The executive at the center of the government's fraud suit against Goldman Sachs told lawmakers Tuesday that the complex financial product at the center of the suit was not purposely designed to fail, even as Democrats tried to use the investment bank’s problems to underscore the need for tighter financial regulation.
"I deny categorically the SEC's allegations," Fabrice Tourre, 31, told the Senate Permanent Subcommittee on Investigations. "I will defend myself in court against this false claim."
The panel said an 18-month probe by Senate investigators revealed Goldman Sachs made and held bets against the general mortgage market – called short positions – and often bet against securities that Goldman had assembled and marketed to clients.
In an Securities and Exchange Commission suit filed earlier this month, Tourre and the bank were accused of creating a collateralized debt obligation (CBO) product linked to subprime mortgages. The SEC has maintained that Tourre and Goldman Sachs didn't tell investors that hedge fund Paulson & Co. helped choose the underlying securities and was betting against the product.
But Tourre said there were only two investors -- bond insurer ACA and the German bank IKB-- and that both were "sophisticated institutional investors."
"I did not mislead" them, Tourre insisted.
Panel members on Tuesday accused Goldman of manufacturing multiple deals designed to profit from the collapsing U.S. mortgage market – taking allegations beyond the single deal outlined in civil fraud charges by the SEC.
Sen. Carl Levin (D-MI) said documents show Goldman Sachs put its own interests ahead of its clients. He said the company repeatedly bundled toxic mortgages into financial products that were sold to clients, while Goldman bet against the success of th eproducts.
"As we speak, lobbyists fill the halls of Congress, hoping to weaken or kill legislation aimed at reforming these abuses," Levin told the Goldman Sachs executives. "Wall Street is on the wrong side of this fight."
Senate Democrats are scheduled to hold a test vote on the financial overhaul Tuesday afternoon. In a similar action Monday, Democrats failed to gain the 60 votes needed to move ahead with the legislation.
Goldman CEO Lloyd Blankfein, who testifies later, is expected to tell the panel that the company was just trying to manage its own risk as the U.S. economy slumped into recession.
In prepared testimony released Monday, Blankfein said Goldman Sachs was not profiteering by selling its own investments short. The firm has said between 2007 and 2008, it lost more than $1 billion in mortgage-related securities.
But Levin maintained the company made $3.7 billion during 2007 by betting against securities that were linked to mortgages.
"Goldman used financial engineering, selling them (financial products laden with toxic mortgages) to pension funds spreading the poison throughout the system," Levin said.
Blankfein is scheduled to be the last witness. In his prepared testimony, the Goldman CEO strongly denied the company did anything wrong. But he also took a conciliatory tone, saying he knows the complex deals look bad to the public.
Goldman Sachs has faced mounting legal problems since the SEC filed civil fraud charges earlier this month. On Monday, shareholders filed suit in Manhattan federal court alleging the company and Blankfein hid information about a risky transaction that led to the SEC action.
It was the third shareholder lawsuit filed since Friday -- a reaction to the SEC civil fraud lawsuit filed April 16. The SEC maintains that Goldman Sachs structured and marketed a collateralized debt obligation that hinged on the performance of subprime residential mortgage-backed securities. But the company failed to tell investors that a major hedge fund -- Paulson & Co. -- helped pick the underlying securities in the CDO and was betting against it.
"Goldman wrongly permitted a client that was betting against the mortgage market 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," said Robert Khuzami, director of the SEC's enforcement division.
Paulson & Co., one of the world's largest hedge funds, has not been accused of wrongdoing.
Goldman has fought back against the fraud charges with a public relations blitz aimed at discrediting the SEC's case and repairing the bank's reputation. Some big clients are publicly backing the firm. But its stock has yet to recover from the fall that followed the SEC lawsuit on April 16.
The subcommittee, which is investigating Goldman's role in the financial crisis, provided excerpts of e-mails showing a progression from late 2006 through the full-blown mortgage crisis a year later. Levin said they show Goldman shifted in early 2007 from neutral to a short position, betting that the mortgage market was likely to collapse.
"That directional change is mighty clear," Levin said. "They decided to go gangbusters selling those securities" while knowing they were toxic.
The 140-year-old investment house's trading strategy in recent years enabled it to weather the financial crisis better than most other big banks. It earned a blowout $3.3 billion in the first quarter of this year.
