CDO Marks

¶One issue that gained intensity as the mortgage market continued its decline was Goldman's practice of selling CDO securities to customers at one price only to mark down the value substantially within days or weeks of the sale, where Goldman had an ongoing client relationship.

¶Goldman used a mark-to-market process to manage its risk, which required valuing its holdings on a daily basis to reflect their current market value.²¹³²²¹³² Subcommittee interview of David Viniar (4/13/2010) and Craig Broderick (4/9/2010). In practice, many of its mortgage related assets were marked on a monthly rather than daily basis, including many of its CDO securities.²¹³³²¹³³ See, e.g., 2/2007 Goldman email chain, "FYIs," GS M BS-E-002339552 (regarding residential credit scratch & dent loan book: "Has the biz agreed with controllers about how frequently each book is to be marked? Daily? W eekly? M onthly?"; Mr. Sparks' response: "For this book I think monthly is the right way as the data comes monthly on performance. Dramatic mkt moves could change things."). CDOs were often marked monthly, as hedge fund clients generally needed month-end valuations of CDOs in their portfolios to enable them to report hedge fund Net Asset Values (NAVs) to clients. See, e.g., 6/28/2007 email from Bear Stearns, "Missing Marks (15).xls," GS MBS-E-001965860 (portfolio manager requesting month-end marks: "I need the 4 bonds marked for 5/31/07 we still need to report an NAV."); 6/19/2007 email from Lester Brafman to Jon Egol, GS M BS-E-003373736 (regarding Abacus CDO securities, Mr. Egol wrote: "W e mark them monthly").Show full note Nonetheless, Goldman appears to have been more active in re-marking the value of its mortgage related assets than other Wall Street firms and to have used lower marks than many of its competitors.²¹³⁴²¹³⁴ See, e.g., 2/12/2007 email from Daniel Sparks, "Post today," GS MBS-E-009763506 (New Century "claim[s] we are the only ones being harsh. C-Bass claims we are the only one margin calling. Our marks are appropriate for moves in the market. More margin calls going out today."). Goldman also had a process for automatically marking down its internal value of any asset held longer than a specified period of time, in order to encourage its trading desks to sell their aged assets.²¹³⁵²¹³⁵ Subcommittee interview of David Lehman (4/12/2010).

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¶During 2007, Goldman's markdowns of the value of its CDO securities became a source of dispute with its customers.²¹³⁶²¹³⁶ Mr. Broderick explained in his interview with the Subcommittee that because of the volatility in the subprime market, Goldman had an unusually large number of disputes with customers over marks or collateral valuation during 2007. Subcommittee interview of Craig Broderick (4/9/2010). See also 8/2/2007 email from Stacy Bash- Polley, "Marks Summary," GS M BS-E-013349723 (transmitting complaints from eight clients that Goldman's marks were far lower than those of other dealers); 2/12/2007 email from Daniel Sparks, "Post today," GS MBS-E- 009763506 (New Century "claim[s] we are the only ones being harsh. C-Bass claims we are the only one margin calling."); 8/10/2007 Goldman memorandum, "Summary of German Bank US Sub Prime Exposure," GS MBS-E-009994305. This memorandum was generated by Goldman's European Investment Banking Division, FICC Sales and Credit. It highlighted losses incurred by many German banks due to markdowns in the value of U.S. subprime assets, necessitating several European Central Bank bailouts. The memorandum stated: "W e understand from clients that valuation marks provided by Goldman Sachs on ABS are substantially lower than the competition's valuations. As a result, clients are irritated by the valuation difference." Goldman's dispute with AIG FP is another example. The two companies disagreed over both the marks and the amount of collateral and margin that AIG had to post with Goldman in connection with various mortgage products. At one point in the dispute, Co-President Jon W inkelried wrote to his colleagues: "[O]ne thing we're not going to do is compromise on what we think the right marks are and our margin process." 8/2/2007 email from Jon W inkelried, "Aig collateral call," GS MBS-E-010055302. Goldman's dispute with AIG continued for over a year until the Federal Reserve, through the Maiden Lane III transaction, ultimately ensured that Goldman and its customers received 100 cents on the dollar on the bulk of their disputed claims against AIG. Subcommittee interview of David Viniar (4/13/2010). Goldman later told regulators that it had more collateral disputes than anticipated during the financial crisis. 11/13/2007 Goldman email, GS MBS-E-010023525 (attachment, 11/14/2007 "Tri-Lateral Combined Comments," GS MBS-E-010135693-715 at 695). According to Goldman documents, as late as October 30, 2007, its Mortgage Department generated approximately 66% of all derivative collateral disputes by Goldman customers. 10/30/2007 Goldman presentation, "Derivative Collateral Dispute Summary," GS MBS-E- 009882064.Show full note Some clients were negatively affected in a variety of ways when lower values were assigned to Goldman's CDO securities. Some had purchased their CDO securities through "repo" financing arrangements with Goldman; under those arrangements, a decline in the value of the CDO securities being financed required the client to post more cash margin with Goldman. In a few other instances, clients had invested in CDO securities through a CDS contract with Goldman. If the CDO securities declined in value, the CDS contracts required those clients to post more cash collateral with Goldman. In other cases, clients did not have to post additional cash collateral, they simply incurred losses from the lower values.²¹³⁷²¹³⁷ See, e.g., 8/10/2007 Goldman memorandum, "Summary of German Bank US Sub Prime Exposure," GS MBS-E-009994305 (highlighting losses incurred by many German banks due to markdowns in the value of U.S. subprime assets, necessitating several European Central Bank bailouts).

¶Lower marks also had significance for Goldman internally, since a CDO security with a marked down value might reduce the firm's profits and reduce its long position. Alternatively, if Goldman held the short side of an investment, a lower mark might increase the firm's profits, increase the value of its short position, and bring in more cash from the long parties. When the firm held a proprietary position in opposition to the position held by a client, the fact that Goldman was marking the value of its own position created a conflict of interest, since Goldman would benefit as the client lost money.

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¶Gameplan Markdowns. When, on May 11, 2007, Goldman executives and the Mortgage Department decided to embark upon a CDO valuation project, Goldman's Chief Risk Officer, Craig Broderick, sent an email to his team to discuss the consequences of lower CDO values for Goldman's clients. He wrote:

"Sparks and the Mtg [Mortgage] group are in the process of considering making significant downward adjustment to the marks on their mortgage portfolios esp[ecially] CDOs and CDO squared. This will potentially have a big P&L [profit and loss] impact on us, but also on our clients due to the marks and associated margin calls on repos, derivatives and other products. We need to survey our clients and take a shot at determining the most vulnerable clients, knock on implications, etc."²¹³⁸²¹³⁸ 5/11/2007 email from Craig Broderick, "CDOs - Mortgages," Hearing Exhibit 4/27-84.

¶Mr. Broderick called for a client survey to identify which clients were "most vulnerable" to financial difficulty if Goldman's CDO securities were marked down in value, and they either incurred losses or were required to post more cash margin or collateral. He also wrote: "This is getting lots of 30th floor attention right now."²¹³⁹²¹³⁹ Id. The reference to the "30th floor" was the floor on which Goldman's most senior executives had office space in its New York headquarters.

¶Some Goldman managing directors also raised the issue of selling CDO securities to clients at a price that would be marked down almost immediately. In a May 11 email to colleagues, for example, Goldman senior executive, Harvey Schwartz, wrote: "[D]on't think we can trade this with our clients andf [sic] then mark them down dramatically the next day."²¹⁴⁰²¹⁴⁰ 5/11/2007 email from Harvey Schwartz to Daniel Sparks, Tom Montag, and others, GS MBS-E-010780864. As explained earlier, some clients were affected by Goldman's marks even after completing purchase of CDO securities, due to repo financing margin requirements, CDS collateral requirements, or other arrangements. Later that day, in an exchange of emails with Mr. Schwartz, Mr. Montag, and Mr. Sparks, Don Mullen acknowledged Mr. Schwartz's concern "about the representations we may be making to clients as well as how we will price assets once we sell them to clients."²¹⁴¹²¹⁴¹ 5/11/2007 chain of email exchanges among Messrs. Mullen, Schwartz, Montag, and Sparks, GS-MBS-E- 010780849, Hearing Exhibit 4/27-103. The Goldman executives also agreed, however, not to "slow or delay" efforts to sell the CDO securities, if the sales force received "strong bids."²¹⁴²²¹⁴² Id.

¶The May 2007 CDO valuation project resulted in lower values for many of Goldman's CDO assets. While those internal markdowns were taken at month's end, around May 25, 2007, Goldman continued to price the CDO securities it was selling at much higher levels, creating the potential for a rapid markdown after an asset was sold.²¹⁴³²¹⁴³ See, e.g., discussion of Timberwolf CDO, below.

¶"Monster CDO Re-Mark." Six weeks later, in mid-June, the Mortgage Department learned that two Bear Stearns hedge funds with a $17 billion portfolio of subprime assets were in financial distress. The Mortgage Department immediately initiated an effort to build a new, large short position to take advantage of the expected drop in the value of subprime mortgage assets.²¹⁴⁴²¹⁴⁴ See Section (3)(a), above. Within two weeks, Goldman had amassed a large number of CDS contracts shorting a variety of subprime mortgage assets. By June 22, 2007, Goldman's short position reached its peak size of approximately $13.9 billion.²¹⁴⁵²¹⁴⁵ 4/2010 "Goldman Sachs Mortgage Department Total Net Short Position, February - December 2007 in $ Billions (including All Synthetic and Cash Positions in Mortgage Related Products)," Hearing Exhibit 4/27-162.

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¶The Bear Stearns hedge funds failed in mid-June, subprime assets plummeted in value, and Goldman established its big short by the end of the month. After its new net short was in place, the Mortgage Department implemented a series of large markdowns in the value of its RMBS and CDO assets. The markdowns had the dual effect of increasing the value of Goldman's net short position, while reducing the value of many of its customers' holdings. Due to their financing arrangements or CDS contracts, the lower values meant that some of the affected clients also had to post more margin or cash collateral with the firm. Goldman issued broad and deep markdowns of its clients' positions at month's end in June, July and August 2007, as well as on intermittent dates in response to mass ratings downgrades of specific RMBS securities in July and August or to individual customer credit issues.

¶One of the markdowns took effect on July 25, 2007,²¹⁴⁶²¹⁴⁶ See 7/25/2007 email from Arbind Jha to Kevin Kao, "Cash bonds," GS MBS-E-011128623 ("huge changes in marks today"). which Mr. Sparks called "the CDO monster remark."²¹⁴⁷²¹⁴⁷ 7/29/2007 email from Daniel Sparks to Tom Montag, "Problem," GS MBS-E-010876595 ("[w]e probably should have taken more time to put through the CDO monster remark"). In an email to Mr. Mullen, Mr. Sparks wrote: "We made massive mark adjustments this week, pushed them through because of basis and counterparty exposure."²¹⁴⁸²¹⁴⁸ 7/29/2007 email from Daniel Sparks to Mr. Mullen, "Problem," GS MBS-E-010876565. In a separate email to Mr. Montag, Mr. Sparks made clear that by "basis," he meant Basis Capital, an Australian hedge fund that had financed the purchase of Timberwolf and other CDO securities using Goldman funds and defaulted on its margin and collateral obligations. Goldman then repurchased those securities at a low price and adjusted its marks for other clients.²¹⁴⁹²¹⁴⁹ 7/29/2007 email from Daniel Sparks to Tom Montag, "Problem," GS MBS-E-010876595 ("we rushed it because of Basis and a desire to protect ourselves against counter-parties"). See also 7/13/2007 email from John McHugh to Michael Swenson and David Lehman, "Talking Points Needed for Gary Cohn," GS MBS-E-010853931 ("BSAM [Bear Stearns Asset Management] & other hedge fund managers (most recently Basis Capital) announced they were halting fund redemptions and/or liquidating holdings, with some likely to fail.").Show full note

¶The CDO markdown drew an immediate negative reaction from Goldman's customers. On July 31, 2007, an internal report was sent to a dozen Goldman senior executives and Mortgage Department personnel regarding pending "mortgage derivative collateral disputes," meaning customers who were disputing the lower valuations and resulting cash margin and collateral calls.²¹⁵⁰²¹⁵⁰ See 7/31/2007 email chain between Tom Montag and Lloyd Blankfein, "Mortgage Derivative Collateral Disputes – 7/31 Update (COB 7/27 marks)," GS MBS-E-009691545. The email identified the "10 largest disputes," naming AIG Financial Products, Morgan Stanley, and Deutsche Bank, among others. It stated: "The overall derivative collateral dispute amount is now $7.0 billion."²¹⁵¹²¹⁵¹ Id. The email also noted that the total in dispute from the prior week had been $3 billion, which suggests that the July 25 markdowns had caused the amount in dispute to more than double in a week. Mr. Montag immediately forwarded the report to Mr. Blankfein: "7 billion of collateral disputes!!!"²¹⁵²²¹⁵² Id. By late August, Goldman had instituted a system that required senior management pre-approval for large markdowns. On August 28, 2007, Mr. Lehman sent Mr. Sparks a list of "Mark changes which are greater than 5% / greater than 10%" for his approval. 8/28/2007 email from David Lehman to Daniel Sparks, GS MBS-E-010623779. Mr. Lehman asked whether he should ask Mr. Mullen for approval of the changes greater than 10%, and Mr. Sparks told him to do so. Id.Show full note

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¶Mr. Blankfein responded: "Make sure they prioritize weaker credits where our risk is threatening."²¹⁵³²¹⁵³ Id. In other words, Mr. Blankfein directed Goldman personnel to focus on disputes with clients that had the weakest credit, and might have fewer resources to pay the amounts owed to Goldman as a result of the downward marks. The same markdowns causing losses for those clients were simultaneously increasing the profitability of Goldman's net short.

¶Two weeks later, the Mortgage Department implemented another large markdown, this time related to Goldman's Abacus CDOs. This markdown took place on August 16, 2007, after the Correlation Trading Desk adjusted its correlation assumptions in a way that resulted in steep markdowns for Abacus CDO customers and a corresponding $94 million increase in the value of the Correlation Trading Desk's net short positions on the same CDOs.²¹⁵⁴²¹⁵⁴ 8/16/2007 email from Daniel Sparks, "Mort P&L explanation," GS MBS-E-010680327. Since Goldman took the entire net short side in many of its Abacus CDOs, the customers' losses translated directly into gains for Goldman. The Mortgage Department as a whole reported a $121 million profit that same day. Mr. Sparks reported to senior management: "94mm ... is from correlation adjustment in ABX (from 50 to 70%) as market observability better recently, rest is from outright shorts."²¹⁵⁵²¹⁵⁵ Id. The Correlation Trading Desk reported $145 million in total profits, which were then offset by losses on other mortgage desks. Also on August 16, 2007, Mr. Egol listed the Correlation Trading Desk's Top Ten Winners and Losers due to Goldman's markdowns and calculated that "[t]he aggregate P&L in the book is $405mm (ie net markdown to customers), much of this is scattered across a bunch of cashflow CDOs."²¹⁵⁶²¹⁵⁶ 8/16/2007 email from Jon Egol to M ichael Swenson, "Projected Corr Customers winners/losers from single- name mark changes," GS MBS-E-011092473, Hearing Exhibit 4/27-33.

¶DD. Customer Losses

¶Goldman's internal marks demonstrate that, at the time it sold its CDO securities, Goldman's senior management knew its sales force was selling CDO securities at inflated prices and that the CDO securities were also rapidly losing value. In addition, soon after selling the CDO securities, Goldman marked down their value, causing some customers to incur substantial losses within days or weeks of a purchase and undergo substantial margin and collateral calls that caused additional financial distress.²¹⁵⁷²¹⁵⁷ See, e.g., 5/11/2007 email from Craig Broderick, "CDOs - Mortgages," GS MBS-E-009976918, Hearing Exhibit 4/27-84; see also 8/10/2007 Goldman internal memorandum, "Summary of German Bank US Sub Prime Exposure," GS MBS-E-009994305.

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¶One Goldman salesperson expressed remorse over the impact on their customers of CDO sales followed by large markdowns within days or weeks of the client's purchase:

"Real bad feeling across European sales about some of the trades we did with clients. The damage this has done to our franchise is significant. Aggregate loss for our clients on just ... 5 trades alone is 1bln+."²¹⁵⁸²¹⁵⁸ 10/12/2007 email to Daniel Sparks, "US ABS SS Intermediation Trades," GS M BS-E-013706095, Hearing Exhibit 4/27-70.

¶At the same time, the salesperson thought the sales force deserved a bigger share of the profits generated for the firm:

"In addition team feels that recognition (sales credits and otherwise) they received for getting this business done was not consistent with the money it ended up making/saving the firm."²¹⁵⁹²¹⁵⁹ Id.

¶A Goldman salesperson in Taiwan sought help in explaining Goldman's markdowns to a bank whose CDO investment had been marked down from about 97 to about 45 cents on the dollar in a matter of weeks:

"[B]ank just bought the altius deal from gs [Goldman Sachs] 5 weeks ago and the mtm [mark-to-market] dropped over 50%. We understand the liquidity is thin, but I really need some info to support this price. ... This is very important as this transaction has a lot to do with our reputation in taiwan market. I understand all deals are down and spread is trading wider now. Unless the principal is at risk now, the mtm is not supposed to drop so quickly during such short period of time."²¹⁶⁰²¹⁶⁰ 7/24/2007 email from [Taiwan], "7/23 CDO/RMBS requests from Taiwan," GS M BS-E-011198375, Hearing Exhibit 4/27-67.

¶On August 2, 2007, Stacy Bash-Polley, a Goldman senior sales executive, sent an email to Messrs. Montag, Mullen, Schwartz, and Sparks outlining eight specific instances in which clients had complained that Goldman's marks were significantly lower that those of other dealers.²¹⁶¹²¹⁶¹ 8/2/2007 email from Stacy Bash-Polley to Messrs. Montag, Mullen, Schwartz, and Sparks, "Marks Summary," GS MBS-E-013349723. Her summary of client concerns included the following:

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"–They have not agreed with our process and recently asked other dealers to analyze – say that we are off significantly from where other dealers are modeling this ....

–We took their mark on Fort Denison from 93.16 to 40.00[.] They admit the AAA CDO mkt is off substantially but feel that this particular bond [has objective characteristics that should make it] ... perform better than the junior AAA market as a whole. Meanwhile, we took Hudson Mezz ... AAA from 80.4 to 65. They would like our thoughts as to why Fort Den[ison] was marked down so much more. ...

–The Alt-A marks were particularly punitive. ... Our offerings are still 10-20 points higher than the marks. Look at GSAMP 2007-7. On financing, [customer] said our HC [haircuts] ... were by far the most onerous of all dealers. ...

–They bought AAA cdos .... They have communicated to sales that GS is by far an outlier and they will never be able to buy another cdo from us based on their lack of confidence in understanding how we are coming up with marks. ...

–Issues with their CDO marks. Said we were many many points behind where other dealers were marking similar positions."²¹⁶²²¹⁶² Id.

¶Even before this email, Goldman's sales force had been vocal in its criticism of Goldman's low marks which were making their sales job more difficult. On June 21, 2007, Mr. Sparks stated in an email: "sales is making significant noise about gs notable conservatism in marking and haircuts."²¹⁶³²¹⁶³ 6/21/2007 email from Mr. Sparks to Lester Brafman, "Repo," GS MBS-E-010847490. Mortgage Department personnel dismissed such criticisms out of hand. One managing director responded: "Would have tho[ugh]t that bsam event [failure of Bear Stearns Asset Management hedge funds] would provide reasonable explanation as to why our marking and haircuts r ok." Mr. Sparks replied: "Kind of stunning – but we are hearing it."

¶Goldman generally declined to offer any written explanations of its marks to clients, and rarely offered any financial accommodation or compromise regarding the marks or related collateral calls.²¹⁶⁴²¹⁶⁴ The Subcommittee did identify at least one instance of a mark change. Goldman's China sales representative contacted the ABS Desk to request an increase in a mark on an RMBS security: "[C]an we try our best to show 'better' indicative prices for [client]? ... [C]lient is under pressure of being questioned that they bought something looks really bad. ... [W ]e showed a price of LBMLT 06 A A1 as of 95-00 . . . this is something hard for client to believe .... [W]e need them to think of GS as the best firm, and we need them to be our best client when next biz boom comes. ... W e would highly appreciate if a slightly aggressive price can be showed from trading desk." 5/21/2007 email from China sales representative to Edwin Chin and others, "Mark to market prices," GS MBS-E- 011068490. Mr. Chin moved the mark in question from 95 to 98, and wrote: "After much discussion internally, we will improve our bid to 98-00 given the market color we have observed in the past two days. The markdown was mostly a reaction to rating agency downgrade and partly reflected the illiquidity of the position, but upon further analysis we have gotten more comfortable with the risk position and agree it should be marked at a higher price." Id.Show full note On one occasion, when a sales representative asked about providing information about the firm's CDO marks to a customer, Mr. Lehman wrote: "We cannot put this on paper - It concerns me they want something specifically in writing."²¹⁶⁵²¹⁶⁵ 8/6/2007 email from David Lehman to Japan sales, "RE: Tokyo Star," GS MBS-E-001927891. When told that other dealers had provided the customer with marks and a written description of their CDO pricing methodologies, Mr. Lehman responded: "Our marking policy is a market price (bid and/or offer) – We do not have a written methodology for pricing and we should tell them that."²¹⁶⁶²¹⁶⁶ Id. In another instance, when a client asked for marks for the two prior months related to a CDO it was considering buying, Mr. Lehman wrote: "Verbal only .... Want to give them our tho[ugh]ts on market levels, not 'marks.'"²¹⁶⁷²¹⁶⁷ 6/6/2007 email from David Lehman to Japan sales, "Point Pleasant Marks – request from Tokyo Star Bank," GS MBS-E-001912408-10 at 9. In his 2007 performance self-evaluation, the head of the SPG Trading Desk, Michael Swenson, wrote:

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"I spent numerous hours on conference calls with clients discussing valuation methodologies for GS issued transactions in the subprime and second lien space .... I said 'no' to clients who demanded that GS should 'support the GSAMP' program [Goldman RMBS securities] as clients tried to gain leverage over us. Those were unpopular decisions but they saved the firm hundreds of millions of dollars."²¹⁶⁸²¹⁶⁸ 9/26/2007 Goldman Sachs 2007 Performance Review for Michael Swenson, "Reviewee's Feedback," GS-PSI- 02399, Hearing Exhibit 4/27-55b.

¶In November 2007, Goldman analysts issued a research report to clients about the crisis in the mortgage market.²¹⁶⁹²¹⁶⁹ 11/20/2007 email from Thomson IFR - ABS, "ABS: Market Tense as Goldman Predicts RMBS CDO Problems to Drag On," GS MBS-E-013782989. Goldman predicted that the mortgage market crisis was likely to continue and would have serious implications for a significant number of financial institutions: "Writedowns and losses will continue to mount .... [M]anagements will need to repair some seriously damaged balance sheets."²¹⁷⁰²¹⁷⁰ Id. Goldman estimated that industry-wide losses reflecting markdowns in subprime mortgage CDOs would approach $150 billion, of which about $40 billion would be taken in the third and fourth quarters of 2007.²¹⁷¹²¹⁷¹ Id.

¶Customers who purchased CDO assets from Goldman in 2007 generally suffered substantial losses from those investments, and several went bankrupt, including IKB, a German bank, and Basis Capital, the Australian hedge fund.²¹⁷²²¹⁷² See 9/17/2007 Goldman presentation to Board of Directors, "Residential Mortgage Business, Global Impact of the Mortgage Crisis," at 2, GS MBS-E-001793840, Hearing Exhibit 4/27-41 (noting bankruptcies of Goldman clients IKB and Basis Capital). See also 8/10/2007 Goldman internal memorandum, "Summary of German Bank US Sub Prime Exposure," GS MBS-E-009994305; 11/27/2007 email from David Lehman to Daniel Sparks, "ACA," GS MBS-E-013746511 (discussing "what would happen upon an ACA bankruptcy (which is the most likely scenario in our opinion).").Show full note Goldman was not only aware of its clients' predicaments, but in some cases, Goldman purchased CDS protection or equity puts on its clients' stock, essentially betting that the stock price would fall or the company would lose value. For example, after ACA Financial Guaranty Corp., the parent company of ACA Management which acted as the collateral manager of Abacus 2007-AC1, purchased Abacus securities, Goldman purchased the short side of a CDS contract that referenced ACA Financial Guaranty. ACA Financial Guaranty encountered extreme financial distress in late 2007.²¹⁷³²¹⁷³ See 6/21/2007 email from Fabrice Tourre, "Post on ACA," GS MBS-E-002562148. See also ACA Financial Guaranty Corp. v. Goldman, Sachs & Co., Complaint (filed 1/6/2011, Sup. Ct. N.Y) at ¶ 7 (ACA now "operates as a run-off insurance company."), available at http://www.aca.com/press/pdfs/2011/20110106-GoldmanComplaint.pdf.

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¶At the Subcommittee hearing, Goldman executives were asked about the four Goldman-originated CDOs highlighted in this Report, Hudson 1, Anderson, Timberwolf, and Abacus 2007- AC1.²¹⁷⁴²¹⁷⁴ April 27, 2010 Subcommittee Hearing at 66. Senator John Tester noted Mr. Birnbaum's testimony that, in 2007, Goldman could "see some things happening,"²¹⁷⁵²¹⁷⁵ Id. and that Goldman itself was betting against the mortgage market. Senator Tester asked Mr. Sparks, in light of those developments, "how [he] got comfortable with sales," and how he "in good faith" sold the CDO securities to Goldman's customers – how he could "sell them out and collect the fees and make the dough?"²¹⁷⁶²¹⁷⁶ Id. Senator Tester and Mr. Sparks then had the following exchange:

Senator Tester: Every one of these [CDOs] were – it looks like a wreck waiting to happen because they were all downgraded to junk in very short order.

Mr. Sparks: Well, Senator, at the time we did those deals, we expected those deals to perform.

¶Senator Tester: Perform in what way?

¶Mr. Sparks: To not be downgraded–

¶Senator Tester: Perform to go to junk, so that the shorts made out?

Mr. Sparks: To not be downgraded to junk in that short a time frame. In fact, to not be downgraded to junk. ...

Senator Tester: Do you feel confident that the information about each one of these [CDOs] ... was given to the investors, all of the information that was out there, and the credit rating agencies too?

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Mr. Sparks: Well, I generally feel that the disclosure for the new issues that Goldman Sachs brought was good.²¹⁷⁷²¹⁷⁷ Id. Mr. Sparks went on to say: "I mentioned we made some bad business decisions. These deals performed horribly. That is bad. ... [T]hat said, just because one person in my business unit or a few people might have had one view, I can tell you there were a lot of people in my business unit that had a very different view, and there were a lot of investors that had a very different view." Id.

¶While Mr. Sparks testified that, in 2007, the Mortgage Department expected its CDOs "to perform," a contemporaneous draft presentation that he helped prepare in May 2007 stated that the "desk expects [the CDOs] to underperform."²¹⁷⁸²¹⁷⁸ See 5/19/2007 draft Goldman presentation, "Mortgages CDO Origination – Retained Positions & W arehouse Collateral, May 2007," GS MBS-E-010951926. Many other emails provide his negative views of the CDO market at the time, including emails in which Mr. Sparks described the subprime market as "bad and getting worse,"²¹⁷⁹²¹⁷⁹ 2/8/2007 email from Mr. Sparks, "Post," Hearing Exhibit 4/27-7. and directed Goldman's mortgage traders to "get out of everything,"²¹⁸⁰²¹⁸⁰ 3/3/2007 email from Mr. Sparks, "Call," Hearing Exhibit 4/27-14. and "stay on the short side."²¹⁸¹²¹⁸¹ 3/8/2007 email from Mr. Sparks, "Mortgage risk," Hearing Exhibit 4/27-75. He wrote, among other things: "Game over,"²¹⁸²²¹⁸² 3/12/2007 Goldman memorandum to Firmwide Risk Committee, "March 7th FW R Minutes," GS MBS-E- 00221171, Hearing Exhibit 4/27-19. "bad news everywhere," and "the business is totally dead."²¹⁸³²¹⁸³ 2/21/2007 email from Daniel Sparks to Jon W inkelried, "Mortgages today," GS M BS-E-010381094, Hearing Exhibit 4/27-10. As Senator Tester noted, many of Mr. Sparks's dire predictions were made before three of the four CDOs discussed at the hearing were even offered to customers.²¹⁸⁴²¹⁸⁴ April 27, 2010 Subcommittee Hearing at 66. The Anderson, Timberwolf, and Abacus 2007-AC1 CDOs were issued in March and April 2007.

¶Mr. Sparks also testified that the Mortgage Department did not expect the Goldman-issued CDOs to be downgraded, but all were within a year of issuance. In April 2007, for example, six of the 20 RMBS deals that comprised the ABX Index were downgraded,²¹⁸⁵²¹⁸⁵ 4/27/2007 email from Deeb Salem to M ichael Swenson, GS MBS-E-012432706 (6 of 20 deals in ABX Index put on watch or downgraded). and the Hudson CDO that referenced them followed soon after. Many of the RMBS securities referenced in the other three CDOs were downgraded within three months of the issuance of the last CDO in April 2007, making the downgrade of the CDOs themselves all but inevitable.²¹⁸⁶²¹⁸⁶ 7/10/2007 email to George Maltezos, "GS Cashflow/ABACUS CDOs Mentioned in S&P Report on CDO Exposure to Subprime RMBS," GS MBS-E-001837256; 7/10/2007 email from Goldman Sachs analyst to Goldman Sachs Japan salesman, "GS Cashflow/ABACUS CDOs Mentioned in S&P Report on CDO Exposure to Subprime RMBS," GS M BS-E-001990255 (updating percentage exposure from 25% to 35%). For example, when Moody's and S&P announced their first mass downgrades of RMBS securities on July 10, 2007, the S&P downgrade affected 35% of the assets in Timberwolf.²¹⁸⁷²¹⁸⁷ Id. Ultimately, all of the CDOs discussed at the Subcommittee's hearing were downgraded to junk status. On October 26, 2007, a Goldman employee sent an email about Abacus 2007-AC1, even noting this dubious distinction:

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"This deal was number 1 in the universe of CDO's that were downgraded by Moody's and S&P. 99.89% of the underlying assets were downgraded."²¹⁸⁸²¹⁸⁸ 10/26/2007 email from Goldman salesman to Michael Swenson, "ABACUS 2007-AC1 – Marketing Points (INTERNAL ONLY) [T-Mail]," GS MBS-E-016034495.

¶(b) Goldman's Conflicts of Interest

¶In late 2006 and 2007, Goldman's securitization business was marked, not just by its hard sell tactics, but also by multiple conflicts of interest in which Goldman's financial interests were opposed to those of its clients. The following examples illustrate the problem.

¶(i) Conflicts of Interest Involving RMBS Securities

¶In 2006 and 2007, Goldman originated 27 CDO and 93 RMBS securitizations. Beginning in December 2006, Goldman originated and aggressively marketed some of these securities at the same time that subprime and other high risk loans were defaulting at alarming rates, the subprime and CDO markets were deteriorating, and Goldman was shorting subprime mortgage assets. At times, Goldman originated and sold RMBS securities that it knew had poor quality loans that were likely to incur abnormally high rates of default. At times, Goldman went further and sold RMBS securities to customers at the same time it was shorting the securities and essentially betting that they would lose value. Two examples illustrate how Goldman constructed and sold poor quality RMBS securities and profited from the decline of the very securities it had sold to its clients.

¶Long Beach RMBS. The first example involves Washington Mutual Bank (WaMu) and its subprime lender, Long Beach Mortgage Corporation. WaMu, Long Beach, and Goldman had collaborated on at least $14 billion in loan sales and securitizations.²¹⁸⁹²¹⁸⁹ See "List of W aMu-Goldman Loans Sales and Securitizations," Hearing Exhibit 4/13-47b. In February 2006, Long Beach had a $2 billion warehouse account with Goldman, which was the largest of Goldman's warehouse accounts at that time.²¹⁹⁰²¹⁹⁰ 2/13/2006 Goldman chart, "Current W arehouse Facilities and Funded Balances," GS MBS-E-001157934.

¶Long Beach was known within the industry for originating some of the worst performing subprime mortgages in the country. As explained in Chapter III, in 2005, a surge of early payment defaults in its subprime loans required Long Beach to repurchase over $837 million of nonperforming loans from investors, as well as book a $107 million loss.²¹⁹¹²¹⁹¹ See Chapters III and IV, above. Similar EPD problems affected its loans in 2006 and 2007. WaMu reviews and audits of Long Beach, as well as examinations by the Office of Thrift Supervision, repeatedly identified serious deficiencies in its lending practices, including lax underwriting standards, unacceptable loan error and exception rates, weak risk management, appraisal problems, inadequate oversight of third party brokers selling loans to the firm, and loan fraud. While these reviews were not available to the public, the performance of Long Beach paper was. Long Beach securitizations had among the worst credit losses in the industry from 1999-2003; in 2005 and 2006, Long Beach securities were among the worst performing in the market.²¹⁹²²¹⁹² See, e.g., 4/14/2005 OTS email, "Fitch," OTSW ME05-012 0000806, Hearing Exhibit 4/13-8a.

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¶Nevertheless, in May 2006, Goldman acted as co-lead underwriter with WaMu to securitize about $532 million in subprime second lien mortgages originated by Long Beach. Long Beach Mortgage Loan Trust 2006-A (LBMLT 2006-A) issued approximately $495 million in RMBS securities backed by those Long Beach mortgages. The top three tranches, representing about 66% of the principal loan balance, received AAA ratings from S&P, even though the pool contained subprime second lien mortgages – loans which could recover funds in the event of a default only after the primary loan was repaid — and even though the loans were issued by one of the nation's worst performing mortgage lenders. Yet Goldman was able to use two-thirds of that extremely risky debt to issue AAA rated securities which Goldman then sold to its customers.

¶In less than a year, the Long Beach loans began incurring delinquencies. In February 2007, a Goldman analyst reported internally that all of Goldman's 2006 subprime second lien RMBS securities were deteriorating in performance, but "deals backed by Fremont and Long Beach collateral have generally underperformed the most."²¹⁹³²¹⁹³ 2/8/2007 email from Goldman analyst to Mr. Sparks, Mr. Gasvoda, and others, "2006 Subprime 2nds Deals Continue to Underperform **INTERNAL ONLY**," GS MBS-E-003775340, Hearing Exhibit 4/27-167d. The analyst predicted "lifetime losses in the teens, and over 20% in some deals." By May 2007, the cumulative net loss on the LBMLT 2006-A mortgage pool had climbed to over 12%, eliminating most of the financial cushion protecting the investment grade securities from loss. That month, S&P downgraded six out of the seven credit ratings for the mezzanine tranches of the securitization. The Long Beach securities plummeted in value.

¶Goldman held some of the unsold Long Beach mezzanine securities on its books, meaning LBMLT 2006-A securities that carried credit ratings of BBB or BBB-. Goldman had also purchased the short side of a CDS contract that would pay off if those same securities lost value. On May 17, 2007, Deeb Salem, a trader on the Mortgage Department's ABS Desk, learned of additional losses in the Long Beach securitization and wrote to his supervisor Michael Swenson with the news:

"[B]ad news … [The loss] wipes out the m6s [mezzanine tranches] and makes a wipeout of the m5 imminent. … [C]osts us about 2.5 [million dollars]. … [G]ood news ... [W]e own 10 [million dollars] protection at the m6 … [W]e make $5 [million]."²¹⁹⁴²¹⁹⁴ 5/17/2007 email from Deeb Salem to Michael Swenson, "FW : LBML 06A," GS M BS-E-012550973, Hearing Exhibit 4/27-65.

¶In other words, Goldman lost $2.5 million from the unsold Long Beach securities still on its books, but gained $5 million from the CDS contract shorting those same securities. Overall, Goldman profited from the decline of the same type of securities it had earlier sold to its customers.

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¶By May 2008, even the AAA securities in LBMLT 2006-A had been downgraded to default status. By March 2010, the securities recorded a cumulative net loss of over 66%.²¹⁹⁵²¹⁹⁵ See wamusecurities.com.

¶Fremont RMBS. The second example involves Fremont Loan & Investment, another subprime lender notorious for issuing poor quality loans.²¹⁹⁶²¹⁹⁶ For more information about Fremont, see Chapter IV, Section D(2)(d). In March 2007, Fremont reported in an 8-K filing with the SEC that the FDIC filed a cease and desist order to which the company consented. Among other matters, it order Fremont to stop "[m]arketing and extending adjustable–rate mortgage products to subprime borrowers in an unsafe and unsound manner that greatly increases the risk that borrowers will default on the loans or otherwise causes losses."²¹⁹⁷²¹⁹⁷ 3/7/2007 Fremont General Corporation 8-K filing with the SEC.

¶Even before the actions taken by regulators in March 2007, Goldman was aware of the poor quality of at least some of Fremont's loans. In a November 2006 exchange of emails, for example, two Goldman sales representatives were discussing trying to sell Fremont RMBS securities to a client. One salesperson forwarded to the other the client's explanation of why it did not want to buy the securities and its low opinion of Fremont's loan pools: "Fremont refused to make any forward looking statements so we really got nothing from them on the crap pools that are out there now."²¹⁹⁸²¹⁹⁸ 11/16/2006 Goldman internal email, "ACA and Freemont [sic] deal," Hearing Exhibit 4/27-173. In March 2007, Goldman initiated a detailed review of its Fremont loan inventory to identify deficient loans that it could return to the lender for a refund. Mr. Gasvoda placed a priority on reviewing Fremont loans "since they still have cash but may not for long."²¹⁹⁹²¹⁹⁹ 3/14/2007 Goldman email, "NC Visit," GS-MBS-E-002048050. One loan pool review conducted on March 14, 2007, found that "on average, about 50% of about 200 files look to be repurchase obligations," meaning that fully half of the reviewed loans should be returned to the lender.²²⁰⁰²²⁰⁰ Id.; see also 8/10/2007 email from Michelle Gill, "Fremont - Incremental Information," GS MBS-E-009860358 (Goldman's repurchase claims against Fremont would have amounted to a 9% ownership stake in Fremont after a proposed buyout by investor group; Goldman was not the largest purchaser of Fremont loans but its repurchase claims were 3-4 times larger than the claims of the nearest counterparty). Goldman eventually made about $46 million in repurchase requests to Fremont, which was one of the top five mortgage originators from whom Goldman made repurchase requests in 2006 and 2007.²²⁰¹²²⁰¹ See Goldman Sachs response to Subcommittee QFR at PSI_QFR_GS0040.

¶Despite these and other indications of Fremont's poor quality loans, Goldman continued to underwrite and market securities backed by Fremont loans. In an internal February 2007 memorandum to its Mortgage Capital Committee, Goldman wrote that it had a "significant relationship with Fremont," based upon past securitizations, whole loan purchases, and warehouse fees.²²⁰²²²⁰² 2/20/2007 Goldman memorandum to Mortgage Capital Committee, "Request for renewal of the existing $1 billion ... 1-year revolving warehouse facility," GS MBS-E-001157942. Goldman wrote that Fremont produced "revenues totaling $13.38 million in 2006 of which $620,000 came in the form of warehouse usage and commitment fees." In March 2007, at the same time it was sending millions of dollars in loan repurchase requests to Fremont, Goldman securitized over $1 billion in Fremont subprime loans in one of its warehouse accounts, originating GSAMP Trust 2007-FM2.²²⁰³²²⁰³ See 2/2/2007 Goldman memorandum to the Mortgage Capital Committee, "Agenda for Monday, February 5, 2007," GS MBS-E-002201064; 2/5/2007 Mortgage Capital Committee Memorandum regarding GSAMP Trust 2007-FM2, GS MBS-E-002201055 - 58. At Goldman's request, Moody's and S&P rated the securities, even though analysts at both rating firms expressed concern about the quality of Fremont loans. At S&P, for example, in a January 2007 email to his supervisor, a credit ratings analyst wrote: "I have a Goldman deal with subprime Fremont collateral. Since Fremont collateral has been performing not so good, is there anything special I should be aware of?"²²⁰⁴²²⁰⁴ 1/24/2007 S&P internal email, "Quick Question: Fremont," Hearing Exhibit 4/23-93b. See also 2/1/2007 S&P internal email, "Defaults cause Fremont to end ties to 8,000 brokers," Hearing Exhibit 4/23-93d (S&P analysts circulated an article about how Fremont had stopped using 8,000 brokers due to loans with some of the highest delinquency rates in the country). One supervisor told him: "No, we don't treat their collateral any differently," while another wrote that, as long as the analyst had current FICO scores for the borrowers, he was "good to go."²²⁰⁵²²⁰⁵ 1/24/2007 S&P internal email, "RE: Quick Question: Fremont," Hearing Exhibit 4/23-93c. Both agencies gave AAA ratings to the top five tranches of the securitization.²²⁰⁶²²⁰⁶ 4/17/2010 S&P downgrade of GSAMP Trust 2007-FM2 containing Fremont mortgages, Hearing Exhibit 4/23- 93f.

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¶Goldman marketed and sold the Fremont securities to its customers, while at the same time purchasing $15 million in CDS contracts referencing some of the Fremont securities it underwrote.²²⁰⁷²²⁰⁷ See 3/21/2007 Goldman spreadsheet, "RMBS CDS Trade History 19Jan06 - 19Mar07 v3," GS MBS-E- 013648130. Seven months later, by October 2007, the ratings downgrades had begun; by August 2009, every tranche in the GSAMP securitization had been downgraded to junk status.²²⁰⁸²²⁰⁸ See Standard & Poor's www.globalcreditportal.com.

¶In both examples involving Long Beach and Fremont RMBS securities, Goldman obtained CDS protection and essentially bet against the very securities it was selling to clients. In each case, Goldman profited from the fall in value of the same securities it sold to its clients and which caused those clients to suffer substantial losses.

¶(ii) Conflicts of Interest Involving Sales of CDO Securities

¶As with some of its RMBS securities, Goldman at times originated CDO securities using assets that it believed were of poor quality and would lose value, and sold the securities at higher prices than it believed they were worth.²²⁰⁹²²⁰⁹ In some cases, Goldman used assets from its own inventory or warehouse accounts, so that it could transfer assets with falling value to the CDO and the investors who purchased the CDO securities. The Subcommittee examined seven CDOs issued by Goldman, and of those, 57% of the CDOs' assets were sourced from Goldman, including over $3 billion in synthetic assets in which Goldman was the short party, and therefore stood to profit from a decline in the value of the underlying assets.Show full note In addition, Goldman took steps that created multiple conflicts of interest with the clients to whom it sold the CDO securities, and placed its financial interests ahead of those of its clients. Four examples involving the Hudson 1, Anderson, Timberwolf, and Abacus 2007-AC1 CDOs illustrate the problems. Those problems include troubling and sometimes abusive practices related to how Goldman designed the CDOs and selected their assets; marketed and sold the CDO securities; designated the value of the CDO securities pre- and post-sale; and executed its duties as liquidation agent and collateral put provider.

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¶AA. Hudson Mezzanine Funding 2006-1

¶Hudson Mezzanine Funding 2006-1 (Hudson 1) was a $2 billion synthetic CDO that referenced mezzanine subprime RMBS assets²²¹⁰²²¹⁰ Mezzanine subprime RMBS assets are RMBS securities that carry a credit rating of BBB or BBB- or CDS contracts that reference those types of RM BS securities. Mezzanine RM BS assets are riskier than AAA, AA, and A rated RMBS securities, but less risky than those that carry, for example, BB, B, or CCC ratings. and assets linked to the ABX Index.²²¹¹²²¹¹ The ABX Index tracks the performance of a designated basket of 20 subprime RMBS securitizations. It consists of five separate indices, each of which tracks a different subset of the RMBS basket, divided according to credit ratings. The indices that track the mezzanine RMBS securities, for example, track the 20 RMBS securities that carry BBB and BBB- credit ratings. In ABX assets, investors enter into CDS contracts in which one party takes the long side, essentially betting that the ABX indices tracking the mezzanine RMBS securities will increase in value, while the other party takes the short side, essentially betting that the indices will fall in value. Prior to establishing the Hudson CDO, Goldman had taken the long side in a number of CDS contracts linked to the ABX indices tracking mezzanine RMBS securities.Show full note This CDO was the second in a series of three "Hudson" branded CDOs, which according to Goldman marketing materials were intended "to create a consistent, programmatic approach to invest in attractive relative value opportunities in the RMBS and structured product market."²²¹²²²¹² 10/2006 Goldman document, "Hudson M ezzanine Funding 2006-1, Ltd.," Hearing Exhibit 4/27-87. The first Hudson CDO, Hudson High Grade, was issued in September 2006. The second, discussed here, was Hudson Mezzanine 2006-1, issued in October 2006. The third was Hudson Mezzanine 2006-2, issued in February 2007. One key feature of the three Hudson CDOs was that Goldman itself, without any third party participation, selected the CDO's assets, which were supposed to remain with the CDO until they reached maturity or were deemed "credit risk assets," at which point Goldman, acting as the liquidation agent for the CDO, was responsible for selling them.²²¹³²²¹³ Id. For more information about Goldman's role as the liquidation agent in Hudson, see Section C(5)(b)(iii)AA, below. In each of the Hudson CDOs, Goldman played multiple roles in its formation and administration, including selecting assets and serving as the underwriter, initial purchaser of the CDO securities, collateral put provider,²²¹⁴²²¹⁴ In synthetic CDOs, the cash proceeds from the sales of the CDO securities were used to purchase "collateral debt securities." Later, when cash was needed to make payments to a long or short party, those collateral securities were sold, and the cash was used to make the payments. In the event the collateral securities could not be sold for face (par) value, the collateral put provider paid the difference to the CDO. For more information about the role of collateral put providers, see Section C(5)(b)(iii)BB, below.Show full note senior swap counterparty, and credit protection buyer.²²¹⁵²²¹⁵ See 2/18/2008 Goldman document, "CDO Transactions (July 1, 2006 - December 31, 2007) in which Goldman Sachs acted as underwriter," GS MBS 0000004337 at 4338. Acting as the "senior swap counterparty" meant that Goldman served as an intermediary between the Hudson CDO and the super senior investor. Acting as "credit protection buyer" meant that Goldman initially took the short side of the CDO and, in the case of Hudson 1, kept 100% of the short side during the life of the CDO.Show full note In Hudson 1, Goldman took 100% of the short side of the CDO, and when the Hudson 1 securities declined in value, Goldman made a $1.35 billion profit at the expense of the clients to whom it had sold the Hudson 1 securities.

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¶Transferring Risk. Hudson 1 was conceived and designed by Goldman to transfer the risk associated with a large collection of ABX assets in its inventory, in which Goldman held the long side of CDS contracts referencing mezzanine subprime RMBS securities that were tracked by the ABX Index and that might go down in value. The objective of the CDO was to transfer the risk of unwanted financial assets off of Goldman's books. In response to questions from the Subcommittee, Goldman explained that Hudson 1 was "initiated by the firm as the most efficient method to reduce long ABX exposures."²²¹⁶²²¹⁶ See Goldman response to Subcommittee QFR at PSI_QFR_GS0239. Contemporaneous notes from Goldman's Firmwide Risk Committee meetings also stated that Hudson 1 was an "exit for our long ABX risk."²²¹⁷²²¹⁷ 9/20/2006 email from Arbind Jha to Josh Birnbaum, GS MBS-E-012685289. See also 9/20/2006 Firmwide Risk Committee Minutes, GS MBS 0000004472. Goldman records show that the firm used Hudson 1 to short $1.2 billion worth of the ABX assets in the firm's inventory as well as $800 million in single name CDS contracts referencing subprime RMBS securities carrying mostly BBB or BBB- credit ratings. Hudson 1 was one of several methods Goldman used to transfer its risk associated with its subprime mortgage holdings during the fall of 2006.²²¹⁸²²¹⁸ See 10/24/2006 email from Jonathan Sobel to Tom Montag, Dan Sparks, and others, GS MBS-E-010919930 ("CDO should price tomorrow and is in good shape. ... W e also are starting to see some short covering, which we will sell into to further reduce our risk toward your 50% goal.").

¶Conceiving Hudson 1. In the months leading up to the creation of Hudson 1, Goldman had accumulated billions of dollars in ABX assets referencing mezzanine subprime RMBS securities.²²¹⁹²²¹⁹ Subcommittee interview of Michael Swenson (4/16/2010). Mr. Swenson told the Subcommittee that Goldman had been long "several billion" in ABX in September 2006. By August 2006, Goldman management had decided that this ABX trade had "run its course," and directed the Mortgage Department's ABS Desk to sell off its ABX holdings.²²²⁰²²²⁰ 8/9/2006 Firmwide Risk Committee Minutes, GS M BS-E-009682590; Subcommittee interview of Joshua Birnbaum (10/1/2010). Mr. Birnbaum recalled a "directive" to reduce ABX exposure in the summer of 2006. After several weeks of effort, however, the ABS Desk was unable to find many buyers, and its ABX mezzanine assets, which were dropping in value, were losing millions of dollars for the firm.²²²¹²²²¹ See, e.g., 9/21/2006 email from Jonathan Sobel to Tom Montag, "ABX wider again today," GS MBS-E- 009739145 ("Down about $10mm."); 9/12/2006 email from Jonathan Sobel to Michael Swenson and Daniel Sparks, "ABX," GS MBS-E-012681410 ("The last post you gave me was this morning when you thought things were 'firm'. Now I find out that we're down $6mm on the day. I understand things move, but you need to post me. Also, I want to reduce this position."); 9/9/2006 Firmwide Risk Committee Minutes, GS M BS 0000004468 ("Business continuing to reduce volatile ABX position."); 8/23/2006 Firmwide Risk Committee Minutes, GS MBS-E-009615593 ("Mortgages sold down another net 15% of their large ABX position.").Show full note

¶On September 19, 2006, Jonathan Sobel and Daniel Sparks called an 8:00 a.m. meeting to discuss the ABX problem with Joshua Birnbaum, head of ABX trading, and Michael Swenson, head of both the Structured Product Group (SPG) Trading Desk and ABS Trading Desk.²²²²²²²² 9/19/2006 email from Jonathan Sobel to Daniel Sparks, Michael Swenson, and Josh Birnbaum, GS MBS-E- 012683946. Mr. Swenson was unable to attend, and in a later email from Mr. Birnbaum who recounted the meeting to him, Mr. Sobel and Mr. Sparks wanted to know whether the Mortgage Department should sell all of its ABX mezzanine holdings or "double down" the ABX holdings, which could happen only if it found a "structured place to go with the risk."²²²³²²²³ 9/19/2006 email from Josh Birnbaum to M ichael Swenson, GS MBS-E-012683946. Mr. Sobel also informed Mr. Swenson later that day: "W e need to reach a conclusion on the viability of a structured exit." 9/19/2006 email from Jonathan Sobel to Michael Swenson, GS MBS-E-012328199.

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¶Later that day, Mr. Sparks approached Peter Ostrem, who headed the desk that originated CDOs for Goldman, and asked "if there was something [the CDO Desk] could do with ABX."²²²⁴²²²⁴ Subcommittee interview of Peter Ostrem (10/5/2010). Mr. Ostrem spoke with Darryl Herrick, who worked for him on the CDO Desk and who eventually became the Hudson 1 deal captain, about crafting a CDO to reduce the firm's ABX risk. The two brainstormed a structure that became the foundation of Hudson 1.²²²⁵²²²⁵ Id.; Subcommittee interview of Darryl Herrick (10/13/2010).

¶That same evening, September 19, 2006, Mr. Swenson scheduled a meeting with several traders on the ABS Desk he oversaw, Joshua Birnbaum from the ABX Desk, and Mr. Ostrem and other personnel from the CDO Origination Desk to discuss "ABX and Single-Name Opportunities."²²²⁶²²²⁶ 9/19/2006 calendar invite from Michael Swenson, GS MBS-E-012328194. After the meeting, around 8:00 p.m., Mr. Ostrem sent his CDO team an email announcing "Hudson Mezz - new":

"We have been asked to do a CDO of $2bln [billion] for the ABS desk. Approx. $1.2bln will be CDS off single-names referenced from the AB[X] index 06-1 and 06-2. This is a trade we need to execute for the desk over the next 4-6 weeks and involves selling half the equity (at least 30mm to sell) and the seniors and the mezz (at least half of the BBBs to get true sale). I would like everyone to work together on this one. We expect to charge ongoing 10bp [basis point] liquidation agent fees and 1-1.5pts upfront. ... Obviously important to overall SP [Structured Product] floor and Sobel and Sparks are focused on this happening."²²²⁷²²²⁷ 9/19/2006 email from Peter Ostrem, GS MBS-E-01818608, Hearing Exhibit 4/27-86. Goldman later told the Subcommittee that Hudson actually offset $1.39 billion in ABX assets on its books. Goldman response to Subcommittee QFR, PSI_QFR_GS0239.

¶Also that evening, Mr. Swenson emailed Mr. Sobel to inform him they were "proceeding with the CDO solution, the CDO team has 60 single-names that they will be able to begin to build a deal around."²²²⁸²²²⁸ 9/20/2006 email from Michael Swenson to Jonathan Sobel, GS MBS-E-012328203. See discussion of selection of 60 single names by Mr. Herrick and Mr. Salem, below.

¶The next day, Mr. Sobel reported to senior executives at Goldman's Firmwide Risk Committee that the CDO Desk was working on the first ever ABX CDO, which would function as an exit for the firm's long ABX position.²²²⁹²²²⁹ 9/20/2006 Firmwide Risk Committee Minutes, GS MBS 0000004472; 9/20/2006 email from Arbind Jha to Josh Birnbaum, GS MBS-E-012685289. Later that same afternoon Mr. Sobel sent an email to Goldman senior executive Thomas Montag, discussing the Mortgage Department's ABX losses and stating: "I think most hedge funds have been right on this (i.e. they've been short). ... The synthetic CDO seems like a viable takeout here."²²³⁰²²³⁰ 9/21/2006 email from Jonathan Sobel to Tom Montag, GS MBS-E-009739145.

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¶A Goldman risk officer, Arbind Jha, began contacting Goldman mortgage traders and CDO personnel for regular Hudson updates.²²³¹²²³¹ See, e.g., 10/16/2006 email from John Li to Darryl Herrick, "Call Arbind Jha," GS MBS-E-018209595 ("Regarding Hudson Mezz Risk issue"). In fact, the day after the ABS and CDO teams came up with the Hudson 1 concept, Mr. Jha emailed Mr. Birnbaum asking about the CDO: "Sobel this morning mentioned in the Firmwide Risk Committee meeting that we are looking at CDO exit for our long ABX risk. Wanted to get some color on this."²²³²²²³² 9/20/2006 email from Arbind Jha to Josh Birnbaum, GS M BS-E-012685289. W hen asked about this email and Hudson 1 in general, Mr. Birnbaum told the Subcommittee that he had no specific recollection of any involvement with the Hudson 1 CDO. Subcommittee interview of Joshua Birnbaum (10/1/2010). On another occasion, Mr. Jha asked Darryl Herrick:

"Do we really have scenario risk on $2bn [billion] not'l [notional]? $1.2bn of not'l is being sourced from ABX desk - this risk is already being captured in our risk number for SPG Trading desk. ... The remaining $0.8bn will be composed of single name CDS. Since we do not have any pre-existing long (credit), we will be going short after we price this CDO and therefore will have a risk mitigating impact on our risk. Please correct me if I am getting this wrong."²²³³²²³³ 10/12/2006 email from Arbind Jha, "Re: Risk Issue," Hearing Exhibit 4/27-88.

¶Designing Hudson 1. At the time Hudson 1 was conceived, no other investment bank had issued a CDO in which the majority of assets referenced ABX assets.²²³⁴²²³⁴ 9/20/2006 Firmwide Risk Committee Minutes, GS MBS 0000004472. Prior to that, the major credit rating agencies refused to rate any CDO with more than a 5% exposure to credit default swaps (CDS) using an ABX index as the reference obligation.²²³⁵²²³⁵ See, e.g., 3/23/2007 "CDO Rating Factors: Inclusion of Tranched ABX Indices in ABS CDOs," M oody's, Document No. SF95049. CDS that used an ABX index as the reference obligation allowed the parties to the CDS to make a pure bet on the composite performance of a basket of 20 RMBS securities. Credit rating agencies were concerned that the inclusion of ABX assets in CDOs would increase market-wide correlation and make CDO performance more volatile.

¶In order to get around that limitation and create a CDO that the credit rating agencies would be willing to rate, Goldman took several steps. First, it decided Hudson 1 would reference the two ABX 06-1 indices and the two ABX 06-2 indices that referenced RMBS securities with BBB and BBB- ratings. Since each of those four indices tracked 20 subprime mezzanine RMBS securities, altogether they tracked 80 RMBS securities.²²³⁶²²³⁶ The ABX 06-1 Index and the ABX 06-2 Index each tracked a completely different set of 20 RMBS securitizations. Each Index also had its own subset of five indices tracking individual securities issued by those 20 securitizations, divided by credit rating. For example, one of the RMBS securitizations tracked by the ABX 06-2 Index was called CW L 2006-8. One of the sub-indices within the ABX 06-2 Index tracked BBB rated securities that were issued as part of the 20 securitizations, including the M8 tranche of CW L 2006-8 which carried a BBB rating. Another of the five indices tracked the securities carrying a BBB- rating, including the M9 tranche of CW L 2006-8 which carried that credit rating. The CW L 2006-8 M8 and CW L 2006-M9 securities were just two of the 40 BBB and BBB- rated securities issued by the 20 RM BS securitizations in the ABX 06-2 Index. The ABX 06-1 Index functioned the same way; its sub-indices tracked another 40 mezzanine RMBS securities from the 20 RMBS securitizations that composed that Index.Show full note Next, Goldman created 80 single name CDS contracts, each of which used as its reference obligation one of the subprime mezzanine RMBS securities tracked by the ABX indices.²²³⁷²²³⁷ A "single name CDS" contract uses a single security as its reference obligation, such as a specific RMBS security. Goldman's ABS Desk took the short position in each of those 80 contracts, while Goldman's CDO Origination Desk took the long position.²²³⁸²²³⁸ For simplicity, all 20 assets in each of the ABX baskets were given the same weighted price in Hudson 1. By taking the short position in the 80 single name CDS contracts, the ABS Desk essentially offset its long position in the corresponding ABX contracts. Next, the CDO Origination Desk entered into a CDS contract with Hudson 1, taking the short side while the Hudson CDO assumed the long side of the 80 single name CDS contracts. The end result was that Hudson 1 took the long side and assumed the risk associated with the long position for $1.2 billion worth of CDS single name contracts referencing the RMBS securities comprising the ABX 06-1 and 06-2 BBB and BBB- indices.²²³⁹²²³⁹ See, e.g., 4/27/2007 email from Fabrice Tourre to Michael Swenson, Deeb Salem, and Edwin Chin, GS MBS-E- 012432742. By transferring the long CDS position to Hudson, Goldman effectively transferred the risk associated with its ABX long assets to any investors who bought the Hudson securities.

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¶In order to attract investors and convince them to buy the Hudson securities, Goldman decided to make use of a pricing difference between CDS contracts referencing the ABX Index versus single name RMBS securities.²²⁴⁰²²⁴⁰ Mr. Swenson described this situation in his testimony before the Subcommittee: "Throughout 2006, numerous clients wanted to sell the ABX in order to express a negative view on the U.S. residential housing market. As a result of these trades, we took on long positions. In order to hedge those positions, we began to increase our short position in single-names. By November 2006, volatility in the ABX increased, pushing prices down. Because our positions in single names did not match identically the basket of securities that comprised the ABX, the positions moved at different rates and even different directions, resulting in losses for the ABS desk." Prepared statement of Michael Swenson, April 27, 2010 Subcommittee Hearing, at 208-09.Show full note In 2006, at the time Hudson was being constructed, the price of CDS contracts that used an ABX index as the reference obligation was lower than the price of CDS contracts that used an individual RMBS security as its reference obligation. Because Goldman exercised complete control over the CDO and created CDS contracts referencing assets from its own inventory, Goldman also exercised complete control over the pricing of those contracts. When Goldman set up the 80 single name CDS contracts, and sold the long side of those contracts to Hudson 1, Goldman decided internally what it would charge the CDO to acquire the long side of those contracts. Goldman decided to price the contracts, not according to the cost of a single name CDS contract on the market, but instead according to the cost of a CDS contract for the long side of the relevant ABX index that day.²²⁴¹²²⁴¹ Goldman decided to price the single name assets at one point below the median ABX trading price. See 9/21/2006 email from Darryl Herrick to Deeb Salem, Michael Swenson, Joshua Birnbaum, Peter Ostrem, and Edwin Chin, GS MBS-E-012685645. By using this pricing method, Goldman enabled Hudson to purchase the single name CDS contracts at the lower ABX prices, which meant it could tell investors that, by purchasing Hudson securities, they would be purchasing the single name CDS contracts at the discount price at which Hudson acquired them.²²⁴²²²⁴² See 10/2/2006 email from Darryl Herrick to Michael Swenson, Joshua Birnbaum, Deeb Salem, Peter Ostrem, and Daniel Sparks, GS MBS-E-010913416 ("W e plan to announce Hudson Mezzanine Funding tomorrow in the am for Europe, Asia and the US[.] I'm circulating around to everyone the CDO portfolio and spreads we will be showing investors and agencies, based on our agreed upon amounts and levels from last week."). Mr. Swenson responded: "Darryl we should use the 265 and 245 spread for the ABX2 and ABX1 triple-B minus spreads and 145 and 130 for triple-B ABX2 and ABX1 triple-B spreads." Id.Show full note

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¶The pricing differential also benefitted Goldman's ABS Desk in two ways. First, it created a modest incentive for investors to buy Hudson securities and take the long position needed to offset Goldman's ABX risk. Second, it left Goldman with a short position in the form of CDS single name contracts, which Goldman expected to become more valuable than a short position in CDS contracts that referenced ABX indices. The ABS Desk kept both its long ABX positions and its short single name CDS positions in the same dedicated account. Over time, the short position in single name CDS did gain in value and boosted the overall value of the portfolio of assets held by the ABS Desk by more than $1 million, producing additional profits for Goldman.²²⁴³²²⁴³ The gain generated by the CDS single name contracts was retained on the books of the ABS Desk, and created a favorable "basis" compared to the cost of the ABX long position held by the desk. See 4/27/2007 email from Fabrice Tourre to Michael Swenson, Deeb Salem, and Edwin Chin, GS MBS-E-012432742; Goldman response to Subcommittee QFR at PSI_QFR_GS0239. See also 9/19/2006 email from Michael Swenson to Thomas Cornacchia and Joshua Birnbaum, GS MBS-E-012684557 ("[ABX] Index to single-name basis is at the wides[t] (ie 40 bp at BBB- level). Index to cash is even more extreme at 70bp. Bids for cash deals remain strong and have barely widened."); Performance Review for Michael Swenson, GS-PSI-02396, Hearing Exhibit 4/27-55b (describing the mortgage trading desk's strategy of shorting single-name RMBS to offset long ABX positions: "[D]uring the early summer of 2006 it was clear that the market fundamentals in subprime and the highly levered nature of CDOs was going to have a very unhappy ending. The beauty of the CDO short was that it allowed for a very efficient method for capturing the value in the ABX to single-name basis from the short side.").Show full note

¶In addition to the $1.2 billion in single name CDS contracts to offset Goldman's ABX risk, Mr. Herrick from the CDO Origination Desk and Deeb Salem from the ABS Desk worked together to select $800 million in additional single name CDS contracts to include in the Hudson CDO.²²⁴⁴²²⁴⁴ Subcommittee interview of Darryl Herrick (10/13/2010). See also 10/8/2006 email from Darryl Herrick to a Goldman salesperson, GS MBS-E-017502983 (discussing Hudson 1: "Omar, I realize lack of manager may be tough hurdle for them [investors]. May be helpful to let Deeb and I get on a call with the investor and discuss our asset selection criteria and I can go through asset sale criteria."). Mr. Herrick told the Subcommittee that he gave Mr. Salem a specific set of criteria for selecting these CDS contracts, including a list of RMBS names that he wanted to be included, a list of RMBS names that he did not want to be included, and an acceptable price range for each CDS contract. Since Goldman planned to take 100% of the short side of Hudson 1, these lists were presumably used to identify RMBS contracts that Goldman expected to offset Goldman's long positions. Mr. Herrick told the Subcommittee that Mr. Salem responded with an initial list of 60 possible RMBS reference obligations, 52 of which were ultimately included in Hudson 1.²²⁴⁵²²⁴⁵ See 9/19/2006 email from Darryl Herrick to Deeb Salem, Peter Osterm, others, GS MBS-E-011402123, with attachment GS M BS-E-011403442 (Mr. Salem wrote to Mr. Herrick: "Attached are 60 RMBS Ref Obs ... for the CDO we're discussing. On the RM BS side, we chose 30 Baa2 and 30 Baa3 CUSIPs evenly split btw 2005 and 2006 vintage. W e can add a few alt-a names as well. How many of those would you like?"). W hen interviewed by the Subcommittee, Mr. Salem had no specific recollection of how assets were selected for Hudson 1 and little specific recollection about Hudson 1 as a whole. Subcommittee interview of Deeb Salem (10/6/10).Show full note

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¶According to Goldman's contemporaneous records and its responses to Subcommittee questions, 100% of the CDS contracts included in Hudson 1 were supplied by Goldman's Mortgage Department.²²⁴⁶²²⁴⁶ See, e.g., Goldman response to Subcommittee QFR, PSI_QFR_GS0192. Because Hudson 1 contained only CDS contracts, it was entirely "synthetic"; it contained no loan pools or RMBS securities that directed actual cash payments to the CDO. Instead, the only cash payments made to Hudson 1 consisted of the cash paid by investors making initial purchases of the Hudson securities and the premiums that Goldman paid into Hudson 1 as the sole short party.²²⁴⁷²²⁴⁷ Goldman used the cash paid into Hudson 1 to purchase "collateral securities," as discussed further below.

¶Marketing Hudson. After establishing its basic characteristics and selecting the CDS assets to be included in Hudson 1, Goldman began to look for investors. A key development took place early on, when near the end of September 2006, Morgan Stanley's proprietary trading desk committed to entering into a CDS agreement with Goldman referencing the "super senior" portion of Hudson 1, meaning the CDO's lowest risk tranche that would be the first to receive payments to the CDO.²²⁴⁸²²⁴⁸ See 10/30/2006 email from Peter Ostrem, GS MBS-E-0000057886, Hearing Exhibit 4/27-90 ("Super senior note ($1.2bln in size) was executed in the first week of the transaction and was a key driver of this deal[']s success."). Morgan Stanley agreed to take the long side of a CDS that represented $1.2 billion of the $2 billion CDO, while Goldman took the short side.²²⁴⁹²²⁴⁹ The $1.2 billion investment made by Morgan Stanley did not correspond to the CDO's $1.2 billion in CDS contracts referencing RM BS securities in the two ABX indices. Rather, Morgan Stanley was investing in the top tier of the CDO as a whole, which included CDS contracts referencing both the ABX and other RMBS securities. As part of its agreement to invest in Hudson 1, Morgan Stanley was permitted to review the $800 million in single name CDS contracts to be included in the CDO and, in fact, vetoed the proposed inclusion of certain CDS contracts referencing commercial mortgage backed securities.²²⁵⁰²²⁵⁰ Subcommittee interview of Darryl Herrick (10/13/2010). See further discussion of Morgan Stanley investment in Section C(5)(b)(iii)AA, below.

¶After getting the commitment from Morgan Stanley, Goldman turned its focus to selling the remaining Hudson securities. On September 27, 2007, Mr. Swenson, the SPG Trading Desk and ABS Desk head, sent an email to set up a meeting, which later became a conference call, on "Marketing Strategy for the ABX CDO Trade."²²⁵¹²²⁵¹ 9/27/2006 email from Michael Swenson to Crystal Young, GS M BS-E-012328848. Mr. Swenson told the Subcommittee that he had no recollection of this conference call, and that it would have been unusual for him to be involved in the marketing efforts of a CDO. Subcommittee interview of Michael Swenson (10/8/2010). The invitees included Daniel Sparks, Jon Sobel, Peter Ostrem, Darryl Herrick, and others. Mr. Herrick circulated a draft copy of the Hudson 1 termsheet and transaction overview for review in advance of the call.²²⁵²²²⁵² 9/28/2006 email from Darryl Herrick, GS MBS-E-014042217, with attachments GS MBS-E-014042218 and GS MBS-E-014042220.

¶Goldman's CDO marketing strategy typically involved its sales personnel sending clients a marketing booklet outlining different features of a particular CDO. Mr. Herrick drafted the marketing booklet for Hudson 1, and circulated it for review to Mr. Ostrem and other members of the CDO Origination Desk including Benjamin Case and Matthew Bieber.²²⁵³²²⁵³ 9/30/2006 email from Darryl Herrick to Peter Ostrem, Benjamin Case, and Matthew Bieber, GS MBS-E- 014367160, with attachment GS MBS-E-014367161; 9/30/2006 Goldman internal email chain among Darryl Herrick, Peter Ostrem, Benjamin Case, and Matthew Bieber, GS MBS-E-017504075. The executive summary of the marketing booklet described Goldman's Hudson CDO program generally and Hudson 1 in particular:

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"Goldman Sachs developed the Hudson CDO program in 2006 to create a consistent, programmatic approach to invest in attractive relative value opportunities in the RMBS and structured product market[.]

-We successfully launched Hudson High Grade in September. This is a continuation of the program using mezzanine Baa2/Baa3 quality RMBS[.]

Hudson CDOs are non-managed and static in nature and provide term non-recourse funding where Goldman Sachs acts as Liquidation Agent on an ongoing basis. The Liquidation Agent will be responsible for efficiently selling credit risk assets ...

Goldman Sachs has aligned incentives with the Hudson program by investing in a portion of equity and playing the ongoing role of Liquidation Agent."²²⁵⁴²²⁵⁴ 10/2006 Hudson Mezzanine Funding 2006-1, LTD., GS MBS-E-009546963, at 966, Hearing Exhibit 4/27-87.

¶The marketing booklet also described the Hudson 1 assets, and the selection process for those assets:

"The portfolio composition of Hudson Mezzanine Funding 2006-1 will consist of 100% CDS on RMBS.

60% of the RMBS will be single name CDS on all 40 obligors in ABX 2006-1 and ABX 2006-2

40% of the RMBS will consist of single name CDS on 2005 and 2006 vintage RMBS ...

¶Goldman Sachs' portfolio selection process:

Assets sourced from the Street. Hudson Mezzanine Funding is not a Balance Sheet CDO - Goldman Sachs CDO desk pre-screens and evaluates assets for portfolio suitability - Goldman Sachs CDO desk reviews individual assets in conjunction with respective mortgage trading desks (Subprime, Midprime, Prime, etc.) and makes decision to add or decline[.]"²²⁵⁵²²⁵⁵ Id. at 966, 978.

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¶The marketing booklet statement that "Goldman Sachs had aligned incentives with the Hudson program by investing in a portion of equity," was misleading. Goldman did, in fact, purchase approximately $6 million in Hudson equity.²²⁵⁶²²⁵⁶ See Goldman response to Subcommittee QFR, at PSI_QFR_GS0223. However, that $6 million equity investment was outweighed many times over by Goldman's $2 billion short position, which made Goldman's interest adverse to, rather than aligned with, the Hudson investors. Neither the marketing booklet nor other offering materials disclosed to investors the size or nature of Goldman's short position in Hudson 1.

¶The marketing booklet also stated that Hudson's assets were "sourced from the Street," and that it was "not a Balance Sheet CDO," even though all of the CDS contracts had been produced and priced internally by Goldman and $1.2 billion of the contracts offset Goldman ABX holdings. The plain meaning of the phrase, "sourced from the Street," is that the Hudson 1 assets were purchased from several broker-dealers on Wall Street.²²⁵⁷²²⁵⁷ Barron's Dictionary of Finance and Investment Terms defines "the Street" as "referring to the financial community in New York City and elsewhere. It is common to hear 'The Street likes XYZ.' This means there is a national consensus among securities analysts that XYZ's prospects are favorable." Indeed, a former Goldman salesperson who sold Hudson 1 securities to investors told the Subcommittee that he thought "sourced from the Street" referred to assets being acquired from a variety of different broker-dealers at the best prices, and was surprised to learn that all of the Hudson assets had been provided by Goldman's ABS Desk.²²⁵⁸²²⁵⁸ Subcommittee interview of Andrew Davilman (9/30/2010). A Hudson 1 investor told the Subcommittee that it had also interpreted the phrase "sourced from the Street" to mean assets acquired from a variety of different broker-dealers.²²⁵⁹²²⁵⁹ Subcommittee interview of Morgan Stanley (6/24/2010).

¶The Subcommittee asked several Goldman traders involved in Hudson 1 to explain their understanding of the phrase, and received inconsistent answers. Darryl Herrick, who drafted the Hudson marketing booklet, stated that "sourced from the Street" meant the assets were "sourced from a street dealer at street prices." His supervisor, CDO Managing Director Peter Ostrem, stated that "sourced from the Street" referred to the fact the underlying RMBS securities were not originated or underwritten by Goldman.²²⁶⁰²²⁶⁰ The Subcommittee asked Mr. Ostrem whether he considered the Hudson 1 assets to be the RM BS securities or the credit default swaps referencing those securities, and Mr. Ostrem responded that the assets in the CDO were the RMBS securities which had been originated by a variety of financial institutions on W all Street. W hen asked why it would be important to indicate to investors that not all the underlying RM BS securities were underwritten by Goldman, given that this information would be clear to a professional reviewing the names of the reference assets in Hudson 1, Mr. Ostrem replied that he didn't know. Subcommittee interview of Peter Ostrem (10/5/2010).Show full note Deeb Salem, a Goldman mortgage trader who selected 40% of the assets in Hudson 1, described "the Street" as simply "short hand for all broker-dealers."²²⁶¹²²⁶¹ Subcommittee interview of Deeb Salem (10/6/2010). David Lehman, who became the head of the CDO Origination Desk after Mr. Ostrem, and Matthew Bieber, who worked for Mr. Ostrem and later Mr. Lehman, claimed that it was accurate to say the Hudson assets were "sourced from the Street," even though all the assets were acquired from the Goldman ABS Desk, because Goldman was part of "the Street."²²⁶²²²⁶² Subcommittee interview of David Lehman (9/27/2010); Subcommittee interview of Matthew Bieber (10/21/2010).

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¶By using the phrase, "sourced from the Street," Goldman may have misled investors into thinking that the referenced assets had been purchased from several broker-dealers and obtained at arms-length prices, rather than simply taken directly from Goldman's inventory and priced by its own personnel. Moreover, this phrase also appears to hide the fact that Goldman had an adverse interest to investors and was seeking to transfer unwanted risk from its own inventory to the clients it was soliciting. By claiming it was "not a Balance Sheet CDO," Goldman may have misled investors into believing that Goldman had little interest in the performance of the referenced assets in Hudson, rather than having selected the assets to offset risks on its own books.

¶In addition to the Hudson marketing booklet, in December 2006, Goldman issued an Offering Circular which it distributed to potential investors.²²⁶³²²⁶³ 12/3/2006 Hudson Mezzanine 2006-1, LTD. Offering Circular, GS MBS-E-021821196. The Offering Circular contained the statement that no independent third party had reviewed the prices at which the CDS contracts were sold to Hudson 1.²²⁶⁴²²⁶⁴ Id. at 021821241. In addition to lacking third party verification, no external counterparty had participated in any aspect of the CDS contracts – all of the CDS contracts had been produced, signed, and priced internally by two Goldman trading desks which exercised complete control over the Hudson CDO.

¶Internally, while Hudson 1 was being constructed, Goldman personnel acknowledged that they were using a novel pricing approach.²²⁶⁵²²⁶⁵ See, e.g., 9/19/2006 email from Michael Swenson to Thomas Cornacchia and Joshua Birnbaum, GS MBS-E- 012684557 ("we are going to price an innovative full capital structure $1+bb CDO deal with 60% of the risk in ABX (no one has done this before)."); 9/21/2006 email from Darryl Herrick to Deeb Salem, Michael Swenson, Joshua Birnbaum, Peter Ostrem, and Edwin Chin, GS MBS-E-012685645. At one point, Mr. Swenson sent an email to Mr. Birnbaum, raising questions about how they could explain some of the pricing decisions. Mr. Swenson wrote that he was: "concerned that the levels we put on the abx cdo for single-a and triple-bs do not compare favorably with the single-a off of a abx 1 + abx 2 trade," telling Mr. Birnbaum "[w]e need a goo[d] story as to why we think the risk is different."²²⁶⁶²²⁶⁶ 9/27/2006 email from Michael Swenson to Joshua Birnbaum, GS MBS-E-012689798. The prices that Goldman established for the CDS contracts that Hudson "bought" affected the value of the CDO and the Hudson 1 securities Goldman sold to investors, but the Offering Circular failed to disclose the extent to which Goldman had single-handedly controlled the pricing of 100% of the CDO's assets.

¶Perhaps the most serious omission from the marketing booklet and other offering materials was Goldman's failure to disclose the fact that it would be the sole short party in the entire $2 billion CDO. The Goldman materials told investors that an affiliate, Goldman Sachs International (GSI), would be the "credit protection buyer" or initial short party for the Hudson 1 CDO.²²⁶⁷²²⁶⁷ 12/3/2006 Hudson Mezzanine 2006-1, LTD. Offering Circular, GS MBS-E-021821196, at 021821229. This disclosure related to the master credit default swap, where Goldman Sachs International served as the credit protection buyer facing the Hudson Mezzanine 2006-1, Ltd., the legal entity that issued the Hudson 1 securities. See 12/1/2006 ISDA Master Agreement, GS MBS-E-021822056. In this role, Goldman was serving as an intermediary, and was protecting the CDO from credit risk by placing the Goldman Sachs name on the transaction and assuring investors that a single credit-worthy entity would be making all required payments to the Hudson 1 trust. Having one broker-dealer intermediate between the market and a CDO vehicle was desirable to credit rating agencies in order to minimize risk in the CDO, and Goldman clearly disclosed this role to investors.Show full note It was common practice for underwriters to act as the initial short party in a CDO, acting as an intermediary between the CDO vehicle and broker-dealers offering competitive bids in order to short the assets referenced in the CDO.²²⁶⁸²²⁶⁸ Goldman intermediated between other broker-dealers and the CDO vehicle in Anderson Mezzanine Funding 2007-1, Camber 7, Hudson Mezzanine 2006-1, Hudson Mezzanine 2006-2, and Timberwolf I, among several other CDOs. See Goldman response to Subcommittee QFR, at PSI_QFR_GS0192. The disclosure provided by Goldman contained boiler plate language suggesting that would be the role played by GSI in the Hudson transaction. Goldman never disclosed that it had provided all of Hudson's assets internally, GSI was not acting as an intermediary, and GSI would not be passing on any portion of the short interest in Hudson to any other party, but would be keeping 100% of the short position. The Hudson disclosures failed to state that, rather than serving as an intermediary, Goldman was making a proprietary investment in the CDO which placed it in a direct, adverse position to the investors to whom it was selling the Hudson securities.

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¶The Offering Circular contained a section entitled, "Certain Conflicts of Interest," which included a subsection entitled, "The Credit Protection Buyer and Senior Swap Counterparty," in which Goldman could have disclosed its short position. Rather than disclose that short position, however, Goldman stated in part:

"GSI and/or any of its affiliates may invest and/or deal, for their own respective accounts for which they have investment discretion, in securities or in other interests in the Reference Entities, in obligations of the Reference Entities or in the obligors in respect of any Reference Obligations or Collateral Securities (the "Investments"), or in credit default swaps (whether as protection buyer or seller), total return swaps or other instruments enabling credit and/or other risks to be traded that are linked to one or more Investments."²²⁶⁹²²⁶⁹ 12/3/2006 Hudson Mezzanine 2006-1, LTD. Offering Circular, GS MBS- E-021821196, at 021821251.

¶This disclosure indicates that GSI or an affiliate "may invest and/or deal" in securities or other "interests" in the assets underlying the Hudson CDO, and "may invest and/or deal" in CDS contracts that are "linked to" the Hudson "investments." The Offering Circular, however, misrepresented Goldman's investment plans. At the time it was created in December 2006, Goldman had already determined to keep 100% of the short side of the Hudson CDO and act as the sole counterparty to the investors buying Hudson securities, thereby acquiring a $2 billion financial interest that was directly adverse to theirs.

¶Tracking Hudson. Once it constructed the Hudson CDO, Goldman personnel were focused on completing and selling the Hudson 1 securities as quickly as possible. At least one other CDO was pushed back to facilitate the execution of Hudson 1.²²⁷⁰²²⁷⁰ 10/16/2006 email exchange between Daniel Sparks and Peter Ostrem, GS MBS-E-010916991 ("Cambridge is upset that we are delaying their deal. They know that Hudson Mezz (GS prop deal) is pushing their deal back.").

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¶Goldman senior executives closely followed Hudson's development and sale. Hudson was discussed, for example, at five different Firmwide Risk Committee meetings attended by senior Goldman executives.²²⁷¹²²⁷¹ Firmwide Risk Committee meetings were often chaired by David Viniar and frequently attended by Lloyd Blankfein and Gary Cohn. See 9/20/2006 Firmwide Risk Committee Minutes, GS MBS 0000004472; 9/27/2006 Firmwide Risk Committee Minutes, GS MBS 0000004474; 10/4/2006 Firmwide Risk Committee Minutes, GS MBS 0000004476; 10/11/2006 Firmwide Risk Committee Minutes, GS MBS 0000004478; 11/1/2010 Firmwide Risk Committee Minutes, GS MBS 0000004484. See also 10/11/2006 email from Arbind Jha to Joshua Birnbaum, GS MBS-E-012695030 ("Sobel this morning in the firmwide risk committee mentioned that we have circled up the junior and some of the equity tranches").Show full note Mortgage Department executives also sent progress reports to the senior executives on Hudson 1. On October 25, 2006, for example, Mr. Sobel sent an email to COO Gary Cohn and CFO David Viniar alerting them to Hudson sales efforts and the pricing of its securities.²²⁷²²²⁷² 10/25/2006 email from Jonathan Sobel to David Viniar and Gary Cohn, GS MBS-E-009757821. During discussions over the best price at which to market the CDO's equity tranche, a senior executive emailed Peter Ostrem and others: "keep in mind the overall objective - this is not about one trade - having said that, I agree that [the proposed price] may be too low."²²⁷³²²⁷³ 10/12/2006 email from Thomas Cornacchia to Peter Ostrem and others, GS MBS-E-0000066413. On October 26, 2006, Mr. Jha, a Goldman risk officer, circulated a Mortgage Department Risk Report to a number of Goldman executives, including CEO Lloyd Blankfein and COO Gary Cohn, noting in the forwarding email: "Risk reduction [in the Mortgage Department] is primarily due to pricing of $2bn Hudson Mez synthetic CDO."²²⁷⁴²²⁷⁴ 10/26/2006 email from Arbind Jha, "MarketRisk: Mortgage Risk Report (cob 10/25/2006)," GS MBS-E- 0000056041, Hearing Exhibit 4/27-89. That same day, October 26, 2006, Mr. Swenson also described the risk transfer to Goldman executive Bill McMahon when updating him on the trading desk's ABX position: "In addition to $2bb of risk that was placed into the CDO, we have sold to retail since 4pm yesterday $2bb of BBB- risk." 10/26/2006 email from Michael Swenson to Bill McMahon, others, GS MBS-E-0000054856.Show full note

¶Selling Hudson. Once the Hudson CDO was ready for sale, the Goldman sales force had difficulty selling Hudson securities to investors due to its reliance on BBB and BBB- rated subprime RMBS securities. Allied Irish Bank (AIB), for example, apparently referred to the Hudson securities as "junk."²²⁷⁵²²⁷⁵ 10/11/2006 Goldman internal email, "FW : Hudson Mezz," GS MBS-E-017502610, Hearing Exhibit 4/27-170c. (A Goldman employee asked a sales associate: "what specifically did AIB say was 'junk' about the hudson mezz deal?" The employee then forwarded the email to M r. Herrick saying: "You may want to ask [the sales associate] about this when she's there tomorrow and Friday. ... She said 'AIB are too smart to buy this kind of junk.'").Show full note One Goldman employee emailed the CDO team and asked:

"[D]o we have anything talking about how great the BBB sector of RMBS is at this point in time ... a common response I am hearing on both Hudson & HGS1 is a concern about the housing market and BBB in particular? We need to arm sales with a bit more."²²⁷⁶²²⁷⁶ 10/19/2006 email from Mitchell Resnick to Jonathan Egol, Darryl Herrick, and David Rosenblum, GS MBS-E- 009557391. "HGS1" refers to Abacus HGS1, a CDO 2 where Goldman, as in Hudson 1, held 100% of the short interest.

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¶Another Goldman salesman emailed Mr. Herrick on the CDO Desk, telling him:

"The guy at Schroders looking at this deal has one main issue h[e] has to get over: He is worried about how he is going to convince his boss to invest in a pool of sub prime mortgages with probably their greatest exposures in California and Florida. He is nervous on US house prices. ... Anything else we could offer? He is not a big believer in the Moody's data and rating system. I WANT THIS GUY THERE AND IN SIZE! Please help if you can - just three bullet points would help."²²⁷⁷²²⁷⁷ 10/20/2006 email from Paul Carrett to Darryl Herrick, GS MBS-E-018321286 [emphasis in original].

¶Mr. Herrick kept the SPG Trading Desk posted on the progress of sales. On October 11, 2006, Mr. Herrick informed the group: "This [sale] clears the team of majority the senior risk Equity and BBs we are hammering away on and hope to get traction tomorrow/Friday."²²⁷⁸²²⁷⁸ 10/11/2006 email from Darryl Herrick to Michael Swenson, David Lehman, and Josh Birnbaum, GS MBS-E- 0000030518. Mr. Swenson told the Subcommittee he had no recollection of being involved in the marketing of Hudson 1. Mr. Swenson said he did not work on CDOs and would not typically be involved in the marketing of CDOs. Subcommittee interview of Michael Swenson (10/8/2010). Mr. Swenson responded: "you are doing an awesome job, keep it up." Mr. Swenson emailed the sales team manager: "I am extremely impressed by darryl [a]nd the rest of your team."²²⁷⁹²²⁷⁹ 10/12/2006 email from Michael Swenson to David Rosenblum and Peter Ostrem, GS MBS-E-0000030518.

¶On October 25, 2006, Mr. Sobel sent a Hudson update to COO Gary Cohn and CFO David Viniar: "$1.6bn of the $2bn sold, with the majority of the unsold bonds being investment grade. Equity more than 85% sold."²²⁸⁰²²⁸⁰ 10/25/2006 email from Jonathan Sobel to David Viniar and Gary Cohn, GS MBS-E-009757821.

¶The Goldman sales force sold most of the Hudson securities prior to the CDO's closing in December 2006, and continued its sales efforts after the closing as well. Two months after the closing, in February 2007, Goldman had $296 million in unsold Hudson securities, not including the $6 million equity investment Goldman had announced in the Hudson marketing material that it would purchase and hold. Over the following months, Goldman sold an additional $38 million worth of securities to investors, and received bids on several other securities but decided the bid prices were too low and kept the securities on its books instead.²²⁸¹²²⁸¹ Subcommittee interview of Darryl Herrick (10/13/2010). The unsold Hudson securities were split between the CDO Origination Desk and ABS Trading Desk.²²⁸²²²⁸² Subcommittee interview of Darryl Herrick (10/13/2010). W hen asked if it was common to divide unsold securities between the CDO Desk and the ABS Desk, Mr. Herrick said unsold securities were usually split with the sponsor of a CDO. His response suggests that Goldman viewed the ABS Desk as the sponsor of Hudson 1, since it was designed to offset the risk associated with the ABS Desk's ABX assets. See also 2/28/2007 email from David Rosenblum to Peter Ostrem, GS M BS-E-001800707 ("are we still sharing 50pct of ups and downs on [Hudson].").Show full note

¶Overall, Goldman sold Hudson securities to 25 investors. Morgan Stanley made the largest investment, taking $1.2 billion of the super senior portion of the CDO. Other investors included the National Australia Bank, which purchased $80 million worth of the AAA rated securities; Security Benefit Mutual, which bought $10 million of the AA rated securities; and Bear Stearns, which bought $5 million of the equity tranche.

530

¶Profiting from Hudson. On October 30, 2006, after Hudson 1 was presented to investors and pre-sold most of its securities, Peter Ostrem, the head of the CDO Origination Desk, sent a celebratory email to the ABS and CDO teams with Hudson highlights. He wrote: "Goldman was the sole buyer of protection on the entire $2.0 billion of assets," meaning Goldman had kept 100% of the short position. By shorting Hudson, Goldman had transferred $1.2 billion worth of risky ABX assets Goldman wanted off its books, and shorted another $800 million in RMBS securities. Mr. Ostrem also listed these "highlights":

"P&L [Profit and Loss] booked of $8.5mm .... Plus, ongoing P&L to GS for acting as liquidation agent equal to $2.5mm per year for the next 4 years

Hudson Mezz went long $1.2bln of BBB/BBB- ABX from ABS trading desk at market wides 4 weeks ago

Fastest execution of a SP [Structured Product] CDO done at Goldman (4 weeks from inception to pricing)

Over half the Equity was sold by Andy Davilman

... Super senior note ($1.2bln in size) was executed in the first week of the transaction and was a key driver of this deal[']s success (covered by Nicole Martin)."²²⁸³²²⁸³ 10/30/2006 email from Peter Ostrem, "Great Job on Hudson Mezz," GS MBS-E-0000057866, Hearing Exhibit 4/27-90.

¶Over the next year, Goldman pocketed nearly $1.7 billion in gross revenues from Hudson 1, all of which was at the expense of the Hudson investors.²²⁸⁴²²⁸⁴ Goldman told the Subcommittee that Hudson experienced a gross gain of $1.697 billion offset by a loss of $1.39 billion (rather than $1.2 billion) in ABX assets on its balance sheet. 8/4/2010 email from Goldman to the Subcommittee, PSI_QFR_GS0243. As the value of the RMBS securities referenced in the ABX indices declined, Goldman, as the sole short party in Hudson, collected $1.393 billion in gains directly from the investors to whom it had sold the Hudson securities. Goldman's $1.393 billion gains were, in turn, offset internally at the firm by the ABX losses recorded on the books of its ABS Desk. Goldman made another $304 million in gains due to its short of the other $800 million in single name CDS contracts included in Hudson 1.²²⁸⁵²²⁸⁵ See Goldman response to Subcommittee QFR at PSI_QFR_GS0239. That $304 million gain was also at the expense of the investors to whom Goldman had sold the Hudson securities.

¶Goldman also profited in other ways. It received substantial fees from the roles it played in underwriting and administering Hudson 1, including $31 million in underwriting fees, $3.1 million for serving as the liquidation agent, and $1 million for serving as the collateral put provider.²²⁸⁶²²⁸⁶ Id. The ABS Desk warehouse account that contained both the long ABX assets and the 80 offsetting single name CDS contracts reported a gain of approximately $1.2 million due to the higher value of the single name CDS compared to the ABX CDS.²²⁸⁷²²⁸⁷ Id.

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¶Goldman also incurred some losses in connection with Hudson 1. Although Goldman sold some additional Hudson securities several months after the CDO closed, it incurred a $267 million loss from the Hudson 1 securities that it was unable to sell at the prices it wanted and instead retained in its inventory. Goldman lost another $111 million from serving as the collateral put provider for Hudson collateral securities which also lost value.²²⁸⁸²²⁸⁸ Id., at PSI_QFR_GS_0280. Overall, however, Goldman recorded a profit from Hudson 1 of more than $1.35 billion.

¶In contrast to Goldman, Hudson 1 investors suffered substantial losses. In March 2007, less than three months after the issuance of the Hudson securities, when asked to analyze how a holder of Hudson securities could hedge against a drop in their value, a Goldman trader wrote: "their likelihood of getting principal back is almost zero."²²⁸⁹²²⁸⁹ 3/4/2006 email from Fabrice Tourre to George Maltezos, others, GS MBS-E-006638833. Six months later, the credit rating downgrades began. In September 2007, Moody's downgraded several Hudson 1 securities and followed with additional downgrades in November 2007. S&P began downgrades of Hudson 1 in December 2007, and by February 2008, had downgraded even the AAA rated securities.²²⁹⁰²²⁹⁰ See Goldman response to Subcommittee QFR, at PSI_QFR_GS0211.

¶Morgan Stanley, the largest Hudson investor, lost $930 million.²²⁹¹²²⁹¹ 11/21/2008 letter from Goldman to Morgan Stanley, HUD-CDO-00005125. As other investors incurred increasing losses, they sold their securities back to Goldman at rock bottom prices. In September 2007, for example, nine months after the Hudson securities were first issued, Goldman repurchased $10 million worth of Hudson securities from Greywolf Capital at a price of five cents on the dollar; in October 2007, another hedge fund sold $1 million in Hudson securities back to Goldman at a price of 2.5 cents on the dollar.²²⁹²²²⁹² See Goldman response to Subcommittee QFR, at PSI_QFR_GS0223 and PSI_QFR_GS0235. In November 2008, Hudson 1 was completely liquidated by Goldman. Today, Hudson securities are worthless.

¶Analysis. Goldman constructed Hudson 1 as a way to transfer its ABX risk to the investors who bought Hudson securities. When marketing the Hudson securities, Goldman misled investors by claiming its investment interests were aligned with theirs, when it was the sole short party and was betting against the very securities it was recommending. Goldman also implied that Hudson's assets had been purchased from outside sources, and failed to state that it had selected the majority of the assets from its own inventory and priced the assets without any third party participation. By holding 100% of the short position at the same time it solicited clients to buy the Hudson securities, Goldman created a conflict of interest with its clients, concealed the conflict from them, and profited at their expense.

532

¶BB. Anderson Mezzanine Funding 2007-1

¶In the summer of 2006, Goldman began work on Anderson Mezzanine Funding 2007-1 (Anderson), a synthetic CDO whose assets were single name CDS contracts referencing subprime RMBS securities with mezzanine credit ratings.²²⁹³²²⁹³ "Mezzanine" CDS assets reference securities that carry a credit rating of BBB or BBB-. Mezzanine assets are riskier than AAA, AA, and A rated assets, but less risky than those that carry, for example, BB, B, or CCC ratings. To execute the Anderson CDO, Goldman partnered with GSC Partners (GSC), a New York hedge fund. Goldman personnel working on the CDO included Peter Ostrem, head of the CDO Origination Desk, and Matthew Bieber, a CDO Origination Desk employee assigned to be deal captain for the Anderson CDO.

¶The CDO was originally conceived as part of the Hudson series of non-managed, proprietary CDOs in which Goldman acted as the principal.²²⁹⁴²²⁹⁴ Some documents indicate the CDO was slated to be Hudson Mezzanine 2006-2. But in December 2006, Goldman delayed Anderson in favor of issuing an ABX based CDO named Hudson Mezzanine 2006-2. Several of the documents cited in this section use the terms "Hudson" or "Hudson Mezz" when in fact they refer to Anderson. None of the Goldman employees interviewed by the Subcommittee could recall the reason for changing the name of the CDO to Anderson.Show full note But Goldman decided to enlist GSC to take part in structuring the $500 million CDO.²²⁹⁵²²⁹⁵ 9/25/2006 Goldman memorandum to the Mortgage Capital Committee, GS MBS-E-013475756-62 (hereinafter "9/25/2006 MCC Memorandum"). The MCC Memorandum states that Goldman was approached by GSC, but may be using standard language reused in many MCC Memoranda. In an interview with the Subcommittee, Edward Steffelin, a Senior Trader at GSC, stated that Goldman approached GSC about partnering in the transaction, and the memorandum language was "probably backward." Subcommittee interview of Edward Steffelin (12/10/2010).Show full note

¶Partnering on Anderson. GSC Partners was founded by Alfred C. Eckert, III, a former partner and former head of private equity, distressed debt investing, and corporate finance at Goldman.²²⁹⁶²²⁹⁶ 9/25/2006 MCC Memorandum, GS MBS-E-013475756-62. Goldman had a longstanding relationship with GSC. In addition to Mr. Eckert, at least five other former Goldman Managing Directors were employed by GSC, and at least eight other former and current Managing Directors had invested in one or more of GSC's funds.²²⁹⁷²²⁹⁷ See Goldman response to Subcommittee QFR at PSI_QFR_GS0434. Goldman noted in its QFR response that the information used for its response had been voluntarily provided by Goldman employees. In the spring of 2006, GSC circulated information through Goldman about raising money for its Elliot Bridge Fund, a "fixed income arb[itrage] fund focusing primarily on ABS using cash and synthetics, long/short strategies."²²⁹⁸²²⁹⁸ 5/10/2006 email from Curtis Willing to David Solomon and Dan Holland, GS MBS-E-013870906-7. The Elliot Bridge Fund eventually invested in Anderson. When discussing the fund with other Goldman employees, Curtis Willing, the Goldman sales representative responsible for covering GSC wrote: "They are a strategic partner with the Synthetic desk and have handed us multiple CDO/CLO mandates."²²⁹⁹²²⁹⁹ 4/17/2006 email from Curtis W illing to David Solomon and Dan Holland, GS MBS-E-013870906-7. After being informed of the internal conversations almost a month later, Mr. Sparks informed Mr. Willing that it was a "[m]istake not to involve me from early on," telling Mr. Willing, "I've run a bunch of traps for [GSC] in the past."²³⁰⁰²³⁰⁰ 5/14/2006 and 5/10/2006 emails from Dan Sparks to Curtis W illing, GS MBS-E-013870906-7.

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¶GSC agreed to partner with Goldman on the Anderson CDO and to share in the associated risk, including by splitting the equity tranche and sharing the risk with Goldman that the Anderson assets would lose value while being warehoused.²³⁰¹²³⁰¹ 9/25/2006 MCC Memorandum, GS MBS-E-013475756-62. GSC also participated in selecting the assets for the CDO.²³⁰²²³⁰² 8/8/2006 email from Edward Steffelin to Peter Ostrem and others, "GS/GSC EB Prop deal," GS MBS-E- 000904603. 8/8/2006 email from Peter Ostrem to Edward Steffelin, Joshua Bissu and others, GS MBS-E- 000904603 (M r. Ostrem writes: "Happy to source assets via GSC."). See e.g., 9/26/2006 email from Mr. Bissu to Matthew Bieber, "Names for tomorrow," GS MBS-E-014335388. Later on, Goldman consulted with GSC on whether to liquidate or underwrite Anderson,²³⁰³²³⁰³ Subcommittee interview of Edward Steffelin (12/10/2010). and allowed GSC to participate in pricing issues,²³⁰⁴²³⁰⁴ See 3/5/2007 emails between Matthew Bieber and Joshua Bissu, GS MBS-E-014605918. while GSC at times assisted in marketing Anderson.²³⁰⁵²³⁰⁵ See 3/6/2007 email from Joshua Bissu to Matthew Bieber and Peter Ostrem, GS MBS-E-014597705.

¶Goldman offered to let GSC take a short interest in the CDO by offering to "sell protection on BBBs to GSC at market for 0.75% times notional," and agreeing to "source assets via GSC," meaning GSC could propose assets for the CDO that GSC wanted to get rid of or short.²³⁰⁶²³⁰⁶ 8/8/2006 email from Edward Steffelin to Peter Ostrem and others, "GS/GSC EB Prop deal," GS MBS-E- 000904603. GSC frequently executed trades with Goldman's Correlation Trading Desk, and was known to have a "long/short strategy" in which it shorted assets it considered expensive and went long assets it thought were undervalued. See 9/15/2006 email from Geoffrey W illiams to Correlation Trading Desk, GS MBS-E-009471708. See e.g., 10/31/2006 email from Shelly Lin to Joshua Bissu, and Matthew Bieber, GS MBS-E-016473768.Show full note GSC responded by shorting a select group of RMBS securities to hedge its risk while those assets were in the Anderson warehouse account.²³⁰⁷²³⁰⁷ 10/31/2006 email from Curtis W illing, GSC Trades, GSC-CDO-FCIC-0029698; 10/31/2006 email from Deeb Salem, "Re: GSC-Hudson Mezz 2," GS M BS-E-000905571. A former GSC employee interviewed by the Subcommittee also indicated that the short positions were taken on Anderson assets in an effort to hedge GSC's warehouse risk. Subcommittee interview of Edward Steffelin (12/10/2010). For instance, at one point in October 2006, GSC sought to add $56 million in assets to the Anderson CDO, while also taking a short position on $9 million of those assets, which it described as "GSC Hedge Amount."²³⁰⁸²³⁰⁸ 10/31/2006 email from Shelly Lin to Joshua Bissu and Matthew Bieber, GS MBS-E-016473768. See also 10/31/2006 email from Shelly Lin to Deeb Salem, Edwin Chin, and Matthew Bieber, GS MBS-E-000905571 ("GSC wants to short into the deal the amounts listed below. They'd like to trade the ones they want to hedge with your desk as well. I think they also did this with your desk a few weeks ago."). W hen Mr. Bieber was shown this document during his 10/21/2010 interview with the Subcommittee he stated he didn't know if GSC had shorted assets and that he didn't know what Ms. Lin meant by her statement. Subcommittee interview of Matthew Bieber (10/21/2010).Show full note

¶Designing Anderson. GSC and Goldman participated together in the selection of assets for Anderson. Anderson was designed to be a synthetic CDO whose assets would consist solely of CDS contracts referencing RMBS securities whose average credit ratings would be BBB or BBB-. GSC proposed some of the referenced RMBS securities, but it is unclear how many were included in Anderson.²³⁰⁹²³⁰⁹ Subcommittee interview of Matthew Bieber (10/20/2010); Subcommittee interview of Edward Steffelin (12/10/2010). GSC and Goldman employees interviewed by the Subcommittee had no specific recollection of the asset selection process, beyond each party selecting some RMBS securities and the other having veto rights.²³¹⁰²³¹⁰ Id.

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¶Anderson's assets were purchased from 11 different broker-dealers from September 2006 to March 2007. Goldman was the source of 28 of the 61 CDS contracts in Anderson, and Goldman retained the short side. The next largest short party was Lehman Brothers which sold six CDS contracts to Anderson and retained the short side. Goldman also served as the sole credit protection buyer to the Anderson CDO, acting as the intermediary between the CDO and the various broker-dealers selling it assets.²³¹¹²³¹¹ See Goldman response to Subcommittee QFR at PSI_QFR_GS0192.

¶By February 2007, the Anderson warehouse account contained $305 million out of the intended $500 million worth of single name CDS, many of which referenced mortgage pools originated by New Century, Fremont, and Countrywide, subprime lenders known within the industry for issuing poor quality loans and RMBS securities. Approximately 45% of the referenced RMBS securities contained New Century mortgages.²³¹²²³¹² This number was compiled using a list of referenced securities supplied by Goldman at QFR_PSI_GS0192 and registration statements available at www.sec.gov. When looking at all mortgages underlying each reference security, New Century originated 48% by value of the underlying mortgages. However, each mortgage may have a different weight in the Anderson CDO based on the size of the reference security it is held in. Therefore, the economic effect of the New Century mortgages could be greater than or less than 48%. The next largest mortgage originator by value was Countrywide at 8%.Show full note

¶Falling Mortgage Market. During the same time period in which the Anderson single name CDS contracts were being accumulated, Goldman was becoming increasingly concerned about the subprime mortgage market, was reacting to bad news from the subprime lenders it did business with,²³¹³²³¹³ See, e.g., 1/4/2007 Goldman presentation, "Sub-Prime Mortgage Lenders - Update," GS MBS-E-009978840-59, Hearing Exhibit 4/27-169. and was building a large short position against the same types of BBB rated RMBS securities referenced in Anderson.²³¹⁴²³¹⁴ See discussion of Goldman's net short position, Section C(4), above. By February 2007, the value of subprime RMBS securities was falling, and the Goldman CDO Origination Desk was forced to mark down the value of the long single name CDS contracts in its CDO warehouse accounts, including Anderson.

¶Goldman was also aware that its longtime customer, New Century, was in financial distress. On February 7, 2007, New Century announced publicly it would be restating its 2006 earnings, causing a sharp drop in the company's share price. On February 8, 2007, Goldman's Chief Credit Officer Craig Broderick sent Mr. Sparks and others a press clipping about New Century and warned:

"[T]his is a materially adverse development. The issues involve inadequate [early payment default] provisions and marks on residuals .... [I]n a confidence sensitive industry it will be ugly even if all problems have been identified. ... We have a call with the company in a few minutes (to be led by Dan Sparks)."²³¹⁵²³¹⁵ 2/8/2007 email from Craig Broderick to Daniel Sparks, David Viniar, others, GS MBS-E-002201486.

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¶On some occasions, Mr. Sparks addressed negative news about New Century in the same email he discussed liquidating assets in warehouse accounts for upcoming CDOs. On March 8, 2007, for example, Mr. Sparks noted in an email to senior executives: "New Century remains a problem" due to loans experiencing early payment defaults, and informed them that the Mortgage Department had "liquidated a few deals and could liquidate a couple more."²³¹⁶²³¹⁶ 3/8/2007 email from Daniel Sparks to senior executives, GS MBS-E-002206279, Hearing Exhibit 4/27-75.

¶On February 23, 2007, Mr. Sparks sent an email to senior Goldman executives estimating that Goldman had lost $72 million on the holdings in its CDO warehouse accounts, due to falling prices.²³¹⁷²³¹⁷ 2/23/2007 email from Daniel Sparks to senior executives, GS MBS-E-009759477. He directed Mortgage Department personnel to liquidate rather than securitize the assets in certain warehouse accounts. Two days later, on February 25, 2007, Mr. Sparks informed senior executives of the possibility of liquidating Anderson:

"[T]he CDO business liquidated 3 warehouses for deals of $530mm (about half risk was subprime related). ... One more CDO warehouse may be liquidated this week - approximately $300mm with GSC as manager."²³¹⁸²³¹⁸ 2/25/2007 email from Daniel Sparks to Tom Montag, GS MBS-E-019164799. See also 2/23/2007 email from Daniel Sparks to senior executives, GS MBS-E-009759477 ("W e liquidated 3 CDO warehouses today and started the liquidation of another. W e may liquidate one more next week.").

¶Three days later, David Rosenblum, head of Goldman's Collateralized Loan Obligations activities, emailed Mr. Ostrem, head of the CDO Origination Desk, stating: "Dan tells me that SP [Structured Product] CDO desk has reported -77 [million dollars] from retained debt (Hmezz 1+2, etc), and -129 [million dollars] from unrealized and realized CDO WH [warehouse] markdowns."²³¹⁹²³¹⁹ 2/28/2007 email from David Rosenblum to Peter Ostrem, GS MBS-E-001800707.

¶On February 24, 2007, a Saturday, several persons from the Mortgage Department worked to analyze the costs of unwinding and liquidating the assets collected for the Anderson CDO. Deeb Salem, a trader on the ABS Desk, estimated that unwinding Anderson would result in a $60 million loss due to the falling value of its single name CDS.²³²⁰²³²⁰ 2/24/2007 email from Deeb Salem to Michael Swenson, Edwin Chin, and Josh Birnbaum, GS MBS-E- 018936137-38. On the same day, Mr. Ostrem sent his colleagues this explanation of why the losses in the CDO warehouse accounts were growing so rapidly:

"Each warehouse is marked by either (a) MTM [mark-to-market] on each asset or (b) mark to model [MTModel] which involves taking the portfolio through the expected CDO execution and calculating Goldman's P&L [profit and loss] given current market yields on debt and equity. MTM is preferred if CDO execution is highly uncertain or portfolio is small. Both the MTM and the MTModel take into account risk sharing arrangements with 3rd parties.

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As CDO execution has become more uncertain we have moved a couple warehouses closer to their MTM which has significantly increased our losses. Also, our MTModel results have shown losses as expected liability spreads have widened significantly and the overall strength of the CDO market has waned due to fundamental credit decline in 06/07 in RMBS subprime (90+% of assets) and increased co[r]relation between ABX/TABX levels and mezz debt levels in CDOs. We expect this co[r]relation to increase volatility in our warehouse marks for the [sic] a while (this series of events have happened quickly within the last month and the co[r]relation is getting closer to 1 as global markets get more familiar with fundamentals in subprime and trading levels in ABX/TABX).

Additional losses have also resulted from the liquidation of 3 warehouses. In each case, the realized loss from the sale of assets has been higher than our MTM or MTModel. This is attributable to both volatility in subprime markets and that our competitors are closing their CDO warehouse accounts from buying our subprime or CDO positions. The buyer base has suddenly shrunk significantly. As this continues, we expect this lack of liquidity to further weaken our MTMs and feed into our losses in our remaining warehouse marks."²³²¹²³²¹ 2/24/2007 email from Peter Ostrem to colleagues, GS MBS-E-010383828-29.

¶At about 11 p.m. that Saturday night, February 24, 2007, Mr. Sparks seemed to reach a decision to liquidate Anderson. He sent an email to Mr. Ostrem, Mr. Bieber, and several others stating: "I want to liquidate Anderson Monday – we should begin the discussion with gsc asap."²³²²²³²² 2/24/2007 email from Daniel Sparks to Peter Ostrem, others, GS MBS-E-001996601, Hearing Exhibit 4/27-95.

¶After Mr. Sparks relayed this decision, Messrs. Ostrem and Bieber began to strategize ways to convince Mr. Sparks to reverse his decision.²³²³²³²³ 2/25/2007 Goldman internal email chain, GS MBS-E-001996601, Hearing Exhibit 4/27-97. Messrs. Ostrem and Bieber assembled a list of likely buyers of the Anderson securities to present to Mr. Sparks, and brainstormed about other CDOs that could potentially buy Anderson securities for their asset pools.²³²⁴²³²⁴ Id. Mr. Ostrem also proposed allowing a hedge fund to short assets into the deal as an incentive to buy the Anderson securities, but Mr. Bieber thought Mr. Sparks would want to "preserve that ability for Goldman."²³²⁵²³²⁵ Id.

¶At some point, Mr. Sparks changed his mind and decided to go forward with underwriting the Anderson CDO. None of the Goldman personnel interviewed by the Subcommittee could recall why the final decision was made to go forward with Anderson. In one email on March 2, 2007, Jonathan Egol, head of the Goldman Correlation Trading Desk, suggested adding $195 million more in assets to Anderson, with Goldman selecting the assets internally and shorting them.²³²⁶²³²⁶ 3/2/2007 email from Jon Egol to Daniel Sparks and others, GS MBS-E-010637566, Hearing Exhibit 4/27-97. Mr. Sparks rejected any expansion of Anderson, responding: "we are not ramping - execute deal as is."²³²⁷²³²⁷ 3/2/2007 email from Daniel Sparks to Jon Egol and others, GS MBS-E-010637566, Hearing Exhibit 4/27-97.

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¶The Anderson CDO closed on March 20, 2007. As finally constructed, 100% of its assets were CDS contracts referencing $307 million in mezzanine subprime RMBS securities, meaning RMBS securities carrying BBB or BBB- credit ratings. About 45% of the subprime mortgages in the referenced RMBS securities were issued by New Century. Another 8% were issued by Countrywide, and almost 7% were issued by Fremont. Goldman took about 40% of the short side of the Anderson CDO. Ten other investors held the rest of the short interest in the CDO.

¶Selling Anderson. During March, selling Anderson securities became a top priority for Goldman. Goldman even put another deal on hold, the Abacus 2007-AC1 deal with the Paulson hedge fund, to promote Anderson. As Mr. Egol advised Goldman personnel: "Given risk priorities, subprime news and market conditions, we need to discuss side-lining [Abacus 2007-AC1] in favor of prioritizing Anderson in the short term."²³²⁸²³²⁸ 3/2/2007 email from Jon Egol to colleagues, "Re: Abacus AC1," GS MBS-E-002676413, Hearing Exhibit 4/27- 64.

¶On March 13, 2007, Goldman issued internal talking points for its sales force on the Anderson CDO. Among the points highlighted were:

"Portfolio selected by GSC. Goldman is underwriting the equity and expects to hold up to 50%. ... Low fee structure[.] ... No reinvestment risk."²³²⁹²³²⁹ 3/13/2007 email from Peter Ostrem to Scott W isenbaker and M atthew Bieber, GS M BS-E-000898410, Hearing Exhibit 4/27-172.

¶The talking points described Goldman as holding up to 50% of the equity tranche in the CDO – worth about $21 million, without mentioning that Goldman would also be holding 40% – about $135 million – of the short side of Anderson, placing its investment interests in direct opposition to the investors to whom it was selling Anderson securities.

¶The large number of poor assets referenced in Anderson raised investor questions and was an impediment to sales.²³³⁰²³³⁰ In mid-March, Mr. Ostrem informed the GSI Risk Committee that Goldman's estimated losses on the assets in the Anderson warehouse account had reached $22.9 million. 3/16/2007 Goldman Sachs International Risk Committee memorandum, "GSI W arehousing for Structured Product CDOs," GS MBS-E-001806010-16. One potential investor wrote to a Goldman sales representative explaining its decision not to purchase the Anderson securities:

"We're going to pass on this deal for a number of reasons: Two bonds . . . have been downgraded or are on negative watch; Another 12 bonds in the portfolio are negatively impacted by the downgrades lower in the capital structure; 28% of the portfolio is failing delinquency triggers; We show that a lot of these bonds will take principal hits; Not crazy about the deal structure given the quality of the portfolio."²³³¹²³³¹ 5/31/2007 email from Goldman client to Andrew Davilman, GS MBS-E-015550857-58. Andrew Davilman relayed the message to Matthew Bieber, who suggested the client might be interested in higher rated securities. Mr. Davilman responded: "I'll check, but given the portfolio I suspect he's looking for a cleaner start."

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¶Other investors expressed concerns that the CDO would be downgraded.²³³²²³³² 3/16/2007 email from Russell Brocato to Scott W isenbaker, GS MBS-E-000902498, Hearing Exhibit 4/27-172. Mr. Bieber and M r. Ostrem were also informed by a salesperson that the client was "out on Anderson – they feel like the deal will be dow[n]graded and have interest coverage issues." Mr. Ostrem instructed the Goldman salesperson to "[f]ix the miscommunication so the probability [of sale] goes up."Show full note Goldman did not disclose to these investors that it had almost canceled the CDO, due to its assets' falling values.

¶Of particular concern for investors was the concentration of New Century mortgages in Anderson.²³³³²³³³ 3/14/2007 email from Matthew Bieber to Scott W isenbaker and others, GS MBS-E-000908336, Hearing Exhibit 4/27-172 ("Looking like both dcp and terwin out. New Century issues."). On March 13, 2007, a potential investor, Rabobank, asked Goldman sales representatives: "how did you get comfortable with all the new centu ry [sic] collateral in particular the new century serviced deals – con sidering [sic] you are holding the equity and their servicing may not be around is that concerning for you at all?"²³³⁴²³³⁴ 3/13/2007 email from W endy Rosenfeld at Rabobank to Olivia Ha at Goldman, GS MBS-E-000898417, Hearing Exhibit 4/27-172. Goldman and GSC prepared a list of talking points with which to respond to the investor:

"- Historically New Century has on average displayed much better performance in terms of delinq[uency] and default data - Prepayments have tended to be higher lowering the extension risk - Losses and REO [Real Estate Owned by a lender taking possession of a property] are historically lower than the rest of the market - Traditionally the structures have strong enhancement/subordination."²³³⁵²³³⁵ 3/6/2007 email from Joshua Bissu to Matthew Bieber and Peter Ostrem, GS MBS-E-014597705.

¶The talking points did not disclose that, in fact, Goldman, too, was uncomfortable with New Century mortgages. On March 8, 2007, five days before receiving the investor's inquiry, Mr. Sparks had reported to senior Goldman executives, including Co-President Gary Cohn and CFO David Viniar, that New Century mortgages "remain[ed] a problem for [early payment default]."²³³⁶²³³⁶ 3/8/2007 email from Daniel Sparks to senior executives, GS MBS-E-002206279, Hearing Exhibit 4/27-75. On March 13, the same day as the investor inquiry, Goldman personnel completed a review of New Century mortgages with early payment defaults that were on Goldman's books and found fraud, "material compliance issues," and collateral problems. The review found that "62% of the pool has not made any pmts [payments]" and recommended "putting back 26% of the pool" to New Century for repurchase "if possible."²³³⁷²³³⁷ 3/13/2007 email from Manisha Nanik to Loren Morris, "New Century EPDs," at GS MBS-E-002146861, Hearing Exhibit 4/27-77. See also 2/2/2007 email from Matthew Nichols to Kevin Gasvoda and others, GS MBS-E- 005556331 ("NC is running a 10% drop rate [due diligence drop] at ~6 points / drop and 4% EPD rate at close to 20 points."); 2/8/2007 email from John Cassidy to Joseph Ozment, others, GS M BS-E-002045021 ("Given the current state of the company I am no longer comfortable with the practice of taking loans with trailing docs . . . that we need in order to conduct compliance testing.").Show full note Goldman also did not disclose to the investor that it was shorting 40% of the Anderson CDO.

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¶Some Goldman clients also had questions about GSC's involvement in Anderson. An Australian sales representative wanted "more color on asset selection process, especially with respect to GSC involvement."²³³⁸²³³⁸ 3/1/2007 email from Scott W isenbaker to Peter Ostrem and Matthew Bieber, GS M BS-E-000893661, Hearing Exhibit 4/27-172. This clarification was necessary, because although GSC's role was mentioned in numerous internal Goldman documents, the official Anderson marketing materials did not mention GSC's role in asset selection.²³³⁹²³³⁹ 2/2007 Anderson Mezzanine Funding 2007-1, Ltd. Debt Marketing Book, GS MBS-E-000855351. In previous drafts of the marketing materials, for example, Goldman stated that "Goldman Sachs and GSC Group co-selected the assets"; "GSC pre-screens and evaluates assets for portfolio suitability"; the CDO was "co-sponsored by Goldman and GSC Eliot Bridge Fund"; and "Goldman Sachs and GSC ha[ve] aligned incentives with Anderson Funding by investing in a portion of equity."²³⁴⁰²³⁴⁰ 2/2007 Anderson Mezzanine Funding 2007-1, Ltd. Equity Marketing Book, GS MBS-E-000892557-598 at 560, 569. But all of the references to GSC were removed from the final documents.²³⁴¹²³⁴¹ 2/2007 Anderson Mezzanine Funding 2007-1, Ltd. Debt Marketing Book, GS MBS-E-000855351. Anderson Mezzanine Funding 2007-1, Ltd. Debt Marketing Book, GSC-CDO-FCIC-0031712 at 726. Around the time Goldman was deciding whether to underwrite Anderson, Fred Horton, head of CDOs at GSC, left the firm. While discussing whether to issue or underwrite the CDO with Matthew Bieber, Mr. Ostrem commented: "W ill need disclosure on Horton. This looks bad." 2/25/2007 email from Peter Ostrem to Matthew Bieber, GS MBS-E- 001996601, Hearing Exhibit 4/27-95.Show full note Mr. Bieber told the Subcommittee that he did not recall specifically why the references to GSC were removed, but recalled GSC having an issue with disclosing its name in the offering documents.²³⁴²²³⁴² Subcommittee interview of Matthew Bieber (10/21/2010). Edward Steffelin, a Senior Trader at GSC, also did not recall the specifics regarding why the references to GSC were removed, but told the Subcommittee that he felt GSC's role in the Anderson CDO did not rise to the level of "co-selecting."²³⁴³²³⁴³ Subcommittee interview of Edward Steffelin (12/10/2010). The marketing materials also stated that the Anderson assets were "sourced from the Street." Mr. Steffelin described this as a "weird phrase," but felt it implied "it would be open, sourced from all over." See discussion of the phrase, "sourced from the Street," in the prior section on Hudson 1. Mr. Steffelin said that although GSC had the ability to suggest assets and veto others, he felt that "co-selecting" implied a level of control over the portfolio that GSC didn't have.²³⁴⁴²³⁴⁴ Id. Despite GSC's not being listed as having helped select the Anderson assets, some investors appeared to be aware of its involvement, perhaps from talking to Goldman personnel. See 3/28/2007 email from Matthew Bieber to Edward Steffelin, "ACA Meeting," GS MBS-E-014419176 ("Questions on [Anderson] – but also want to do manager due diligence. They've heard the GSC team shows well – so want to meet you in person.").Show full note

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¶Despite the poor reception by investors, Goldman continued "pushing the axe" with its sales force to sell Anderson securities.²³⁴⁵²³⁴⁵ 3/12/2007 email from Robert Black to Matthew Bieber, others, GS MBS-E-000898037. Mr. Bieber identified and monitored potential investors and attempted to sell Anderson securities to pension funds and place Anderson securities in other Goldman CDOs as collateral securities.²³⁴⁶²³⁴⁶ Id. On March 20, 2007, when Mr. Bieber reported selling $20 million in Anderson securities, his supervisor, Mr. Ostrem, responded with the single word: "Profit!"²³⁴⁷²³⁴⁷ 3/20/2007 email from Peter Ostrem to Matthew Bieber and others, GS MBS-E-000906269, Hearing Exhibit 4/27-172. In a separate email a week later, Mr. Ostrem told Mr. Bieber he did "an excellent job pushing to closure these deals in a period of extreme difficulty."²³⁴⁸²³⁴⁸ 3/27/2007 email from Peter Ostrem to Matthew Bieber, GS MBS-E-000907935, Hearing Exhibit 4/27-172.

¶After several months of effort, Goldman was able to sell only a third, or about $102 million of the $307 million in Anderson securities.²³⁴⁹²³⁴⁹ See Goldman response to Subcommittee QFR at PSI_QFR_GS0223 and PSI_QFR_GS0235. The nine investors included Beneficial Life, Moneygram, and GSC which purchased the entire $11 million class D portion of the CDO.²³⁵⁰²³⁵⁰ GSC paid a price of 108.21% for the securities. See Goldman response to Subcommittee QFR at PSI_QFR_GS0223 and PSI_QFR_GS0235.

¶Losing Money from Anderson. Due to its inability to sell two-thirds of the Anderson securities, Goldman lost money overall on the CDO. Goldman's biggest gain came from holding 40% of the short position on certain Anderson assets, which produced a $131 million gain at the direct expense of the investors to whom Goldman had sold the Anderson securities. Goldman was also paid $200,000 for serving as the liquidation agent,²³⁵¹²³⁵¹ See Goldman response to Subcommittee QFR at PSI_QFR_GS0223 and PSI_QFR_GS0235. and collected $2 million in CDS premiums while it warehoused Anderson assets.²³⁵²²³⁵² See Goldman response to Subcommittee QFR at PSI_QFR_GS0239.

¶Despite those gains, Goldman incurred a $185 million loss from the Anderson securities it was unable to sell and had to keep on its books. It incurred another $122 million loss due to the decreased value of the securities Goldman had purchased as collateral for the CDO.

¶Anderson's nine investors suffered more substantial losses. Seven months after its issuance, in November 2007, Anderson securities experienced their first ratings downgrades. At that point, 27% of the assets underlying Anderson were downgraded below a B- rating.²³⁵³²³⁵³ 1/3/2008 email from Shelly Lin to M r. Sparks, GS MBS-E-021880171 (attached file, "Deal Summary," Excel Spreadsheet showing credit ratings for Anderson). GSC then sold back to Goldman a portion of the Anderson securities it had purchased at a price of 3 cents on the dollar.²³⁵⁴²³⁵⁴ See Goldman response to Subcommittee QFR at PSI_QFR_GS0223 and PSI_QFR_GS0235. Within a year, Anderson securities that were originally rated AAA had been downgraded to BB. In the end, the Anderson investors were wiped out and lost virtually their entire investments.

¶Analysis. Goldman constructed the Anderson CDO using CDS contracts referencing subprime RMBS securities, the majority of which were issued by subprime lenders like New Century who were known for issuing poor quality loans. When potential investors asked how Goldman was able to "get comfortable" with the New Century mortgage pools referenced in Anderson, Goldman attempted to dispel concerns about the New Century loans, withheld information about its own discomfort with New Century, and withheld that it was taking 40% of the short side of the CDO, essentially betting against the very securities it was selling to its clients. Instead, Goldman instructed its sales force to tell potential investors that Goldman was buying up to 50% of the equity tranche. Goldman also did not disclose to potential investors that it had almost cancelled the CDO due to the falling value of its assets.

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