(The opinions expressed here are those of Alison Frankel, a
columnist for Reuters.)
By Alison Frankel
NEW YORK It is an axiom of the financial
crisis that Goldman Sachs realized before any of the other big
banks that the mortgage-backed securities market was going to
implode in 2007. Goldman dumped MBS and shorted the market,
turning a profit in its mortgage department when every other
major financial institution suffered record losses.
So what tipped Goldman to start off-loading its MBS exposure
at the end of 2006? In a new brief in its securities fraud case
against the bank, the Federal Housing Finance Agency has an
According to the conservator for Fannie Mae and Freddie Mac,
Goldman received a report on December 10, 2006 from the CEO of
Senderra, a subprime mortgage lender partially owned by Goldman.
Goldman had taken a stake in Senderra -- a relatively small
mortgage originator -- to stay informed about the state of the
mortgage market, according to FHFA.
In the December 10 emailed report, Senderra CEO Brad Bradley
supplied grim market intelligence. "Credit quality has risen to
become the major crisis in the non-prime industry," he wrote to
Kevin Gasvoda, the head of Goldman's whole loan trading desk.
"We are seeing unprecedented defaults and fraud in the market,
inflated appraisals, inflated income and occupancy
Gasvoda forwarded the proprietary report to other Goldman
executives, along with what he called a "very telling" follow-up
email from Senderra that warned of "irrational" mortgage
originators chasing "any loan which smells of quality."
Four days later -- after the confidential Senderra report
circulated within the bank -- the head of Goldman's mortgage
department met with senior bank officials, including CFO David
Viniar, to discuss how Goldman could take advantage of the
imminent mortgage meltdown. That very day, according to the FHFA
brief, Goldman launched the sell-off of its MBS holdings.
"Goldman had unique and confidential access to the dire
warnings directly provided by its own affiliate and proprietary
originators that the sub-prime mortgage market was experiencing
'unprecedented defaults and fraud,'" the brief said. "Yet
Goldman failed to respond, except to the extent it sought to
profit through shorting the market."
FHFA's lawyers at Quinn Emanuel Urquhart & Sullivan contend
that the Senderra report is just one of the reasons that Goldman
should not be permitted to argue to a jury that it conducted a
reasonable investigation of the mortgage loans underlying the
securities it sold to Fannie and Freddie.
The agency has asked the judge overseeing the Fannie Mae and
Freddie Mac litigation, U.S. District Judge Denise Cote of
Manhattan, to grant summary judgment precluding Goldman from
asserting a so-called due diligence defense when the case goes
to trial on Sept. 29.
Goldman's diligence, according to the Fannie and Freddie
conservator, was at best "ramshackle" and at worst a tool of
deception. Either way, FHFA said, the bank did an inadequate
job, as a matter of law, of assuring that underlying mortgage
pools lived up to its promises to investors.
In addition to the Senderra email revelation, the other
marquee accusation in FHFA's new brief is that Goldman did
conduct independent investigations on the value of some of the
properties whose mortgages it bought from originators -- but the
bank supposedly used that information for its own benefit rather
than for the benefit of MBS investors.
The alleged duplicity involved a key MBS benchmark, the
ratio between the size of each underlying mortgage and the
actual value of the mortgaged property, otherwise known as the
loan-to-value ratio, or LTV.
If the property is worth less than it's mortgaged for,
homeowners are likelier to walk away from their loans, which
diminishes the stream of revenue to MBS noteholders.
In about 170 instances, according to the FHFA brief, after
Goldman ran its own checks on properties with apparently
outsized mortgages, it kicked those loans back to the mortgage
originators from which it had purchased them.
FHFA's brief said that Goldman then repurchased 11 of those
mortgages from originators at a discounted price, based on its
finding that the value of the property didn't justify the size
of the loan.
But according to the FHFA brief, when Goldman included the
repriced loans in MBS pools, it did not tell investors that the
loan-to-value ratio was out of whack. "Goldman used these 'final
values' to negotiate lower prices for itself," FHFA said, "but
it reported LTV ratios to investors based on the originators'
stated values -- which Goldman believed to be false."
I'm sure Goldman's lawyers at Sullivan & Cromwell will have
lots to say about FHFA's allegations when they file their
response to FHFA later this month. For starters, Goldman will
probably emphasize that FHFA has claimed it renegotiated prices
on a grand total of 11 underlying loans, of the tens of
thousands at issue in the case.
You can also expect the bank to argue that the Senderra
report in December 2010 was old news: The mortgage industry was
already rife with talk of loose underwriting standards and
In fact, according to a joint summary judgment brief filed
in June by three of the remaining FHFA defendants, including
Goldman, Fannie Mae and Freddie Mac knew those rumors as well as
anyone in the MBS marketplace. (Unfortunately, most of the
banks' specific evidence of what Fannie and Freddie were told in
2006 is redacted.)
Summary judgment is supposed to rest on undisputed facts,
and Goldman will certainly claim that the facts here are in
dispute. On the other hand, Judge Cote, as you know, has
consistently sided with FHFA in this litigation, which is why
banks have already coughed up $15 billion in settlements with
With a trial date only weeks away, is Goldman willing to
risk adverse summary judgment rulings that will increase FHFA's
Goldman still has one potential trump card -- a motion that
could end the litigation and make all of the banks that have
settled with FHFA wish they'd stuck it out too. But you'll have
to wait until my post tomorrow to find out what Goldman's Hail