SENATOR COLLINS QUESTIONS GOLDMAN SACHS EXECUTIVES ABOUT HOUSING MARKET COLLAPSE, CLIENT COMMITMENT
Senator Susan Collins, Ranking Member of the Senate Homeland Security and Governmental Affairs Committee, questioned Goldman Sachs executives regarding questionable business practices that critics have said helped lead to the collapse of the U.S. housing market.
The firm, charged by the Securities and Exchange Commission with securities fraud, also reportedly sold mortgage-related investment products to clients and then “bet” that those products would fail by taking what are called “short” positions in the market – a decision that reaped the company billions of dollars when the housing market did indeed collapse.
Senator Collins noted that top-tier investment banks such as Goldman Sachs do not have a fiduciary responsibility to their clients, something that financial advisers do have. The results, she said, “are conflicts of interest” that helped create the economic damage that ensued.
The hearing was the latest before the Senate's Permanent Subcommittee on Investigations, headed by Sen. Carl Levin (D-Mich.), which is examining the roles of various industry sectors in the collapse of financial markets. Senator Collins gave an opening statement at the start of Tuesday’s hearing. That text is below:
“Mr. Chairman, thank you for leading this investigation into the root causes of the Great Recession of 2008. You and the Ranking Member, Senator Coburn, have cast a bright light into the dark corners of financial institutions that helped to inflate the housing bubble and then reaped billions of dollars when it burst, leaving millions of Americans in debt and jobless, with destroyed dreams and financial insecurity.
“This investigation raises two overarching issues. First, we must recognize that the dynamic innovation of our capital markets can have a downside. It can produce pain rather than prosperity. Financial markets require updated and effective regulation to help prevent excesses that can inflict great harm on wholly innocent Americans -- be they workers, retirees, or small business owners.
“The lack of regulation of the trillions of dollars in credit default swaps is a prime example. That is why it is so important that financial regulatory reform legislation include a council of regulators whose job it will be to assess systemic risk and to identify regulatory gaps.
“I recognize that even measured regulation may limit the potential benefits that unfettered markets can produce. The question, however, is whether those benefits are outweighed by the terrible harm such markets can cause. Recent history certainly suggests that is the case, that the combination of lax or absent regulation plus unbridled greed can produce devastating results.
“Second, even legal practices may raise ethical concerns. Assuming Goldman's role as a market maker and its desire to hedge its risk provided legal justification for some of its practices -- a question that must ultimately be decided by the courts -- there is something unseemly about Goldman betting against the housing market at the same time that it is selling to its clients mortgage-backed securities containing toxic loans.
“And it is unsettling to read emails of Goldman executives celebrating the collapse of the housing market when the reality for millions of Americans is lost homes and disappearing jobs. That is especially the case in light of Goldman's decision to opt for status as a bank holding company to secure benefits effectively underwritten, at least in part, by those same Americans.
“During its previous hearings on the financial crisis, this Subcommittee revealed the reckless, and at times predatory, lending behavior of some mortgage brokers and banks like Washington Mutual. These banks discarded decades of reliable and pragmatic lending practices. Instead, they opted to offer high-risk loans to borrowers whom they knew could not afford to repay them. “Traditionally, such behavior would have exposed the originating banks to high levels of unacceptable risk. In other words, the offending banks would have paid dearly for their own underwriting errors.
“But with the advent of “securitization” during the past decade, lenders have been able to insulate themselves by selling off toxic loans -- pitching them as assets to investment banks. Those investment banks, in turn, bundled the toxic loans inside mortgage-backed securities, which were then bought and sold by investors.
“The cash that flowed back to the banks from investors buying these securities only made matters worse. The cash was akin to throwing fuel on the hot fire of greed and recklessness. The in-flow of dollars encouraged loan originators to put that money to work again and again and again, turning over loan applications as quickly as possible, applying little scrutiny because they ultimately had no stake in the loan.
“This cycle was based on a dangerous and false assumption that the housing market would always move upward. It was based on the fantasy, the myth, that what goes up stays up, and never comes crashing down. “When it all collapsed, like a house of cards, we realized too late how incredibly fragile and tragically interconnected the system had become. The fallout wasn’t limited; the debris field wasn’t contained. The damage was widespread, profound, and nearly catastrophic.
“The architects of this scheme entangled neighborhood banks and large brokerage firms across America; their toxic linkages ensnared borrowers and investors from Main Street to Wall Street. They deluded themselves into believing that the basic principles could be defied and ignored. And when that delusion met reality, the bubble burst.
“Today we will look at the top tier of this system – a major investment bank – and examine how its trading practices amplified the rise and fall of the housing market. Today’s witnesses are from Goldman Sachs, which was one of the few Wall Street firms to actually profit from the financial crisis.
“This hearing is not to celebrate that ignoble feat; rather, it is to examine how the trading practices of Goldman during that time made such profits possible. It is to examine how Goldman sold financial products that were tied to the health of the housing market even while Goldman itself was betting that the housing market would collapse.
“The SEC case accuses Goldman Sachs of marketing a complex product to its clients while allegedly failing to disclose that the same company that hand-selected the components, the hedge fund Paulson & Company, also planned to bet on its failure. Goldman sold the product to long-time, trusting clients without disclosing this fact. The “bet” Paulson made earned him $1 billion, while at least one of Goldman’s clients – a German bank – went bankrupt.
“Although Goldman lost money on that particular deal, it reaped billions of dollars in the mortgage-backed securities market as a whole. While the market was on the verge of collapse, Goldman decided to go short, and earned billions from that strategy. Some have alleged that Goldman did so while continuing to sell clients long investments in the mortgage markets. While such conflicts of interest may not be illegal, they certainly seem ethically questionable. And these conflicts of interest appear to be rooted in the fact that broker/ dealers do not have a fiduciary obligation to their clients. That is an issue we will be considering.
“The system must be reformed so that Wall Street banks are not seen as unscrupulous operators who seek to profit from the public’s misfortune, even as they are pitching toxic investments and even as hard-working, struggling taxpayers are left to pick up the tab.”
The firm, charged by the Securities and Exchange Commission with securities fraud, also reportedly sold mortgage-related investment products to clients and then “bet” that those products would fail by taking what are called “short” positions in the market – a decision that reaped the company billions of dollars when the housing market did indeed collapse.
Senator Collins noted that top-tier investment banks such as Goldman Sachs do not have a fiduciary responsibility to their clients, something that financial advisers do have. The results, she said, “are conflicts of interest” that helped create the economic damage that ensued.
The hearing was the latest before the Senate's Permanent Subcommittee on Investigations, headed by Sen. Carl Levin (D-Mich.), which is examining the roles of various industry sectors in the collapse of financial markets. Senator Collins gave an opening statement at the start of Tuesday’s hearing. That text is below:
“Mr. Chairman, thank you for leading this investigation into the root causes of the Great Recession of 2008. You and the Ranking Member, Senator Coburn, have cast a bright light into the dark corners of financial institutions that helped to inflate the housing bubble and then reaped billions of dollars when it burst, leaving millions of Americans in debt and jobless, with destroyed dreams and financial insecurity.
“This investigation raises two overarching issues. First, we must recognize that the dynamic innovation of our capital markets can have a downside. It can produce pain rather than prosperity. Financial markets require updated and effective regulation to help prevent excesses that can inflict great harm on wholly innocent Americans -- be they workers, retirees, or small business owners.
“The lack of regulation of the trillions of dollars in credit default swaps is a prime example. That is why it is so important that financial regulatory reform legislation include a council of regulators whose job it will be to assess systemic risk and to identify regulatory gaps.
“I recognize that even measured regulation may limit the potential benefits that unfettered markets can produce. The question, however, is whether those benefits are outweighed by the terrible harm such markets can cause. Recent history certainly suggests that is the case, that the combination of lax or absent regulation plus unbridled greed can produce devastating results.
“Second, even legal practices may raise ethical concerns. Assuming Goldman's role as a market maker and its desire to hedge its risk provided legal justification for some of its practices -- a question that must ultimately be decided by the courts -- there is something unseemly about Goldman betting against the housing market at the same time that it is selling to its clients mortgage-backed securities containing toxic loans.
“And it is unsettling to read emails of Goldman executives celebrating the collapse of the housing market when the reality for millions of Americans is lost homes and disappearing jobs. That is especially the case in light of Goldman's decision to opt for status as a bank holding company to secure benefits effectively underwritten, at least in part, by those same Americans.
“During its previous hearings on the financial crisis, this Subcommittee revealed the reckless, and at times predatory, lending behavior of some mortgage brokers and banks like Washington Mutual. These banks discarded decades of reliable and pragmatic lending practices. Instead, they opted to offer high-risk loans to borrowers whom they knew could not afford to repay them. “Traditionally, such behavior would have exposed the originating banks to high levels of unacceptable risk. In other words, the offending banks would have paid dearly for their own underwriting errors.
“But with the advent of “securitization” during the past decade, lenders have been able to insulate themselves by selling off toxic loans -- pitching them as assets to investment banks. Those investment banks, in turn, bundled the toxic loans inside mortgage-backed securities, which were then bought and sold by investors.
“The cash that flowed back to the banks from investors buying these securities only made matters worse. The cash was akin to throwing fuel on the hot fire of greed and recklessness. The in-flow of dollars encouraged loan originators to put that money to work again and again and again, turning over loan applications as quickly as possible, applying little scrutiny because they ultimately had no stake in the loan.
“This cycle was based on a dangerous and false assumption that the housing market would always move upward. It was based on the fantasy, the myth, that what goes up stays up, and never comes crashing down. “When it all collapsed, like a house of cards, we realized too late how incredibly fragile and tragically interconnected the system had become. The fallout wasn’t limited; the debris field wasn’t contained. The damage was widespread, profound, and nearly catastrophic.
“The architects of this scheme entangled neighborhood banks and large brokerage firms across America; their toxic linkages ensnared borrowers and investors from Main Street to Wall Street. They deluded themselves into believing that the basic principles could be defied and ignored. And when that delusion met reality, the bubble burst.
“Today we will look at the top tier of this system – a major investment bank – and examine how its trading practices amplified the rise and fall of the housing market. Today’s witnesses are from Goldman Sachs, which was one of the few Wall Street firms to actually profit from the financial crisis.
“This hearing is not to celebrate that ignoble feat; rather, it is to examine how the trading practices of Goldman during that time made such profits possible. It is to examine how Goldman sold financial products that were tied to the health of the housing market even while Goldman itself was betting that the housing market would collapse.
“The SEC case accuses Goldman Sachs of marketing a complex product to its clients while allegedly failing to disclose that the same company that hand-selected the components, the hedge fund Paulson & Company, also planned to bet on its failure. Goldman sold the product to long-time, trusting clients without disclosing this fact. The “bet” Paulson made earned him $1 billion, while at least one of Goldman’s clients – a German bank – went bankrupt.
“Although Goldman lost money on that particular deal, it reaped billions of dollars in the mortgage-backed securities market as a whole. While the market was on the verge of collapse, Goldman decided to go short, and earned billions from that strategy. Some have alleged that Goldman did so while continuing to sell clients long investments in the mortgage markets. While such conflicts of interest may not be illegal, they certainly seem ethically questionable. And these conflicts of interest appear to be rooted in the fact that broker/ dealers do not have a fiduciary obligation to their clients. That is an issue we will be considering.
“The system must be reformed so that Wall Street banks are not seen as unscrupulous operators who seek to profit from the public’s misfortune, even as they are pitching toxic investments and even as hard-working, struggling taxpayers are left to pick up the tab.”
