Starting Points: Goldman Sachs

Apr 17, 2010

For Goldman Sachs, a Winning Bet Carries a Price - NYTimes.com

By LOUISE STORY and GRETCHEN MORGENSON

For Goldman Sachs, it was a relatively small transaction. But for the bank — and the rest of Wall Street — the stakes couldn’t be higher.

Accusations that Goldman defrauded customers who bought investments tied to risky subprime mortgages have only just begun to reverberate through the financial world.

The civil lawsuit filed against Goldman on Friday by the Securities and Exchange Commission seemed to confirm many Americans’ worst suspicions about Wall Street: that the game is rigged, the odds stacked in the banks’ favor. It is the first big case — but probably not the last, legal experts said — to delve into a Wall Street firm’s role in the mortgage fiasco.

The move against Goldman came at a particularly sensitive time for Wall Street. Washington policy makers are hotly debating a sweeping overhaul of the nation’s financial regulations, and the news could embolden those seeking to rein in the banks. President Obama on Saturday stepped up pressure for financial reform by accusing Republicans of “cynical and deceptive” attacks on the measure.

The S.E.C.’s action could also hit Wall Street where it really hurts: the wallet. It could prompt dozens of investor claims against Goldman and other Wall Street titans that devised and sold toxic mortgage investments.

And it raises new questions about Goldman, the bank at the center of more concentric circles of economic and political power than any other on Wall Street. Goldman — whose controversial success has leapt from the financial pages to the cover of Rolling Stone — has fiercely defended its actions before, during and after the financial crisis. On Friday, it called the S.E.C.’s accusations “unfounded.”

Wall Street played a complex and, at times, seemingly conflicted role in the mortgage meltdown. Goldman and others worked behind the scenes, bundling home loans into investments for sale to investors the world over. Even now, more than 18 months after Washington rescued the teetering financial system, no one knows for sure how much money was lost on those investments.

The public outcry against the bank bailouts was driven in part by suspicions that a heads-we-win, tails-you-lose ethos pervades the financial industry. To many, that Goldman and others are once again minting money — and paying big bonuses to their employees — is evidence that Wall Street got a sweet deal at taxpayers’ expense. The accusations against Goldman may only further those suspicions.

“The S.E.C. suit against Goldman, if proven true, will confirm to people their suspicions about the total selfishness of these financial institutions,” said Steve Fraser, a Wall Street historian and author of “Wall Street: America’s Dream Palace.” “There’s nothing more damaging than that. This is way beyond recklessness. This is way beyond incompetence. This is cynical, selfish exploiting.”

On Friday, Goldman’s stock took a beating, falling 13 percent and wiping out more than $10 billion of the company’s market value. It was a possible sign that investors fear that the S.E.C. complaint will damage Goldman’s reputation and its ability to keep its hands on so many sides of a trade — a practice that is immensely profitable for the firm.

It is unclear whether the S.E.C. can prevail against Goldman. The bank has long maintained that it puts its clients first and, in a letter in its latest annual report, reiterated that position. Goldman said that it never “bet against our clients” in its trades but rather was trying to hedge against other trading positions.

Still, Wall Street analysts said Goldman and other banks, having navigated the financial crisis, might now face a new kind of risk: angry investors. Most major Wall Street banks also created collateralized debt obligations, which are at the heart of the Goldman case. C.D.O.’s, which are essentially bundles of securities backed by mortgages or other debt securities, turned out to be among the most toxic investments ever devised.

“Any investor who bought these C.D.O.’s and lost a significant amount of money is probably looking at their investment and wanting to know: what were the details behind the sale?” said William Tanona, an analyst at Collins Stewart. “Will they contact the S.E.C. and say, ‘Here’s the transaction we participated in, and we’d love to know who is on the other side of it?’ ”

Among the investors were several European banks, the S.E.C. complaint said. The biggest victim was the Royal Bank of Scotland, which inherited a loss of $841 million after it took over the Dutch bank ABN Amro, which made the original investments in 2007. According to a person briefed on the matter, Royal Bank, now controlled by the British government, is studying the documents but is not yet ready to decide whether to take action to recoup some or all of the money from Goldman.

Goldman faces a dilemma in its response. Wall Street firms tend to settle cases like this one, but Goldman’s statement Friday indicated it intended to dig in its heels and fight, perhaps in part to discourage suits by investors. But that strategy could set it up for a drawn-out, messy and public battle.

The S.E.C. complaint named just one Goldman employee: Fabrice Tourre, a vice president in the bank’s mortgage operation who worked on the questionable transaction.

But securities lawyers say Mr. Tourre appears to be a small fish. Federal investigators may try to gain his cooperation and extend their investigation to other Goldman employees. On Friday Mr. Tourre’s lawyer did not provide a comment on the complaint.

A big question is how far up this might go. The S.E.C. said the deal in its complaint had been approved by a committee at Goldman called the Mortgage Capital Committee.

“It’s typical that they’d start with someone lower down on the chain and try to exert pressure on that person,” said Bradley D. Simon of Simon & Partners, a white-collar defense lawyer in New York. “Is it really conceivable that no one else was involved in this?”

As the housing market began to fracture in 2007, senior Goldman executives began overseeing the mortgage department closely, according to four former Goldman Sachs employees, who spoke on the condition of anonymity because of the sensitivity of the matter.

Senior executives routinely visited the unit. Among them were David A. Viniar, the chief financial officer; Gary D. Cohn, the president; and Pablo Salame, a sales and trading executive, these former employees said. Even Goldman’s chief executive, Lloyd C. Blankfein, got involved.

Top executives met routinely with Dan Sparks, the head of the mortgage trading unit, who retired in the spring of 2008. Managers instructed several traders to sell housing-related investments. Indeed, they urged Mr. Tourre and a colleague, Jonathan Egol, to place more bets against mortgage investments, the former employees said.

A Goldman spokesman did not reply to a request for comment on these executives’ roles. It is unclear if any of the top executives knew about all of Mr. Tourre’s actions.

Mr. Blankfein has already been questioned about the toxic vehicles Goldman devised and sold, even as the bank realized the housing market was in trouble.

Recent public statements made by Mr. Blankfein seem to conflict with the account laid out by the S.E.C.

In testimony before the Financial Crisis Inquiry Commission in January, for example, Mr. Blankfein described Goldman’s approach to dealing with its clients: “Of course, we have an obligation to fully disclose what an instrument is and to be honest in our dealings, but we are not managing somebody else’s money.”

But the S.E.C. complaint says Goldman misled investors who bought one of the bank’s so-called Abacus deals. The bank failed to tell them that the mortgage bonds that underpinned the investment had been selected by a prominent hedge fund manager who wanted to bet against the investment, the S.E.C. says. Those bonds were especially vulnerable, the commission says.

The deal cost investors just over $1 billion, a relatively small deal by Wall Street standards. At a conference in New York in November, Mr. Blankfein talked about the risks to the firm’s reputation that it faced as a result of the mortgage mania and ensuing credit crisis.

“Are we worried about our image and reputation, and what are we doing to fix it? The answer, of course, is we’re very concerned about this,” Mr. Blankfein said. He added: “People understand our bona fides who deal with us.”

Graham Bowley contributed reporting.

Jul 17, 2009

JPMorgan’s Profit Soars Despite Downturn

By GRAHAM BOWLEY

A new order is emerging on Wall Street after the worst crisis since the Great Depression — one in which just a couple of victors are starting to tower over the handful of financial titans that used to dominate the industry.

On Thursday, JPMorgan Chase became the latest big bank to announce stellar second-quarter earnings. Its $2.7 billion profit, after record gains for Goldman Sachs, underscores how the government’s effort to halt a collapse has also set the stage for a narrowing concentration of financial power.

“One theme here is that Goldman Sachs and JPMorgan really have emerged as the winners, as the last of the survivors,” said Robert Reich, a professor at the University of California, Berkeley, who was secretary of labor in the Clinton administration.

Both banks now stand astride post-bailout Wall Street, having benefited from billions of dollars in taxpayer support and cheap government financing to climb over banks that continue to struggle. They are capitalizing on the turmoil in financial markets and their rivals’ weakness to pull in billions in trading profits.

For the most part, the worst of the financial crisis seems to be over. Yet other large banks, including Citigroup and Bank of America, are still struggling to return to health. Both are expected to report a more profitable quarter on Friday, but a spate of management changes and looming losses from credit cards and commercial real estate have thwarted a stronger recovery.

And then there are the legions of regional and small banks that are falling in greater numbers across the country. While many have racked up large losses, they stand to bleed more red ink if the recession wears on. Fifty-three have failed this year, and the Federal Deposit Insurance Corporation is girding for scores to follow.

Uncertainties over the economy mean that Goldman and JPMorgan may be enjoying a fragile dominance, industry experts said. JPMorgan reported big declines in its consumer business on Thursday, and it has set aside more than $30 billion to cover future losses from surging credit card charge-offs and mortgage and home equity losses.

“Nobody is through this until unemployment turns around,” said Moshe Orenbuch, a Credit Suisse banking analyst.

And if regulation being considered in Washington is passed, banks would face new limits on the amount of their own capital they may trade. That could limit the profits that banks like Goldman and JPMorgan make from their trading businesses, and level the playing field, experts say.

Other former Wall Street stars like Morgan Stanley, which was hurt more by the crisis and has avoided taking big risks in the new era, may also rebound and begin to take on old rivals.

But for now, Goldman Sachs and JPMorgan are surging. “The stronger players are positioned to take advantage of the crisis and they will dominate clearly in the near term,” said James Reichbach, the head of Deloitte’s United States financial practice.

JPMorgan’s renewed strength, like Goldman’s, comes as it vaults ahead of longtime rivals, especially in investment banking, including bond and equity trading, and underwriting debt to help companies issue shares and bonds. Traders took advantage of big market swings and less competition to post big gains in fixed-income and equities.

Michael J. Cavanagh, the chief financial officer at JPMorgan, said its profit and fees from this business were “a record for us in a quarter and a record for anybody at any firm in any quarter.” The bank, he added, was “so very proud of those results.”

It has also profited from the demise of weaker banks to enlarge its market share in mortgages and retail banking. On Tuesday, as the CIT Group, a lender to many small businesses, negotiated with the government to avoid collapse, JPMorgan signaled that it was watching.

“It would be an opportunity for us in these states if CIT was unable to continue lending to borrowers,” Tom Kelly, a spokesman at Chase, was quoted by Dow Jones Newswires as saying.

And revenue from the retail bank Washington Mutual, which JPMorgan acquired last fall, is starting to help earnings. Morgan is also profiting from its government-assisted purchase of Bear Stearns last year. JPMorgan is now No. 1 globally in equity and debt capital markets, according to Dealogic.

Amid the surge, Jamie Dimon, JPMorgan’s chief executive, has cemented his status as one of America’s most powerful and outspoken bankers. He has vocally distanced himself from the government’s financial support, calling the $25 billion in taxpayer money the bank received in December a “scarlet letter” and pushing with Goldman Sachs, Morgan Stanley and others to repay the money swiftly. Those three banks repaid the money last month.

Yet JPMorgan’s transformation into one of the industry’s strongest players is underpinned by the shelter it received from the government: The bank used the money as a cushion until it was able to raise new capital. “There is no doubt all of us benefited from the government help — all of us,” said a senior executive at another Wall Street bank.

A spokesman for JPMorgan said the bank accepted aid at the request of the government but would not comment beyond that.

Few banks have undergone such a turnaround. Only a few years ago, JPMorgan was struggling after years of poor management and a failure to digest a series of big acquisitions. But under Mr. Dimon, it cut costs and strengthened its balance sheet.

The payoff began last year. With the industry teetering on the verge of collapse, JPMorgan snapped up Bear Stearns in March 2008 and Washington Mutual last fall in two government-assisted transactions. Clients say that its growing dominance has given it more leverage to charge for lending and other services.

After aggressively lobbying to repay its taxpayer money, Mr. Dimon has also been driving a hard bargain over the repurchase of warrants the government received from the bank last autumn in exchange for taxpayer support. JPMorgan is now planning to let the Treasury Department auction off the warrants to private investors after the two sides failed to agree on a price.

Mr. Dimon is also gearing up for a series of battles in Washington. One is over tighter regulations for derivatives, a business where the bank generates lucrative fees as one of the industry’s largest players.

Another is the creation of a new consumer protection agency, which could threaten the profitability of the bank’s mortgage and credit card businesses if it introduces tougher regulations.

JPMorgan’s stock has risen 20 percent since early March. It closed Thursday at $35.76.

Eric Dash and David Jolly contributed reporting.