Washington – The chairman and CEO of investment titan Goldman Sachs acknowledged Wednesday that his company had engaged in “improper” behavior when it made financial bets against $40 billion in securities backed by risky U.S. home loans that it was selling to investors as safe products.
Lloyd Blankfein made the shocking acknowledgement before the Financial Crisis Inquiry Commission, a 10-member panel that Congress created to look into the causes of the worst financial crisis since the Great Depression.
In November, McClatchy reported exclusively that in 2006 and 2007, Goldman sold more than $40 billion in bonds backed by over 200,000 in risky home mortgages while secretly betting on a sharp downturn in housing prices that would depress the value of those securities.
During today’s inaugural hearing, the CEOs of the nation’s most prominent banks also acknowledged serious flaws in their models and business practices that helped bring about the nation’s financial crisis.
Many of the toughest questions from panel members were put to Blankfein, whose firm is a goliath and a virtual farm team for top government posts in the White House and at the Treasury Department.
Commission Chairman Phil Angelides, a former California state treasurer, warned Blankfein that he’d be “brutally honest” in his questioning. Then he went straight to the question of why Goldman thought it was necessary to take out protection against securities it was selling by purchasing insurance-like credit-default swaps. Angelides likened it to selling a car while knowing that its brakes were bad.
Blankfein acknowledged “that the behavior is improper, and I regret the consequence that people have lost money in it.” However, he went on to defend his company’s role as a market maker, suggesting it’s a middleman that’s exposed to risks both on what it buys and what it sells.
The heads of JPMorgan Chase, Morgan Stanley and Bank of America acknowledged that they’d paid a huge price for failing to build the possibility of declines in home prices into their risk-management models.
That failure had disastrous consequences, since the banks packaged mortgages into pools that were sold to investors worldwide as securities, often with top ratings from credit-rating agencies such as Moody’s Investors Service. When home prices fell, these securities lost money, faith was lost in credit ratings and panic was amplified by the insurance-like bets that were taken out by the very companies that were offering these “safe” securities.
“Given enough time, everything will happen, not can happen,” Blankfein said, noting that in the aftermath of the housing meltdown his firm models for even the most improbable scenarios in all its lines of business.
James Dimon, the CEO of JPMorgan Chase, the bank that’s emerged the least tarnished in the crisis, said that in retrospect it should have been obvious that mortgages given to people with little or no proof of income was a terrible idea that should have sparked concern.
However, Dimon cautioned, “You never saw losses in these products, because home prices were going up.”
The sector’s failure, he added, was the assumption that prices can only go up.
“I would say that was one of the big misses,” Dimon said. “That is now part of the stress test” that JPMorgan conducts.
Bank of America’s new CEO, Brian Moynihan, said that post-crisis, his company modeled for a range of improbable but possible scenarios in all areas where it extended credit.
Another criticism of most of the big banks that packaged mortgages into securities is that they didn’t retain portions of what they were selling. They weren’t exposed themselves to the risk that they were exposing others to. In plain speaking, they weren’t eating their own cooking.
“We did eat our own cooking, and we choked on it,” John Mack, the chairman of Morgan Stanley, said in one of the frankest exchanges of the morning.
Many academics and financial analysts think that one major cause of the crisis was the Federal Reserve keeping its benchmark interest rates low for an unusually long period after the economic shock from the 9/11 terrorist attacks. Former Fed Chairman Alan Greenspan denies that the low lending rates, which amounted to cheap money, sparked an unsustainable rise in home prices.
Bank CEOs said Wednesday that they thought that the era of cheap money was a contributing factor, their own shortcomings notwithstanding.
“The commodity of money got less scarce, and people paid less attention to it,” Blankfein said, adding that this led to a “lack of rigor” in a number of transactions. He said that the global economy had been booming, technology was bringing numerous advances and the good mood clouded judgment.
At a later point in the hearing, JPMorgan’s Dimon agreed that low lending rates helped foster the weakened lending standards.
“I do think it’s part of the problem, taken as a whole,” he said.
Just before releasing the bank CEOs from testimony, Angelides doubled back on Goldman Sachs, criticizing Blankfein for failing to acknowledge publicly that the 2008 bailout of the financial sector saved his firm. Investment banks such as Goldman and Morgan Stanley saw the value of their stocks plunge, and it wasn’t until the Federal Reserve allowed them to become bank holding companies, subject to greater regulation, that the run on bank stocks eased.
Angelides then compared Goldman’s sale of securities it was betting against to the 1920s, when Wall Street firms peddled Latin American debt to investors while knowing that default was probable.
“At what point do you have a responsibility? What is the sense of responsibility?” he asked Blankfein, who answered that his firm sold complex securities to big institutional investors that wanted exposure to risk and were just as much to blame for the lack of due diligence.
Blankfein did acknowledge that his firm, and others that packaged mortgages for sale as securities, had amplified bad mortgage lending because they provided more funding for lenders who were eroding their own standards, with consequences later borne by every American.