The Great Exposure: What we've learnt from Goldman Sachs

Stephen Foley looks back on an extraordinary week in which the bank we all love to hate was forced to reveal its darkest secrets
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The Independent Online

The protesters who stood behind Goldman Sachs traders as they testified before Congress this week were dressed in prison garb. It wasn't a subtle message. They want to see Wall Street executives behind bars.

On the heels of civil fraud charges laid against Goldman by regulators this month comes word that a criminal investigation is also under way into the bank's mortgage-trading activities, so no one at the bank can be sure that the protesters won't have satisfaction. Lloyd Blankfein, Goldman's chief executive, went blue in the face months ago protesting the bank's innocence. This week his face went all the way through purple and beyond.

But if there is one thing that Tuesday's hearing made plain, it's that Wall Street talks a different language to the rest of us. This week we all got to go inside Goldman Sachs, to examine the ticking timebombs at the heart of the credit crisis, and to get close and personal with traders who threw our mortgages around like they were poker chips. There was a little exegesis, a little catharsis. But at the end of it all, what exactly have we learnt?

We know what Fabulous Fab looks like

Of course, the assembled crowd was very interested in the causes of the credit crisis and the consequences for financial reform, but didn't you think that Fabrice Tourre was a bit of a hottie? Grown his hair a little, thought Bess Levin of the Wall Street blog Dealbreaker.com. The New York Post's Jeane MacIntosh gushed over the "slick act" of "the smooth-talking bad-boy trader who played Goldman Sachs investors for fools while simultaneously romancing two French paramours".

It was the public debut of the 31-year-old millionaire trader who, two weeks ago, became the first Goldman employee to be charged with fraud, and whose innermost thoughts were made embarrassingly public, making him a household name before anyone could put a face to it.

In a seductive French accent, he told lawmakers he regretted those emails to his two girlfriends, in which he interspersed declarations of love with jokes about selling Goldman's most dangerous investments to "widows and orphans".

We've learnt that there was a lot of effluent floating around...

You aren't supposed to hear the word "shitty" on daytime television in the US, but Carl Levin, the senator in charge of Tuesday's hearings, turned the airwaves blue.

Long before the outside world had cottoned on, you see, Goldman's traders held the subprime mortgage market in bad odour, and they weren't shy in saying so. Loans from the worst mortgage firms formed "crap pools", in the phrase of one email. This, Senator Levin said, did not discourage Goldman from dipping into these pools to create mortgage derivatives for sale to clients. Quite the opposite. It made the traders determined to get the smelliest out the door and as far away from the bank as possible. "Boy, that Timberwolf was one shitty deal," one executive wrote of one such derivative. It took Goldman a long time to find someone to buy Timberwolf; but they got there in the end.

You knew it was a shitty deal, Senator Levin pressed his witnesses, and you sold it anyway. More than a dozen times he pressed. He didn't really want an answer; he just knew the power of repetition. As memories of this week's hearings fade, you'll remember this: Goldman gives you a shitty deal.

...and that a lot of effort went into hiding the effluent

The vast Wall Street market for parcels of mortgages (and parcels of those parcels, and parcels of those...) required finding new and ingenious ways to pretend that the quality was not, in fact, collapsing. We've been familiar for a while with crazy innovations like "stated income" loans, given to people who just stated their income, on the promise that no one would ask if they were lying.

To this we can now add the idea of "thin files", a description of borrowers whose strong credit score was illusory. They had a high score only because they had taken out hardly any loans before.

And then there's "barbelling". Bundle a bunch of mortgages from people with low credit scores together with mortgages from people with high scores – like two ends of a barbell – and the average looks good enough, but in reality you have been able to offload some of your most toxic loans. Neat, eh?

If you don't understand this stuff, don't worry, neither do the senators

Time and again, the august members of the Permanent Subcommittee on Investigations revealed that they haven't mastered the arcana they purport to be investigating. When John McCain muddled the firms hired to assemble mortgage pools with the credit-rating agencies hired to rate them, you could dismiss it as a senior moment.

When Jon Tester appeared uninterested in the distinction between the housing market (people buying and selling houses on your street) and the mortgage market (traders buying and selling mortgages on Wall Street), the Goldmanites looked exasperated.

If you're a senator who doesn't understand this stuff, don't worry, neither do the boys at Goldman

Under other circumstances it might have been a rather charming admission. David Viniar, the Goldman executive who appeared on Tuesday's second panel, directly after Fab and his fellows, was asked how well he comprehended the products traded by the mortgage division. Only "at the highest levels", he said. "You had the experts on this morning." Mr Viniar is Goldman's chief financial officer, the bank's main numbers guy.

And as for the "experts"? Well, Mr Tourre had quite the admission in a private email he sent while surveying the crumbling mortgage scene in 2007: "The only potential survivor the fabulous Fab... standing in the middle of all these complex, highly levered, exotic trades he created without necessarily understanding all the implications of those monstrosities !!!"

One thing above all: that Goldman people did nothing wrong

The hearing wrapped up at 8.45pm without a single "sorry" or expression of regret or admission of wrongdoing having been uttered.

The bank is just a humble market maker, Mr Blankfein said, bringing together buyers and sellers, people who want to bet on things going up and people who want to bet on things going down. It does not "bet against its clients".

On Goldman's telling, the people who have it wrong are the folk of the Securities & Exchange Commission. Those fraud charges were not just misguided, they were cruel, don't you know? "The last week has been challenging for me and my family," Mr Tourre complained, "as I have been the target of unfounded attacks on my character and motives".

Indeed, it would have been impossible for Goldmanites to have been doing anything unethical, because they live by "14 Business Principles" of which No 14 is "integrity and honesty are at the heart of our business", and every employee gets a "360-degree performance review" from his bosses, peers and staff. Josh Birnbaum told senators: "If you weren't cognisant of ethics, you would not get paid and you would probably get fired."

In fact, they were brilliant.

That Abacus deal, the one for which Mr Tourre and Goldman are charged with fraud, was not "designed to fail", as the regulator alleges. It did not fail

Abacus was an investment vehicle created to behave like a bundle of mortgage derivatives, and it behaved exactly like a bundle of mortgage derivatives: it collapsed to zero in a few short months, leaving buyers with $1bn (£650m) in losses. Goldman's other client – the hedge-fund manager for whom Abacus was created so he could bet against it – made $1bn. A straight-faced Mr Blankfein called it a success. He really did.

And we got to hear from the traders themselves, thanks to those 360-degree performance reviews (aka, the annual bonus negotiation). You really have to sell yourself hard to get a mega-bonus, it seems.

Michael "Swenny" Swenson called 2007 the year he was "most proud of"; he and his colleague Joshua Birnbaum both boasted of inventing ingenious early bets against the mortgage market by which Goldman made billions. Neither of them sounds like a humble market maker; Mr Swenson doesn't mention working on behalf of clients once.

That you can do anything to your clients as long as they are "sophisticated"

It is the Wall Street "get out of jail free" card, and Goldman played it again and again. Its clients are "sophisticated investors", often "highly sophisticated". Those banks that lost money on Abacus? "Two of the most sophisticated institutional investors in these products anywhere in the world." In other words, if we were selling them a dog, they really ought to have known it was a dog.

The most important three letters at Goldman are LDL

As in, let's discuss live. It hadn't seemed to have occurred to anyone at Goldman that it might have been wrong for them to release all of Mr Tourre's intimate emails last weekend. They came out in the bank's dossier of evidence claiming it never bet against clients or against the mortgage market as a whole.

It is ingrained in Goldman employees from day one that nothing sensitive should be put in emails. Anyone who breaks the rule can expect to pay the price. As for what sensitive discussions might have been going on away from future lawmakers' subpoena power, one can only guess, but senators pointed out that Goldmanites all-too-frequently signed off their emails with LDL.

As if the bank needed any more conspiracy theories, chief financial officer David Viniar caused a gasp when he was asked how he felt that traders had been selling something they described in an internal email as a "shitty" investment. He said: "I think that is unfortunate to have in an email." He later apologised, saying he didn't mean to imply he was only upset that the trader had written it down.

Even Las Vegas wants to disassociate itself from Goldman

"I'd like to avoid the betting analogy," Dan Sparks said, after yet another senator compared the antics of his mortgage trading business to a casino – and he wasn't the only one.

John Ensign, Nevada's representative, jumped in to defend his state's gambling capital against the slur. "In Las Vegas, people know that the odds are against them," he thundered. "On Wall Street, they manipulate the odds while you are playing the game."

By the end of the week, though, the gambling industry had turned the tables. Via Intrade, the online gambling site, punters can place a spread bet on the chances of Mr Blankfein being out of a job by December. When he exited the hearing room on Tuesday, Intrade put his survival at 50:50. By yesterday, as the bruises faded, his chances were up to almost 70 per cent. After as gruelling a week as this one, that is a silver lining for the Goldman boss. But of course, Mr Blankfein knows better than anyone else that the market does not always get it right.

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