Goldman Sachs (GS) misled clients and Congress about the firm's investments in securities tied to real estate deals, according to a two-year investigation of the financial crisis, says Sen. Carl Levin [D-Mich.], chairman of the Senate panel that led the investigation.

The Senator says he wants the Justice Department and the Securities and Exchange Commission to examine whether Goldman Sachs violated the law by misleading clients who bought collateralized debt obligations without knowing the firm was betting they would fall in value.  

And Sen. Levin wants federal prosecutors to review whether to bring perjury charges against Goldman Sachs chief executive Lloyd Blankfein as well as other current and former employees who testified in Congress last year.

Last April, Goldman's CEO Blankfein denied under oath before the Senate panel that the firm had what the firm itself called a "big short" against the housing market in documents the Senate had collected from the firm. 

In April 2010, CEO Blankfein testified: "Much has been said about the supposedly massive short Goldman Sachs had on the U.S. housing market. The fact is we were not consistently or significantly net 'short the market' in residential mortgage-related products in 2007 and 2008..We didn't have a massive short against the housing market and we certainly did not bet against our clients."

Potential perjury charges may also zero in on testimony given by a Goldman Sachs executive before the Senate Permanent Subcommittee on Investigations about an asset-backed securities deal dubbed “Timberwolf,” people close to the matter say.

A probe could also lead to testimony from former top Goldman Sachs executive Thomas Montag, now president of global banking and markets at Bank of America Merrill Lynch (BAC), and other Goldman executives, regarding email correspondence, sources indicate.

The Department of Justice did not return calls for comment, and the SEC declined comment. A source close to the matter at Bank of America says Montag was never interviewed by the Senate panel. 

“Our testimony was truthful and accurate, and that applies to all of our testimony,” says Goldman Sachs spokesman Michael DuVally.

DuVally also emailed this statement: “While we disagree with many of the conclusions of the report, we take seriously the issues explored by the Subcommittee. We recently issued the results of a comprehensive examination of our business standards and practices and committed to making significant changes that will strengthen relationships with clients, improve transparency and disclosure and enhance standards for the review, approval and suitability of complex instruments.”

And Goldman’s DuVally emailed this statement about the allegedly misleading testimony:

“The testimony we gave was truthful and accurate and this is confirmed by the Subcommittee's own report. The report references testimony from Goldman Sachs witnesses who repeatedly and consistently acknowledged that we were intermittently net short during 2007. We did not have a massive net short position because our short positions were largely offset by our long positions, and our financial results clearly demonstrate this point.”

Zeroing in on the Timberwolf Deal

Last April, Sen. Levin questioned Daniel Sparks, the Goldman executive who ran Goldman Sachs’s mortgage business at the time, on whether Goldman Sachs was misleading clients into buying investments its executives knew were steadily dropping into junk territory.

Sen. Levin pointed out an e-mail exchange Montag sent to Sparks on the Timberwolf deal, a $1 billion collateralized debt obligation.

“'Boy that Timberwolf was one sh---- deal,' Levin quoted from Montag’s 2007 email. "How much of that sh---- deal did you sell?"

A source close to the matter at Bank of America says: "Tom was just referring to the deal being bad for Goldman, because it was losing money from the time it launched the deal. The market imploded, clients and Goldman were losing money on it. It actually could have been very good for a client to buy at a deal value much lower than launched." (Note: A source contacted FBN after this story ran to indicate Montag was referring only to the firm losing money in his email, not Goldman's clients.)

During the Senate's April hearing, Senator Jon Tester [D-Mont.] noted other testimony that, in 2007, Goldman could “see some things happening,” and that Goldman itself was betting against the mortgage market.

Senator Tester asked Goldman’s Sparks, in light of those developments, “how [he] got comfortable with sales,” and how he “in good faith” sold the CDO securities to Goldman’s customers – how he could “sell them out and collect the fees and make the dough?”

Senator Tester and Sparks then had the following exchange:

Senator Tester: Every one of these [CDOs] were – it looks like a wreck waiting to happen because they were all downgraded to junk in very short order.

Sparks: Well, Senator, at the time we did those deals, we expected those deals to perform.

Senator Tester: Perform in what way?

Sparks: To not be downgraded–

Senator Tester: Perform to go to junk, so that the shorts made out?

Sparks: To not be downgraded to junk in that short a time frame. In fact, to not be downgraded to junk. ...

Senator Tester: Do you feel confident that the information about each one of these [CDOs]... was given to the investors, all of the information that was out there, and the credit rating agencies too?

Sparks: Well, I generally feel that the disclosure for the new issues that Goldman Sachs brought was good."

However, while Sparks testified that, in 2007, the Mortgage Department expected its CDOs “to perform,” a "contemporaneous draft presentation that he allegedly helped prepare in May 2007 stated that the 'desk expects [the CDOs] to underperform,'” the Senate report says.

Other emails allegedly provide Sparks’ negative views of the CDO market at the time, including emails in which Sparks allegedly described the subprime market as “bad and getting worse,” and allegedly directed Goldman’s mortgage traders to “get out of everything,” and “stay on the short side,” the Senate report charges.

Sparks allegedly wrote in emails, among other things: “Game over,” “bad news everywhere,” and “the business is totally dead,” the Senate report says.

And many of Sparks’s dire predictions were made before three of the four CDOs discussed at the hearing were even offered to customers, the Senate report says.

Sparks also testified that the Mortgage Department did not expect the Goldman-issued CDOs to be downgraded, even though all were within a year of issuance.

Ultimately, all of the CDOs discussed at the Subcommittee’s hearing were downgraded to junk status.

Timberwolf Deal Plunges in Value

Within five months of Timberwolf’s debut, the Triple-A rated CDO had lost almost 80% of its value, and it was liquidated in 2008, according to the panel’s report.

The CDO had Goldman’s clients making optimistic bets on its performance of CDOs, with Goldman buying derivatives that took the pessimistic side, as the subcommittee’s report indicates Goldman routinely did.

According to the Senate report, Goldman’s Timberwolf deal allegedly relied on “CDO assets that began to fall in value almost as soon as the Timberwolf securities were issued,” yet Goldman “solicited clients to buy the securities.”

The report alleges Timberwolf “contained or referenced CDO assets with more than 4,500 unique mortgage related securities, but Goldman offered potential investors little help in understanding those securities, and targeted clients with limited or no experience in CDO investments.”

The report charges: “When marketing Timberwolf, Goldman withheld its internal marks showing the securities losing value and did not mention its short position.”

Inflated Assets

Top Goldman executives allegedly knew the firm “was selling poor quality assets at inflated prices,” but because of its short position, “Goldman profited at the expense of the clients to whom it sold the Timberwolf securities,” the Senate report alleges.

Overall, Goldman lost money on the deal because Goldman was forced to keep many of the unsold Timberwolf securities on its books, the report says.

Specifically, Goldman had taken a short position on about 36% of the $1 billion in assets underlying the Timberwolf CDO and made money from that investment, but ultimately lost money when it could not sell all of the Timberwolf securities, the report says.

Goldman was the CDO’s placement agent, initial purchaser, collateral put provider, and liquidation agent.

It also hired a hedge fund with former Goldman employees, Greywolf Capital Management, to act as the collateral manager. Greywolf selected the CDO’s assets, with Goldman’s approval.

Montag Weighs In

As Timberwolf’s securities rapidly began losing value, almost as soon as they were purchased, in February 2007, Goldman’s Sparks told  Thomas Montag, then a top executive with Goldman, that Timberwolf was one of two deals “to worry about,” according to Senate disclosures.

Specifically, on February 26, 2007, Montag asked Sparks about two CDO-squared transactions being assembled by the CDO Origination Desk, Timberwolf and Point Pleasant, the report says. Sparks allegedly expressed his concern about both. According to Senate disclosures: 

Montag: “cdo squared–how big and how dangerous.”

Sparks: “Roughly 2bb, and they are the deals to worry about.”

But Goldman rushed Timberwolf to market, and it closed on March 27, 2007, approximately six weeks ahead of schedule, according to the Senate report.

However, “despite doubts about its performance and asset quality, Goldman engaged in an aggressive campaign to sell the Timberwolf securities," the report alleges.

As part of its tactics, a Goldman executive instructed Goldman personnel not to provide written information to investors about how Goldman was valuing or pricing the Timberwolf securities, and its sales force offered no additional assistance to potential investors trying to evaluate the 4,500 underlying assets, the Senate report charges.

Even so, Sparks and another Goldman executive put the full court press on, sending out numerous sales directives to the Goldman sales force, stressing that Timberwolf was a priority for the firm, the Senate report alleges.

But behind the scenes, Goldman was internally lowering the value of Timberwolf, the Senate report charges. And Goldman continued to sell the securities at a much higher price than the company knew it was worth.

Targets "Non-Traditional" Buyers

Goldman also began targeting Timberwolf sales to “non-traditional” buyers and those with little CDO familiarity, such as increasing its marketing efforts in Europe and Asia, the Senate report charges.

On June 18, 2007, Goldman sold $100 million worth of Timberwolf securities to an Australian hedge fund, Basis Capital, the report says.

But just 16 days later, on July 4, Goldman informed Basis Capital that the securities had lost value, and it had to post additional cash collateral to secure its CDS contract, the Senate report says.

On July 12, 2007, Goldman told Basis Capital that the value had dropped again, and still more collateral needed to be posted, the Senate report alleges.

In less than a month, the value of Timberwolf had fallen by $37.5 million. Basis Capital posted the additional capital, but soon after declared bankruptcy. Basis Capital is now suing Goldman Sachs.

Before the Basis sales, on June 1, 2007, Goldman Sachs had sold $36 million in Timberwolf securities to a Korean life insurance company, Hungkuk Life, that had little familiarity with the product, the Senate report says.

The head of the Korean sales office said his office was willing to sell the company additional securities, if assured the office would receive a 7% sales credit.

Goldman agreed, and said “get ‘er done,” the Senate report says.

The sales office sold another $56 million in Timberwolf securities to the life insurance company which paid $76 per share when Goldman’s internal value for the security was $65, the Senate report alleges.

Within ten days of that sale, Montag, the senior Goldman executive, sent an email to the Mortgage Department head, Sparks, stating: “boy that timeberwof [Timberwolf] was one sh---- deal,” the Senate report says.

Despite that comment, Goldman continued to market Timberwolf securities to its clients, the Senate report alleges.

In the fall of 2007, a Goldman analyst provided executives with a price history for Timberwolf securities, the Senate report notes.

It showed that, in five months, Timberwolf securities had lost 80% of their value, falling from $94 in March to $15 in September, the Senate report says.

Upon receiving the pricing history, Goldman’s Timberwolf deal captain, Matthew Bieber, wrote that March 27 – the day Timberwolf issued its securities – was “a day that will live in infamy,” the Senate report says.

Bear Stearns Hedge Funds Collapse

Hastening the collapse of these CDOs’ values was the failure of two Bear Stearns hedge funds had also triggered a rapid decline in the value of subprime mortgage related assets held in CDOs like Timberwolf.

The creditors of the Bear Stearns hedge funds met with Bear Stearns management in an attempt to organize a “workout” solution to stabilize the funds, the Senate report says. 

Goldman and Bear Stearns agreed to an unwind in which Goldman bought back $300 million of two Triple-A CDO tranches of Goldman’s Timberwolf CDO, which the hedge funds had purchased two months earlier in April 2007.

Goldman paid Bear Stearns 96 and 90 cents on the dollar, respectively, for the two Timberwolf tranches, the Senate report says.

Unsuccessful Workout

But the attempt to organize a workout solution for the funds was ultimately unsuccessful, the Senate report notes.

“Large blocks of subprime assets from the Bear Stearns hedge funds’ inventory began flooding the market, further depressing subprime asset values,” the Senate report says.

The Bear Stearns hedge funds failed in mid-June, subprime assets plummeted in value, and Goldman established what firm executives internally called its "big short" by the end of the month, the Senate report notes.

Goldman's Net Short

After its net short was in place, Goldman’s Mortgage Department began rapidly marking down the value of its residential mortgage-backed securities and its CDO assets, the Senate report says.

That had the dual effect of raising the value of Goldman’s net short position, while cutting the value of many of its customers’ holdings, the Senate report alleges.

Goldman Takes a Battle Axe

Goldman took a battle axe to these assets, cutting a broad and deep swath through its clients’ positions by month’s end in June, July and August 2007, due to plummeting ratings downgrades.
When one of the markdowns took effect on July 25, 2007, which Sparks called “the CDO monster remark,” Senate disclosures show.

In an email to a Goldman executive, Sparks wrote: “We made massive mark adjustments this week, pushed them through because of basis and counterparty exposure.”

In a separate email to Montag, Sparks made clear that by “basis,” he meant Basis Capital, the Australian hedge fund that had financed the purchase of Timberwolf.

AIG, Morgan Stanley and Deutsche Bank Get Angry

However, the CDO markdown drew an immediate negative reaction from Goldman’s customers, Senate disclosure show.

A July 31, 2007, internal report was sent to a dozen Goldman senior executives and Mortgage Department personnel regarding pending “mortgage derivative collateral disputes,” meaning customers who were disputing the lower valuations and resulting cash margin and collateral calls, the Senate disclosures indicate.

The email identified the “10 largest disputes,” listing AIG Financial Products, Morgan Stanley, and Deutsche Bank, among others, Senate disclosures show.

The email stated: “The overall derivative collateral dispute amount is now $7.0 billion.”

The email also noted that the total in dispute from the prior week had been $3 billion, which suggests that the July 25 markdowns had caused the amount in dispute to more than double in a week, the Senate report indicates.

Montag immediately forwarded the report to Goldman’s CEO Blankfein: “7 billion of collateral disputes!!!” (sic).

Blankfein responded: “Make sure they prioritize weaker credits where our risk is threatening,” Senate disclosures indicate.

In other words, Blankfein directed Goldman personnel to focus on disputes with clients that had the weakest credit, and might have fewer resources to pay the amounts owed to Goldman as a result of the downward marks, the Senate report indicates.

The same markdowns causing losses for those clients were simultaneously increasing the profitability of Goldman’s net short, the Senate report says.

Goldman's Losses

Goldman’s 36% short position in Timberwolf produced about $330 million in revenues “at the direct expense of the clients to whom Goldman had sold the Timberwolf securities,” the Senate report says.

Goldman also made $3 million in interest while the Timberwolf assets were in Goldman’s warehouse account, the report says.

But because Goldman was unable to sell about a third of the Timberwolf securities, it had to keep the unsold securities on its books, the report says. So it ended up losing $562 million from them, the report says.

Goldman also lost $226 million from the decline in the value of the collateral securities securing the CDO, the report says.

When offset by the profits from its Timberwolf short, Goldman ended up with a total loss of about $455 million, the report says.

Timberwolf’s investors lost virtually their entire investments, the report says.

Elizabeth MacDonald joined FOX Business Network (FBN) as stocks editor in September 2007 and is the author of Skirting Heresy: The Life and Times of Margery Kempe (Franciscan Media, June 2014).
Follow Elizabeth MacDonald on Twitter @LizMacDonaldFOX.