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Goldman’s brass had a hand in mortgages

Bank profited on rise, fall of housing

By Louise Story
New York Times / April 19, 2010

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NEW YORK — Tensions were rising inside Goldman Sachs.

It was late 2006, and an argument had broken out inside the Wall Street bank’s prized mortgage unit — a dispute that would eventually reach the executive suite.

One camp was insisting the housing market was safe. Another thought it was poised for collapse.

Among those who saw disaster looming were an effusive young Frenchman, Fabrice P. Tourre, and his quiet colleague, Jonathan M. Egol, the mastermind behind mortgage deals known as the Abacus investments.

Their elite mortgage unit is now at the center of allegations that Goldman and Tourre, 31, defrauded investors with one of those complex deals.

The Securities and Exchange Commission filed a civil suit Friday that essentially says Goldman built the financial equivalent of a time bomb and then sold it to unwitting investors. Egol, 40, was not named in the suit.

Goldman has vowed to fight. But the allegations have left many wondering how far the investigation might spread.

Pressure on Goldman mounted yesterday as two members of Congress and Gordon Brown, Britain’s prime minister, called for investigations into the bank’s role in the mortgage market. Germany also said it was considering legal action against the bank.

According to interviews with eight former Goldman employees, senior bank executives played a pivotal role in overseeing the mortgage unit just as the housing market began to go south. These people spoke on the condition that they not be named so as not to jeopardize business relationships or to anger executives at Goldman, viewed as the most powerful bank on Wall Street.

According to these people, executives up to and including Lloyd C. Blankfein, the chairman and chief executive, took an active role in overseeing the mortgage unit. It was Goldman’s top leadership, these people say, that ended the dispute on the mortgage desk by siding with those who, like Tourre and Egol, believed home prices would decline.

Lucas van Praag, a Goldman spokesman, said senior executives were not involved in approving the Abacus deals. He said the executives had sought to balance Goldman’s positive bets on the mortgage market, rather than take an overall negative view.

Tourre declined to comment, as did Egol.

Mortgage specialists were, in a sense, the mad scientists of the subprime era. They devised investments by bundling together bonds backed by home loans, which enabled mortgage lenders to make even more loans.

By early 2007, Goldman’s mortgage unit had become a hive of intense activity. In addition to Blankfein, Gary D. Cohn, Goldman’s president, and David A. Viniar, the chief financial officer, visited the mortgage unit frequently.

The decision to get rid of positive bets on mortgages turned out to be prescient. Unlike most other Wall Street banks, Goldman profited from its mortgage business as the housing bubble was inflating and then again when the bubble burst.

As recently as 2007, Goldman’s mortgage division was split into 11 subgroups, each with a specialty, according to an internal Goldman document.

One group, for instance, handled actual home loans. Another provided mortgage advice. A third syndicated loans. Another handled commercial real estate.

Goldman in 2006 alone underwrote $26 billion of bundled mortgage securities known as collateralized debt obligations, according to Dealogic, a financial data provider. Many CDOs have turned out to be bad investments.

But in 2006, some at Goldman began to worry about housing. Daniel L. Sparks, the Texan who ran the mortgage unit, sided with those who believed the market was safe. Two of his traders, Joshua S. Birnbaum and Michael J. Swenson, had placed a big bet that mortgage bonds would rise in value. But this camp clashed with Goldman sales staff working with hedge funds that wanted to bet against subprime mortgages.

Birnbaum told the team to stop promoting bets against some mortgage investments since such trades were hurting the market and Goldman’s own position, according to two former Goldman employees.

But a few desks away, Tourre and Egol were quietly working on the Abacus deals.

Their Abacus deals included insurance-like protection that would pay out if certain mortgage bonds soured. Such credit-default swaps were not worth much in 2005, when housing was flying high, but became highly valuable once the market sputtered. “Egol and Fabrice were way ahead of their time,’’ said one of the former Goldman workers. “They saw the writing on the wall in this market as early as 2005.’’

Tourre and Egol created a way for a prominent hedge fund manager, John A. Paulson, to bet against risky mortgages.

With Paulson’s help, Goldman created an Abacus investment that, the SEC now says, was devised to fall apart. By betting against it, Paulson reaped $1 billion in profit, according to the SEC. Paulson was not named in the SEC complaint.

Goldman’s top ranks changed its stance on housing in December 2006. Viniar and Cohn gathered about 10 executives for a briefing. Sparks, the head of the mortgage unit, walked them through the numbers. The group was unanimous: Goldman had to reduce its exposure to the mortgage market.

A few months later, in February 2007, senior executives began turning up on the trading floor. The message, one former employee said, was clear: management was watching.

The executives told Sparks to tell his traders to sell Goldman’s positive bets on housing. The short positions — that is, negative bets, mostly used to hedge other investments — were placed in a central trading account.

Goldman turned over all these negative positions to Swenson and Birnbaum. Along with Sparks, they have been credited for managing the short position that yielded a $4 billion profit for Goldman in 2007. Sparks retired in 2008. Birnbaum also left in 2008, to start a hedge fund.

But former Goldman employees said those traders benefited from the short positions that were given to them. And their trading was tightly overseen by senior executives.