On January 4, 2008 I published an online article, “Goldman’s Toxic CMOs” (Collateralized Mortgage Obligations), exposing the fraudulent manner in which Goldman Sachs not only sold its toxic CMOs, but the manner in which Goldman Sachs traded against these CMOs, which Goldman had sold to its customers.
On January 11, 2008, I wrote letters, calling for an investigation into Goldman Sachs’ sales of worthless CMOs to the company’s customers, and sent copies to Christopher Cox, Chairman of the Securities and Exchange Commission; to Anne Nazareth, Paul Atkins and Kathleen Casey, Commissioners of the SEC; to Michael Mukasey, Attorney General of the United States; and to Michael Garcia, United States Attorney for the Southern District of the State of New York. I concluded these letters with this paragraph:
“In the 1970’s Goldman Sachs signed a consent decree with the Securities and Exchange Commission concerning Goldman’s dumping of Penn Central commercial paper unto Goldman’s unknowing customers. Goldman’s dumping of toxic CMOs merits an SEC investigation and enforcement action. Goldman Sachs is responsible for the losses on the CMOs that Goldman Sachs dumped on its unwary customers.”
On January 11, 2008, I also wrote to Andrew Cuomo, Attorney General of the State of New York. In this letter I also called for an investigation of Goldman Sachs’s dumping of CMOs. I also referred to the SEC Enforcement Action and to other lawsuits, which were pursued against Goldman Sachs.
On January 29, 2008 Goldman Sachs stated in its annual report that regulators had subpoenaed Goldman Sachs for information related to sub prime mortgages and other residential mortgages (CMOs).
Today’s article is an explication of Goldman’s liability.
Not one media outlet has joined The Black Star News in commenting upon the liability of Goldman Sachs for peddling its toxic waste Collateralized Mortgage Obligations (CMOs). My column argues that Goldman is liable for the tens of billions of dollars of CMOs that Goldman dumped upon its customers. Moreover, there exists precedence for this liability- and it involves Goldman Sachs itself.
In 1970 Goldman Sachs was peddling the Commercial Paper of a company called Penn Central Transportation Company to its customers. Commercial Paper is a money market security issued by a bank or company with a maturity that cannot exceed 270 days. The Commercial Paper of Penn Central was rated “Prime,” by the National Credit Office (NCO), a wholly owned subsidiary of Dun & Bradstreet.
On February 5, 1970 Goldman Sachs learned that Brown Brothers, Harriman & Co. had removed Penn Central from its approved list of Commercial Paper- thus, lowering Brown Brothers’ credit rating of Penn Central Commercial Paper.
On February 6, 1970 Goldman Sachs informed Penn Central that it would only hold $5 million of the Commercial Paper of Penn Central in its inventory- and would reduce its inventory of the Commercial Paper of Penn Central from $15 million to $5 million.
On February 9, 1970 Penn Central repurchased $10 million of its Commercial Paper from Goldman Sachs. Yet, Goldman continued to inform its clients that Penn Central Commercial Paper was rated “Prime,” and continued to sell the Commercial Paper to its customers- stressing that the Commercial Paper of Penn Central was rated “Prime.”
On June 21, 1970 Penn Central with $7 billion in assets filed for Bankruptcy, which at that time was the largest bankruptcy ever.
The CMO crisis began to unfold in 2007. Did Goldman learn any lessons from the Penn Central disaster?
On December 14, 2006 David Viniar, Chief Financial Officer of Goldman Sachs, chaired a meeting of senior members of the trading desk, the risk department, the controller’s office and other senior employees of Goldman Sachs, according to a media report. Lloyd Blankfein, Chairman of Goldman Sachs; Jon Winkelried, Co-President of Goldman Sachs; and Gary Cohn, Co-President of Goldman Sachs, were informed of the proceedings of the meeting, the article reported.
Goldman Sachs determined that it was losing money on its positions in CMOs. It was decided that Goldman Sachs should reduce its inventory of CMOs by selling these CMOs to Goldman’s customers. Goldman Sachs has acknowledged to the press that Goldman had reduced the CMOs in its inventory to $400 million and had reduced the CDOs in its inventory to $1.2 billion. Goldman has refused to provide the dollar value of CMOs and CDOs, which beginning in the fourth quarter of 2006 the company had sold to its customers.
Recall that decades earlier during the Penn Central case, Goldman decided to reduce its inventory of Penn Central Commercial Paper and Penn Central repurchased its Commercial Paper from Goldman. Goldman continued to sell Penn Central Commercial Paper to its customers- but it did not dump the $5 million of Penn Central Commercial Paper, which it held in its inventory upon its customers.
In 2006 and 2007 Goldman was peddling CMOs with an AAA rating by Dun & Bradstreet among others- to Goldman’s customers. Note: Commercial Paper with a rating of “Prime” is comparable to CMOs with a rating of AAA, which is the highest rating that can be given.
But in 2006 and 2007 Goldman held billions of dollars of CMOs, which Goldman knew to be substandard and worthless, and Goldman dumped these CMOs upon its customers. To reduce its inventory of toxic CMOs, Goldman sold billions of dollars of valueless CMOs, which Goldman held in its proprietary account, to its customers. Goldman increased its profits at the expense of its customers.
Goldman then purchased credit-default swaps, which would become profitable only if the CMOs that Goldman had sold to its customers had drastically declined in value.
To understand the point, consider how the Penn Central Case was resolved.
In the Spring of 1970 Goldman Sachs sold $87 million of Commercial Paper of the Penn Central Transportation Company, including $600,000 of Penn Central Commercial Paper to the University Hill Foundation, insisting the rating was “Prime.” In June 1970 Penn Central filed for bankruptcy and the University Hill Foundation lost its investment.
The University Hill Foundation sued Goldman Sachs because Goldman knew of the deteriorating condition of Penn Central and because Goldman itself had reduced its holdings of Penn Central Commercial Paper.
In University Hill Foundation, Plaintiff, v. Goldman Sachs, Defendant, 422 F.Supp. 879, 34, 35, October 27, 1976) the Court held: “We find that Goldman Sachs impliedly represented that in its opinion, Penn Central was creditworthy. It represented that there was a reasonable basis for this opinion, i.e., that a reasonable credit investigation had been conducted. We further find that, in the circumstances of this transaction, Goldman Sachs represented the paper to be rated “Prime” by NCO.”
The court also said: “The materiality of the false representation that a reasonable credit investigation had been conducted… is apparent from the reliance so many investors placed on the identity of the dealer of a particular issue.”
Moreover, the court found: “For the reasons set above, the Foundation is entitled to rescind the purchase and recover the consideration for the notes plus interest from the date of the sale.”
Fast forward to the current situation involving CMOs, where Goldman Sachs did far worse than the Penn Central Case:
Goldman represented that the CMOs, which Goldman Sachs was peddling to its customers were rated AAA, the highest rating. Goldman Sachs knowingly sold toxic CMOs, which Goldman held in its proprietary account and which Goldman knew were not of investment grade quality, to Goldman’s customers.
Then Goldman, after assuring the market and its customers that the CMOs were of the highest investment grade, purchased billions of dollars of credit-default swaps that would have become valuable only if the market value of the CMOs, which Goldman was selling to its public customers collapsed.
Goldman had even endangered its own capital base, the amount of money that is required for Goldman to continue as a major investment firm and to cover its liabilities, because Goldman had risked so much of its own money by purchasing such enormous amounts of these credit-default swaps.
Goldman Sachs sold these CMOs in bad faith and with misrepresentation and the purchasers of these CMOs are entitled to receive the purchase price plus interest that has been foregone- as was the case when Goldman knowingly sold the “Prime” rated Commercial Paper of Penn Central, which Goldman knew was not of investment grade quality, to its customers.
In 1970 approximately 60 lawsuits were initiated against Goldman Sachs for its role in selling $87 million of Penn Central Commercial Paper. The damages sought were approximately $87 million- the value of the Penn Central Commercial Paper that Goldman Sachs had sold. Goldman’s capital was slightly greater than $50 million. Goldman lost several lawsuits and then quickly settled the other lawsuits. Goldman Sachs almost went out of business.
The Securities and Exchange Commission filed a Complaint against Goldman Sachs. On May 2, 1974 Goldman signed a consent decree (formally called a Stipulation of Settlement, No. 74-1916) with the Securities and Exchange Commission in which decree Goldman Sachs neither admitted nor denied guilt. “Goldman Sachs will conduct such investigation as may be required under the circumstances to give Goldman Sachs reasonable ground to believe that such issuer will have the ability to pay such commercial paper as it matures,” the decree stated.
Extrapolate this consent decree to the CMOs debacle. It is obvious that once Goldman Sachs discovered that the CMOs were grossly overvalued, Goldman continued to dump these CMOs unto its costumers and even took out credit-default swaps that would earn Goldman billions when the CMOs collapsed.
Goldman dumped its worthless CMOs, which Goldman held in its inventory, unto its customers, just as Goldman dumped the Commercial Paper of Penn Central before Penn Central defaulted.
When contacted by The Black Star News for a response regarding Goldman’s liabilities to customers with respect to the CMOs, the Office of the United States Attorney of the Southern District of New York stated: “It is the policy of the United States Attorney neither to confirm or deny the existence of an investigation.”
Likewise, a spokesperson for the Securities and Exchange Commission said:“The SEC cannot confirm or deny the existence or nonexistence of any kind of investigative activity.”
Goldman Sachs did not return a call seeking comments.
On January 29, 2008 the Federal Bureau of Investigation (FBI) disclosed that it, in cooperation with the Securities and Exchange Commission, had initiated investigations into 14 firms for sub prime mortgage fraud and insider trading.
