Goldman Sachs controversies

On April 14, 2011, the United States Senate's Permanent Subcommittee on Investigations released a 635-page report entitled Wall Street and the Financial Crisis: Anatomy of a Financial Collapse which described some of the causes of the financial crisis. The report alleged that Goldman Sachs may have misled investors and profited from the collapse of the mortgage market at their expense.[22] The Chairman of the Subcommittee referred the report to the United States Department Of Justice to determine whether Goldman executives had broken the law,[23] and two months later the Manhattan district attorney subpoenaed Goldman for relevant information on possible securities fraud,[2][24] but on August 9 the Justice Department announced it had decided not to file charges against Goldman Sachs or its employees for trades made during the subprime mortgage portfolio.[25]

In April 2009, Floyd Norris, chief financial correspondent of the New York Times, accused Goldman Sachs of misleading investors by having "puffed up" its first quarter 2009 earnings by creating a December "orphan month" into which it shifted large write-downs, so they did not appear in any "quarterly number".[26][27] In April 2009, the company reported a $780 million net loss for the single month of December but reported net earnings of $1.81 billion for the first quarter of 2009.[26][28]

However, the accounting change to a calendar fiscal year, which created the stub month of December 2008, was required when the firm converted to a bank holding company and declared in Item 5.03 of its Form 8-K U.S. Securities and Exchange Commission (SEC) filing of December 15, 2008.[29] The December loss also included a $850 million mark-to-market write-down on loans to chemical maker LyondellBasell since it became clear in December that Lyondell would file for bankruptcy protection and would not be able to meet its debt obligations.[30]

While the results of December 2008 were detailed in the press release reporting the results of December 2008 and the first quarter of 2009 and the related conference call with analysts,[28] according to an article in the Washington Post by David S. Hilzenrath, "the company included a page of charts in its Monday news release showing its December results, but it didn't include a narrative description of those results as it did for the January-through-March period."[31]

Most financial analysts and the mainstream financial press were aware of the required change in fiscal year and deteriorating market conditions into December and were not surprised by the December loss. Analysts focused more on the first quarter results and the planned repayment of TARP funds, but even Merrill Lynch told its clients not to "forget about December".[32]

Merrill Lynch took at least $8.1 billion of losses in the same period,[33] and Morgan Stanley, which was also required to switch to a calendar year for accounting purposes as a result of its conversion to a bank holding company, also reported a large loss for its stub month of December, although, unlike Goldman, Morgan Stanley also lost money in the first quarter of 2009.[34]

In June 2009, after the firm repaid the TARP investment from the U.S. Treasury, Goldman made some of the largest bonus payments in its history due to its strong financial performance.[35][36] Andrew Cuomo, then New York Attorney General, questioned Goldman's decision to pay 953 employees bonuses of at least $1 million each after it received TARP funds in 2008.[37] That same period, however, CEO Lloyd Blankfein and 6 other senior executives opted to forgo bonuses, stating they believed it was the right thing to do, in light of "the fact that we are part of an industry that's directly associated with the ongoing economic distress".[38]

American International Group received $180 billion in government loans during the financial crisis. The money was used to repay customers of its security-lending program and was paid as collateral to counterparties under credit insurance contracts purchased from AIG. However, due to the size and nature of the payouts, there was considerable controversy in the media and amongst some politicians as to whether banks, including Goldman Sachs, should have been forced to take greater losses and should not have been paid in full via government loans to AIG.[26][39] The New York State Attorney General Andrew Cuomo announced in March 2009 that he was investigating whether AIG's trading counterparties improperly received government money.[40] Goldman Sachs was a major beneficiary of the government loans to AIG and received $12.9 billion during the unwind of credit default swap (CDS) contracts by AIG after receiving the government loans.[41]

Goldman Sachs maintained that its net exposure to AIG was 'not material', and that the firm was protected by hedges (in the form of CDSs with other counterparties) and $7.5 billion of collateral.[42] The firm stated the cost of these hedges to be over $100 million.[43] According to Goldman, both the collateral and CDSs would have protected the bank from incurring an economic loss in the event of an AIG bankruptcy (however, because AIG was bailed out and not allowed to fail, these hedges did not pay out).[44] CFO David Viniar stated that profits related to AIG in the first quarter of 2009 "rounded to zero", and profits in December were not significant. He went on to say that he was "mystified" by the interest the government and investors have shown in the bank's trading relationship with AIG.[45]

Considerable speculation remains that Goldman's hedges against its AIG exposure would not have paid out if AIG was allowed to fail. According to a report by the United States Office of the Inspector General of TARP, if AIG had collapsed, it would have made it difficult for Goldman to liquidate its trading positions with AIG, even at discounts, and it also would have put pressure on other counterparties that "might have made it difficult for Goldman Sachs to collect on the credit protection it had purchased against an AIG default."[46] Finally, the report said, an AIG default would have forced Goldman Sachs to bear the risk of declines in the value of billions of dollars in collateral debt obligations.

Goldman argued that CDSs are marked to market (i.e. valued at their current market price) and their positions netted between counterparties daily. Thus, as the cost of insuring AIG's obligations against default rose substantially in the lead-up to its bailout, the sellers of the CDS contracts had to post more collateral to Goldman Sachs. The firm claims this meant its hedges were effective and the firm would have been protected against an AIG bankruptcy and the risk of knock-on defaults, had AIG been allowed to fail.[43] However, in practice, the collateral would not protect fully against losses both because protection sellers would not be required to post collateral that covered the complete loss during a bankruptcy and because the value of the collateral would be highly uncertain following the repercussions of an AIG bankruptcy.[47] If the government let AIG default, according to money manager Michael Lewitt, "its collapse would be as close to an extinction-level event as the financial markets have seen since the Great Depression".[48]

Some have said, incorrectly according to others,[49] that Goldman Sachs received preferential treatment from the government by being the only Wall Street firm to have participated in the crucial September meetings at the New York Fed, which decided AIG's fate. Much of this has stemmed from an inaccurate but often quoted New York Times article.[50] The article was later corrected to state that Blankfein, CEO of Goldman Sachs, was "one of the Wall Street chief executives at the meeting" (emphasis added). Bloomberg has also reported that representatives from other firms were indeed present at the September AIG meetings.[51] Furthermore, Goldman Sachs CFO David Viniar stated that CEO Blankfein had never "met" with his predecessor and then-US Treasury Secretary Henry Paulson to discuss AIG;[52] However, there were frequent phone calls between the two of them.[53] Paulson was not present at the September meetings at the New York Fed. Morgan Stanley was hired by the Federal Reserve to advise on the AIG bailout.[54]

According to the New York Times, Paulson spoke with the CEO of Goldman Sachs two dozen times during the week of the bailout, though he obtained an ethics waiver before doing so.[55] While it is common for regulators to be in contact with market participants to gather valuable industry intelligence, particularly in a crisis, the Times noted he spoke with Goldman's Blankfein more frequently than with other large banks. Federal officials say that although Paulson was involved in decisions to rescue A.I.G, it was the Federal Reserve that played the lead role in shaping and financing the A.I.G. bailout.[55]

On May 10, 2009, Goldman Sachs agreed to pay up to $60 million to end an investigation by the Massachusetts attorney general's office into whether the firm helped promote unfair home loans in the state. The settlement will be used to reduce the mortgage payments of 714 Massachusetts residents who had secured subprime mortgages funded by Goldman Sachs. Michael DuVally, a spokesman for Goldman, said it was "pleased to have resolved this matter," and declined to comment further. This settlement may open the door to state government actions against Goldman throughout the United States aimed at securing compensation for predatory mortgage lending practices.[56]

Stephen Friedman, a former director of Goldman Sachs, was named Chairman of the Federal Reserve Bank of New York in January 2008. Although he had retired from Goldman in 1994, Friedman continued to own stock in the firm. Goldman's conversion from a securities firm to a bank holding company in September 2008 meant it was now regulated by the Fed and not the SEC. When it became apparent that Timothy Geithner, then president of the New York Fed, would leave his role there to become Treasury Secretary, Friedman was granted a temporary one-year waiver of a rule that forbids "class C" directors of the Fed from direct interest with those it regulates. Friedman agreed to remain on the board until the end of 2009 to provide continuity in the wake of the turmoil caused by Lehman Brothers' bankruptcy. Had the waiver not been granted, the New York Fed would have lost both its president and its chairman (or Friedman would have had to divest his Goldman shares).[83] This would have been highly disruptive for the New York Fed's role in the capital markets. Friedman later said he agreed to stay on the NY Fed board out of a sense of public duty, but that his decision was "being mischaracterized as improper".[84]

Media reports in May 2009 concerning Friedman's involvement with Goldman, and in particular, his purchase of the firm's stock when it traded at historical lows in the fourth quarter of 2008,[83] fueled controversy and criticism over what was seen as a conflict of interest in Friedman's new role as supervisor and regulator to Goldman Sachs. These events prompted his resignation on May 7, 2009. Although Friedman's purchases of Goldman stock did not violate any Fed rule, statute, or policy, he said that the Fed did not need this distraction. He also stated his purchases, made while approval of a waiver was pending, were motivated by a desire to demonstrate confidence in the company during a time of market distress.[85]

Rajat Gupta

In April 2010, Goldman director Rajat Gupta was named in an insider-trading case. It was said Gupta had "tipped off a hedge-fund billionaire", Raj Rajaratnam of Galleon Group, about the $5 billion Berkshire Hathaway investment in Goldman during the financial crisis of 2007–2008. According to the report, Gupta had told Goldman the month before his involvement became public that he wouldn't seek re-election as a director.[20] In early 2011, with the delayed Rajaratnam criminal trial about to begin,[88] the United States Securities and Exchange Commission (SEC) announced civil charges against Gupta covering the Berkshire investment as well as confidential quarterly earnings information from Goldman and Procter & Gamble (P&G). Gupta was board member at P&G until voluntarily resigning the day of the SEC announcement, after the charges were announced. "Gupta was an investor in some of the Galleon hedge funds when he passed the information along, and he had other business interests with Rajaratnam that were potentially lucrative.... Rajaratnam used the information from Gupta to illegally profit in hedge fund trades.... The information on Goldman made Rajaratnam's funds $17 million richer.... The Procter & Gamble data created illegal profits of more than $570,000 for Galleon funds managed by others, the SEC said." Gupta was said to have "vigorously denied the SEC accusations". He was also a board member of AMR Corporation.[89]

Gupta was convicted in June 2012 on insider trading charges stemming from Galleon Group case on four criminal felony counts of conspiracy and securities fraud. He was sentenced in October 2012 to two years in prison, an additional year on supervised release and ordered to pay $5 million in fines.[90]

In April 2010, the U.S. Securities and Exchange Commission (SEC) charged Goldman Sachs and one of its vice-presidents, Fabrice Tourre, with securities fraud. The SEC alleged that Goldman had told buyers of a synthetic CDO, a type of investment, that the underlying assets in the investment had been picked by an independent CDO manager, ACA Management. In fact, Paulson & Co. a hedge fund that wanted to bet against the investment had played a "significant role" in the selection,[3] and the package of securities turned out to become "one of the worst-performing mortgage deals of the housing crisis" because "less than a year after the deal was completed, 100% of the bonds selected for Abacus had been downgraded".[101]

The particular synthetic CDO that the SEC's 2010 fraud suit charged Goldman with misleading investors with was called Abacus 2007-AC1. Unlike many of the Abacus securities, 2007-AC1 did not have Goldman Sachs as a short seller, in fact, Goldman Sachs lost money on the deal.[102] That position was taken by the customer (John Paulson) who hired Goldman to issue the security (according to the SEC's complaint). Paulson and his employees selected 90 BBB-rated mortgage bonds[101][103] that they believed were most likely to lose value and so the best bet to buy insurance for.[4] Paulson and the manager of the CDO, ACA Management, worked on the portfolio of 90 bonds to be insured (ACA allegedly unaware of Paulson's short position), coming to an agreement in late February 2007.[103] Paulson paid Goldman approximately US$15 million for its work in the deal.[104] Paulson ultimately made a US$1 billion profit from the short investments, the profits coming from the losses of the investors and their insurers. These were primarily IKB Deutsche Industriebank (US$150 million loss), and the investors and insurers of another US$900 million—ACA Financial Guaranty Corp,[105] ABN AMRO, and the Royal Bank of Scotland.[106][107]

The SEC alleged that Goldman "materially misstated and omitted facts in disclosure documents" about the financial security,[3] including the fact that it had "permitted a client that was betting against the mortgage market [the hedge fund manager Paulson & Co.] to heavily influence which mortgage securities to include in an investment portfolio, while telling other investors that the securities were selected by an independent, objective third party," ACA Management.[106][108] The SEC further alleged that "Tourre also misled ACA into believing ... that Paulson's interests in the collateral section [sic] process were aligned with ACA's, when in reality Paulson's interests were sharply conflicting."[106]

In reply Goldman issued a statement saying the SEC's charges were "unfounded in law and fact", and in later statements maintained that it had not structured the portfolio to lose money,[109] that it had provided extensive disclosure to the long investors in the CDO, that it had lost $90 million, that ACA selected the portfolio without Goldman suggesting Paulson was to be a long investor, that it did not disclose the identities of a buyer to a seller and vice versa as it was not normal business practice for a market maker,[109] and that ACA was itself the largest purchaser of the Abacus pool, investing US$951 million. Goldman also stated that any investor losses resulted from the overall negative performance of the entire sector, rather than from a particular security in the CDO.[109][110]

While some journalists and analysts have called these statements misleading,[111] others believed Goldman's defense was strong and the SEC's case was weak.[112][113][114]

Some experts on securities law such as Duke University law professor James Cox, believed the suit had merit because Goldman was aware of the relevance of Paulson's involvement and took steps to downplay it. Others, including Wayne State University Law School law professor Peter Henning, noted that the major purchasers were sophisticated investors capable of accurately assessing the risks involved, even without knowledge of the part played by Paulson.[115]

Critics of Goldman Sachs point out that Paulson went to Goldman Sachs after being turned down for ethical reasons by another investment bank, Bear Stearns who he had asked to build a CDO. Ira Wagner, the head of Bear Stearns's CDO Group in 2007, told the Financial Crisis Inquiry Commission that having the short investors select the referenced collateral as a serious conflict of interest and the structure of the deal Paulson was proposing encouraged Paulson to pick the worst assets.[116][117] Describing Bear Stearns's reasoning, one author compared the deal to "a bettor asking a football owner to bench a star quarterback to improve the odds of his wager against the team."[118] Goldman claimed it lost $90 million, critics maintain it was simply unable (not due to a lack of trying) to shed its position before the underlying securities defaulted.[102]

Critics also question whether the deal was ethical, even if it was legal.[119][120] Goldman had considerable advantages over its long customers. According to McLean and Nocera there were dozens of securities being insured in the CDO—for example, another ABACUS[121]—had 130 credits from several different mortgage originators, commercial mortgage-backed securities, debt from Sallie Mae, credit cards, etc. Goldman bought mortgages to create securities, which made it "far more likely than its clients to have early knowledge" that the housing bubble was deflating and the mortgage originators like New Century had begun to falsify documentation and sell mortgages to customers unable to pay the mortgage-holders back[122]—which is why the fine print on at least one ABACUS prospectus warned long investors that the 'Protection Buyer' (Goldman) 'may have information, including material, non-public information' which it was not providing to the long investors.[122]

According to an article in the Houston Chronicle, critics also worried that Abacus might undermine the position of the US "as a safe harbor for the world's investors" and that "The involvement of European interests as losers in this allegedly fixed game has attracted the attention of that region's political leaders, most notably British Prime Minister Gordon Brown, who has accused Goldman of "moral bankruptcy". This is, in short, a big global story ... Is what Goldman Sachs did with its Abacus investment vehicle illegal? That will be for the courts to decide, ... But it doesn't take a judge and jury to conclude that, legalities aside, this was just wrong."[120]

On July 15, 2010, Goldman settled out of court, agreeing to pay the SEC and investors US$550 million, including $300 million to the U.S. government and $250 million to investors, one of the largest penalties ever paid by a Wall Street firm.[4] In August 2013 Tourre was found liable on 6 of 7 counts by a federal jury.[123][124] The company did not admit or deny wrongdoing, but did admit that its marketing materials for the investment "contained incomplete information", and agreed to change some of its business practices regarding mortgage investments.[4]

The 2010 Goldman settlement did not cover charges against Goldman vice president and salesman for ABACUS, Fabrice Tourre.[4][102]

Tourre unsuccessfully sought a dismissal of the suit,[125] which then went to trial in 2013. On August 1, a federal jury found Tourre liable on six of seven counts, including that he misled investors about the mortgage deal. He was found not liable on the charge that he had deliberately made an untrue or misleading statement.[124]

Frederick Kaufman, a contributing editor of Harper's Magazine, argued in a 2010 article that Goldman's creation of the Goldman Sachs Commodity Index (now the S&P GSCI) helped passive investors such as pension funds, mutual funds and others engage in food price Speculation by betting on financial products based on the commodity index. These financial products disturbed the normal relationship between supply and demand, making prices more volatile and defeating the price stabilization mechanism of the futures exchange.[128][129][130]

A June 2010 article in The Economist defended commodity investors and oil index-tracking funds, citing a report by the Organisation for Economic Co-operation and Development that found that commodities without futures markets and ignored by index-tracking funds also saw price rises during the period.[131]

In a July 2013 article, David Kocieniewski, a journalist with The New York Times accused Goldman Sachs and other Wall Street firms of "capitalizing on loosened federal regulations" to manipulate "a variety of commodities markets", particularly aluminum, citing "financial records, regulatory documents and interviews with people involved in the activities."[21] After Goldman Sachs purchased aluminum warehousing company Metro International in 2010, the wait of warehouse customers for delivery of aluminum supplies to their factories—to make beer cans, home siding and other products—went from an average of 6 weeks to more than 16 months, "according to industry records."[12][21] "Aluminum industry analysts say that the lengthy delays at Metro International after Goldman took over are a major reason the premium on all aluminum sold in the spot market has doubled since 2010."[21] The price increase has cost "American consumers more than $5 billion" from 2010 to 2013 according to former industry executives, analysts and consultants.[21] The cause of this was alleged to be Goldman's ownership of a quarter of the national supply of aluminum—a million and a half tons—in network of 27 Metro International warehouses Goldman owns in Detroit, Michigan.[21][132] To avoid hoarding and price manipulation, the London Metal Exchange requires that "at least 3,000 tons of that metal must be moved out each day". Goldman has dealt with this requirement by moving the aluminum—not to factories, but "from one warehouse to another"—according to the Times.[21]

In August 2013, Goldman Sachs was subpoenaed by the federal Commodity Futures Trading Commission as part of an investigation into complaints that Goldman-owned metals warehouses had "intentionally created delays and inflated the price of aluminum."[133] In December 2013, it was announced that 26 cases accusing Goldman Sachs and JPMorgan Chase, the two investment banks' warehousing businesses, and the London Metal Exchange in various combinations—of violating U.S. antitrust laws, would be assigned to United States District Court for the Southern District of New York Judge Katherine B. Forrest in Manhattan.[134]

According to Lydia DePillis of Wonkblog, when Goldman bought the warehouses it "started paying traders extra to bring their metal" to Goldman's warehouses "rather than anywhere else. The longer it stays, the more rent Goldman can charge, which is then passed on to the buyer in the form of a premium."[135] The effect is "amplified" by another company, Glencore, which is "doing the same thing in its warehouse in Vlissingen".[135]

Michael DuVally, a spokesman for Goldman Sachs, said the cases are without merit.[134] Robert Lenzner, a columnist at Forbes, wrote that Goldman Sachs controls only 3% of the global market and is therefore too small to have pricing power.[136] An article published by Bloomberg L.P. also debunked the conspiracy theory.[137]

In December 2014, Goldman Sachs sold its aluminum warehousing business to Ruben Brothers.[138][139][140]

Investment banks, including Goldman, have also been accused of driving up the price of gasoline by speculating on the oil futures exchange. In August 2011, "confidential documents" were leaked "detailing the positions"[141] in the oil futures market of several investment banks, including Goldman Sachs, Morgan Stanley, JPMorgan Chase, Deutsche Bank, and Barclays, just before the peak in gasoline prices in the summer of 2008. The presence of positions by investment banks on the market was significant for the fact that the banks have deep pockets, and so the means to significantly sway prices, and unlike traditional market participants, neither produced oil nor ever took physical possession of actual barrels of oil they bought and sold. Journalist Kate Sheppard of Mother Jones called it "a development that many say is artificially raising the price of crude".[141] However, another source stated that "Just before crude oil hit its record high in mid-2008, 15 of the world's largest banks were betting that prices would fall, according to private trading data...."[142]

In April 2011, a couple of observers—Brad Johnson of the blog Climate Progress,[143] founded by Joseph J. Romm, and Alain Sherter of CBS MoneyWatch[144]—noted that Goldman Sachs was warning investors of a dangerous spike in the price of oil. Climate Progress quoted Goldman as warning "that the price of oil has grown out of control due to excessive speculation" in petroleum futures, and that "net speculative positions are four times as high as in June 2008." when the price of oil peaked.[142]

It stated that "Goldman Sachs told its clients that it believed speculators like itself had artificially driven the price of oil at least $20 higher than supply and demand dictate."[143] Sherter noted that Goldman's concern over speculation did not prevent it (along with other speculators) from lobbying against regulations by the Commodity Futures Trading Commission to establish "position limits", which would cap the number of futures contracts a trader can hold, and thus prevent speculation.[144]

According to Joseph P. Kennedy II, by 2012, prices on the oil commodity market had become influenced by "hedge funds and bankers" pumping "billions of purely speculative dollars into commodity exchanges, chasing a limited number of barrels and driving up the price".[145] The problem started, according to Kennedy, in 1991, when

just a few years after oil futures began trading on the New York Mercantile Exchange, Goldman Sachs made an argument to the Commodity Futures Trading Commission that Wall Street dealers who put down big bets on oil should be considered legitimate hedgers and granted an exemption from regulatory limits on their trades. The commission granted an exemption that ultimately allowed Goldman Sachs to process billions of dollars in speculative oil trades. Other exemptions followed[145]

and "by 2008, eight investment banks accounted for 32% of the total oil futures market."[145]