PART 14

Subcommittee that it would have been useful information, though it would have been more

concerned if the tranches it was purchasing were not fully subscribed.1483

(e) Gemstone Losses

Gemstone 7 closed on March 15, 2007, and received credit ratings from S&P and

Moody’s on the same day.1484 The top three tranches, representing 73% of the value of the

CDO, received AAA ratings. The next three tranches received investment grade ratings of AA,

A, and BBB.1485 The CDO received these ratings even though one third of its underlying assets

carried non-investment grade ratings.

Eight months later, in November 2007, five of its seven tranches were downgraded,

including one of its AAA rated tranches. By July 2008, all seven tranches had been downgraded

to junk status, and the Gemstone securities were nearly worthless. This chart, using S&P data,

displays the downgrades.1486

Gemstone VII Ratings by Tranche

Tranche Initial Rating: Date 1st Downgrade: Date 2nd Downgrade: Date 3rd Downgrade: Date

Class A-1a AAA: March 15, 2007 A+: Feb. 5, 2008 BB+: July 11, 2008 CC: August 19, 2009

Class A-1b AAA: March 15, 2007 B-: Feb. 5, 2008 CC: July 11, 2008 n/a

Class A-2 AAA: March 15, 2007 AA-: Nov. 21, 2007 CCC-: Feb. 5, 2008 CC: July 11, 2008

Class B AA: March 15, 2007 BBB: Nov. 21, 2007 CC: Feb. 5, 2008 n/a

Class C A: March 15, 2007 B-: Nov. 21, 2007 CC: Feb. 5, 2008 n/a

Class D BBB: March 15, 2007 CCC+: Nov. 21, 2007 CC: Feb. 5, 2008 n/a

Class E BB+: March 15, 2007 CCC: Nov. 21, 2007 CC: Feb. 5, 2008 n/a

Preference

Shares Not rated

Source: S&P

Investors contacted by the Subcommittee reported that they had lost all or most of their

investments. In June 2008, M&T Bank wrote down the value of its Gemstone 7 securities to

1482 Subcommittee interview of Kevin Jenks (10/13/2010).

1483 Subcommittee interview of M&T (9/20/2010). In addition, Standard Chartered reported that it didn’t know that

a portion of the CDO was unsold, and that it would have been information worth knowing but that it wouldn’t have

ultimately impacted its decision to invest in Gemstone 7. Subcommittee interview of counsel for Standard

Chartered (10/14/2010).

1484 3/15/2007 letter from S&P to Gemstone CDO VII Ltd, GEM7-00001658-61; 3/15/2007 letter from Moody’s to

Gemstone CDO VII Ltd., GEM7-00001657.

1485 Gemstone 7 ratings from S&P’s RatingsDirect on the Global Credit Portal,

https://www.globalcreditportal.com/ratingsdirect/Login.do, with subscription.

1486 Chart prepared by the Subcommittee using data from S&P’s RatingsDirect on the Global Credit Portal,

https://www.globalcreditportal.com/ratingsdirect/Login.do, with subscription.

372

about 2% of their original value – from $82 million to $1.87 million.1487 Wachovia Bank told

the Subcommittee that its $40 million investment in Gemstone paid out approximately $3 million

from 2007-2010, but is currently worth nothing.1488 Standard Chartered Bank told the

Subcommittee that, in 2008, it liquidated its Gemstone investment and received approximately

25-30% of its initial $224 million investment.1489 Commerzbank told the Subcommittee that its

initial $16 million investment in Gemstone is currently worth nothing.1490

(6) Other Deutsche Bank CDOs

Gemstone 7 was only one of many CDOs that Deutsche Bank assembled and underwrote

as the mortgage market deteriorated in 2007. From December 2006 through December 2007,

Deutsche Bank issued 15 new CDOs with assets totaling $11.5 billion.1491 The Subcommittee

did not examine these CDOs, but a brief discussion of a few shows that the bank’s issuance of

high risk mortgage related assets was not confined to Gemstone 7.

Magnetar CDOs. Magnetar is a Chicago based hedge fund that, according to press

reports, worked with several financial institutions to create CDOs with riskier assets and then bet

on those CDOs to fail.1492 Deutsche Bank underwrote one of those CDOs and served as trustee

for two other Magnetar CDOs.

According to press reports, Magnetar’s investment strategy was to purchase the riskiest

portion of a CDO – the equity – and, at the same time, to purchase short positions on other

tranches of the same CDO.1493 Thus, Magnetar would receive a large return on the equity if the

security did well, but would also receive a substantial payment from its short positions if the

securities lost value. This strategy was dubbed by some as the “Magnetar Trade.” It apparently

generated large profits for Magnetar. By the end of 2007, when the market was in turmoil,

Magnetar’s Constellation Fund was up 76% and its Capital Fund was up 26%.1494

Mr. Lippmann disapproved of the Magnetar CDOs.1495

1487 M&T Bank Corporation v. Gemstone CDO VII, (N.Y. Sup.), Complaint (June 16, 2008), DB_PSI_00000027-

79, at ¶ 52. For a list of customers and their allocations of Gemstone 7, see Gemstone VII Summary,

DB_PSI_00711305.

In August 2006, when an

investor asked Mr. Lippmann about Magnetar, he responded that it was a “Chicago based hedge

1488 11/19/2010, 11/23/2010 emails from counsel of Wachovia to Subcommittee staff.

1489 Subcommittee interview of counsel of Standard Chartered (11/23/2010).

1490 12/7/2010 email from counsel of Commerzbank to Subcommittee staff.

1491 ABS CDOs Issued by DBSI (between 2004 and 2008), PSI-Deutsche_Bank-02-0005-23.

1492 See, e.g., “The Magnetar Trade: How One Hedge Fund Helped Keep the Bubble Going,” ProPublica (4/9/2010),

http://www.propublica.org/article/the-magnetar-trade-how-one-hedge-fund-helped-keep-the-housing-bubble-going.

1493 Id.

1494 “Magnetar’s Exit: A Deal So Bad Even a Credit-Rating Agency Balked,” ProPublica (4/9/2010),

http://www.propublica.org/article/magnetars-exit-a-deal-so-bad-even-a-credit-rating-agency-balked.

1495 Subcommittee interview of Greg Lippmann (10/18/2010).

373

fund that is buying tons of cdo equity and shorting the single names .… [T]hey are buying equity

and shorting the single names … a bit devious.”1496

In May 2006, Magnetar created its first CDO, Orion 2006-1 Ltd, a $1.3 billion hybrid

CDO with cash and synthetic assets.1497 The CDO closed on May 26, 2006, and was

underwritten by Calyon and managed by NIBC Credit Management, Inc.1498 Deutsche Bank’s

Special Situations Group purchased equity in Orion, and helped create the CDO.1499 A Deutsche

Bank employee, Michael Henriques, who worked on Orion as managing director of the Special

Situations Group, left Deutsche Bank and ultimately went to work for Magnetar.1500

Although Orion received investment grade ratings from Fitch and Moody’s in June

2006,1501 a little over a year later, on August 21, 2007, Fitch issued the first of several rating

downgrades.1502 In November 2007, Moody’s downgraded the Class A notes six notches and the

Class B notes seven notches.1503 By May 2008, every class of Orion’s securities had been

downgraded to junk status.1504

START CDOs. Deutsche Bank also underwrote six START CDOs with a combined

value of $5.25 billion from June 2005 to December 2006.1505

1496 8/23/2006 email from Jeremy Coon at Passport Management to Greg Lippmann, DBSI_PSI_EMAIL01603121.

In another email, when asked how Magnetar distorted the market, Mr. Lippmann responded, “easy but lengthy

answer get him on the phone and call me.” 8/31/2006 email from Warren Dowd at Deutsche Bank to Greg

Lippmann, DBSI_PSI_EMAIL01641089.

In one of the deals, Deutsche Bank

worked with Elliot Advisors, a hedge fund that bought the equity tranche in the CDO and

1497 See Loreley Financing v. Credit Agricole Corporate and Investment Bank, (N.Y. Sup.), (10/29/2010). Orion

2006-1 is one of two Magnetar CDOs that are the subjects of this lawsuit filed by Loreley Financing, a Europeanbased

investment fund, and Crédit Agricole, a French bank. See also “Magnetar Deals at Center of New Lawsuit,”

ProPublica (10/25/2010), http://www.propublica.org/article/magnetar-deals-at-center-of-new-lawsuit.

1498 See Loreley Financing v. Credit Agricole Corporate and Investment Bank, (N.Y, Sup.), (10/29/2010) (alleging

Calyon permitted Magnetar to select poor assets for the two Magnetar CDOs and fraudulently induced investors to

purchase the securities).

1499 “Magnetar Gets Started,” ProPublica (4/9/2010), http://www.propublica.org/article/magnetar-gets-started;

Loreley Financing v. Credit Agricole Corporate and Investment Bank, (N.Y. Sup.), (10/29/2010).

1500 Loreley Financing v. Credit Agricole Corporate and Investment Bank, (N.Y. Sup.), (10/29/2010).

1501 “Fitch Rates Orion 2006-1, Ltd./LLC.,” BusinessWire (5/26/2006),

http://www.thefreelibrary.com/Fitch+Rates+Orion+2006-1,+Ltd.%2FLLC.-a0146274727; 6/9/2006 “$292.5

Million of Debt Securities Rated, $936 Million of Senior Credit Swap Risk Rated,” Moody’s,

http://v3.moodys.com/viewresearchdoc.aspx?docid=PR_109282.

1502 Fitch downgraded the CDO’s Class A notes from AAA to AA, the Class B notes from AA to A-, the Class C

notes from A to BB, and the Class D notes from BBB to B+. “Fitch Downgrades $289MM of Orion 2006-1, Ltd.,”

BusinessWire (8/21/2007), http://www.highbeam.com/doc/1G1-167859601.html.

1503 11/1/2007 “Moody’s takes neg action on Orion 2006-1,” Moody’s,

http://v3.moodys.com/viewresearchdoc.aspx?docid=PR_143474.

1504 10/28/2010 “Moody’s lowers ratings of 95 Notes issued by 56 structured finance CDO transactions,” Moody’s,

http://v3.moodys.com/viewresearchdoc.aspx?docid=PR_208444.

1505 They included Static Residential 2005-A for $1 billion; Static Residential 2005-B for $1 billion; Static

Residential 2005-C for $500 million; Static Residential 2006-A for $1 billion; Static Residential 2006-B for $1

billion; and Static Residential 2006-C for $750 million. Chart, ABS CDOs Issued by DBSI (between 2004 and

2008), PSI-Deutsche_Bank-02-0005-23.

374

simultaneously bought CDS protection against the entire structure, essentially shorting the deal

and betting that the value of its assets would fall.1506 On four of the deals, Deutsche Bank

worked with Paulson Advisors, a hedge fund that bought the equity tranche and apparently

shorted the rest of the CDO, while Deutsche Bank sold the rest of the securities.1507

“The $1 billion START 2005-B trade was backed by a static pool of CDS on mezzanine

RMBS for Paulson Advisors ($4 bln risk arb hedge fund). Paulson retained the bottom

6% of the trade and we sold the rest of the capital structure. Paulson, who came to us

with the strong desire to short the U.S. housing market, wrote CDS on underlying ABS

(over 100 names) to DB [Deutsche Bank] and DB intermediated them into the deal.”

An internal

Deutsche Bank email explained one of the 2005 START CDOs as follows:

1508

Mr. Lamont told the Subcommittee that Mr. Paulson shorted the START deals, and he

believed investors were aware of that fact. Mr. Lamont told the Subcommittee that Mr.

Lippmann also shorted all of the START CDOs, but Mr. Lippmann explained to the

Subcommittee that he did not short the CDOs directly, but instead shorted their underlying

assets. In an email discussing START with a Deutsche Bank colleague, Mr. Lippmann advised

him to buy protection for the bank against START. He wrote: “Start is crap you should short

because I bet we’ll have to… buyback cash ones next year.”1509

Mr. Lippmann told the Subcommittee that Deutsche Bank ended up losing a great deal of

money on the START deals. One Deutsche Bank employee wrote to Mr. Lippmann regarding

one of the deals in June 2007: “This along with our remaining held inventory if we can’t sell

away we repack into a CDO 2 balance sheet dump later this summer. Worst case we hold it but

it is probably the lesser of two evils (the greater evil being our held START position).”1510

(7) Analysis

Deutsche Bank was the fourth largest issuer of CDOs in the United States. It continued

to issue CDOs after mortgages began losing money at record rates, investor interest waned, and

its most senior CDO trader concluded that the mortgage market in general and the specific

RMBS securities being included in the bank’s own CDOs were going to lose value. Mr.

Lippmann derided specific RMBS securities and advised his clients to short them, at the same

time his desk was allowing the very same securities to be included or referenced in Gemstone 7,

a CDO that the bank was assembling for sale to its clients. In fact, the bank was selling some

assets that Mr. Lippmann believed contained “crap.” While the Gemstone CDO was constructed

and marketed by the bank’s CDO Desk, which is separate from the trading desk controlled by

Mr. Lippmann, both desks knew of Mr. Lippmann’s negative views. The bank managed to sell

$700 million in Gemstone 7 securities which then failed within months, leaving the bank’s

clients with worthless investments.

1506 Subcommittee interview of Michael Lamont (9/29/2010).

1507 Subcommittee interview of Greg Lippmann (10/18/2010).

1508 10/10/2005 email from Michael Raynes at Deutsche Bank to Greg Lippmann, DBSI_PSI_EMAIL00574452.

1509 12/14/2006 email from Greg Lippmann to Taranjit Sabharwal at Deutsche Bank, DBSI_PSI_EMAIL01895617.

1510 6/14/2007 email from Richard Kim at Deutsche Bank to Greg Lippmann, DBSI_PSI_EMAIL02202920.

375

This case history raises several concerns. The first is that Deutsche Bank allowed the

inclusion of Gemstone 7 assets which its most senior CDO trader was asked to review and saw

as likely to lose value. Second, the bank sold poor quality assets from its own inventory to the

CDO. Third, the bank aggressively marketed the CDO securities to clients despite the negative

views of its most senior CDO trader, falling values, and the deteriorating market. Fourth, the

bank failed to inform potential investors of Mr. Lippmann’s negative views of the underlying

assets and its inability to sell over a third of Gemstone’s securities. Each of these issues focuses

on the poor quality of the financial product that Deutsche Bank helped assemble and sell. Still

another concern raised by this case history is the fact that the bank made large proprietary

investments in the mortgage market that resulted in multi-billion-dollar losses – losses that, in

this instance, did not require taxpayer relief but, due to their size, could have caused material

damage to both U.S. investors and the U.S. economy.

376

“Wall Street and the Financial Crisis: The Role o 1511 f Investment Banks,” before the U.S. Senate Permanent

Subcommittee on Investigations, S.Hrg. 111-674 (4/27/2010) (hereinafter “April 27, 2010 Subcommittee Hearing”).

1512 See, e.g., Responses to Questions for the Record from Goldman Sachs, including Lloyd C. Blankfein; David A.

Viniar; Craig W. Broderick; Daniel L. Sparks; Michael J. Swenson; Joshua S. Birnbaum; and Fabrice P. Tourre,

PSI_QFR_GS0001-548 [Redacted]. Unredacted version maintained in the files of the Subcommittee [Sealed

Exhibit]. (Hereinafter referred to as “Response to Subcommittee QFR.”)

C. Failing to Manage Conflicts of Interest:

Case Study of Goldman Sachs

The Goldman Sachs case study shows how one investment bank profited from the

collapse of the mortgage market and engaged in troubling and sometimes abusive practices that

raise multiple conflict of interest concerns. The first part of this case study shows how Goldman

used structured finance products, including CDO, CDS, and ABX instruments, to take a

proprietary net short position against the subprime mortgage market. Reaching its peak at $13.9

billion, Goldman’s net short investments realized record gains for the Structured Products Group

in 2007 of over $3.7 billion which, when combined with other mortgage losses, resulted in

overall net revenues for Goldman’s Mortgage Department of $1.2 billion. The second half of the

case study shows how Goldman engaged in securitization practices that magnified risk in the

market by selling high risk, poor quality mortgage products to investors around the world. The

Hudson, Anderson, Timberwolf, and Abacus CDOs show how Goldman used these financial

instruments to transfer risk associated with its high risk assets, assist a favored client make a $1

billion gain, and profit at the direct expense of the clients that invested in the Goldman CDOs. In

addition, the case study shows how conflicts of interest related to proprietary investments led

Goldman to conceal its adverse financial interests from potential investors, sell investors poor

quality investments, and place its financial interests before those of its clients.

(1) Subcommittee Investigation and Findings of Fact

During the course of its investigation into the Goldman Sachs case study, the

Subcommittee issued 13 document subpoenas as well as multiple document request letters to

financial institutions, government agencies, hedge funds, due diligence firms, insurance

companies, individuals, and others. The Subcommittee obtained tens of millions of pages of

documents, including internal reports, memoranda, correspondence, spreadsheets, and email.

The Subcommittee conducted over 55 interviews and one deposition, including interviews with a

variety of senior executives and Mortgage Department personnel at Goldman Sachs. The

Subcommittee also spoke with agency officials, law enforcement, and industry and academic

experts in financial products and securities law. On April 27, 2010, the Subcommittee held a

hearing which took testimony from Goldman senior executives and current and former

employees of its Mortgage Department, and released 173 hearing exhibits.1511 After that hearing,

the Subcommittee gathered additional information in post-hearing interviews and through posthearing

questions for the record.1512

377

In connection with the hearing, the Subcommittee released a joint memorandum from

Chairman Levin and Ranking Member Coburn summarizing the investigation to date into the

role of the investment banks in the financial crisis. The memorandum contained the following

findings of fact, which this Report reaffirms, regarding the Goldman Sachs case study.

1. Securitizing High Risk Mortgages. From 2004 to 2007, in exchange for lucrative

fees, Goldman Sachs helped lenders like Long Beach, Fremont, and New Century,

securitize high risk, poor quality loans, obtain favorable credit ratings for the resulting

residential mortgage backed securities (RMBS), and sell the RMBS securities to

investors, pushing billions of dollars of risky mortgages into the financial system.

2. Magnifying Risk. Goldman Sachs magnified the impact of toxic mortgages on

financial markets by re-securitizing RMBS securities in collateralized debt obligations

(CDOs), referencing them in synthetic CDOs, selling the CDO securities to investors,

and using credit default swaps and index trading to profit from the failure of the same

RMBS and CDO securities it sold.

3. Shorting the Mortgage Market. As high risk mortgage delinquencies increased, and

RMBS and CDO securities began to lose value, Goldman Sachs took a net short

position on the mortgage market, remaining net short throughout 2007, and cashed in

very large short positions, generating billions of dollars in gain.

4. Conflict Between Client Interests and Proprietary Trading. In 2007, Goldman

Sachs went beyond its role as market maker for clients seeking to buy or sell

mortgage related securities, traded billions of dollars in mortgage related assets for the

benefit of the firm without disclosing its proprietary positions to clients, and

instructed its sales force to sell mortgage related assets, including high risk RMBS

and CDO securities that Goldman Sachs wanted to get off its books, and utilizing key

roles in CDO transactions to promote its own interests at the expense of investors,

creating a conflict between the firm’s proprietary interests and the interests of its

clients.

5. Abacus Transaction. Goldman Sachs structured, underwrote, and sold a synthetic

CDO called Abacus 2007-AC1, did not disclose to the Moody’s analyst overseeing

the rating of the CDO that a hedge fund client taking a short position in the CDO had

helped to select the referenced assets, and also did not disclose that fact to other

investors.

6. Using Naked Credit Default Swaps. Goldman Sachs used credit default swaps

(CDS) on assets it did not own to bet against the mortgage market through single

name and index CDS transactions, generating substantial revenues in the process.

378

The background information about Goldman in this section was taken f 1513 rom several sources. See “Profile,

Goldman Sachs,” Reuters.com; “Profile, The Goldman Sachs Group, Inc.,” Hoovers.com; 4/19/2010, “A Brief

History of Goldman Sachs – Timeline,” Wall Street Journal; 1/2010, “The Bank Job,” Vanity Fair (written with

cooperation of Goldman Sachs).

1514 During 2006 and 2007, Goldman’s headquarters were at 85 Broad Street in Manhattan. In 2010, the firm moved

its headquarters to 200 West Street in Manhattan. See “Morgan Stanley May Lease Old Goldman Sachs Building,”

Bloomberg (10/18/2010).

1515 See Goldman Sachs Form 10-K for the fiscal year ending Nov. 30, 2007, filed with the SEC on 1/28/2008, at 64;

11/30/2007 “SPG Trading Mortgages Weekly Metrics 30-November-2007,” GS MBS-E-015646485.

1516 See supra note 1513.

1517 Id.

1518 “Prime brokers” are generally large broker-dealers that provide a special set of services to special clients,

including securities lending, leveraged trade execution, and cash management. See definition of “prime brokerage”

at Investopedia.com.

1519 See supra note 1513.

(2) Goldman Sachs Background

Goldman Sachs was established in 1869 as an investment bank.1513 Originally a private

partnership, in 1999, it became a publicly traded corporation. In 2008, it converted to a bank

holding company. Its headquarters are located in New York City, and the firm manages about

$870 billion in assets.1514 Goldman employs about 14,000 employees in the United States and

32,500 worldwide. In 2007, it reported net revenues of $11.6 billion, of which $3.7 billion was

generated by the Structured Products Group in the Mortgage Department, primarily as a result of

its subprime investment activities.1515

Unlike other Wall Street banks, Goldman has no retail banking operations. It does not

accept deposits from, nor lend to, retail customers, nor does its broker-dealer provide advice to or

execute trades on behalf of retail customers. Goldman provides services only to so-called

“sophisticated” institutional investors, generally large corporations, financial services firms,

pension funds, hedge funds, and a few very wealthy individuals.1516

For most of its history, Goldman operated exclusively as an investment bank, providing

investment advice to corporate clients, arranging and executing mergers and acquisitions, and

arranging financing for customers through stock and bond offerings. After the 1999 repeal of the

Glass-Steagall Act, which had restricted the activities that could be engaged in by investment

banks, Goldman expanded its operations.1517

Over the last ten years, traditional investment banking activities have become a small

percentage of Goldman’s business. Goldman has instead become primarily a Wall Street trading

house, providing broker-dealer services to institutional customers, acting as a prime broker to

hedge funds,1518 structuring and financing deals for customers from its own capital, and

conducting proprietary trading activities for its own benefit. In the years leading up to the

financial crisis, Goldman became an active investor and participant in the deals and transactions

that it was handling for clients as well as selling to investors.1519

379

Subcommittee interview of David Viniar (4/13/2010); 1520 Craig Broderick (4/9/2010); and Daniel Sparks

(4/15/2010).

1521 2/6/2007 Goldman Sachs Form 10-K filing with the SEC.

1522 Id.

1523 Id.

1524 Id.

1525 Id.

1526 Subcommittee interview of Daniel Sparks (4/15/10).

1527 Id.

1528 Id.

1529 Id.

Goldman Sachs Mortgage Department. In 2006 and 2007, the time period reviewed by

the Subcommittee, the most senior Goldman executives were the Chairman of the Board and

Chief Executive Officer Lloyd Blankfein; Chief Operating Officer and Co-President Gary Cohn;

Co-President Jon Winkelried; and Chief Financial Officer David Viniar. Goldman’s Chief Risk

Officer, Craig Broderick, was head of the Market Risk Management & Analysis area of the firm,

which monitored and measured risk for the firm as a whole and for each business unit.

Goldman’s Treasurer, Sarah Smith, was in charge of the Controllers area of the firm, which was

responsible for financial accounting, profit and loss statements, customer credit, collateral/margin

matters, and position valuation verification.1520

In 2006 and 2007, Goldman Sachs’ operating activities were divided into three segments:

Investment Banking, Trading and Principal Investments, and Asset Management and Securities

Services.1521 The Trading and Principal Investments Segment was divided into three businesses:

Fixed Income, Currency and Commodities (FICC); Equities; and Principal Investments.1522 FICC

had five principal businesses: commodities; credit products; currencies; interest rate products;

and mortgage related securities and loan products and other asset backed instruments.1523

In its mortgage business, Goldman Sachs acted as a market maker, underwriter,

placement agent, and proprietary trader in residential and commercial mortgage related securities,

loan products, and other asset backed and derivative products.1524 The Mortgage Department was

responsible for buying and selling virtually all of the firm’s mortgage related assets. It

originated and invested in residential and commercial mortgage backed securities; developed,

traded, and marketed structured products and derivatives backed by mortgages; and traded

mortgage market products on exchanges.1525

In 2006 and 2007, the head of the Mortgage Department was Daniel Sparks. Goldman

Co-Presidents Gary Cohn and Jon Winkelried, as well as CFO David Viniar, had been involved

in Mr. Sparks’ earlier career at Goldman, and he maintained frequent, direct contact with them

regarding the Mortgage Department.1526 In 2006, Mr. Sparks formally reported first to Jonathan

Sobel, who had run the Mortgage Department prior to Mr. Sparks.1527 He next reported to

Richard Ruzika, who was then co-head of Commodities.1528 In late 2006, Mr. Sparks began

reporting directly to Thomas Montag, who was co-head of Global Securities for the Americas,

which included both the FICC Division and the Equities Division.1529 In mid-2007, Mr. Sparks

380

1530 Id.

1531 “North America Mortgages,” chart prepared by Goldman Sachs, GS MBS-E-007818849 (showing organization

of Mortgage Department).

1532 Id.

1533 See, e.g., 6/27/2006 email from Brian O’Brien to John Cassidy, “Conduit Sellers and u’writing guides,” GS

MBS-E-004060914.

1534 Subcommittee interview of Michael Swenson (4/16/2010).

1535 4/22/2010 Goldman Sachs Form 8-K filing with the SEC. Of the 23 Abacus CDOs, 16 contained primarily

mortgage related assets.

began reporting to Donald Mullen, who was head of U.S. Credit Sales & Trading, and Mr.

Mullen in turn reported to Mr. Montag.1530

The Mortgage Department was divided into seven different desks: (1) the Residential

Whole Loan Trading Desk; (2) the Structured Product Group (SPG) Trading Desk; (3) the CDO

Origination Desk, which also handled collateralized loan obligations (CLOs); (4) the Structured

Product Syndicate and Asset Backed Security (ABS) Finance Desk; (5) the Collateralized

Mortgage Obligations (CMO) and Derivatives Desk; (6) the Advisory Group Desk; and (7) the

Commercial Real Estate Loan Trading Desk.1531

The Residential Whole Loan Trading Desk was headed by Kevin Gasvoda.1532 It bought

packages of residential whole loans; issued RMBS securities in the subprime, Alt A and prime

categories; originated residential and commercial mortgages; and gave lines of credit to certain

selected mortgage lenders in exchange for direct access to pools of mortgages they originated, in

so-called “conduit” arrangements.1533

The SPG Trading Desk was headed by Michael Swenson.1534 It was further subdivided

into three different desks: the ABS Desk, the Correlation Trading Desk, and the Commercial

Mortgage Backed Securities (CMBS) Desk. The ABS Desk was also headed by Michael

Swenson and traded mainly synthetic asset backed securities, particularly RMBS and CDO

securities and single name CDS contracts related to RMBS and CDOs. The ABS Desk also had

an important sub-desk called the ABX Trading Desk, which was headed by Joshua Birnbaum,

and traded synthetic mortgage backed securities based on the ABX Index. The Correlation

Trading Desk was headed by Jonathan Egol. It structured, marketed, and traded complex

synthetic structured finance products, including a series of 23 CDOs known as Abacus.1535 The

CMBS Desk was headed by David Lehman and traded commercial mortgage backed securities.

With the exception of the Correlation Desk, the SPG Trading Desk was primarily devoted to

“secondary trading,” meaning the buying and selling of pre-existing asset backed securities. The

SPG Trading Desk was also sometimes referred to as the “Mortgage Secondary Trading Desk.”

381

“North America Mortgages,” chart prepared by Goldman, 1536 GS MBS-E-007818849 (showing organization of

Mortgage Department). In 2006, Mr. Ostrem co-headed the CDO Origination Desk with David Rosenblum, who

was primarily involved in the CLO aspects of the desk’s activities. Mr. Rosenblum was in the process of leaving the

Mortgage Department for a position in the Credit business in late 2006, though he continued to have some

responsibilities with respect to the CDO Origination Desk.

1537 See discussion of the disclosure obligations of broker-dealers, underwriters, and placement agents, above. The

Correlation Trading Desk, which also arranged for the issuance of new CDOs had the same obligations as the CDO

desk when issuing a new CDO.

1538 “North America Mortgages,” chart prepared by Goldman, GS MBS-E-007818849 (showing organization of

Mortgage Department).

1539 “Mortgages Organizational Structure,” chart prepared by Goldman Sachs, GS MBS-E-010872812.

1540 Id.

1541 Undated chart prepared by Goldman for the Subcommittee, GS-PSI-00172.

1542 Undated chart prepared by Goldman for the Subcommittee, GS MBS 0000021129 and GS MBS 0000004276.

1543 Id.

1544 Id.

The CDO Origination Desk was headed by Peter Ostrem.1536 This desk structured and

originated most of Goldman’s CDOs and CLOs, excluding Abacus. The CDO Desk was

primarily an underwriting desk that arranged for the issuance of new securities which had not yet

been sold in the marketplace. Because of its underwriting focus, the CDO Desk’s activities

required a higher level of disclosure to customers regarding newly issued securities than was

ordinarily required of a secondary trading desk, which buys and sells only pre-existing

securities.1537 Goldman maintained an inventory of RMBS and CDO securities to carry out

activities for its clients and proprietary trading for the firm.

The Structured Product (SP) Syndicate and ABS Finance Desk was headed by Bunty

Bohra and Curtis Probst.1538 This desk was often referred to simply as the “Syndicate.” It

coordinated Goldman’s sales efforts and the issuance of different securities across different

desks.

In the middle of 2007, the Mortgage Department was restructured. One key change was

that the CDO Origination Desk was moved into the secondary trading area under the SPG

Trading Desk. Mr. Lehman was designated as head of the CDO Origination Desk, with

assistance from Mr. Swenson.1539 As a result, the SPG Trading Desk had responsibility for

selling new Goldman-originated CDO securities as well as engaging in secondary trading of preexisting

CDOs and RMBS securities, related credit default swaps (CDS), ABX trading,

correlation trading, property derivatives, CMBS, and other asset backed securities.1540

In 2006 and 2007, the Residential Whole Loan Trading Desk underwrote 93 RMBS

worth $72 billion.1541 The CDO Origination Desk acted as a placement agent and underwrote

approximately 27 mortgage based CDOs worth $28 billion.1542 Of the 27 CDOs, 84% were

hybrid CDOs, 15% were synthetic, and only about 1% were cash CDOs with physical assets.1543

The mortgage-based CDOs included 8 CDOs on the Abacus platform, with $5 billion in issued

securities;1544 a $2 billion synthetic CDO known as Hudson Mezzanine 2006-1; a $300 million

synthetic CDO known as Anderson Mezzanine 2007-1; and $1 billion hybrid CDO known as

Timberwolf I.

382

See net short chart prepared by the Subcommittee, below; 9/17/2007 1545 Presentation to GS Board of Directors,

Residential Mortgage Business at 5, GS MBS-E-001793845, Hearing Exhibit 4/27-41; 3/10/2007 email to Daniel

Sparks, “Mortgage Presentation to the board,” GS MBS-E-013323395, Hearing Exhibit 4/27-17.

1546 7/25/2007 email from Mr. Viniar to Mr. Cohn, “Private & Confidential: FICC Financial Package 07/25/07,” GS

MBS-E-009861799, Hearing Exhibit 4/27-26.

1547 10/2007 Global Mortgages, Business Unit Townhall at 4-5, GS MBS-E-013703463, Hearing Exhibit 4/27-47.

1548 4Q07 Fact Sheet prepared for David Viniar, GS MBS-E-009724276, Hearing Exhibit 4/27-159.

1549 See discussion of risk limits, VAR measurements, and risk reports, below.

(3) Overview of Goldman Sachs Case Study

This Report looks at two activities undertaken by Goldman in 2006 and 2007. The first is

Goldman’s intensive effort, beginning in December 2006 and continuing through 2007, to profit

from the subprime mortgage market collapse, particularly by shorting subprime mortgage assets.

The second is how, in 2006 and 2007, Goldman used mortgage related CDOs to unload the risk

associated with its faltering high risk mortgage assets onto clients, help a favored client make a

$1 billion gain, and profit from the failure of the very CDO securities it sold to its clients.

These activities raise questions related to Goldman’s compliance with its obligations to

provide suitable investment recommendations to its clients and disclose its material adverse

interests to potential investors. They also raise questions about whether some of Goldman’s

incomplete disclosures were deceptive, and whether some of its activities generated conflicts of

interest in which Goldman placed its financial interests before those of its clients. They also

raise questions about the high risk nature of some structured finance products and their role in

U.S. financial markets.

( a) Overview of How Goldman Shorted the Subprime Mortgage Market

Beginning in December 2006 and continuing through 2007, Goldman twice built and

profited from large net short positions in mortgage related securities, generating billions of

dollars in gross revenues for the Mortgage Department. Its first net short peaked at about $10

billion in February 2007, and the Mortgage Department as a whole generated first quarter

revenues of about $368 million, after deducting losses and writedowns on subprime loan and

warehouse inventory.1545 The second net short, referred to by Goldman Chief Financial Officer

David Viniar as “the big short,”1546 peaked in June at $13.9 billion. As a result of this net short,

the SPG Trading Desk generated third quarter revenues of about $2.8 billion, which were offset

by losses on other mortgage desks, but still left the Mortgage Department with more than $741

million in profits.1547 Altogether in 2007, Goldman’s net short positions from derivatives

generated net revenues of $3.7 billion.1548 These positions were so large and risky that the

Mortgage Department repeatedly breached its risk limits, and Goldman’s senior management

responded by repeatedly giving the Mortgage Department new and higher temporary risk limits

to accommodate its trading.1549 At one point in 2007, Goldman’s Value-at-Risk measure

383

Id. “Value-at-Risk” or VAR is a key risk measurement system used by Goldman. A 1550 t a 95% confidence level,

VAR represents the dollar amount a business unit could expect to lose once every 20 trading days or about once per

month. Subcommittee interview of Craig Broderick (4/9/2010). See also Philippe Jorion, “Value at Risk: The New

Benchmark for Managing Financial Risk,” at 20 (3d ed. 2007).

1551 11/18/2007 email from Lloyd Blankfein, “RE: NYT,” GS MBS-E-009696333, Hearing Exhibit 4/27-52.

indicated that the Mortgage Department was contributing 54% of the firm’s total market risk,

even though it ordinarily contributed only about 2% of its total net revenues.1550

To build its net short positions, Goldman’s Mortgage Department personnel used

structured finance products to engage in multiple, complex transactions. Its efforts included

selling high risk loans, RMBS, CDO, ABX, and other mortgage related assets from its inventory

and warehouse accounts; shorting RMBS and CDO securities, either by shorting the assets

themselves or by taking the short side of CDS contracts that referenced them, in order to profit

from their fall in value; and shorting multiple other mortgage backed assets simultaneously,

including different tranches of the ABX Index, tranches of CDOs, and CDS contracts on such

assets. To lock in its profits after the short assets fell in value, Goldman often entered into

offsetting CDS contracts to “cover its shorts,” as explained below. Senior Goldman executives

directed and monitored these activities.

The evidence reviewed by the Subcommittee shows that some of the transactions leading

to Goldman’s short positions were undertaken to advance Goldman’s own proprietary financial

interests and not as a function of its market making role to assist clients in buying or selling

assets. In the end, Goldman profited from the failure of many of the RMBS and CDO securities

it had underwritten and sold. As Goldman CEO Lloyd Blankfein explained in an internal email

to his colleagues in November 2007: “Of course we didn’t dodge the mortgage mess. We lost

money, then made more than we lost because of shorts.”1551

Covering Shorts to Lock In Profits. To understand how Goldman profited from its

short positions, it is important to understand references in its internal documents to “covering” or

“monetizing” its shorts. When Goldman built its short positions, it generally used CDS contracts

to short a variety of mortgage related securities, including individual RMBS and CDO securities

and baskets of 20 RMBS securities identified in the ABX indices. Goldman’s shorts then gained

or lost value over time, depending upon how the underlying referenced assets performed during

the same period.

Most CDS contracts expire after a specified number of years. As explained earlier,

during the covered period, the short party makes periodic premium payments to the opposing

long party in the CDO. The short party is essentially betting that a “credit event” will take place

during the covered period that will result in the long party having to provide it with a large

384

Under standard CDS contracts designed by the International Swaps and 1552 Derivatives Association (ISDA), a credit

event is defined as a (1) bankruptcy; (2) failure to pay; (3) restructuring; (4) repudiation of or moratorium on

payment in the event of an authorized government intervention; or (5) an acceleration of an obligation. Another

common credit event is incurring a credit rating loss.

1553 See, e.g., 10/17/2006-10/18/2006 email from Tom Montag to Daniel Sparks, “3 things,” GS MBS-E-

010917469 (acquisition of a large net long position described as “slipp[ing] up a bit”). In an email to Goldman Co-

President Gary Cohn, Richard Ruzika criticized the accumulation of the large net long position: “You know and I

know this position was allowed to get too big – for the liquidity in the market, our infrastructure, and the ability of

our traders. That statement would be the same even if we had gotten the market direction correct – although the

payment that outweighs the cost of the short party’s premium payments.1552 However, the short

party does not have to wait for a credit event in order to realize a gain on its CDS contract.

One possible alternative is for the short party simply to sell its short position to another

party for a profit. If, however, the short party does not want to sell or has no ready buyer, the

short party can still lock in a gain by entering into a second, offsetting CDS contract in which it

takes the long position on an offsetting asset, an action often referred to as “covering the short.”

In practice, there were several different, technical methods for a party to cover its short

positions. The simplest example is if the short party bought a $100,000 CDS contract whose

reference asset is a single RMBS security. Suppose after one month the RMBS security performs

so poorly that the market value of the short position increases to $150,000. If the short party

wanted to lock in the $50,000 gain, it could do so simply by entering into a new offsetting CDS

contract, referencing the same RMBS security, in which it takes the long position with a new

party who takes the short position at the new higher market value of $150,000. The result would

be that the original short party would own a short position and a long position that offset each

other, and would lock in the $50,000 difference in value as profit.

During 2007, Goldman executives repeatedly directed the Mortgage Department to

“cover its shorts” and lock in the gains from the increased value of its short positions. When it

covered its short positions by entering into offsetting contracts, the Mortgage Department

simultaneously “monetized” its short positions – recorded the locked in profit. That is because,

when it covered a short by entering into an offsetting contract, the Mortgage Department’s

general practice was to record a profit on its books equal to the gain on the original short

position. Because the original purchase price of the CDS was known and fixed, and the new

higher price obtained in the offsetting transaction was known and fixed, the Mortgage

Department was able to capture the difference between the two prices as profit.

Going Past Home: The First Net Short. Because Goldman’s activities were so varied

and complex during the period reviewed, this overview provides a brief summary of the key

events detailed in the following sections. The review begins in mid to late 2006, when Goldman

realized that the market for subprime mortgage backed securities was beginning to decline, and

the large long positions it held in ABX assets, loans, RMBS and CDO securities, and other

mortgage related assets began to pose a disproportionate risk to both the Mortgage Department

and the firm.1553 In October 2006, the Mortgage Department designed a synthetic CDO called

385

vultures wouldn’t be circling. You also know that we probably would have gotten the position correct had I been

involved a year ago – I probably would have gotten short to protect our warehouse and general hedge against the

business given our outlook in the space.” 2/5/2007 email from Richard Ruzika to Gary Cohn, “Are you living

Morgatages? [sic],” GS MBS-E-016165784.

1554 For more information about the Hudson CDO, see below.

1555 See, e.g., 12/7/2006 email from Tom Montag, GS MBS-E-009756572 (“I don’t think we should panic regarding

ABX holdings”).

1556 12/14/2006 email from Daniel Sparks, “Subprime risk meeting with Viniar/McMahon Summary,” GS MBS-E-

009726498, Hearing Exhibit 4/27-3.

1557 Subcommittee interview of David Viniar (4/13/2010).

Hudson Mezzanine 2006-1, which included over $1.2 billion of long positions on CDS contracts

to offset risk associated with ABX assets in Goldman’s own inventory and another $800 million

in single name CDS contracts referencing subprime RMBS securities that Goldman wanted to

short; the Mortgage Department then sold the Hudson securities to its clients.1554 While this

CDO transferred $1.2 billion of subprime risk from Goldman’s inventory to its clients and gave

Goldman an opportunity to short another $800 million in RMBS securities it thought would

perform poorly, the Mortgage Department still held billions of dollars of long positions in

subprime mortgage related assets, primarily in ABX index assets.1555

On December 14, 2006, as Goldman’s mortgage related assets continued to lose value,

Goldman’s Chief Financial Officer, David Viniar, held a meeting with key Mortgage Department

personnel and issued instructions for the Department to “get closer to home.”1556 By “closer to

home,” Mr. Viniar meant for the Mortgage Department to assume a more neutral risk position,

one that was neither substantially long nor short, but actions taken by the Mortgage Department

in response to his instructions quickly shot past “home,” resulting in Goldman’s first large net

short position in February 2007.1557

The actions taken by the Mortgage Department included selling outright from its

inventory large numbers of subprime RMBS, CDO, and ABX assets, even at a loss, while

simultaneously buying CDS contracts to hedge the long assets remaining in its inventory. The

Mortgage Department also halted new RMBS securitizations, began emptying its RMBS

warehouse accounts, and generally stopped purchasing new assets for its CDO warehouse

accounts. It also purchased the short side of CDS contracts referencing the ABX index for a

basket of AAA rated subprime residential loans, as a kind of “disaster insurance” in the event

that even AAA rated mortgages started defaulting.

Within about a month of the “closer to home” meeting, in January 2007, the Mortgage

Department had largely eliminated or offset Goldman’s long positions on subprime mortgage

related assets. The Mortgage Department then started to build a multi-billion-dollar short

position to enable the firm to profit from the subprime RMBS and CDO securities starting to lose

value. By the end of the first quarter of 2007, the Mortgage Department had swung from a $6

billion net long position in December 2006, to a $10 billion net short position in late February

386

3/10/2007 email to Daniel Sparks, “Mortgage Presentation to the b 1558 oard,” GS MBS-E-013323395, Hearing

Exhibit 4/27-17. 12/13/2006 Goldman email, “Subprime Mortgage Risk,” Hearing Exhibit 4/27-2.

1559 8/23/2007 email from Tom Montag, “Current Outstanding Notional SN ames,” GS MBS-E-010621231.

1560 11/13/2007 Goldman email, GS MBS-E-010023525 (attachment, 11/14/2007 “Tri-Lateral Combined

Comments,” GS MBS-E-010135693-715 at 695).

1561 9/7/2007 Fixed Income, Currency and Commodities Annual Individual Review Book, Self-Review of Deeb

Salem, GS-PSI-03157-80 at 72 (hereinafter “Salem 2007 Self-Review”).

1562 Id.

2007, a $16 billion reversal.1558 A senior Goldman executive later described a net short position

of $3 billion in subprime mortgage backed securities as “huge and outsized.”1559 But Goldman’s

net short position in February 2007 was $10 billion – more than triple that size.

In late February, Goldman’s Operating Committee, a subcommittee of its Firmwide Risk

Committee, became concerned about the size of the $10 billion net short position. The Firmwide

Risk Committee (FWRC) was co-chaired by Mr. Viniar, and Messrs. Cohn and Blankfein

regularly attended its meetings.1560 The concern arose, in part, because the $10 billion net short

position had dramatically increased the Mortgage Department’s Value-at-Risk or “VAR,” the

primary measure Goldman used to compute its risk. The Committee ordered the Department to

lock in its profits by “covering its shorts,” as explained above. The Mortgage Department

complied by covering most, but not all, of the $10 billion net short and brought down its VAR. It

then maintained a relatively lower risk profile from March through May 2007.

Attempted Short Squeeze. In May 2007, the Mortgage Department’s Asset Backed

Security (ABS) Trading Desk attempted a “short squeeze” of the CDS market that was intended

to compel other market participants to sell their short positions at artificially low prices.1561

Goldman’s ABS Desk was still in the process of covering the Mortgage Department’s shorts by

offering CDS contracts in which Goldman took the long side. The ABS Desk devised a plan in

which it would offer those CDS contracts to short parties at lower and lower prices, in an effort

to drive down the overall market price of the shorts. As prices fell, Goldman’s expectation was

that other short parties would begin to sell their short positions, in order to avoid having to sell at

still lower prices. The ABS Desk planned to buy up those short positions at the artificially low

prices it had caused, thereby rebuilding its own net short position at a lower cost.1562 The ABS

Desk initiated its plan, and during the same period Goldman customers protested the lower

values assigned by Goldman to their short positions as out of line with the market. Despite the

lower prices, the parties who already held short positions generally kept them and did not try to

sell them. In June, after learning that two Bear Stearns hedge funds specializing in subprime

mortgage assets might collapse, the ABS Desk abandoned its short squeeze effort and

recommenced buying short positions at the prevailing market prices.

The Big Short. In mid-June 2007, the two Bear Stearns hedge funds did collapse,

triggering another steep decline in the value of subprime mortgage assets. In response, Goldman

immediately went short again, to profit from the falling prices. Within two weeks, Goldman had

massed a large number of CDS contracts shorting a variety of subprime mortgage assets. On

387

See chart entitled, “Goldman Sachs Mortgage Department Total Net Short Position, F 1563 ebruary-December 2007 in

$ Billions,” prepared by the Permanent Subcommittee on Investigations, Hearing Exhibit 4/27-162 (April 2010

version), updated January 2011 (updated version), derived from Goldman Sachs Mortgage Strategies, Mortgage

Dept Top Sheets provided by Goldman Sachs (hereinafter “PSI Net Short Chart”), See Section C(4)(g).

1564 For more information about the mass rating downgrades, see Chapter V, above. See also 7/10/2007 Goldman

email, “GS Cashflow/Abacus CDOs Mentioned in S&P Report on CDO Exposure to Subprime RMBS,” GS MBS-E-

001837256.

1565 10/2007 Global Mortgages, Business Unit Townhall at 4-5, GS MBS-E-013703463, Hearing Exhibit 4/27-47.

1566 Quarterly Breakdown of Mortgage P/L, GS MBS-E-009713204 at 205. Goldman’s gross revenues from all

derivative products, without deduction of related losses, were apparently $5.9 billion. 4Q07 Fact Sheet prepared for

David Viniar (FY07 P&L [profit and loss]: . . . derivatives +5.9B), GS MBS-E-009724276, Hearing Exhibit 4/27-

159.

1567 Swenson self evaluation, Hearing Exhibit 4/27-55b.

June 22, 2007, Goldman’s net short position reached its peak of approximately $13.9 billion, as

calculated by the Subcommittee.1563 That total included the $9 billion in AAA ABX assets that

Goldman had earlier acquired as “disaster protection,” in case the subprime market as a whole

lost value. The resulting net short, referred to by Mr. Viniar as the “big short,” was nearly 40%

larger than its first net short which had peaked at $10 billion in February 2007.

To lock in its profits on the $13.9 billion short, the Mortgage Department began working

to cover its shorts, buying long assets and entering into offsetting CDS contracts in which it took

the long position. On July 10, 2007, the credit rating agencies issued the first of many mass rating

downgrades that affected hundreds and then thousands of RMBS and CDO securities, whose

values began to fall even more rapidly.1564 The Mortgage Department was able to purchase long

assets at a low cost, managed to cover most of its short positions, and locked in its profits. At the

same time, the Mortgage Department maintained a net short position in higher risk subprime

RMBS securities carrying credit ratings of BBB or BBB-, betting that those securities would lose

still more value and produce still more profits for the firm. In August, however, Goldman senior

management again became concerned about the size of the Department’s net short position and its

VAR levels, which had reached record levels. On August 21, 2007, Goldman’s Chief Operating

Officer Gary Cohn ordered the Mortgage Department to “get down now.”

Big Short Profits. In response, the Mortgage Department began another round of

covering its shorts and locking in its profits, including the shorts referencing BBB and BBB- rated

RMBS securities. In the third quarter of 2007, the SPG Trading Desk reported record revenues

from its short positions totaling $2.8 billion.1565 By the end of 2007, the SPG Trading Desk in the

Mortgage Department recorded year-end net revenues totaling $3.7 billion, which were used to

offset losses on other desks, leaving the Mortgage Department as a whole with record net

revenues of over $1.2 billion for the year.1566 The head of the SPG Desk, Michael Swenson, later

wrote that 2007 was “the [year] I am most proud of to date,” because of the “extraordinary

profits” from the short positions he had advocated.1567 His colleague, Joshua Birnbaum who

headed the ABX Desk within SPG, also reviewed the year in terms of the profitable short

positions it built. He wrote: “The prevailing opinion within the department was that we should

just ‘get close to home’ and pare down our long,” but he decided his ABS Desk should “not only

388

Birnbaum self 1568 evaluation, Hearing Exhibit 4/27-55c.

1569 Id.

1570 Quarterly Breakdown of Mortgage P/L, GS MBS-E-009713204 at 205.

1571 5/11/2007 email from Daniel Sparks, “You okay?,” GS MBS-E-019659221.

... get flat, but get VERY short.”1568 He wrote: “[W]e implemented the plan by hitting on almost

every single name CDO protection buying opportunity in a 2-month period. Much of the plan

began working by February as the market dropped 25 points and our very profitable year was

under way.” When the subprime mortgage market fell further in July after the credit rating mass

downgrades, he wrote: “We had a blow-out [profit and loss] month, making over $1Bln that

month.”1569

The $3.7 billion in net revenues from the SPG’s short positions helped to offset other

mortgage related losses, and, at year’s end, at a time when mortgage departments at other large

financial institutions were reporting record losses, Goldman’s Mortgage Department reported

overall net revenues of $1.2 billion.1570

(b) Overview of Goldman’s CDO Activities

This Report also examines four CDOs that Goldman originated, underwrote, and marketed

in the years leading up to the financial crisis: Hudson Mezzanine 2006-1, Anderson Mezzanine

2007-1, Timberwolf I, and Abacus 2007-AC1. Hudson was conceived in 2006, and issued its

securities in December 2006, as Goldman began its concerted effort to sell its mortgage holdings.

Anderson, Timberwolf, and Abacus issued their securities in 2007, as RMBS and CDO securities

were losing value, and Goldman was shorting the subprime mortgage market.

During 2007, as Goldman built and profited from its net short positions in the first and

third quarters of the year, it continued to design, underwrite, and sell CDO securities. Due to

waning investor interest, in February 2007, Goldman conducted a review of the CDOs in its

pipeline. The Mortgage Department decided to cancel four pending CDOs, downsize another

two, and bring all of its remaining CDOs to market as quickly as possible. Also in February 2007,

the Mortgage Department limited its CDO Origination Desk to carrying out only the CDO

transactions already underway.

“Gameplan” for CDO Valuation Project. In the first quarter of 2007, Goldman’s

Mortgage Department worked to sell the warehouse assets from the discontinued CDOs, the

securities issued by past Goldman-originated CDOs, and the new securities from CDOs being

originated by Goldman in 2006 and 2007. In May 2007, as CDO sales slowed dramatically,

Goldman became concerned about the lack of sales prices to establish the value of its CDO

holdings. Goldman needed accurate values, not just to establish its CDO sales prices, but also to

value the CDO securities for collateral purposes and in compliance with Goldman’s policy of

using up-to-date market values for all of its holdings.1571 On May 11, 2007, Goldman senior

executives, including Mr. Cohn and Mr. Viniar, Mortgage Department personnel, controllers, and

389

Id.; 5/14/2007 email from David Lehman, “Gameplan – asset model analysis,” G 1572 S MBS-E-001865782 (last

email in a longer email chain).

1573 Id.; 5/14/2007 email from Elisha Weisel, “Modelling Approaches for Cash ABS CDO/CDO^2,” GS MBS-E-

001863618.

1574 5/14/2007 email from Tom Montag to Daniel Sparks, GS MBS-E-019642797.

1575 5/11/2007 email from Harvey Schwartz to Daniel Sparks, Tom Montag, and others, GS MBS-E-010780864.

1576 5/20/2007 email, “Viniar Presentation - Updated,” GS MBS-E-010965211 (attached file, “Mortgages

Department, May 2007,” Goldman presentation, GS MBS-E-010965212); see also 5/19/2007 “Mortgages CDO

Origination – Retained Positions & Warehouse Collateral, May 2007,” Goldman presentation, GS MBS-E-

010951926.

1577 5/19/2007 “Mortgages CDO Origination – Retained Positions & Warehouse Collateral, May 2007,” Goldman

presentation, GS MBS-E-010951926.

1578 Compare 5/19/2007 “Mortgages CDO Origination – Retained Positions & Warehouse Collateral, May 2007,”

Goldman presentation, GS MBS-E-010951926, with 5/20/2007 “Mortgages Department, May 2007,” Goldman

presentation, GS MBS-E-010965212.

others held a meeting and developed a “Gameplan” for a CDO valuation project.1572 The

Gameplan called for the Mortgage Department, over the course of about a week, to use three

different valuation methods to price all of its CDO warehouse assets, unsold securities from past

CDOs, and new securities from the CDOs currently being marketed to clients.1573