSI_QFR_GS0026 2704 “Goldman Sachs’ Lloyd Blankfein Defends ‘Market Maker’ Firm On ‘Charlie Rose Show,’” Huffington Post (5/1/2010), http://www.huffingtonpost.com/2010/05/01/goldman%1esachs%1elloyd%1eblank_n_559606.html (video of Charlie Rose interview of Lloyd Blankfein embedded) 2705 Id 2706 April 30, 2010 Transcript of The Charlie Rose Show at 12-14 Mr Blankfein made similar claims the following week on CNBC’s “Power Lunch” during a one-on-one interview with David Faber May 7, 2010 Transcript of Power Lunch at 2707 See, e.g., 12/14/2006 email from Daniel Sparks to Thomas Montag, “Subprime risk meeting with Viniar/McMahon Summary,” GS MBS-E-009726498, Hearing Exhibit 4/27-3; Subcommittee interview of David Viniar (4/13/2010) 2708 12/14/2006 email from Kevin Gasvoda to his staff, “Retained bonds,” GS MBS-E-010935323, Hearing Exhibit 4/27-72 2709 1/31/2007 email from Daniel Sparks to Tom Montag, “MTModel,” Hearing Exhibit 4/27-91 2710 3/9/2007 email exchange between Mr Sparks and sales managers, “help,” GS MBS-E-010643213 2711 Id 2712 4/19/2007 email from Daniel Sparks to Bunty Bohra, GS MBS-E-010539324, Hearing Exhibit 4/27-102 2713 3/21/2007 email from Syndicate, “Non-traditional Buyer Base for CDO ASEX,” GS MBS-E-003296460, Hearing Exhibit 4/27-78 2714 3/9/2007 email exchange between Mr Sparks and sales managers, “help,” GS MBS-E-010643213, Hearing Exhibit 4/27-76 2715 3/30/2007 email from Fabrice Tourre to Mr Sparks and others, GS MBS-E-002678071 2716 5/20/2007 Goldman presentation, “Mortgage Department, May 2007,” GS MBS-E-010965212 See also 3/1/2007 email from Michael Swenson, “names,” GS MBS-E-012504595 (SPG Trading target list tiered according to likelihood of purchasing); 2/14/2007 email to Matthew Bieber, “Timberwolf I, Ltd – Target Account List,” GS MBS-E-001996121 (list of U.S accounts “we should be directly targeting” for Timberwolf sales); 3/2/2007 email from David Lehman, “ABX/Mtg Credit Accts,” GS MBS-E-011057632 (mortgage credit business shared with SPG Trading Desk “a fairly lengthy list of accounts that are considered to be ‘key’”) 2717 5/24/2007 email from Ysuf Aliredha to Mr Sparks and others, “Priority Axes,” GS MBS-E-001934732 2718 See, e.g., 5/20/2007 email from George Maltezos to Mr Lehman, “T/wolf and Basis,” GS MBS-E-001863555; 5/22/2007 email from Mr Maltezos to Basis Capital, JUL 000685 2719 6/7/2007 email from Omar Chaudhary to Mr Sparks and others, GS MBS-E-001866450, Hearing Exhibit 4/27-104 2720 Basic v Levinson, 485 U.S 224, 231-32 (1988) (quoting TSC Industries v Northway, 426 U.S 438, 449 (1976)) Utilizing the SEC’s guidance, the issue could also be framed as evaluating “the significance the reasonable investor would place on the withheld or misrepresented information.” 2721 Goldman Response to Subcommittee QFR at PSI_QFR_GS0192 2722 Typically, the equity tranche, which is the first to incur any losses sustained by a securitization, is retained by the originator Equity tranches are typically not rated by the credit rating agencies and often not sold to third parties 2723 In Abacus, Goldman also failed to disclose the role of the hedge fund in the Abacus asset selection process See Abacus section C(5)(b)(ii)DD, above 2724 12/3/2006 Goldman Offering Circular, “Hudson Mezzanine 2006-1, LTD.,” at 56, GS MBS-E-021821196 The Goldman offering circulars for Timberwolf and Anderson contain similar sections See 3/23/2007 Goldman Offering Circular, “Timberwolf I, LTD.,” GS MBS-E-021825371 at 427; 3/16/2007 Goldman Offering Circular, “Anderson Mezzanine Funding 2007-1, LTD.,” GS MBS-E-000912574, at 623 2725 See, e.g., Goldman response to Subcommittee QFR at PSI_QFR_GS0192 and PSI_QFR_GS00235 2726 See, e.g., SEC v Czuczko, Case No CV06-4792 (USDC CD Calif.), Order Granting Plaintiff’s Unopposed Motion for Summary Judgment (Dec 5, 2007) (finding defendant made a material misstatement to potential investors when he disclosed that officers, directors, employees and members of their families “may” trade in the stocks recommended on his website, without disclosing that he, his father, and business partner were trading in those stocks and had an interest in them) See also In the Matter of Arleen Hughes, Securities Exchange Act Rel No 4048 (Feb 1948) (holding a broker-dealer, who is also a registered investment adviser, had to disclose the “nature and extent” of its adverse interest); In the Matter of Edward D Jones & Co., L.P., Exchange Act Rel No 50910 (Dec 22, 2004) (settled order), at 21 (disclosure inadequate for failing to disclose full nature and extent of the broker-dealer’s conflict of interest) 2727 Goldman sometimes referred to this position as the “Credit Protection Buyer” or “Synthetic Security Counterparty.” 2728 10/2006 Hudson Mezzanine Funding 2006-1, LTD., GS MBS-E-009546963, at 966, Hearing Exhibit 4/27-87 2729 See Goldman response to Subcommittee QFR at PSI_QFR_GS0223 2730 See, e.g., 10/30/2006 email from Mr Ostrem, “Great Job on Hudson Mezz,” GS MBS-E-0000057886, Hearing Exhibit 4/27-90 2731 See discussion of Goldman’s actions as the Hudson liquidation agent, above 2732 3/13/2007 email from Mr Ostrem to Scott Wisenbaker and Matthew Bieber, GS MBS-E-000898410, Hearing Exhibit 4/27-172 2733 See Goldman response to Subcommittee QFR at PSI_QFR_GS0192 2734 Timberwolf flipbook, GS MBS-E-000676809, Hearing Exhibit 4/27-99a 2735 Goldman purchased its share of the Timberwolf equity tranche in March 2007, actually held it for only two months, and then, in May, sold it to Greywolf See also Goldman response to Subcommittee QFR at PSI_QFR_GS0226 2736 See, e.g., 6/5/2007 email from Benjamin Case to David Lehman, GS-MBS-E-001919861 (indicating Goldman was shorting some of the assets underlying Timberwolf using CDS contracts outside of the CDO) 2737 See, e.g., Goldman spreadsheet produced in response to a Subcommittee QFR, at GS MBS 0000037361 (identifying lenders whose stock Goldman shorted) 2738 See discussion of Goldman’s net short positions, section C(4)(b), above 2739 That Goldman’s own investment decisions might be material information for an investor is demonstrated by a court ruling in a famous case in the 1970s, in which Goldman, an exclusive dealer, was sued by an investor who alleged that Goldman had sold it Penn Central notes without disclosing, among other things, that Goldman had recently reduced and placed limits on its own inventory of those same notes Alton Boxboard v Goldman, Sachs and Company, 560 F.2d 916 (8th Cir 1977) Although the court decided the case on another basis, the Eighth Circuit found that the materiality of the undisclosed facts alleged was a question to be decided by a trier of fact The court took note of the testimony from two sophisticated institutional purchasers concerning Goldman’s reduction of inventory in Penn Central notes Id at n.10 One sophisticated investor “testified that this information would have been a ‘red flag’ to him, and had he known of Goldman Sachs’ inventory decision, he would have wanted notes from another issuer.” Id The other witness “stated he would have been concerned about such information and would have conveyed it to his customers, because it indicated that Goldman, Sachs did not have confidence in [the] notes.” Id 2740 Each of these matters is discussed in detail, above 2741 SEC Study on Investment Advisers and Broker-Dealers at 55 2742 SEC v Tambone, 550 F.3d 106, 135 (1st Cir 2008) [citations omitted] 2743 SEC Study on Investment Advisers and Broker-Dealers at 63 [citations omitted] 2744 Id at 61 2745 See Goldman response to Subcommittee QFR at PSI_QFR_GS0048 2746 See, e.g., 1/23/2007 email from Fabrice Tourre to Marine Serres, GS MBS-E-003434918, Hearing Exhibit 4/27-62 (Tourre wrote: “[S]tanding in the middle of all these complex, highly levered, exotic trades he [Mr Tourre] created without necessarily understanding all the implications of these monstruosities [sic] !!!”) 2747 See discussion of Abacus in section C(5)(b)(ii)DD, above 2748 12/18/2006 email from Fabrice Tourre, “Paulson,” GS MBS-E-003246145, Hearing Exhibit 4/27-107 2749 SEC deposition of Paolo Pellegrini (12/3/2008) PSI-Paulson-04 (Pellegrini Depo)-0001, at 175-76 2750 April 23, 2010 Subcommittee Hearing Transcript at 64 2751 2/27/2007 email from Ed Steffelin to Peter Ostrem, GS MBS-E-009209654 2752 Subcommittee interview of Ed Steffelin (12/10/2010) 2753 4/15/2007 email from Cactus Raazi to Daniel Chan, “Dan: ABACUS 07-AC1,” Hearing Exhibit 4/27-82 2754 10/26/2007 email from Goldman salesman to Michael Swenson, “ABACUS 2007-AC1 – Marketing Points (INTERNAL ONLY) [T-Mail],” GS MBS-E-016034495 2755 Error! Main Document Only Securities and Exchange Commission v Goldman Sachs, Case No 10-CV- 3229 (S.D.N.Y.), Complaint (April 16, 2010) 2756 SEC v Goldman, Sachs & Co and Tourre, Case No 10-CV-3329 (BSJ) (S.D.N.Y.), Consent of Defendant Goldman, Sachs & Co (July 14, 2010) 2757 See discussion of Hudson CDO in section C(5)(b)(ii)AA, above 2758 Goldman response to Subcommittee QFR at PSI_QFR_GS0249 2759 9/20/2006 email from Arbind Jha to Josh Birnbaum, GS MBS-E-012685289 2760 3/12/2007 Goldman memorandum to Mortgage Capital Committee, “ABACUS Transactions sponsored by ACA,” GS MBS-E002406025, Hearing Exhibit 4/27-118 2761 10/2006 Hudson Mezzanine Funding 2006-1, LTD., GS MBS-E-009546963, at 978, Hearing Exhibit 4/27-87 2762 See discussion of Anderson CDO in section C(5)(b)(ii)BB, above Another 8% were dependent upon loans issued by Countrywide 2763 2/24/2007 email from Deeb Salem to Michael Swenson and others, GS MBS-E-018936137 2764 2/24/2007 email from Mr Sparks to Mr Ostrem and others, GS MBS-E-001996601, Hearing Exhibit 4/27-95 2765 See, e.g., 2/8/2007 email from Craig Broderick to Mr Sparks and others, GS MBS-E-002201486 (calling New Century’s announcement that it would restate its earnings “a materially adverse development”); 3/14/2007 Goldman email, “NC Visit,” GS MBS-E002048050 (stating Fremont still has cash “but not for long”); 3/13/2007 email from Mr Ostrem to Scott Wisenbaker and Matthew Bieber, GS MBS-E-000898410, Hearing Exhibit 4/27- 172 (providing talking points for selling Anderson securities to customers) 2766 3/13/2007 email from Manisha Nanik, “New Century EPDs,” GS MBS-E-002146861, Hearing Exhibit 4/27- 77 2767 3/14/2007 Goldman email, “NC Visit,” GS MBS-E-002048050 2768 See, e.g., 3/6/2007 email from Joshua Bissu to Mr Ostrem and Mr Bieber, GS MBS-E-014597705 (talking points for Goldman personnel to respond to investor concerns about the New Century loans) 2769 See e.g., Goldman response to Subcommittee QFR at PSI_QFR_GS0223 2770 See, e.g., 9/17/2007 email from Christopher Creed, “Timberwolf,” GS MBS-E-000766370, Hearing Exhibit 4/27-106 (showing price for Timberwolf securities dropped from $94 on 3/31/2007 to $87 on 4/30/2007) 2771 8/23/2007 email from Jay Lee to Mr Lehman and others, GS MBS-E-001927784 2772 2/26/2007 email exchange between Mr Sparks and Mr Montag, GS MBS-E-019164799, Hearing Exhibit 4/27-71 2773 5/20/2007 email from Paul Bouchard, “Materials for Meeting,” GS MBS-E-001863725 2774 5/14/2007 email from Mr Sparks to Mr Montag and Mr Mullen, GS MBS-E-019642797 2775 See, e.g., Goldman response to Subcommittee QFR at PSI_QFR_GS0223 2776 See, e.g., example involving Basis Capital in discussion of Timberwolf in section C(5)(b)(ii)CC, above 2777 6/22/2007 email from Mr Montag to Mr Sparks, “Few Trade Posts,” GS MBS-E-010849103, Hearing Exhibit 4/27-105 2778 April 30, 2010 transcript of The Charlie Rose Show, at 14 2779 3/12/2007 Goldman Firmwide Risk Committee, “March 7th FWR Minutes,” GS MBS-E-00221171, Hearing Exhibit 4/27-19; 3/3/2007 email from Mr Sparks, “Call,” GS MBS-E-010401251, Hearing Exhibit 4/27-14 2780 Until its repeal in 1999, the Glass-Steagall Act prohibited banks from engaging in proprietary trading Glass- Steagall Act, Section 16 The Act’s prohibition on proprietary trading was weakened over the years and finally repealed by the Financial Services Modernization Act of 1999, P.L 106-102 (1999) Since Goldman did not become a bank holding company until 2008, neither the GlassSteagall prohibition nor its repeal affected its activities during the time period examined by the Subcommittee 2781 Financial institutions that trade for their own accounts at the same time that they conduct trades on behalf of their clients may experience conflicts of interest See, e.g., 4/23/2010 letter from John Reed, former Chairman and CEO of Citigroup, to Senators Merkley and Levin (“When a firm is focused on market gain through proprietary trading, it too often will employ every available device to achieve those gains B including take advantages of clients and putting the firm at risk.”); In re Merrill Lynch, Pierce, Fenner & Smith, Incorporated, Exchange Act Rel No 34-63760, Admin Proc 3-14204 (Jan 25, 2011) (settling allegations that Merrill Lynch’s proprietary traders misused information about their customers’ trading); 7/19/2005 speech by Annette Nazareth before the Securities Industry Association Compliance and Legal Division Member Luncheon (discussing increased potential for conflicts of interest) In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act, P.L 111-603, restored the prohibition on proprietary trading by banks, subject to certain exceptions See Section 619, amending the Bank Holding Company Act of 1956, to be codified at 12 U.S.C §1851 Regulations implementing Section 619, also known as the Merkley-Levin provisions after the Senators who authored them or the Volcker Rule after former Federal Reserve Chairman Paul Volcker who championed the ban, are due by October 2011 2782 1/2011 “Report of the Business Standards Committee,” at In May 2010, at Goldman’s annual shareholders’ meeting, CEO Lloyd Blankfein announced the formation of a Business Standards Committee to conduct an extensive review of the firm’s business standards and practices to determine the extent to which the firm was adhering to its own written “Business Principles,” and to make appropriate recommendations Id The Committee’s January 2011 report provided recommendations in the areas of Client Relationships and Responsibilities, Conflicts of Interest, Structured Products, Transparency and Disclosure, Committee Governance, and Training and Professional Development 2783 9/26/2007 email to Mr Blankfein, “Fortune: How Goldman Sachs Defies Gravity,” GS MBS-E-009592726, Hearing Exhibit 4/27135 2784 See, e.g., 1/21/2010, The Goldman Sachs Group Inc., 4Q 2009 Earnings Call Transcript, Q&A (David Viniar states that, in most years, proprietary trading accounts for “10% roughly plus or minus a couple of percent.”), http://seekingalpha.com/article/183723-thegoldman-sachs-group-inc-q4-2009-earnings-call-transcript?part=qanda 2785 1/11/2011 Goldman Form 8-K filed with the SEC (announcement of change in reporting categories) Goldman’s change in its reporting categories implemented one of the recommendations outlined in Goldman’s “Report of the Business Standards Committee” published in January 2011 2786 See 1/19/2011 Goldman press release on 2010 earnings, available at www2.goldmansachs.com 2787 Subcommittee interview of David Viniar (4/13/2010) See also “More Goldman Traders to Exit for Funds,” Financial Times (1/9/2011) Goldman may be eliminating the desk in response to the Dodd-Frank prohibition on proprietary trading 2788 See “Goldman to Shut Global Macro Trading Desk,” New York Times (2/16/2011) Goldman may be eliminating this desk in response to the Dodd-Frank prohibition on proprietary trading 2789 Subcommittee interview of Darryl Herrick (10/13/2010) To the extent that its activities are limited to long term investments, the SSG unit would not be affected by the Dodd-Frank prohibition on proprietary trading which applies only to trading accounts used “principally for the purpose of selling in the near term (or otherwise with the intent to resell in order to profit from short-term price movements),” and does not affect long term investments See Section 619(h)(6) Under Section 620 of the Dodd-Frank Act, banking regulators are also conducting an 18-month review of all permitted bank investment activities, both long and short term, to gauge the risk of each activity, any negative effect the activity may have on the safety and soundness of the banking entity or the U.S financial system, and the “appropriateness” of each activity for a federally insured bank 2790 Subcommittee interview of Darryl Herrick (10/13/2010) 2791 Id 2792 Id 2793 Subcommittee interviews of Mr Sparks (4/15/2010); Mr Birnbaum (4/22/2010); and Mr Broderick (4/9/2010) See also 12/17/2007 email from Michael DuVally to Mr Sparks, “WSJ Responses,” GS MBS-E-013821884 (“Some traders are allowed to express their own market views using the firm’s capital.”) 2794 Subcommittee interview of Daniel Sparks (4/15/2010) 2795 Subcommittee interview of Joshua Birnbaum (4/22/2010) 2796 Subcommittee interview of Craig Broderick (4/9/2010) 2797 Id Goldman’s Chief Financial Officer David Viniar provided similar information in response to questions from the Financial Crisis Inquiry Commission, indicating that Goldman did not specifically “break out” its proprietary trading from its other business results See FCIC Hearing, Testimony of David Viniar (7/2/2010), www.fcic.gov 2798 The Dodd-Frank Act defines “proprietary trading” as “engaging as a principal for the trading account of [a] banking entity in any transaction to purchase or sell, or otherwise acquire or dispose of, any security, any derivative, any contract of sale of a commodity for future delivery, any option on any such security, derivative, or contract or any other security or financial instrument that the appropriate Federal banking agencies may, by rule determine.” 12 U.S.C ' 1851(h)(4) The Act further defines “trading account” as one used for “near term” trading or for capturing profits from “short term price movements.” Section 1851(h)(6) These provisions are subject to further refinement through implementing regulations 2799 See, e.g., description of proprietary trading in Deutsche Bank’s 3/26/2008 Form 20-F filed with the SEC at 24 (“Within Corporate Banking & Securities, we conduct proprietary trading, or trading on our own account, in addition to providing products and services to customers Most trading activity is undertaken in the normal course of facilitating client business For example, to facilitate customer flow business, traders will maintain long positions (accumulating securities) and short positions (selling securities we not yet own) in a range of securities and derivative products, reducing this exposure by hedging transactions where appropriate While these activities give rise to market and other risk, we not view this as proprietary trading However, we also use our capital to exploit market opportunities, and this is what we term proprietary trading.”) 2800 4/13/2006 email from Mr Sparks to Messrs Cohn, Sobel, and Mullen, “Morgan Super Traders Worry Hedge Funds,” GS MBS-E016187625 2801 Id See also Glenn Bedwin, International Research Director, Thomson Financial, Trading for Investors Forum, Financial News Supplement at 14 (2004) (noting the value of “information [banks] gain from looking at the flow going through their desk”) 2802 11/16/2007 email from John McHugh to Mr Sparks, “FICC 2008 business plan presentation to Firm,” GS MBS-E-013797964 2803 Id 2804 Id 2805 Subcommittee interview of Daniel Sparks (10/3/2010) 2806 Daniel Sparks response to Subcommittee QFR at PSI-QFR_GS0452 2807 The difficulties associated with distinguishing between proprietary trading and market making activities are examined in a recent study by the new Financial Stability Oversight Council (FSOC), an intra-governmental council established by the Dodd-Frank Act, comprised of ten regulators in the financial services sector, and charged with identifying risks and responding to emerging threats to U.S financial stability See FSOC FAQs, www.treasury.gov; 1/2011 “Study & Recommendations on Prohibitions on Proprietary Trading & Certain Relationships with Hedge Funds & Private Equity Funds” (hereinafter “FSOC Study”), at 22-44 The FSOC Study observed: “Absent robust rules and protections, banking entities may have the opportunity to migrate existing proprietary trading activities from the standalone business units that are presently recognized as ‘proprietary trading” into more mainstream ‘sales and trading’ or other operations that engage in permitted activities.” Id See also “Proprietary Trading Goes Under Cover: Michael Lewis,” Bloomberg, (10/27/2010) (quoting a bank trader who reportedly said “from here on out, if he wants to take a proprietary position he will argue that he bought the position because a customer wanted to sell the position, and he was providing liquidity”) 2808 These totals include Goldman’s net shorts from both its mortgage trading and CDO securitization activities 2809 Subcommittee interview of Daniel Sparks (4/15/2010) 2810 See, e.g., documents cited in Section C(4)(b) (sales efforts to reduce Goldman’s $6 billion long position) and Section C(5)(a)(iii) (sales efforts to reduce Goldman-originated RMBS and CDO securities), above 2811 See, e.g., emails noting difficult sales environment 1/31/2007 email from Mr Sparks to Mr Montag, “MTModel,” Hearing Exhibit 4/27-91 (making “lemonade out of some big old lemons”); 3/9/2007 email from Mr Sparks to Mr Schwartz and others, GS MBS-E010643213, Hearing Exhibit 4/27-76 (“team is working incredibly hard and is stretched”); 3/27/2007 email from Mr Ostrem to Mr Bieber, GS MBS-E-000907935, Hearing Exhibit 4/27-172 (congratulating Mr Bieber for “an excellent job pushing to closure these deals in a period of extreme difficulty”); 6/11/2007 email from Mr Montag, GS MBS-E-001866144 (after a sale of Timberwolf securities, telling the sales team they had done an “incredible job B just incredible”) 2812 6/10/2007 email from Michael Swenson, “CDS on CDOs,” GS MBS-E-012568089; 6/13/2007 email from sales, “CDO protection,” GS MBS-E-012445931 See also 9/7/2007 Fixed Income, Currency and Commodities Annual Individual Review Book, Salem 2007 SelfReview, GS-PSI-03157 at 71 (in his self-evaluation Mr Salem wrote that his desk sold short positions on single name CDS contracts only to customers that could provide Goldman with useful information: “We were very aggressive with pricing and only shared risk [short positions] with smart guys if they gave us insight on names to go short or go long in return.”) 2813 3/2/2007 email exchange between Mr Broderick and Patrick Welch, GS MBS-E-009986805, Hearing Exhibit 4/27-63 2814 9/26/2007 EMD Reviews, Joshua Birnbaum Self-Review, GS-PSI-01975, Hearing Exhibit 4/27-55c Mr Birnbaum’s comments indicate that Goldman’s proprietary activities extended to its CDO activities As explained earlier, while Abacus 2007-AC1 was undertaken in response to a client request, Hudson was conceived by the Mortgage Department as a way to transfer risk associated with poorly performing ABX assets in its inventory Goldman supplied 100% of the CDS contracts that made up Hudson’s assets, took 100% of the short side, and profited at the expense of the Hudson investors In October 2006, Mr Ostrem, head of the CDO Origination Desk, wrote to Mr Sparks that a client was upset, because it knew “Hudson Mezz (GS prop deal) is pushing their deal back,” clearly identifying Hudson as a “prop” or proprietary transaction 10/16/2006 email from Mr Ostrem to Mr Sparks, GS MBS-E-010916991, Hearing Exhibit 4/27-59 See also 2/25/2007 email exchange between Peter Ostrem and Matthew Bieber, at GS MBS-E-001996601, Hearing Exhibit 4/27-95 (Mr Ostrem proposed allowing a hedge fund to include assets in Anderson and then short them, but Mr Bieber thought Mr Sparks would want to “preserve that ability for Goldman”); 12/29/2006 email from Mr Birnbaum to Mr Lehman, GS MBSE-011360438, Hearing Exhibit 4/27-5 (when discussing certain proposed CDO deals that would generate $1 to $3 billion in short positions and reference certain RMBS securities, Mr Birnbaum stated: “On baa3 [RMBS securities with credit ratings of BBB-], I’d say we definitely keep it for ourselves On baa2 [RMBS securities with BB ratings], I’m open to some sharing to the extent that it keeps these customers engaged with us.”) 2815 10/3/2007 “SPG Trading B 2007,” presentation prepared by Joshua Birnbaum with input from other SPG employees, but which was not ultimately provided to senior management, GS MBS-E-015654036, at 44 [emphasis in original] Mr Birnbaum reaffirmed his analysis in a 2010 written response to Subcommittee questions See Mr Birnbaum’s response to Subcommittee QFR at PSI_QFR_GS0509 2816 9/7/2007 Fixed Income, Currency and Commodities Annual Individual Review Book, Salem 2007 Self-Review, GS-PSI-03157, at 71 2817 3/26/2007 Presentation to Goldman Board of Directors, “Subprime Mortgage Business,” GS MBS-E-005565527, Hearing Exhibit 4/27-22 2818 9/17/2007 Board of Directors Meeting Financial Summary, GS MBS-E-009776907, Hearing Exhibit 4/27-42 2819 3/9/2007 email from Sheara Fredman to David Viniar and others, GS MBS-E-009762678, Hearing Exhibit 4/27-16 When preparing a later internal presentation, in October 2007, Dan Sparks was even more blunt: “The desk benefitted from a proprietary short position in CDO and RMBS single names.” 10/5/2007 draft of “Business Unit Townhall Presentation, Q3 2007,” prepared by Mr Sparks, Hearing Exhibit 4/27-47 Mr Sparks removed this phrase from the final version of the presentation and told the Subcommittee he had been mistaken to include it in the earlier draft 2820 10/4/2007 letter from Goldman to the SEC, GS MBS-E-009758287, Hearing Exhibit 4/27-46 2821 10/29/2007 presentation by Craig Broderick to the Tax Department, GS MBS-E-010018512, Hearing Exhibit 4/27-48 See also 10/5/2007 draft presentation by Mr Sparks, for a Business Unit Townhall meeting, GS MBS-E- 013703468, Hearing Exhibit 4/27-47 (“The desk benefited from a proprietary short position in CDO and RMBS single names.”) 2822 11/18/2007 email from Mr Blankfein, “NYT,” GS MBS-E-009696333, Hearing Exhibit 4/27-52 2823 1/2011 “Study & Recommendations on Prohibitions on Proprietary Trading & Certain Relationships with Hedge Funds & Private Equity Funds,” at 22-44 2824 8/10/2007 email from Mr Ostrem to Mr Sparks, “Leh CDO Fund,” GS MBS-E-010898470 2825 Id 2826 8/10/2007 email from Mr Sparks to Mr Ostrem, “Leh CDO Fund,” GS MBS-E-010898476 2827 Subcommittee interview of Daniel Sparks (10/4/2010) 2828 3/3/2007 email from Mr Salem, “Another idea ,” GS MBS-E-012511081 2829 Id 2830 Id 2831 6/7/2007 email from Mr Swenson to Mr Salem, “Fyi,” GS MBS-E-012444245 2832 Id 2833 7/12/2007 email from Mr Birnbaum, GS MBS-E-012944742, Hearing Exhibit 4/27-146 (“He’s definitely the man in this space, up 23 bil on this trade We were giving him a run for his money for a while but now are a definitive #2.”) 2834 See slides prepared by Mr Birnbaum, “SPG Trading B 2007,” GS MBS-E-015654036 -50 2835 Mr Birnbaum response to Subcommittee QFR at PSI_QFR_GS0509 2836 Mr Birnbaum, for example, received $17 million in 2007 Subcommittee interview of Joshua Birnbaum (4/22/2010) 2837 Two of the largest U.S investment banks, Goldman Sachs and Morgan Stanley, are currently structured as bank holding companies and so are subject to the ban on proprietary trading 2838 Section 619 of the Dodd-Frank Act (creating a new §13(a) in the Banking Holding Company Act of 1956) 2839 Id at §13(d)(1) 2840 Id at §13(d)(2) 2841 Id at §13(d)(1)(G) and (I); (d)(4); and (f) 2842 Id See section discussing Deutsche Bank, above 2843 Id See, e.g., 6/12/2010 Cambridge Winter Center report, “Test Case on the Charles,” (explaining how State Street Bank bailed out the funds it managed, but then itself needed several emergency taxpayer-backed programs) 2844 “Lesson Not Learned: On Redesigning Our Current Financial System,” GMO Newsletter Special Topic, at (10/2009), available at http://www.scribd.com/doc/21682547/Jeremy-Grantham 2845 Section 621 of the Dodd-Frank Act (creating a new § 27B(a) in the Securities Act of 1933) 2846 Id at § 621 2847 Section 717 and Title IX of the Dodd-Frank Act 2848 “Interagency Statement on Sound Practices Concerning Complex Structured Finance Activities,” 69 Fed Reg 97 (5/19/2004) 2849 “Interagency Statement on Sound Practices Concerning Elevated Risk Complex Structured Finance Activities,” 72 Fed Reg (1/11/2007) (issued by the Office of the Comptroller of the Currency; Office of Thrift Supervision; Federal Reserve System; Federal Deposit Insurance Corporation; and Securities and Exchange Commission) ... Street and The Financial Crisis: Anatomy of a Financial Collapse April 13, 2011 In the fall of 2008, America suffered a devastating economic collapse Once valuable securities lost most or all of their... to the financial crisis, using as a case study Washington Mutual Bank (WaMu) At the time of its failure, WaMu was the nation s largest thrift and sixth largest bank, with $300 billion in assets,... failures that set the stage for those losses were a proximate cause of the financial crisis (3) Inflated Credit Ratings: Case Study of Moody s and Standard & Poor s The next chapter examines