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EARLY : SPREADING SUBPRIME WORRIES
In addition, Goldman President and Chief Operating Officer Gary Cohn testified:
“During the two years of the financial crisis, Goldman Sachs lost . billion in its
residential mortgage–related business. . . . We did not bet against our clients, and
these numbers underscore that fact.”
Indeed, Goldman’s short position was not the whole story. The daily mortgage
“Value at Risk” measure, or VaR, which tracked potential losses if the market moved
unexpectedly, increased in the three months through February. By February, Gold-
man’s company-wide VaR reached an all-time high, according to SEC reports. The
dominant driver of the increase was the one-sided bet on the mortgage market’s con-
tinuing to decline. Preferring to be relatively neutral, between March and May, the
mortgage securities desk reduced its short position on the ABX Index; between
June and August, it again reversed course, increasing its short position by purchasing
protection on mortgage-related assets.
The Basis Yield Alpha Fund, a hedge fund and Goldman client that claims to have
invested . million in Goldman’s Timberwolf CDO, sued Goldman for fraud in
. The Timberwolf deal was heavily criticized by Senator Carl Levin and other
members of the Permanent Subcommittee on Investigations during an April
hearing. The Basis Yield Alpha Fund alleged that Goldman designed Timberwolf to
quickly fail so that Goldman could offload low-quality assets and profit from betting
against the CDO. Within two weeks of the fund’s investment, Goldman began mak-
ing margin calls on the deal. By the end of July , it had demanded more than
million. According to the hedge fund, Goldman’s demands forced it into bank-
ruptcy in August —Goldman received about million from the liquidation.
Goldman denies Basis Yield Alpha Fund’s claims, and CEO Blankfein dismissed the
notion that Goldman misled investors. “I will tell you, we only dealt with people who
knew what they were buying. And of course when you look after the fact, someone’s
going to come along and say they really didn’t know,” he told the FCIC.
In addition to selling its subprime securities to customers, the firm took short po-
sitions using credit default swaps; it also took short positions on the ABX indices and
on some of the financial firms with which it did business. Like every market partici-
pant, Goldman “marked,” or valued, its securities after considering both actual mar-
ket trades and surveys of how other institutions valued the assets. As the crisis
unfolded, Goldman marked mortgage-related securities at prices that were signifi-
cantly lower than those of other companies. Goldman knew that those lower marks
might hurt those other companies—including some clients—because they could re-
quire marking down those assets and similar assets. In addition, Goldman’s marks
would get picked up by competitors in dealer surveys. As a result, Goldman’s marks
could contribute to other companies recording “mark-to-market” losses: that is, the
reported value of their assets could fall and their earnings would decline.
The markdowns of these assets could also require that companies reduce their
repo borrowings or post additional collateral to counterparties to whom they had
sold credit default swap protection. In a May email, Craig Broderick, who as Gold-
man’s chief risk officer was responsible for tracking how much of the company’s
money was at risk, noted to colleagues that the mortgage group was “in the process
