Goldman's Timberwolf deal leads to much howling

NEW YORK Tue Apr 27, 2010 5:07pm EDT

NEW YORK (Reuters) - Lawmakers probing Goldman Sachs Group Inc's role in the financial crisis on Tuesday often pointed to a $1 billion subprime mortgage-linked security called Timberwolf 1, as a prime example of how the bank profited at its customers' expense.

At one point in the proceeding, Senator Carl Levin, the chairman of the Senate Permanent Subcommittee on Investigations, seemed to relish calling the Timberwolf transaction "one shitty deal.

Former Goldman mortgage executive Thomas Montag first used that description of the deal in an email.

This isn't the first time U.S. officials have taken a close look at the Timberwolf deal, a so-called hybrid collateralized debt obligation that Goldman took to market in March 2007, just as the U.S. housing market was beginning to crumble.

A team of federal prosecutors in Brooklyn, New York, also scrutinized the Timberwolf deal, said several people familiar with the investigation. They did so when pursuing a criminal case against two former Bear Stearns hedge fund managers because the Bear funds had been a major investor in that ill-fated CDO.

Federal authorities examined the deal because Goldman sold a $300 million portion of the CDO to the Bear funds in March 2007. Prosecutors were particularly intrigued by the fact that Goldman's mortgage trading desk began marking down the value of Timberwolf securities within a week of selling that $300 million slug to the Bear funds and smaller pieces of the deal to other institutional investors, the sources said.

NEW SPOTLIGHT

In fact, within five months, Timberwolf lost 80 percent of its value and was liquidated in 2008.

The Bear funds, which once controlled some $30 billion of CDOs and other subprime mortgage-linked securities, imploded in June 2007 when the funds could not meet a series of margin calls from a dozen Wall Street lenders, including Goldman.

The market for CDOs and other complex securities screeched to a halt after the Bear funds collapsed. Many on Wall Street peg the start of the financial crisis to the day the Bear funds were forced to shut down and liquidate in July 2007.

A year later, federal prosecutors charged former Bear hedge fund mangers Ralph Cioffi and Matthew Tannin with lying to their investors about the perilous state of the once giant funds. Last November, a jury acquitted Cioffi and Tannin of those charges.

The Timberwolf deal ultimately did not factor into the criminal case against Cioffi and Tannin. Prosecutors concluded there was no evidence of any wrongdoing by either the Bear managers or anyone at Goldman, said sources familiar with the situation, who declined to be identified because the inquiries by federal prosecutors were never made public.

But the Senate hearing into Goldman's role in the mortgage mess has thrown a new spotlight on the Timberwolf transaction, which was the focus of a good chunk of the 900 pages of Goldman emails and marketing materials released by the committee.

The committee, in a report released prior to Tuesday's hearing, said one reason Goldman underwrote the Timberwolf deal was so it had a mechanism to "short" the subprime housing market and make money from the collapse of the securities.

QUALMS CITED

During the hearing, former Goldman mortgage executive Daniel Sparks disputed the committee's characterization and said the firm lost more money than it made on Timberwolf.

Still, the deal, as one of the last big CDOs arranged by Goldman, has long been controversial.

Last August Reuters first reported that a number of people once associated with the Bear hedge funds had qualms about the Timberwolf deal. These people had argued that the Bear funds should avoid the deal, since Timberwolf's underlying portfolio was stuffed with many iffy mortgage-backed securities backed by subprime loans.

But Cioffi, the Bear fund's leader manager, went ahead with the purchase despite his colleagues' objections.

People close to the Bear funds also told Reuters last summer that Goldman's decision in April 2007 to begin marking down the value of Timberwolf securities may have hastened the funds' demise.

The quick markdowns also may have benefited Goldman, which was shorting portions of the Timberwolf deal by taking out credit default swaps on some of the subprime mortgage-linked securities that were tied to the deal.

But it may be hard for anyone associated with the Bear funds to argue they were a victim of Goldman. Soon after buying into the Timberwolf deal, the former Bear managers turned around and stuffed some $80 million of those same securities into another CDO being prepared by Bank of America.

In a lawsuit still pending in Manhattan federal court, Bank of America contends the Bear funds, which were charged with picking the collateral for that CDO, "disregarded" the bank's objections about Timberwolf and "caused the issuer to purchase the Timberwolf assets" anyway.

GREYWOLF ROLE

A lawyer for Cioffi, the Bear funds' main manager, could not be reached for comment.

It's not clear just how many other investors purchased Timberwolf securities, which included some securities sitting in Goldman's mortgage "warehouse." The Financial Times reported Tuesday that Basis Yield Alpha Fund, a now defunct Australian fund, was an investor.

Presumably there were other investors. The Senate committee released several Goldman emails in which employees of the firm congratulated each other for managing to sell the securities. Other emails suggest some Timberwolf securities were sold to investors in South Korea.

It is not clear just how much money Goldman lost or made on the Timberwolf deal, which was put together in conjunction with Greywolf Capital Management, a Purchase, New York, asset manager founded by a group of former Goldman distressed debt traders. Greywolf has declined to comment on the deal.

Internal Goldman documents released by the committee reveal the investment bank expected to take in about $7 million in fees from underwriting and selling the deal.

A prospectus for the transaction obtained by the website Zerohedge.com indicates that Goldman and Greywolf "may have interests different from or adverse" to the underlying portfolio of mortgage-backed securities tied to the Timberwolf deal.

Or in plain English, that means both Goldman and Greywolf might be shorting the deal.

(Reported by Matthew Goldstein; Editing by Steve Orlofsky)

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