Using Naked Credit Default Swaps. Goldman Sachs used credit default swaps

Using Naked Credit Default Swaps. Goldman Sachs used credit default swaps

(CDS) on assets it did not own to bet against the mortgage market through single name and index CDS transactions, generating substantial revenues in the process.

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¶(2) Goldman Sachs Background

¶Goldman Sachs was established in 1869 as an investment bank.1513 Originally a private partnership, in 1999, it became a publicly traded corporation. In 2008, it converted to a bank holding company. Its headquarters are located in New York City, and the firm manages about $870 billion in assets.1514 Goldman employs about 14,000 employees in the United States and 32,500 worldwide. In 2007, it reported net revenues of $11.6 billion, of which $3.7 billion was generated by the Structured Products Group in the Mortgage Department, primarily as a result of its subprime investment activities.1515

¶Unlike other Wall Street banks, Goldman has no retail banking operations. It does not accept deposits from, nor lend to, retail customers, nor does its broker-dealer provide advice to or execute trades on behalf of retail customers. Goldman provides services only to so-called "sophisticated" institutional investors, generally large corporations, financial services firms, pension funds, hedge funds, and a few very wealthy individuals.1516

¶For most of its history, Goldman operated exclusively as an investment bank, providing investment advice to corporate clients, arranging and executing mergers and acquisitions, and arranging financing for customers through stock and bond offerings. After the 1999 repeal of the Glass-Steagall Act, which had restricted the activities that could be engaged in by investment banks, Goldman expanded its operations.1517

¶Over the last ten years, traditional investment banking activities have become a small percentage of Goldman's business. Goldman has instead become primarily a Wall Street trading house, providing broker-dealer services to institutional customers, acting as a prime broker to hedge funds,1518 structuring and financing deals for customers from its own capital, and conducting proprietary trading activities for its own benefit. In the years leading up to the financial crisis, Goldman became an active investor and participant in the deals and transactions that it was handling for clients as well as selling to investors.1519

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¶Goldman Sachs Mortgage Department. In 2006 and 2007, the time period reviewed by the Subcommittee, the most senior Goldman executives were the Chairman of the Board and Chief Executive Officer Lloyd Blankfein; Chief Operating Officer and Co-President Gary Cohn; Co-President Jon Winkelried; and Chief Financial Officer David Viniar. Goldman's Chief Risk Officer, Craig Broderick, was head of the Market Risk Management & Analysis area of the firm, which monitored and measured risk for the firm as a whole and for each business unit. Goldman's Treasurer, Sarah Smith, was in charge of the Controllers area of the firm, which was responsible for financial accounting, profit and loss statements, customer credit, collateral/margin matters, and position valuation verification.1520

¶In 2006 and 2007, Goldman Sachs' operating activities were divided into three segments: Investment Banking, Trading and Principal Investments, and Asset Management and Securities Services.1521 The Trading and Principal Investments Segment was divided into three businesses: Fixed Income, Currency and Commodities (FICC); Equities; and Principal Investments.1522 FICC had five principal businesses: commodities; credit products; currencies; interest rate products; and mortgage related securities and loan products and other asset backed instruments.1523

¶In its mortgage business, Goldman Sachs acted as a market maker, underwriter, placement agent, and proprietary trader in residential and commercial mortgage related securities, loan products, and other asset backed and derivative products.1524 The Mortgage Department was responsible for buying and selling virtually all of the firm's mortgage related assets. It originated and invested in residential and commercial mortgage backed securities; developed, traded, and marketed structured products and derivatives backed by mortgages; and traded mortgage market products on exchanges.1525

¶In 2006 and 2007, the head of the Mortgage Department was Daniel Sparks. Goldman Co-Presidents Gary Cohn and Jon Winkelried, as well as CFO David Viniar, had been involved in Mr. Sparks' earlier career at Goldman, and he maintained frequent, direct contact with them regarding the Mortgage Department.1526 In 2006, Mr. Sparks formally reported first to Jonathan Sobel, who had run the Mortgage Department prior to Mr. Sparks.1527 He next reported to Richard Ruzika, who was then co-head of Commodities.1528 In late 2006, Mr. Sparks began reporting directly to Thomas Montag, who was co-head of Global Securities for the Americas, which included both the FICC Division and the Equities Division.1529 In mid-2007, Mr. Sparks began reporting to Donald Mullen, who was head of U.S. Credit Sales & Trading, and Mr. Mullen in turn reported to Mr. Montag.1530

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¶The Mortgage Department was divided into seven different desks: (1) the Residential Whole Loan Trading Desk; (2) the Structured Product Group (SPG) Trading Desk; (3) the CDO Origination Desk, which also handled collateralized loan obligations (CLOs); (4) the Structured Product Syndicate and Asset Backed Security (ABS) Finance Desk; (5) the Collateralized Mortgage Obligations (CMO) and Derivatives Desk; (6) the Advisory Group Desk; and (7) the Commercial Real Estate Loan Trading Desk.1531

¶The Residential Whole Loan Trading Desk was headed by Kevin Gasvoda.1532 It bought packages of residential whole loans; issued RMBS securities in the subprime, Alt A and prime categories; originated residential and commercial mortgages; and gave lines of credit to certain selected mortgage lenders in exchange for direct access to pools of mortgages they originated, in so-called "conduit" arrangements.1533

¶The SPG Trading Desk was headed by Michael Swenson.1534 It was further subdivided into three different desks: the ABS Desk, the Correlation Trading Desk, and the Commercial Mortgage Backed Securities (CMBS) Desk. The ABS Desk was also headed by Michael Swenson and traded mainly synthetic asset backed securities, particularly RMBS and CDO securities and single name CDS contracts related to RMBS and CDOs. The ABS Desk also had an important sub-desk called the ABX Trading Desk, which was headed by Joshua Birnbaum, and traded synthetic mortgage backed securities based on the ABX Index. The Correlation Trading Desk was headed by Jonathan Egol. It structured, marketed, and traded complex synthetic structured finance products, including a series of 23 CDOs known as Abacus.1535 The CMBS Desk was headed by David Lehman and traded commercial mortgage backed securities. With the exception of the Correlation Desk, the SPG Trading Desk was primarily devoted to "secondary trading," meaning the buying and selling of pre-existing asset backed securities. The SPG Trading Desk was also sometimes referred to as the "Mortgage Secondary Trading Desk."

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¶The CDO Origination Desk was headed by Peter Ostrem.1536 This desk structured and originated most of Goldman's CDOs and CLOs, excluding Abacus. The CDO Desk was primarily an underwriting desk that arranged for the issuance of new securities which had not yet been sold in the marketplace. Because of its underwriting focus, the CDO Desk's activities required a higher level of disclosure to customers regarding newly issued securities than was ordinarily required of a secondary trading desk, which buys and sells only pre-existing securities.1537 Goldman maintained an inventory of RMBS and CDO securities to carry out activities for its clients and proprietary trading for the firm.

¶The Structured Product (SP) Syndicate and ABS Finance Desk was headed by Bunty Bohra and Curtis Probst.1538 This desk was often referred to simply as the "Syndicate." It coordinated Goldman's sales efforts and the issuance of different securities across different desks.

¶In the middle of 2007, the Mortgage Department was restructured. One key change was that the CDO Origination Desk was moved into the secondary trading area under the SPG Trading Desk. Mr. Lehman was designated as head of the CDO Origination Desk, with assistance from Mr. Swenson.1539 As a result, the SPG Trading Desk had responsibility for selling new Goldman-originated CDO securities as well as engaging in secondary trading of pre- existing CDOs and RMBS securities, related credit default swaps (CDS), ABX trading, correlation trading, property derivatives, CMBS, and other asset backed securities.1540

¶In 2006 and 2007, the Residential Whole Loan Trading Desk underwrote 93 RMBS worth $72 billion.1541 The CDO Origination Desk acted as a placement agent and underwrote approximately 27 mortgage based CDOs worth $28 billion.1542 Of the 27 CDOs, 84% were hybrid CDOs, 15% were synthetic, and only about 1% were cash CDOs with physical assets.1543 The mortgage-based CDOs included 8 CDOs on the Abacus platform, with $5 billion in issued securities;1544 a $2 billion synthetic CDO known as Hudson Mezzanine 2006-1; a $300 million synthetic CDO known as Anderson Mezzanine 2007-1; and $1 billion hybrid CDO known as Timberwolf I. (3) Overview of Goldman Sachs Case Study

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¶This Report looks at two activities undertaken by Goldman in 2006 and 2007. The first is Goldman's intensive effort, beginning in December 2006 and continuing through 2007, to profit from the subprime mortgage market collapse, particularly by shorting subprime mortgage assets. The second is how, in 2006 and 2007, Goldman used mortgage related CDOs to unload the risk associated with its faltering high risk mortgage assets onto clients, help a favored client make a $1 billion gain, and profit from the failure of the very CDO securities it sold to its clients.

¶These activities raise questions related to Goldman's compliance with its obligations to provide suitable investment recommendations to its clients and disclose its material adverse interests to potential investors. They also raise questions about whether some of Goldman's incomplete disclosures were deceptive, and whether some of its activities generated conflicts of interest in which Goldman placed its financial interests before those of its clients. They also raise questions about the high risk nature of some structured finance products and their role in U.S. financial markets.

¶(a) Overview of How Goldman Shorted the Subprime Mortgage Market

¶Beginning in December 2006 and continuing through 2007, Goldman twice built and profited from large net short positions in mortgage related securities, generating billions of dollars in gross revenues for the Mortgage Department. Its first net short peaked at about $10 billion in February 2007, and the Mortgage Department as a whole generated first quarter revenues of about $368 million, after deducting losses and writedowns on subprime loan and warehouse inventory.1545 The second net short, referred to by Goldman Chief Financial Officer David Viniar as "the big short,"1546 peaked in June at $13.9 billion. As a result of this net short, the SPG Trading Desk generated third quarter revenues of about $2.8 billion, which were offset by losses on other mortgage desks, but still left the Mortgage Department with more than $741 million in profits.1547 Altogether in 2007, Goldman's net short positions from derivatives generated net revenues of $3.7 billion.1548 These positions were so large and risky that the Mortgage Department repeatedly breached its risk limits, and Goldman's senior management responded by repeatedly giving the Mortgage Department new and higher temporary risk limits to accommodate its trading.1549 At one point in 2007, Goldman's Value-at-Risk measure indicated that the Mortgage Department was contributing 54% of the firm's total market risk, even though it ordinarily contributed only about 2% of its total net revenues.1550

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¶To build its net short positions, Goldman's Mortgage Department personnel used structured finance products to engage in multiple, complex transactions. Its efforts included selling high risk loans, RMBS, CDO, ABX, and other mortgage related assets from its inventory and warehouse accounts; shorting RMBS and CDO securities, either by shorting the assets themselves or by taking the short side of CDS contracts that referenced them, in order to profit from their fall in value; and shorting multiple other mortgage backed assets simultaneously, including different tranches of the ABX Index, tranches of CDOs, and CDS contracts on such assets. To lock in its profits after the short assets fell in value, Goldman often entered into offsetting CDS contracts to "cover its shorts," as explained below. Senior Goldman executives directed and monitored these activities.

¶The evidence reviewed by the Subcommittee shows that some of the transactions leading to Goldman's short positions were undertaken to advance Goldman's own proprietary financial interests and not as a function of its market making role to assist clients in buying or selling assets. In the end, Goldman profited from the failure of many of the RMBS and CDO securities it had underwritten and sold. As Goldman CEO Lloyd Blankfein explained in an internal email to his colleagues in November 2007: "Of course we didn't dodge the mortgage mess. We lost money, then made more than we lost because of shorts."1551

¶Covering Shorts to Lock In Profits. To understand how Goldman profited from its short positions, it is important to understand references in its internal documents to "covering" or "monetizing" its shorts. When Goldman built its short positions, it generally used CDS contracts to short a variety of mortgage related securities, including individual RMBS and CDO securities and baskets of 20 RMBS securities identified in the ABX indices. Goldman's shorts then gained or lost value over time, depending upon how the underlying referenced assets performed during the same period.

¶Most CDS contracts expire after a specified number of years. As explained earlier, during the covered period, the short party makes periodic premium payments to the opposing long party in the CDO. The short party is essentially betting that a "credit event" will take place during the covered period that will result in the long party having to provide it with a large payment that outweighs the cost of the short party's premium payments.1552 However, the short party does not have to wait for a credit event in order to realize a gain on its CDS contract.

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¶One possible alternative is for the short party simply to sell its short position to another party for a profit. If, however, the short party does not want to sell or has no ready buyer, the short party can still lock in a gain by entering into a second, offsetting CDS contract in which it takes the long position on an offsetting asset, an action often referred to as "covering the short."

¶In practice, there were several different, technical methods for a party to cover its short positions. The simplest example is if the short party bought a $100,000 CDS contract whose reference asset is a single RMBS security. Suppose after one month the RMBS security performs so poorly that the market value of the short position increases to $150,000. If the short party wanted to lock in the $50,000 gain, it could do so simply by entering into a new offsetting CDS contract, referencing the same RMBS security, in which it takes the long position with a new party who takes the short position at the new higher market value of $150,000. The result would be that the original short party would own a short position and a long position that offset each other, and would lock in the $50,000 difference in value as profit.

¶During 2007, Goldman executives repeatedly directed the Mortgage Department to "cover its shorts" and lock in the gains from the increased value of its short positions. When it covered its short positions by entering into offsetting contracts, the Mortgage Department simultaneously "monetized" its short positions – recorded the locked in profit. That is because, when it covered a short by entering into an offsetting contract, the Mortgage Department's general practice was to record a profit on its books equal to the gain on the original short position. Because the original purchase price of the CDS was known and fixed, and the new higher price obtained in the offsetting transaction was known and fixed, the Mortgage Department was able to capture the difference between the two prices as profit.

¶Going Past Home: The First Net Short. Because Goldman's activities were so varied and complex during the period reviewed, this overview provides a brief summary of the key events detailed in the following sections. The review begins in mid to late 2006, when Goldman realized that the market for subprime mortgage backed securities was beginning to decline, and the large long positions it held in ABX assets, loans, RMBS and CDO securities, and other mortgage related assets began to pose a disproportionate risk to both the Mortgage Department and the firm.1553 In October 2006, the Mortgage Department designed a synthetic CDO called

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¶Hudson Mezzanine 2006-1, which included over $1.2 billion of long positions on CDS contracts to offset risk associated with ABX assets in Goldman's own inventory and another $800 million in single name CDS contracts referencing subprime RMBS securities that Goldman wanted to short; the Mortgage Department then sold the Hudson securities to its clients.1554 While this CDO transferred $1.2 billion of subprime risk from Goldman's inventory to its clients and gave Goldman an opportunity to short another $800 million in RMBS securities it thought would perform poorly, the Mortgage Department still held billions of dollars of long positions in subprime mortgage related assets, primarily in ABX index assets.1555

¶On December 14, 2006, as Goldman's mortgage related assets continued to lose value, Goldman's Chief Financial Officer, David Viniar, held a meeting with key Mortgage Department personnel and issued instructions for the Department to "get closer to home."1556 By "closer to home," Mr. Viniar meant for the Mortgage Department to assume a more neutral risk position, one that was neither substantially long nor short, but actions taken by the Mortgage Department in response to his instructions quickly shot past "home," resulting in Goldman's first large net short position in February 2007.1557

¶The actions taken by the Mortgage Department included selling outright from its inventory large numbers of subprime RMBS, CDO, and ABX assets, even at a loss, while simultaneously buying CDS contracts to hedge the long assets remaining in its inventory. The Mortgage Department also halted new RMBS securitizations, began emptying its RMBS warehouse accounts, and generally stopped purchasing new assets for its CDO warehouse accounts. It also purchased the short side of CDS contracts referencing the ABX index for a basket of AAA rated subprime residential loans, as a kind of "disaster insurance" in the event that even AAA rated mortgages started defaulting.

¶Within about a month of the "closer to home" meeting, in January 2007, the Mortgage Department had largely eliminated or offset Goldman's long positions on subprime mortgage related assets. The Mortgage Department then started to build a multi-billion-dollar short position to enable the firm to profit from the subprime RMBS and CDO securities starting to lose value. By the end of the first quarter of 2007, the Mortgage Department had swung from a $6 billion net long position in December 2006, to a $10 billion net short position in late February vultures wouldn't be circling. You also know that we probably would have gotten the position correct had I been involved a year ago – I probably would have gotten short to protect our warehouse and general hedge against the business given our outlook in the space." 2/5/2007 email from Richard Ruzika to Gary Cohn, "Are you living Morgatages? [sic]," GS MBS-E-016165784.

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¶2007, a $16 billion reversal.1558 A senior Goldman executive later described a net short position of $3 billion in subprime mortgage backed securities as "huge and outsized."1559 But Goldman's net short position in February 2007 was $10 billion – more than triple that size.

¶In late February, Goldman's Operating Committee, a subcommittee of its Firmwide Risk Committee, became concerned about the size of the $10 billion net short position. The Firmwide Risk Committee was co-chaired by Mr. Viniar, and Messrs. Cohn and Blankfein regularly attended its meetings.1560 The concern arose, in part, because the $10 billion net short position had dramatically increased the Mortgage Department's Value-at-Risk or "VAR," the primary measure Goldman used to compute its risk. The Committee ordered the Department to lock in its profits by "covering its shorts," as explained above. The Mortgage Department complied by covering most, but not all, of the $10 billion net short and brought down its VAR. It then maintained a relatively lower risk profile from March through May 2007.

¶Attempted Short Squeeze. In May 2007, the Mortgage Department's Asset Backed Security (ABS) Trading Desk attempted a "short squeeze" of the CDS market that was intended to compel other market participants to sell their short positions at artificially low prices.1561 Goldman's ABS Desk was still in the process of covering the Mortgage Department's shorts by offering CDS contracts in which Goldman took the long side. The ABS Desk devised a plan in which it would offer those CDS contracts to short parties at lower and lower prices, in an effort to drive down the overall market price of the shorts. As prices fell, Goldman's expectation was that other short parties would begin to sell their short positions, in order to avoid having to sell at still lower prices. The ABS Desk planned to buy up those short positions at the artificially low prices it had caused, thereby rebuilding its own net short position at a lower cost.1562 The ABS Desk initiated its plan, and during the same period Goldman customers protested the lower values assigned by Goldman to their short positions as out of line with the market. Despite the lower prices, the parties who already held short positions generally kept them and did not try to sell them. In June, after learning that two Bear Stearns hedge funds specializing in subprime mortgage assets might collapse, the ABS Desk abandoned its short squeeze effort and recommenced buying short positions at the prevailing market prices.

¶The Big Short. In mid-June 2007, the two Bear Stearns hedge funds did collapse, triggering another steep decline in the value of subprime mortgage assets. In response, Goldman immediately went short again, to profit from the falling prices. Within two weeks, Goldman had massed a large number of CDS contracts shorting a variety of subprime mortgage assets. On

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¶June 22, 2007, Goldman's net short position reached its peak of approximately $13.9 billion, as calculated by the Subcommittee.1563 That total included the $9 billion in AAA ABX assets that Goldman had earlier acquired as "disaster protection," in case the subprime market as a whole lost value. The resulting net short, referred to by Mr. Viniar as the "big short," was nearly 40% larger than its first net short which had peaked at $10 billion in February 2007.

¶To lock in its profits on the $13.9 billion short, the Mortgage Department began working to cover its shorts, buying long assets and entering into offsetting CDS contracts in which it took the long position. On July 10, 2007, the credit rating agencies issued the first of many mass rating downgrades that affected hundreds and then thousands of RMBS and CDO securities, whose values began to fall even more rapidly.1564 The Mortgage Department was able to purchase long assets at a low cost, managed to cover most of its short positions, and locked in its profits. At the same time, the Mortgage Department maintained a net short position in higher risk subprime RMBS securities carrying credit ratings of BBB or BBB-, betting that those securities would lose still more value and produce still more profits for the firm. In August, however, Goldman senior management again became concerned about the size of the Department's net short position and its VAR levels, which had reached record levels. On August 21, 2007, Goldman's Chief Operating Officer Gary Cohn ordered the Mortgage Department to "get down now."

¶Big Short Profits. In response, the Mortgage Department began another round of covering its shorts and locking in its profits, including the shorts referencing BBB and BBB- rated RMBS securities. In the third quarter of 2007, the SPG Trading Desk reported record revenues from its short positions totaling $2.8 billion.1565 By the end of 2007, the SPG Trading Desk in the Mortgage Department recorded year-end net revenues totaling $3.7 billion, which were used to offset losses on other desks, leaving the Mortgage Department as a whole with record net revenues of over $1.1 billion for the year.1566 The head of the SPG Desk, Michael Swenson, later wrote that 2007 was "the [year] I am most proud of to date," because of the "extraordinary profits" from the short positions he had advocated.1567 His colleague, Joshua Birnbaum who headed the ABX Desk within SPG, also reviewed the year in terms of the profitable short positions it built. He wrote: "The prevailing opinion within the department was that we should just 'get close to home' and pare down our long," but he decided his ABS Desk should "not only

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¶... get flat, but get VERY short."1568 He wrote: "[W]e implemented the plan by hitting on almost every single name CDO protection buying opportunity in a 2-month period. Much of the plan began working by February as the market dropped 25 points and our very profitable year was under way." When the subprime mortgage market fell further in July after the credit rating mass downgrades, he wrote: "We had a blow-out [profit and loss] month, making over $1Bln that month."1569

¶The $3.7 billion in net revenues from the SPG's short positions helped to offset other mortgage related losses, and, at year's end, at a time when mortgage departments at other large financial institutions were reporting record losses, Goldman's Mortgage Department reported overall net revenues of $1.1 billion.1570

¶(b) Overview of Goldman's CDO Activities

¶This Report also examines four CDOs that Goldman originated, underwrote, and marketed in the years leading up to the financial crisis: Hudson Mezzanine 2006-1, Anderson Mezzanine 2007-1, Timberwolf I, and Abacus 2007-AC1. Hudson was conceived in 2006, and issued its securities in December 2006, as Goldman began its concerted effort to sell its mortgage holdings. Anderson, Timberwolf, and Abacus issued their securities in 2007, as RMBS and CDO securities were losing value, and Goldman was shorting the subprime mortgage market.

¶During 2007, as Goldman built and profited from its net short positions in the first and third quarters of the year, it continued to design, underwrite, and sell CDO securities. Due to waning investor interest, in February 2007, Goldman conducted a review of the CDOs in its pipeline. The Mortgage Department decided to cancel four pending CDOs, downsize another two, and bring all of its remaining CDOs to market as quickly as possible. Also in February 2007, the Mortgage Department limited its CDO Origination Desk to carrying out only the CDO transactions already underway.

¶"Gameplan" for CDO Valuation Project. In the first quarter of 2007, Goldman's Mortgage Department worked to sell the warehouse assets from the discontinued CDOs, the securities issued by past Goldman-originated CDOs, and the new securities from CDOs being originated by Goldman in 2006 and 2007. In May 2007, as CDO sales slowed dramatically, Goldman became concerned about the lack of sales prices to establish the value of its CDO holdings. Goldman needed accurate values, not just to establish its CDO sales prices, but also to value the CDO securities for collateral purposes and in compliance with Goldman's policy of using up-to-date market values for all of its holdings.1571 On May 11, 2007, Goldman senior executives, including Mr. Cohn and Mr. Viniar, Mortgage Department personnel, controllers, and others held a meeting and developed a "Gameplan" for a CDO valuation project.1572 The Gameplan called for the Mortgage Department, over the course of about a week, to use three different valuation methods to price all of its CDO warehouse assets, unsold securities from past CDOs, and new securities from the CDOs currently being marketed to clients.1573

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¶While the CDO valuation project was underway, Goldman senior executive Thomas Montag asked Daniel Sparks for an estimate of how much the firm would need to write down the value of its CDO assets. Mr. Sparks responded that "the base case from traders is down [$]382 [million]." He also wrote: "I think we should take the write-down, but market [the CDO securities] at much higher levels."1574 Another Goldman senior executive, Harvey Schwartz, expressed concern about selling clients CDO securities at one price and then immediately devaluing them: "[D]on't think we can trade this with our clients andf [sic] then mark them down dramatically the next day."1575 At the same time, Goldman's Chief Credit Risk Officer Craig Broderick told his staff to anticipate deep markdowns and highlighted the need to identify clients that might suffer financial difficulty if Goldman devalued their CDO securities and demanded they post more cash collateral.

¶On May 20, 2007, the Gameplan results were summarized in an internal presentation.1576 It projected that Goldman would have to take from $248 to $440 million in writedowns on unsold CDO securities and warehouse assets, making it clear to Goldman executives that its CDO assets were losing value rapidly.1577 In several drafts of the presentation, the Mortgage Department had also written that Goldman's CDOs were expected "to underperform," but that statement was removed from the final presentation given to senior executives.1578

¶Targeted Sales. The Gameplan also recommended a two-pronged approach to selling the firm's remaining CDO assets. First, it recommended transfer of the CDO warehouse assets to the Mortgage Department's SPG Trading Desk for further valuation and sale. Second, it recommended that the Mortgage Department use a "targeted" approach to sell off the existing and new securities from Goldman-originated CDOs, naming four hedge funds as the primary targets and providing a list of another 35 clients as secondary targets.1579

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¶At the same time, Mr. Sparks named David Lehman, a commercial mortgage backed securities trader, as the new head of the CDO Origination Desk. Shortly thereafter, Goldman dismantled the CDO Origination Desk and moved all remaining CDO securities to the SPG Trading Desk, where he was based. The SPG Trading Desk, which was a secondary trading desk and had little experience with underwriting, assumed responsibility for marketing the remaining unsold Goldman-originated CDO securities. The SPG Trading Desk's lack of underwriting experience meant that it was less familiar with the obligations of underwriters and placement agents to disclose all material adverse interests to potential investors.

¶The SPG Trading Desk worked with Goldman's sales force to market the CDO securities. Goldman employed "hard sell" tactics, repeatedly urging its sales force to sell the CDO securities and target clients with limited CDO familiarity.1580 After trying the Gameplan's "targeted" client approach during May, June, and July 2007, the Mortgage Department switched back to issuing sales directives or "axes" to its entire sales force, including sales offices abroad. Axes on CDOs generally went out at weekly or monthly intervals, identified specific CDO securities as top sales priorities, and offered additional financial incentives for selling them. Despite the CDOs' declining value, the sales force succeeded in selling some of the CDO securities, primarily to clients in Europe, Asia, Australia, and the Middle East, but was unable to sell all of them.

¶The four CDOs that the Subcommittee examined illustrate a variety of conflict of interest issues related to how Goldman designed, marketed, and administered them.

¶Hudson Mezzanine 2006-1. Hudson Mezzanine 2006-1 (Hudson 1) was a $2 billion synthetic CDO comprised of $1.2 billion in ABX assets from Goldman's own inventory, and $800 million in single name CDS contracts on subprime RMBS and CDO securities that Goldman wanted to short. It was called a "mezzanine" CDO, because the referenced RMBS securities carried the riskier credit ratings of BBB or BBB-. Goldman used the CDO to transfer the risk associated with its ABX assets to investors that bought Hudson 1 securities. Goldman also took 100% of the short side of the CDO, which meant that it would profit if any of the Hudson securities lost value. In addition, Goldman exercised complete control over the CDO by playing virtually every key role in its establishment and administration, including the roles of underwriter, initial purchaser of the issued securities, senior swap counterparty, credit protection buyer, collateral put provider, and liquidation agent.

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¶Goldman began marketing Hudson 1 securities in October 2006, soliciting clients to buy Hudson securities. It did not fully disclose to potential investors material facts related to Goldman's investment interests, the source of the CDO's assets, and their pricing. The Hudson 1 marketing materials stated prominently, for example, that Goldman's interests were "aligned" with investors, because Goldman was buying a portion of the Hudson 1 equity tranche.1581 In its marketing materials, Goldman did not mention that it was also shorting all $2 billion of Hudson's assets – an investment that far outweighed its $6 million equity share and which was directly adverse to the interests of prospective investors. In addition, the marketing materials stated that Hudson 1's assets were "sourced from the Street" and that it was "not a balance sheet CDO."1582 However, $1.2 billion of the Hudson assets had been selected solely to transfer risk from ABX assets in Goldman's own inventory.

¶Goldman also did not disclose in the materials that it had priced the assets without using any actual third party sales. The absence of arm's length pricing was significant, because the Hudson CDO was designed to short the ABX Index using single name RMBS securities, and there was a pricing mismatch between the two types of assets.1583 Goldman not only determined the pricing for the RMBS securities purchased by Hudson 1, but retained the profit from the pricing differential. The marketing materials did not inform investors of Goldman's role in the pricing, the pricing methodology used, or the gain it afforded to Goldman. In addition, the marketing materials stated Hudson 1 was "not a balance sheet" CDO, without disclosing that Hudson had been designed from its inception to remove substantial risk from Goldman's balance sheet.

¶The Hudson 1 Offering Circular contained language that may have also misled investors about Goldman's true investment interest in the CDO. The Offering Circular stated:

"[Goldman Sachs International] 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 ... , or in credit default swaps ... , total return swaps or other instruments enabling credit and/or other risks to be traded that are linked to one or more Investments."1584

¶This provision seems to inform investors that Goldman "may invest" for its own account in the CDO's securities, reference obligations, or CDS contracts, while withholding the fact that, by the time the Offering Circular had been drafted, Goldman had already determined to take 100% of the short position in the CDO, an investment which was directly adverse to the interests of Hudson securities investors.

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¶Once Hudson issued its securities, Goldman placed a priority on selling them, and delayed the issuance of a CDO on behalf of another client in order to facilitate Hudson sales. Goldman sales representatives reported that clients expressed skepticism regarding the quality of the Hudson assets, but Goldman continued to promote the sale of the CDO.

¶In 2008, as Hudson's assets lost value and received rating downgrades from the credit rating agencies, Goldman, in its role as liquidation agent, was tasked with selling those assets to limit losses to the long investors. The major Hudson investor, Morgan Stanley, pressed Goldman to do just that. Goldman, however, delayed selling the assets for months. As the assets dropped in value, Goldman's short position increased in value. Morgan Stanley's representative reported to a colleague that when Goldman rejected the firm's request to sell the poorly performing Hudson assets, "I broke my phone."^15851585 2/6/2008 email from John Pearce to Michael Petrick, HUD-CDO-00005146. He also sent an email to the head of Goldman's CDO Desk saying: "[O]ne day I hope I get the real reason why you are doing this to me."1586 Morgan Stanley lost nearly $960 million on its Hudson investment.

¶Anderson Mezzanine 2007-1. Anderson Mezzanine 2007-1 (Anderson) was another synthetic CDO referencing BBB and BBB- rated subprime RMBS securities. It was issued in March 2007. Among other roles, Goldman served as the CDO's placement agent, initial purchaser, collateral put provider, and liquidation agent. Goldman hired another firm, a New York hedge fund founded by former Goldman employees, GSC Partners, to act as the collateral manager. Goldman took a short position on approximately 40% of the $305 million in assets underlying Anderson.

¶Anderson referenced a number of poor quality assets. Those assets had been selected by GSC Partners, with the approval of Goldman. Over 45% of the referenced subprime RMBS securities contained mortgages originated by New Century, a subprime lender known within the industry, including Goldman, for issuing poor quality loans and which was experiencing financial problems while Anderson was being structured and marketed.1587 Inside Goldman, staff were aware of New Century's problems and were taking action to return substantial numbers of substandard loans purchased from New Century and demand repayment for them.1588 Other assets in the Anderson CDO were also performing poorly, and at one point, Goldman personnel estimated its warehouse assets had fallen in value by $22 million.1589 Due to the asset quality problems, the Mortgage Department head, Daniel Sparks, initially decided to cancel Anderson, but later changed his mind and decided to market the CDO as quickly as possible, using the $305 million in assets already in its warehouse account, rather than wait to accumulate all of the $500 million in assets initially planned.

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¶When Anderson issued its securities in March 2007, Goldman placed a high priority on selling them, even delaying another CDO – Abacus 2007-AC1 which was being organized at the request of the Paulson hedge fund – to allow its sales force to concentrate on promoting Anderson. Potential investors raised questions about the quality of its underlying assets, especially the New Century loans, and Goldman provided its sales representatives with talking points to dispel concerns about the New Century assets. When one client asked how Goldman had gotten "comfortable" with the New Century loans, Goldman did not disclose to the client its own negative views of New Century loans or that it had 40% of the short side of the CDO.

¶Goldman marketed Anderson securities to a number of its clients, including pension funds, and recommended using Anderson securities as collateral security in other CDOs.1590 In the end, Goldman sold only $102 million or about one third of the Anderson securities.1591 Seven months after the securities were issued, they suffered their first credit rating downgrade. Currently, all of the Anderson securities have been reduced to junk status, and the Anderson investors have lost virtually their entire investments.

¶Timberwolf I CDO. Timberwolf I was a $1 billion hybrid CDO2 transaction that referenced single-A rated securities from other CDOs. Those CDO securities referenced, in turn, RMBS securities carrying lower credit ratings, primarily BBB. Altogether, Timberwolf referenced 56 unique CDO securities that had over 4,500 unique underlying assets. Goldman served as the CDO's placement agent, initial purchaser, collateral put provider, and liquidation agent. It also hired a hedge fund with former Goldman employees, Greywolf Capital Management, to act as the collateral manager. Greywolf selected the CDO's assets, with Goldman's approval. Goldman took a short position on approximately 36% of the $1 billion in assets underlying Timberwolf.1592

¶Timberwolf's securities began losing value almost as soon as they were purchased. In February 2007, Goldman's Mortgage Department head told a senior executive that Timberwolf was one of two deals "to worry about." He also wrote that the assets in the Timberwolf warehouse account had declined so much in value that they had already exhausted Greywolf's responsibility to pay a portion of any warehouse losses, and any additional losses would be Goldman's exclusive obligation.1593 Goldman rushed Timberwolf to market, and it closed on March 27, 2007, approximately six weeks ahead of schedule.1594 Almost as soon as the Timberwolf securities were issued, they too began to lose value.

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¶Despite doubts about its performance and asset quality, Goldman engaged in an aggressive campaign to sell the Timberwolf securities. As part of its tactics, Mr. Lehman instructed Goldman personnel not to provide written information to investors about how Goldman was valuing or pricing the Timberwolf securities, and its sales force offered no additional assistance to potential investors trying to evaluate the 4,500 underlying assets. Mr. Sparks and Mr. Lehman sent out numerous sales directives or "axes" to the Goldman sales force, stressing that Timberwolf was a priority for the firm.1595 In April, Mr. Sparks suggested issuing "ginormous" sales credits to any salesperson who sold Timberwolf securities, only to find out that large sales credits had already been offered.1596 In May, while Goldman was internally lowering the value of Timberwolf, it continued to sell the securities at a much higher price than the company knew it was worth. At one point, a member of the SPG Trading Desk issued an email to clients and investors, advising them that the market was rebounding and the downturn was "already a distant memory."1597 Goldman also began targeting Timberwolf sales to "non-traditional" buyers and those with little CDO familiarity, such as increasing its marketing efforts in Europe and Asia.

¶On June 18, 2007, Goldman sold $100 million worth of Timberwolf securities to an Australian hedge fund, Basis Capital. Just 16 days later, on July 4, Goldman informed Basis Capital that the securities had lost value, and it had to post additional cash collateral to secure its CDS contract. On July 12, Goldman told Basis Capital that the value had dropped again, and still more collateral needed to be posted. In less than a month, the value of Timberwolf had fallen by $37.5 million. Basis Capital posted the additional capital, but soon after declared bankruptcy.

¶On June 1, 2007, Goldman Sachs sold $36 million in Timberwolf securities to a Korean life insurance company, Hungkuk Life, that had little familiarity with the product. The head of the Korean sales office said his office was willing to sell the company additional securities, if assured the office would receive a 7% sales credit. Goldman agreed, and said "get 'er done." The sales office sold another $56 million in Timberwolf securities to the life insurance company which paid $76 per share when Goldman's internal value for the security was $65.

¶Within ten days of that sale, Thomas Montag, a senior Goldman executive, sent an email to the Mortgage Department head, Daniel Sparks, stating: "boy that timeberwof [Timberwolf] was one shitty deal."1598 Despite that comment, Goldman continued to market Timberwolf securities to its clients.

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¶Goldman had also arranged for its subsidiary, Goldman Sachs International (GSI), to act as both the primary CDS counterparty and the collateral put provider in Timberwolf.1599 Although GSI received a fee for serving as the collateral put provider, GSI began to refuse to approve Timberwolf's purchase of new collateral securities whose values might decline below par value and put Goldman at risk of having to make up the difference. Instead, GSI pressured Timberwolf to keep its collateral in cash, even though an internal Goldman analysis had confirmed that cash collateral produced lower returns for Timberwolf investors than collateral securities. When Greywolf objected to this practice, Goldman backed down and allowed the purchase of a narrow range of very safe, short term asset backed securities as collateral.

¶In the fall of 2007, a Goldman analyst provided executives with a price history for Timberwolf A2 securities. It showed that, in five months, Timberwolf securities had lost 80% of their value, falling from $94 in March to $15 in September. Upon receiving the pricing history, the Timberwolf deal captain, Matthew Bieber, wrote that March 27 – the day Timberwolf issued its securities – was "a day that will live in infamy."1600 Timberwolf was liquidated in 2008.

¶Abacus 2007-AC1. Abacus 2007-AC1 was a $2 billion synthetic CDO that referenced BBB rated mid and subprime RMBS securities issued in 2006 and early 2007. It was a static CDO, meaning once selected, its reference obligations did not change. It was the last in a series of 16 Abacus CDOs that referenced primarily mortgage backed assets and were designed by Goldman. Those Abacus CDOs were known as single tranche CDOs, structures pioneered by Goldman to provide customized CDOs for clients interested in assuming a specific type and amount of investment risk. They enabled the client to select the assets, the size of the investment, the amount of subordination or cushion before the securities would be exposed to loss, and could be issued with a single tranche.1601 The Abacus CDOs also enabled investors to short a selected group of RMBS or CDO securities at the same time. Goldman used the Abacus CDOs not only to sell short positions to investors, but also as a way for Goldman itself to short mortgage assets in bulk.1602

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¶Abacus 2007-AC1 was the first and only Abacus transaction in which Goldman allowed a third party client to essentially "rent" its CDO structure and play a direct, principal role in the selection of the assets. Goldman did not itself intend to invest in the CDO.1603 Instead, it functioned primarily as an agent, earning fees for its roles in structuring, underwriting, and administering the CDO. Those roles included Goldman's acting as the placement agent, collateral securities selection agent, and collateral put provider. Unlike previous Abacus CDOs, Goldman employed a third party to serve as the portfolio selection agent, essentially using that agent to promote sales and mask the role of its client in the asset selection process.

¶Goldman originated Abacus 2007-AC1 in response to a request by Paulson & Co. Inc. (Paulson), a hedge fund that was among Goldman's largest customers for subprime mortgage related assets. Paulson had a very negative view of the mortgage market, which was publicly known, and wanted Goldman's assistance in structuring a transaction that would allow it to take a short position on a portfolio of subprime mortgage assets that it believed were likely to perform poorly or fail. Goldman allowed Paulson to use the Abacus CDO for that purpose. In entering into that arrangement with Paulson and simultaneously acting as the placement agent responsible for marketing the Abacus securities to long investors, Goldman created a conflict of interest between itself and the investors it would be soliciting to buy the Abacus securities.

¶Paulson established a set of criteria to select the reference assets for the Abacus CDO to achieve its investment objective.1604 After establishing those parameters, Paulson worked with the actual portfolio section agent to select the assets. Documents show that Paulson proposed, substituted, rejected, and approved assets for the reference portfolio. Goldman was aware of Paulson's investment objective, the role it played in the selection of the reference assets, and the fact that the selection process yielded a set of poor quality assets. Of the final set of 90 assets referenced in the Abacus CDO portfolio,⁴⁹⁴⁹ "Revenue of the Three Credit Rating Agencies: 2002-2007," chart prepared by the Subcommittee using data from http://thismatter.com/money, Hearing Exhibit 4/23-1g. had been initially proposed by Paulson. Yet Goldman did not publicly disclose the central role played by Paulson in the asset selection process or the fact that the economic interest held by an entity actively involved in the asset selection process was adverse to the interest of investors who would be taking the long position.

¶ACA Management LLC, the company hired by Goldman to serve as the portfolio selection agent, told the Subcommittee that, while it knew Paulson was involved, it was unaware of Paulson's true economic interest in the CDO. The ACA Managing Director who worked on the Abacus transaction stated that ACA believed that Paulson was going to invest in the equity tranche of the CDO, thus aligning its interests with those of ACA and other investors.1605 ACA and its parent company both acquired long positions in the Abacus CDO as did a third investor. The Abacus securities lost value soon after purchase. The three long investors together lost more than $1 billion, while Paulson, the sole short investor, recorded a corresponding profit of about $1 billion. Today, the Abacus securities are worthless.

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¶In addition to not disclosing the asset selection role and investment objective of the Paulson hedge fund, Goldman did not disclose to investors how its own economic interest was aligned with Paulson. In addition to accepting a sizable placement fee paid by Paulson for marketing the CDO securities, Goldman had entered into a side arrangement with the hedge fund in which it would receive additional fees from Paulson for arranging CDS contracts tied to the Abacus CDO that included low premium payments falling within a specified range.1606 While those lower premium payments would benefit Paulson by lowering its costs, and benefit Goldman by providing it with additional fees, they would also reduce the amount of cash being paid into the CDO, disadvantaging the very investors to whom Goldman was marketing the Abacus securities. Goldman nevertheless entered into the arrangement, contrary to the interests of the long investors in Abacus, and failed to disclose the existence of the fee arrangement in the Abacus marketing materials.

¶On April 16, 2010, the SEC filed a complaint against Goldman and one of the lead salesmen for the Abacus CDO, Fabrice Tourre, alleging they had failed to disclose material adverse information to potential investors and committed securities fraud in violation of Section 17(a) of the Securities Act of 1933 and Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934. On July 14, 2010, Goldman reached a settlement with the SEC, admitting:

"[T]he marketing materials for the ABACUS 2007-AC1 transaction contained incomplete information. In particular, it was a mistake for the Goldman marketing materials to state that the reference portfolio was 'selected by' ACA Management LLC without disclosing the role of Paulson & Co. Inc. in the portfolio selection process and that Paulson's economic interests were adverse to CDO investors."1607

¶Goldman agreed to pay a $550 million fine.

¶The Hudson, Anderson, Timberwolf, and Abacus CDOs provide concrete details about how Goldman designed, marketed, and administered mortgage related CDOs in 2006 and 2007. The four CDOs also raise questions about whether Goldman complied with its obligations to offer suitable investments that it believed would succeed, and provide full disclosure to investors of material adverse interests. They also illustrate a variety of conflicts of interest in the CDO transactions that Goldman resolved by placing its financial interests and favored clients before those of its other clients.

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¶Each of the four CDOs examined by the Subcommittee presents conflict of interest concerns and elements of deception related to how information about the CDO was presented to investors, including disclosures related to the relevant CDO's asset selection process, the quality and value of the CDO's assets and securities, and the nature and size of Goldman's proprietary financial interests. The Subcommittee's investigation raises questions regarding whether Goldman complied with its obligations to disclose material information to investors, including its material adverse interests, and to refrain from making investment recommendations that are unsuitable for any investor by recommending financial instruments designed to lose value and perform poorly. A key issue underlying much of this analysis is the structuring of and disclosures related to financial instruments that enable an investment bank to bet against the very financial products it is selling to clients.

¶(4) How Goldman Shorted the Subprime Mortgage Market

¶Having provided an overview of Goldman's shorting activities and CDO activities in the years leading up to the financial crisis, this next section of the Report provides detailed information about how Goldman shorted the subprime mortgage market.

¶(a) Starting $6 Billion Net Long

¶By mid-2006, Goldman's Mortgage Department had a predominantly pessimistic view of the U.S. subprime mortgage market. According to Michael Swenson, head of the Mortgage Department's Structured Products Group: "[D]uring the early summer of 2006 it was clear that the market fundamentals in subprime and the highly levered nature of CDOs [were] going to have a very unhappy ending."1608

¶$6 Billion Long. In mid-2006, Goldman held billions of dollars in long subprime mortgage related securities, in particular the long side of CDS contracts referencing the ABX Index. In September 2006, Mortgage Department head Daniel Sparks and his superior, Jonathan Sobel, initiated a series of meetings with Mr. Swenson, head of the Structured Products Group (SPG), and Mr. Birnbaum, the Mortgage Department's top trader in ABX assets, to discuss the Department's long holdings.1609 In those meetings, they discussed whether the Asset Backed Security (ABS) Trading Desk within SPG should get out of its existing positions or "double- down." After the first meeting, Mr. Birnbaum emailed Mr. Swenson:

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"Sobel and Sparks want to know if we should exit or double down. We double down if we have a structured place to go with the risk. ... [W]e are going to sit down with the CDO guys and talk about a deal."1610

¶If the Department's existing long positions could be transferred off SPG's books by finding a "structured place to go with the risk," the ABS Trading Desk would then be free to "double down" by taking on new positions and risk.

¶That same month, September 2006, the ABS and CDO Desks reached agreement on constructing a new CDO to provide the ABS Desk with a "structured exit" from some of its existing investments. The result was Hudson Mezzanine 2007-1, a CDO designed by Goldman to transfer to Hudson investors the risk associated with $1.2 billion in net long ABX assets then in Goldman's inventory. The Hudson CDO was also designed to allow Goldman to short $800 million in RMBS securities to offset a portion of its long ABX assets.1611

¶In December 2006, even after the $2 billion Hudson CDO was constructed, the Mortgage Department calculated that it still had a $6 billion net long position in subprime mortgage related assets.1612 Goldman's ABX holdings continued to be a major source of its long assets.

¶Goldman's Long ABX Assets. In January 2006, Goldman, Deutsche Bank, and several other Wall Street firms launched the ABX Index which, for the first time, allowed investors to use standardized CDS contracts to invest in baskets of subprime RMBS securities. The ABX Index measured the aggregate performance of a selected basket of 20 RMBS securitizations, producing a single value that rose or fell over time in line with the performance of the underlying RMBS securities.1613 Investors could enter into CDS contracts that used a particular ABX Index as the "reference obligation," without physically purchasing or holding any of the RMBS securities in the underlying basket. Because the ABX Index itself was synthetic, and did not depend upon the acquisition of large blocks of RMBS securities, it enabled an unlimited number of investors to make unlimited bets on the performance of a group of subprime RMBS securities, using standardized contracts that could be bought and sold. The ABX Index also made it economical for investors to short subprime RMBS securities in bulk.1614

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¶In internal documents, Goldman described itself as "the leader and principal driver in the creation of" the ABX Index.1615 In July 2006, Joshua Birnbaum, Rajiv Kamilla, David Lehman, and Michael Swenson from the Mortgage Department nominated Goldman's role in the creation of both the ABX and CMBX – a similar index based on Commercial Mortgage Backed Securities – for an internal Goldman award, called the "Mike Mortara Award for Innovation."1616 That award "recognize[d] the creative, forward-looking, and entrepreneurial contributions of an individual or team" within the equities or fixed income divisions.1617 The Mortgage Department personnel wrote that the new indices "enable[d] market participants to trade risk without ownership of the underlying SP [structured product] security – thereby permitting market participants to efficiently go short the risk of these securities."1618 They also wrote that "Goldman Dominates Client Trading Volume" with "an estimated 40% market share," and also "dominates the inter-dealer market."1619 In 2007, Rajiv Kamilla, the ABS trader who spearheaded Goldman's efforts to launch the ABX Index, wrote that he "[c]ontinued to enhance our trading dominance in ... ABX indices."1620

¶While Mr. Kamilla led Goldman's efforts to develop the ABX Index, the firm's day-to-day ABX trading was conducted primarily by Joshua Birnbaum on the Mortgage Department's Structured Products Group (SPG) Trading Desk.1621 Mr. Birnbaum had a negative view of the subprime mortgage market, and favored the firm's building a net short position.1622 However, during 2006, Goldman's overall ABX position was net long, not net short.

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¶Goldman was net long because, as a market maker that helped launch the ABX Index in 2006, it facilitated ABX trades for a number of clients, and many of those clients – primarily hedge funds – went almost exclusively short, requiring Goldman to take the opposing long side of the CDS contracts referencing the ABX indices.1623 These transactions enabled Goldman to amass a 30-40% market share in ABX trading during its first year of existence. But by mid-2006, they had also contributed to the Mortgage Department's net long position in subprime mortgage related assets. When the mortgage market began showing signs of strain in the second half of 2006, the risks associated with the firm's net long ABX position became more of a concern.1624 Senior

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¶Goldman executives expressed the view that the subprime mortgage related market was likely to get much worse, and the firm should prepare for it.1625

¶In December 2006, Goldman used the Hudson CDO to transfer the risk associated with $1.2 billion of its ABX long holdings to Hudson investors. But even after this transfer, Goldman still had billions of dollars in long ABX holdings on its books.

¶Goldman's Long Mortgage Holdings. In addition to its long ABX holdings, the Mortgage Department's $6 billion net long position in December 2006 was due to a large inventory of RMBS, CDO, and other mortgage related assets in Goldman's investment and sale inventories and in its CDO warehouses. In 2006, the Mortgage Department conducted numerous RMBS and CDO securitizations that required it to acquire and repackage whole loans, RMBS and CDO securities, and other mortgage related assets. When assembling CDOs, Goldman often worked with third party partners. These strategic partners bought a portion of the equity and bore some of the risk of loss in the CDO. The partners were generally smaller financial firms, such as hedge funds or asset managers with expertise in CDOs or a particular asset class. For a fee, the partners also sometimes served as a CDO's collateral manager, helping to select the assets.1626

¶Peter Ostrem, who was head of the CDO Origination Desk from 2006 until May 2007, was aware of substantial problems in the subprime mortgage market, but believed that the market distress was temporary and the market would stabilize.1627 Mr. Ostrem wanted to continue to increase the CDO Desk's business by producing as many marketable CDOs as possible.1628 Darryl Herrick, who worked for Mr. Ostrem on the CDO Origination Desk expressed the view that hedge funds were shorting only the worst CDOs: "[CDO] shelves people are shorting are enhanced garbage."1629

¶The CDO Origination Desk was a primary contributor to the Mortgage Department's net long position, as Goldman often had to hold or "warehouse" subprime assets until they were packaged into a CDO.1630 Each CDO was designed to include or reference hundreds of millions or billions of dollars in assets, which the CDO Origination Desk and its partners had to locate and acquire, a process called "ramping" that averaged six to nine months per CDO.1631 Goldman and its partners acquired these assets from other large Wall Street broker-dealers, often called "the Street," or took them from their own inventory of assets.

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¶When assembling a CDO, Goldman generally opened an internal "warehouse account" for the CDO in which it stored the acquired assets until a target amount was achieved, and the CDO was brought to market. While the assets were in the warehouse account, they were included in Goldman's warehouse balance sheet and contributed to its long or short positions. When the bulk of the target assets were acquired for a particular CDO, perhaps 75% to 95% of the total, in some cases Goldman priced the CDO securities and began selling them to clients who were told what the remaining assets would likely be.1632 When a CDO transaction "closed" and its securities were issued, Goldman transferred the relevant assets from its warehouse account to the corporation or trust established for the CDO.1633 The CDO entity then housed the long assets that had been on Goldman's warehouse books, and Goldman was left with a corresponding short position which it could keep or sell to the CDO's short parties.

¶In 2006 and early 2007, since it was often acquiring assets for several CDOs at once, the CDO Desk generally had a substantial net long position in subprime assets in its CDO warehouse accounts.1634 For example, as of March 16, 2007, Goldman calculated that its CDO warehouses contained $4.7 billion in mortgage related assets.1635 After deducting potential liabilities assumed by Goldman's partners and making other adjustments, Goldman calculated that it had $2.3 billion in net long warehouse risk.1636 In early 2007, Goldman executives began to express concern about the risks posed by the subprime mortgage related assets in the CDO warehouse accounts.1637

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¶On December 7, 2006, Daniel Sparks, the Mortgage Department head, exchanged emails with Goldman senior executive Thomas Montag about why Goldman was not doing more to reduce the firm's risk associated with its net long positions.1638 On the same day, Mr. Montag complained to CFO David Viniar about the Mortgage Department's lack of aggressiveness in trying to reduce its net long ABX position:

"[O]n ABX having numerous conversations–I don't think we should panic out but we certainly didn't do a good job of keeping pressure on ... makes me mad because they should have kept doing it ugh."1639

¶The next week, Mr. Viniar called a meeting with the Mortgage Department to discuss its holdings.

¶(b) Going Past Home: Goldman's First Net Short

¶CFO David Viniar told the Subcommittee that, in early December 2006, he received reports showing that the Mortgage Department had lost money on ten successive days.1640

¶Viniar Meeting. On December 14, 2006, Mr. Viniar convened a meeting in the conference room next to his office on the 30th floor, in which he and other senior Goldman executives met for several hours with Mortgage Department managers, as well as representatives from Market Risk Management & Analysis and from the Controllers group.1641 At the meeting, Mr. Viniar and other Goldman executives conducted an in-depth review of the Mortgage Department's holdings. Mr. Viniar concluded the Mortgage Department's position in subprime mortgage related assets was too long, and its risk exposure was too great.1642

¶Mr. Viniar and others told the Subcommittee that Mr. Viniar's basic message to the Mortgage Department at the December meeting was not necessarily to go short, but instead to "get closer to home."1643 In trading parlance, "home" means a net neutral trading position – a position

¶MBS-E-010989710 ("There are a few deals that look tough now, including a A-rated CDO of CDOs with Greywolf [Timberwolf]").

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¶that is neither significantly short nor long.1644 Mr. Viniar told the Subcommittee that, by telling the Mortgage Department to "get closer to home," he meant that it should assume a more neutral risk position.1645 One way to "get closer to home" was for the Department to sell its long assets. Another way to achieve a more neutral risk position was for the Department to take new short positions to offset its existing long positions.1646

¶Internal documents indicate that the directions given to the Mortgage Department in the December meeting were more detailed than the general instruction to "get closer to home." In an email sent on the same day by Mr. Sparks to Goldman executives Messrs. Montag and Ruzika entitled, "Subprime risk meeting with Viniar/McMahon Summary," Mr. Sparks wrote:

"Followups: 1. Reduce exposure, sell more ABX index outright, basis trade of index vs. CDS too large. 2. Distribute as much as possible on bonds created from new loan securitizations and clean previous positions. 3. Sell some more resid[ual]s 4. Mark [the value of assets in] the CDO warehouse more regularly ... 5. Stay focused on the credit of the originators we buy loans from and lend to 6. Stay focused and aggressive on MLN [Mortgage Lending Network] (warehouse customer and originator we have EPDs [early payment defaults] to that is likely to fail) 7. Be ready for the good opportunities that are coming (keep powder dry and look around the market hard)."1647

¶The next day, December 15, 2006, Mr. Montag forwarded Mr. Sparks' email to Mr. Viniar asking: "is this a fair summary?"1648 Mr. Viniar replied: "Yes." Mr. Viniar noted:

"On ABX, the position is reasonably sensible but is just too big. Might have to spend a little to size it appropriately. On everything else my basic message was let's be aggressive distributing things because there will be very good opportunities as the markets [go] into

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what is likely to be even greater distress and we want to be in a position to take advantage of them."1649

¶In response to the Viniar meeting, the Mortgage Department took immediate action. It began selling its long ABX positions outright when possible and entering into large single name CDS shorts to offset its remaining long assets. Goldman personnel developed a chart depicting the long positions the Mortgage Department had taken on BBB and BBB- rated ABX assets.1650 This chart also showed how quickly the Mortgage Department moved after the Viniar meeting to offset those long positions by amassing single name RMBS and CDS short positions.

[SEE CHART NEXT PAGE: Notionals (ABX convention), prepared by Goldman Sachs, reformatted by the Permanent Subcommittee on Investigations to be readable in black and white print, GS MBS-E- 010214410.]

¶Notionals (ABX convention)

¶10,000,000,000

¶8,000,000,000

¶6,000,000,000

¶BBB Index Only

¶4,000,000,000

BBB Index + CDS BBB- Index Only BBB- Index + CDS

¶2,000,000,000 All BBBs Index Only

¶All BBBs Index + CDS

¶19-Jan 18-Feb 20-Mar 19-Apr 19-May 18-Jun 18-Jul 17-Aug 16-Sep 16-Oct 15-Nov 15-Dec 14-Jan 13-Feb

¶-2,000,000,000

¶BBB bucket includes BBB+ CDS -4,000,000,000 Notionals: refers to current notionals

¶Positive notionals: long risk

¶Prepared by the U.S. Senate Permanent Subcommittee on Investigations, February 2011. Derived from Goldman Sachs document, GS MBS-E-010214410.

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¶Within about a month, in January 2007, the Mortgage Department had largely eliminated or offset its long subprime mortgage assets, but it didn't stop there. In January and February, the Mortgage Department began building a multi-billion-dollar short position as part of a plan by the SPG Trading Desk to profit from the subprime RMBS and CDO securities starting to lose value. The plan was discussed with Mr. Sparks and Mr. Ruzika before it was set in motion. By the end of February 2007, the Department had swung from a $6 billion net long position to a $10 billion net short position, a $16 billion reversal in the span of two months.

¶Selling Assets Outright. On December 14, 2006, the same day as the Viniar meeting, Kevin Gasvoda, head of the Residential Whole Loan Trading group, instructed his staff to begin selling the RMBS securities in Goldman's inventory, focusing on RMBS securities issued from Goldman-originated securitizations. He urged them to "move stuff out" even at a loss:

"[P]ls refocus on retained new issue bond positions and move them out. ... [W]e don't want to be hamstrung based on old inventory. Refocus efforts and move stuff out even if you have to take a small loss."1651

¶In February 2007, to further encourage sales, Mr. Gasvoda issued a sales directive or "axe" to the Goldman sales force to sell the remaining RMBS securities from Goldman-originated RMBS securitizations. On February 9, 2007, the sales force reported a substantial number of sales, and Mr. Gasvoda replied: "Great job syndicate and sales, appreciate the focus."1652

¶In February 2007, Goldman CEO Lloyd Blankfein personally reviewed the Mortgage Department's efforts to reduce its subprime RMBS whole loan, securities, and residual equity positions, asking Mr. Montag: "[W]hat is the short summary of our risk and the further writedowns that are likely[?]"1653 After a short report from Mr. Montag, Mr. Blankfein replied:

"[Y]ou refer to losses stemming from residual positions in old deals. Could/should we have cleaned up these books before and are we doing enough right now to sell off cats and dogs in other books throughout the division?"1654

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¶At the end of February, Goldman's controllers prepared a summary of the changes in Goldman's RMBS and whole loan inventory since December 2006, and reported:

"Residential Credit Loans: The overall loans inventory decreased from $11bn to $7bn. ... subprime loans decreased from $6.3bn to $1.5bn, Second Liens decreased from $1.5bn to $0.7bn and S&D [scratch and dent] Loans remained unchanged at $0.8bn."1655

¶This analysis indicates that, in less than three months, Goldman had reduced its subprime loan inventory by over two-thirds, and its second lien inventory by half.

¶The Mortgage Department reduced its inventory, not only by selling assets outright, but also by reducing its purchase of whole loans and securitization efforts. In March 2007, Goldman informed its Board of Directors and the SEC that it had stopped purchasing subprime loans and RMBS securities through, in its words, the use of "conservative bids."1656 While those presentations did not explain the phrase "conservative bids," an email to Goldman's Chief Credit Officer, Craig Broderick, discussing a March 2007 presentation to Goldman's Audit Committee about the subprime mortgage business, was much more explicit: "Just fyi not for the memo, my understanding is that the desk is no longer buying subprime. (We are low balling on bids)."1657 Still another method to reduce its loan inventory was an ongoing effort by the Mortgage Department to return defaulted or fraudulent loans to the lenders from which it had purchased them.

¶On April 23, 2007, Mr. Gasvoda reported to Messrs. Montag and Sparks a dramatic reduction in Goldman's inventory of subprime loans and RMBS securities:

"[W]e have $180mm in loans (unsecuritized) and $255mm of residuals off old deals. The $180mm of loans is the smallest we've been since we started the business in 2002. We had been running at an average loan position balance in subprime of around $4B . ... The $255mm we have retained is from deals dating back to 2002 and while we've developed some buying partners, it is not a deep market. These have been intentional principal retained positions."1658

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¶The subprime loan balance of $180 million was just over one-tenth of the $1.5 billion total Goldman had held at the end of February 2007, reflecting a reduction in its subprime inventory over a two-month span by nearly 90%. Overall, the $180 million loan balance was down from an average subprime loan position balance of $4 billion, which was a 95% reduction in overall subprime loan inventory levels.

¶Building the First Short Position. At the same time the Residential Whole Loan Trading Desk was selling loans and RMBS securities, the Structured Product Group (SPG) Trading Desk was working to sell its inventory of long CDS contracts linked to the ABX indices.1659 At first, in December and January, because so many market participants were going short, the SPG's ABX Trading Desk found its long ABX positions difficult to sell.1660 The ABS Desk then decided to offset the long ABX assets in part by purchasing the short side of single name CDS contracts on certain RMBS and CDO securities.1661 Within about six weeks, by February 2007, the ABS Desk had acquired a huge net short position in single name CDS contracts referencing RMBS and CDO securities that totaled more than $5 billion. By then, the ABX market had stabilized somewhat, and the ABS Desk was able to sell outright more of its long ABX positions. Rather than slow down once its $6 billion long position was offset, however, the ABS Desk used CDS contracts to short RMBS and CDO securities "at every opportunity," in the words of one trader, going increasingly net short.1662

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¶On February 12, 2007, Mr. Sparks reported to senior management on the Mortgage Department's progress and the substantial profits that its new net short position was already showing:

"(1) +20mm [million] P&L [profit and loss] today. Secondary trading desk is net short risk in the form of single names and structured index vs index longs (some index shorts also). Large move down again today ....

(2) Possible significant upside in book. The desk has been moving [marking down] single names about 1/3 of what they feel the correct correlation [to ABX Index] is (around 70%) .... As the market has moved so much one way, there is the potential for the book to currently have significant upside embedded in it.1663

¶(3) Loan & resid[ual] books flat [i.e., already hedged]."1664

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¶On February 14, 2007, Mr. Sparks again reported to senior management on the Department's progress, describing how it was neutralizing its net long position:

"[O]ur risk reduction program consisted of: (1) selling index outright (2) buying single name protection and (3) buying protection on super-senior portions of the BBB/BBB- index. ... That is good for us position-wise, bad for accounts who wrote that protection ... but could hurt our CDO pipeline position as CDOs will be harder to do."1665

¶"Overall," Mr. Sparks wrote, "as a business we are selling our longs and covering our shorts."1666

¶With respect to market conditions, Mr. Sparks reported:

"Subprime environment – bad and getting worse. Everyday is a major fight for some aspect of the business (think whack-a-mole). Trading position has basically squared ... plan to play from short side. Loan business is long by nature and goal is to mitigate. Credit issues are worsening on deals and pain is broad (including investors in certain GS-issued deals). Distressed opportunities will be real, but we aren't close to that time yet."1667

¶In order to "play from the short side," the Mortgage Department continued building a net short position, employing aggressive strategies.1668 Mr. Birnbaum, Goldman's ABX trader, later wrote: "I concluded that we should not only get flat, but get VERY short."1669 He wrote that he then "socialized," or discussed, his proposal with others in the Mortgage Department, and "we all agreed the plan made sense."1670 The ABS Desk began implementing the plan by taking a very large short position in single name CDS contracts referencing RMBS and CDO securities to offset the Department's remaining ABX long position:

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"After socializing the plan with [Daniel] Sparks and ultimately [Richard] Ruzika, we implemented the plan by hitting on almost [every] single name CDO protection buying opportunity in a 2-month period. Much of the plan began working by February when the market dropped 25 points and our profitable year was underway."1671

¶By clearing the plan with Mr. Sparks and Mr. Ruzika first, SPG Trading Desk informed senior management of its intent to use the firm's capital to build the net short position. Mr. Birnbaum also wrote:

"When we were socializing our plan to get short in the beginning of the year, I put together a tool . . . quantifying our position risk and the p&l [profit and loss] under various market level scenarios. I believe this was key for senior management to gain confidence that we were taking controlled and quantifiable risk that was well understood."1672

¶The Mortgage Department's lead trader in single name CDS contracts referencing RMBS securities, Deeb Salem, also described the plan in his 2007 performance self-evaluation:

"Mike [Swenson], Josh [Birnbaum] and I were able to learn from our bad long position at the end of 2006 and layout the game plan to put on an enormous directional short. The results of that are obvious."1673

¶In an interview, Mr. Salem told the Subcommittee that the "obvious" results he was referring to were the desk's resulting profits.1674

¶The ABS Desk within the Structured Product Group (SPG) used CDS contracts to short RMBS and CDO securities as well as the ABX Index. The Correlation Desk within SPG used a different technique, obtaining approval to use a Goldman-designed CDO platform, Abacus, "to short structured product CDOs in bulk. The ABACUS transactions are currently one of the unique formats available to . . . [short] in large size on this type of structured product risk."1675

¶From January to late February, the Mortgage Department continued to pile on short positions in the subprime mortgage market.1676 By the end of the first quarter in 2007, it had built a

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¶$10 billion net short position. In a later performance self-evaluation, Mr. Salem described the aggregate $10 billion net short position as "HUGE" and "enormous."1677 A Goldman senior executive, Thomas Montag, later referred to a net short position of $3 billion in subprime mortgage backed securities as "huge and outsized."1678 Goldman's net short position in February 2007 was more than three times that size.

¶Profiting from the First Net Short. In February 2007, Goldman's senior management decided that the $10 billion net short position had become too risky, and ordered the Mortgage Department to cover a portion of the short. Covering some of the short not only reduced the risk, but also locked in some of the profit associated with the position.

¶In late February 2007, the Mortgage Department's net short position, coupled with added volatility in the subprime mortgage market, caused a sharp increase in the Department's risk profile, as measured by Value at Risk or "VAR." Goldman had assigned a VAR limit of $35 million to the Mortgage Department.1679 In November 2006, the Department's reported VAR was $13 million, well below its limit.1680 By late February 2007, however, its VAR had reached $85 million – an increase of over 550%.1681

¶Goldman senior management closely monitored the Department's increasing VAR. On February 23, 2007, Goldman risk controllers told senior executives that the Mortgage Department's increasing VAR was "primarily driven by a combination of increased volatility in ABX market and the [SPG] desk increasing their net short risk in RMBS subprime sector."1682 On February 14, 2007, Justin Gmelich, a managing director asked to help Mr. Sparks with the Mortgage Department on a short term basis, sent an email to Mr. Montag expressing unease with the Department's increasing risk profile:

"Abx risk should be working to get closer to home. My opinion, singles v. short index is too big (no news here). Abx correlation trade is good. I think we should be covering a bit of our short. There is a lot to do."1683

¶Business," at 8, GS M BS-E-005565527, Hearing Exhibit 4/27-22 [footnote omitted].

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¶Mr. Montag forwarded Mr. Gmelich's email to Goldman's Co-Presidents, Gary Cohn and Jon Winkelried, as well as to Mr. Ruzika, commenting: "clearly need to opportunistically take position down."1684

¶On February 21, 2007, senior management told Mr. Sparks to reduce the size of the Mortgage Department's $10 billion net short position by covering $3 billion.1685 Mr. Sparks communicated the decision to personnel on the SPG Desk:

"We need to buy back $1 billion single names and $2 billion of the stuff below [CDO securities] – today. I know that sounds huge, but you can do it – spend bid/offer, pay through the market, whatever to get it done.

It is a great time to do it – bad news on HPA [housing price appreciation], originators pulling out, recent upticks in unemployment, originator pain. . . .

This is a time to just do it, show respect for risk, and show the ability to listen and execute firm directives.

¶You called the trade right, now monetize a lot of it.

¶You guys are doing very well."1686

¶Although some SPG traders disagreed with the decision,1687 the Mortgage Department took immediate action in response to the order. By the end of the day, February 21, 2007, Mr. Sparks reported to senior management that the ABS Desk had covered $400 million in single name CDS contracts, but had not been able to reach the $3 billion goal:

"Market sold off significantly (BBB and BBB- indices over 100 bps wider) We covered over $400mm single names – still significant work to do. ...

"We are net short, but mostly in single name CDS and some tranched index vs the some [sic] index longs. We are working to cover more, but liquidity makes it tough. Volatility is causing our VAR numbers to grow dramatically."1688

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¶Mr. Ruzika sent an email to Mr. Montag and Mr. Sparks commenting on the covering efforts:

"I think Dan's guys are being practical. I know Bill [McMahon] was upset but covering the single name bbb and bbb- is prudent as it cuts vol and var the most. ... Guys didn't give up bid ask but they also didn't stand on the bid."1689

¶The Mortgage Department found that its single name CDS contracts were difficult to cover, in part because many of the referenced RMBS and CDO securities had already been acquired by securitizers for inclusion in CDOs and so were not for sale.1690 That meant the SPG Trading Desk could not cover its single name short positions simply by buying the offsetting long asset – the RMBS and CDO securities were no longer available for purchase.1691 Instead, the SPG Desk had to use offsetting CDS contracts, ones which referenced the same RMBS or CDO securities, but in which Goldman took the long side.1692 The problem with those contracts, however, was that many market participants had already acquired short positions on RMBS and CDO securities and weren't in the market to buy more. In addition, their purchases had driven up the price of short contracts. Between market saturation and high price levels, Goldman found few buyers when it wanted to cover its shorts.1693 The Mortgage Department's inability to cover its single name shorts concerned Messrs. Montag and Ruzika, who continued to press for quick progress.

¶On February 25, 2007, Mr. Sparks reported to Messrs. Montag and Ruzika on the Mortgage Department's progress after a week of effort:

"Cover[ed] around [$]1.55 billion single name subprime BBB- CDS and about $700mm single name subprime BBB CDS. The desk also net sold over $400mm BBB- ABX index. Desk is net short, but less than before. Shorts are in senior tranches of indexes sold and in single names. Plan is to continue to trade from short side, cover more single names and sell BBB- index outright."1694

¶On February 27, 2007, Mr. Ruzika sent an email to Messrs. Montag, Gmelich, and Sparks indicating that the Mortgage Department needed to reduce its net short position by covering even more than $3 billion in shorts: "There are two issues – first is the size of the short – I want to see we pushing covering some of singlename. Let's not be bidoffer foolish. The downside isn't worth the upside imo." 2/21/2007 email from Tom Montag to Daniel Sparks, GS MBS-E-017237596. Mr. Sparks replied: "Pushing hard, but need to be realistic with respect to expectation on liquidity. Very hard to force it. Trade has been right, and should continue to run (though there will be bumps). Entire team knows we have to reduce and is focused on it." Id. Mr. Montag responded: "If you sold it in a bad market u ough[t] to be able to buy it." Id.

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¶us getting the short down to 4.5 bil[lion] net. ... Second – the basis in the book needs to be reduced as well."1695 Less than an hour later, Mr. Ruzika sent Mr. Sparks another email at the conclusion of a meeting of Goldman's Operating Committee (OpCom), comprised of Goldman's senior executives. In an email entitled, "OpCom Directive," Mr. Ruzika wrote:

"Dan. Directly from the opcom we have to pick up the pace of buying back single names even if it costs us some money. I know your guys are trying but we can pay away some if it helps to get size done."1696

¶In response, Mr. Sparks immediately sent an email to Messrs. Swenson, Lehman, and Birnbaum regarding the "Opcom directive." He wrote: "Buyback single names in size today."1697 He also sent the SPG and CDO Desk managers a set of "Goals":

"Reduce risk. That means: (1) get m[o]re super-seniors done on CDOs or take other steps to reduce CDO pipeline risk; (2) cover more single name shorts BBB- and BBB (3) reduce the basis trade between BBB- index and BBB- single names (4) reduce the index/index trades in A and AAA."1698

¶Mr. Sparks' list of goals showed that he was closely tracking the SPG Desk's activities and directed them to reduce rather than eliminate its basis and index trades.

¶At the end of February, the Mortgage Department's efforts got a substantial boost when a new hedge fund client, Harbinger, purchased the short side of $4 billion in single name CDS contracts referencing RMBS securities.1699 By taking the long side in those contracts, the Mortgage Department was able to cover its shorts by the same amount.

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¶On February 28, 2007, Mr. Sparks reported at a Firmwide Risk Committee meeting on the Mortgage Department's progress in reducing its VAR.1700 The committee minutes reflect that Mr. Sparks' report stated the following:

"–VaR up due to vols. Business working to reduce exposures; a lot of shorts already covered. –ABX widened 500bp on the week. Business covered $4BN in single names. –Noted a lot of negative news in the subprime market with rumors on everyone. –CDS on CDOs started to widen significantly over the week. ... –Business continuing to clear out loans."1701

¶Five days later, on March 5, 2007, Mr. Montag requested another update: "Do we think the business is net short, long or flat right now?" Mr. Sparks responded: "We think the overall business is net short." Mr. Gmelich added: "I think we have a very modest short across all the businesses at current market levels. I concur with Dan."1702

¶The Mortgage Department's efforts to cover its $10 billion net short position reduced its VAR; it also allowed the Department to lock in and record large profits from its net shorts. In March 2007, in connection with Goldman's quarterly earnings call with analysts, "Mortgage Talking Points" prepared for Mr. Viniar stated that the Department's revenues were primarily the result of its short positions:

"The Mortgage business' revenues were primarily driven by synthetic short positions concentrated in BBB/BBB- sub prime exposure and single A CDO exposure which benefitted from spread widening."1703

¶At the end of the first quarter of 2007, the Mortgage Department reported total net revenues of $368 million.1704

¶The Mortgage Department continued its efforts to cover the rest of its short position. On March 14, 2007, Mr. Sparks reported to Messrs. Cohn and Montag that a Goldman salesperson

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¶"did a fantastic job for the desk by bringing in $1.2BB [billion] in A-rated single names today."1705 Mr. Montag in turn reported to Goldman CEO Lloyd Blankfein: "Covered another 1.2 billion in shorts in mortgages–almost flat–now need to reduce risk."1706

¶That same day, March 14, 2007, in response to his request, the Mortgage Department sent Mr. Ruzika a detailed breakdown of its subprime mortgage holdings.1707 It disclosed that, despite offsetting short and long positions in a number of areas, the SPG Desk still held three sizeable net short positions involving about $2.6 billion in ABX assets, $2.2 billion in single name CDS contracts, and $2 billion in mezzanine CDOs.1708

¶Goldman personnel prepared the following chart tracking the SPG Trading Desk's efforts to cover its BBB and BBB- net short position from February through mid-May 2007.1709

[SEE CHART NEXT PAGE: Notionals (ABX convention), prepared by Goldman Sachs, reformatted by the Permanent Subcommittee on Investigations to be readable in black and white print, GS MBS-E- 012890600.]

¶AAA Disaster Insurance. Despite all the attention paid to the Mortgage Department's subprime mortgage holdings beginning in December 2006, one large short position seemed to have escaped the directives of senior management in the first quarter of 2007 to cover the Department's shorts. It consisted of a massive $9 billion net short position made up of CDS contracts referencing an ABX index that tracked a basket of 20 AAA rated subprime RMBS securities.1710 Goldman representatives could not recall when that short position was acquired, who acquired it, or whether proprietary funds were used,1711 but the CDS contracts appear to have been held at a relatively constant level of $9 billion from some time in 2006 until July 2007.1712 Mr. Sparks told the Subcommittee that the net short position served as a form of low cost "disaster insurance" that would pay off only in a "worst case" scenario – when even the top tier AAA rated RMBS securities, among the safest of all subprime mortgage investments, lost value.1713

¶Notionals (ABX convention)

¶
• 10,000,000,000 — 105

¶Index Price

¶100 8,000,000,000

¶95 6,000,000,000

¶90 BBB Index Only

¶4,000,000,000 BBB Index + CDS

¶BBB- Index Only

¶BBB- Index + CDS 2,000,000,000

¶All BBBs Index Only

¶All BBBs Index + CDS

¶0 06-2 BBB- Index Equiv

19-Jan18-Feb20-Mar19-Apr19-May18-Jun18-Jul17-Aug16-Sep16-Oct15-Nov15-Dec14-Jan13-Feb15-Mar14-Apr14-May13-Jun 75 06-2 BBB- Idx Eq (MRMA)

¶06-2 BBB- Index Equiv -2,000,000,000 (w/Cash)

¶06-2 BBB- Index Price

¶-4,000,000,000

BBB bucket includes BBB+ CDS Notionals: refers to current notionals Positive notionals: long risk

¶-6,000,000,000 60 CDS:^20052005 Early Payment Defaults. Early in 2005, a number of Long Beach loans experienced "early payment defaults," meaning that the borrower failed to make a payment on the loan within three months of the loan being sold to investors. That a loan would default so soon after origination typically indicates that there was a problem in the underwriting process. Investors who bought EPD loans often demanded that Long Beach repurchase them, invoking the representations and warranties clause in the loan sales agreements. Washington Mutual Inc. 10-K filing with the SEC at 27. "President's Club 2005 - Maui, Awards Night Show Script," Washington Mutual Home Loans Group, Hearing Exhibit 4/13-63a. Id. at 98.Show full note / 2006 vintages only

¶Prepared by the U.S. Senate Permanent Subcommittee on Investigations, February 2011. Derived from Goldman Sachs document, GS MBS-E-012890600.

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¶The most comprehensive description of the AAA ABX short position located by the Subcommittee was a chart prepared by a Mortgage Department analyst in August 2007. The analyst sent the chart to Mr. Birnbaum at his request, to show the Mortgage Department's overall position in synthetic products, including CDS contracts referencing ABX, RMBS, and CDO assets.1714 The chart includes the AAA ABX short position as a long, nearly flat line showing an approximately $9 billion net short until early July 2007, when the value turned sharply upward.1715 The analyst wrote in an August email, after much of the AAA ABX net short position had been covered: "M[ortgage] department is short ABX AAA [$]8.7b[illion], splitting among ABS/Alt A/prime/conduit in the beginning of fiscal year 2007, and is now long [$]410m[illion]." While this chart and the covering email do not reveal the origin of the AAA short, they indicate that, by early 2007, it was split between the ABS Trading Desk in the Structured Product Group and three desks in Mr. Gasvoda's Residential Whole Loan Trading area – the Alt A Trading Desk under Genevieve Nestor, the Prime Trading Desk under Clay DeJacinto, and the Conduit for conducting subprime loan pool securitizations under Matt Nichols.

¶Goldman emails provide additional information about the AAA ABX short. One series of emails, from March 2007, indicates that about $8 billion of the $9 billion AAA short was then held by the three desks in Mr. Gasvoda's Residential Whole Loan Trading area, and that he favored maintaining the short, because it provided billions of dollars in coverage and cost only $5 million per quarter in premiums to maintain. On March 4, 2007, Mr. Gasvoda emailed Mr. Sparks with "Quick Thoughts on ABX AAA risk":

"I talked to [Matt] Nichols and Clay [DeJacinto] about the AAA ABX short. Think it offers a good amount downside protection w/ relatively light pain if we're wrong. Below is a $8B ABX AAA short #s. It costs us $5mm/quarter to carry. On the downside, if the market rallies to par ... we drop $50mm. Taking it to 0 spread we lose $80mm.

"On the upside front, we get good jump risk. If AAA's widen to current AA levels ... we gain $70mm and if spreads move up to super senior risk pricing in CDOs ... we're up $190mm.

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"Net, think this is a good position to have on given downside protection and relatively light upside pain. If we get an opportunity to buy some back next week, think we should but I'm thinking buy back $1-2B, not $8B."1716

¶Mr. Sparks replied to Mr. Gasvoda: "Good trading response and thought process. We need to consider daily."1717

¶The next day, March 5, 2007, the Residential Whole Loan Trading Desk under Mr. Gasvoda and the CDO Origination Desk under Peter Ostrem exchanged information about the "ABX hedges" that each business was carrying to reduce the risk associated with its respective long assets.1718 The Residential Whole Loan Trading Desk reported: "[b]elow are all our ABX hedges across our Resi Credit + Prime books," which included approximately $7 billion in AAA ABX holdings.1719 The CDO Origination Desk, in turn, reported holding another $2.25 billion in AAA ABX "hedges."1720 A few days earlier, with respect to the CDO Origination Desk's holdings, Mr. Egol had remarked: "Love that huge AAA abx short."1721

¶Although the $7 billion figure reported by Mr. Gasvoda's group on March 5 was $1 billion less than the $8 billion reported the day before,1722 and the $2.25 billion reported by the CDO Origination Desk was larger than the $1 billion that the August 2007 email later ascribed to the Structured Product Group, all of the evidence indicates that Goldman had a massive AAA ABX short position in 2007. A few days later, on March 8, 2007, in an email to senior management entitled, "Mortgage Risk," Mr. Sparks described the AAA ABX short as a hedge against long positions in the Department's loan books and CDO warehouse accounts:

"[O]verall the department has significant shorts against loan books and the CDO warehouse. The bulk of these shorts ($9BB) are on the AAA index, so the downside is limited as the index trades at 99."1723

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¶In this email to senior executives, Mr. Sparks put the size of the AAA ABX short at $9 billion, which seems to have been the amount most commonly cited for the short.1724

¶When asked about the Gasvoda email which described the AAA ABX short as an inexpensive "jump risk,"1725 Mr. Sparks told the Subcommittee that the email was referring to acquiring "jump insurance" against a sudden, huge loss arising from the total default of an asset.1726 In this context, the short was acquired as insurance against the unlikely event that a significant portion of the AAA rated RMBS securities identified in the ABX Index defaulted simultaneously.1727 Since AAA rated RMBS securities were typically the safest of the RMBS securities offered for sale, it was widely believed in 2006 and 2007, that they would remain untouched even if defaulting mortgages harmed riskier RMBS securities. By shorting AAA rated RMBS securities, Goldman was insuring against a "tail risk" – the risk of an event that appeared to have a very small probability of ever actually occurring, but which was likely to cause catastrophic losses if it did occur. Mr. Sparks also explained that, since the subprime mortgage industry considered losses in AAA rated RMBS securities to be exceedingly unlikely, the price of acquiring and holding such a short position was relatively inexpensive.1728

¶From the time the $9 billion AAA ABX short was acquired in 2006 until July 2007, it was not included in Goldman senior management's directives to cover shorts, and it does not appear to have been part of the Mortgage Department's efforts to get "closer to home," build a net short position in early 2007, or cover that net short in February and March.1729 The $9 billion AAA ABX short may have been left out of management's directives on the first net short, because it was serving as a hedge for long subprime mortgage assets held by several Mortgage Department desks.1730 As those long assets were sold or written down, however, no apparent steps were taken to unwind or remove the $9 billion AAA ABX hedge.1731 By June 2007, it remained almost entirely intact as a net short. The value, cost, and risk associated with the AAA ABX short had been monitored, but not acted upon, until the short suddenly began approaching profitability and began contributing to high VAR levels for the Mortgage Department. It then drew the attention of Goldman senior management which included the AAA ABX short in its directive to cover the firm's second big net short. Covering the AAA ABX net short contributed to the multi-billion- dollar profits realized by Goldman in the third and fourth quarters of 2007.

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¶Report To Board. On March 26, 2007, Mr. Sparks and Goldman senior executives gave a presentation to Goldman's Board of Directors regarding the firm's subprime mortgage business.1732 The presentation recapped for the Board the various steps the Mortgage Department had taken since December 2006, in response to the deterioration of the subprime mortgage market.1733 The presentation noted, among other measures, the following steps:

"– GS reduces CDO activity – Residual assets marked down to reflect market deterioration – GS reverses long market position through purchases of single name CDS and reductions of ABX – GS effectively halts new purchases of sub-prime loan pools through conservative bids – Warehouse lending business reduced – EPD [early payment default] claims continue to increase as market environment continues to soften."1734

¶By the time this presentation was given to the Board of Directors, Goldman's Mortgage Department had swung from a $6 billion net long position in December 2006, to a $10 billion net short position in February 2007, and then acted to cover much of that net short. Despite having to sell billions of dollars in RMBS and CDO securities and whole loans at low prices, and enter into billions of dollars of offsetting long CDS contracts, Goldman's mortgage business managed to book net revenues for the first quarter totaling $368 million.1735

¶In a section entitled, "Lessons Learned," the presentation stated: "Capital markets and financial innovation spread and increase risk,"1736 an acknowledgment by Goldman that "financial innovation," which in this context included ABX, CDO, and CDS instruments, had magnified the risk in the U.S. mortgage market.

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¶(c) Attempted Short Squeeze

¶In May 2007, Goldman's Structured Product Group (SPG) continued to work to cover the Mortgage Department's short position by offering to take the long side of CDS contracts referencing RMBS and CDO securities, but found few buyers. Many market participants had already shorted subprime mortgage assets, driving the price relatively high, and few wanted to buy additional short positions at the prevailing price. In order to turn the situation to its benefit, SPG's traders attempted to carry out a "short squeeze" of the subprime CDS market in May 2007.1737

¶The ABS Desk's traders were already offering single name CDS contracts in which Goldman would take the long position, in order to cover the Mortgage Department's short position.1738 To effectuate a short squeeze, they appear to have decided to offer the short positions on those contracts at lower and lower prices, in order to drive down the market price of subprime CDS shorts to artificially low levels. Once prices fell below what the existing CDS holders had paid for their short positions, the CDS holders would have to record a loss on their holdings and might have to post additional cash collateral with their opposing long parties. Goldman hoped the CDS holders would react by selling their short positions at the lower market price. When the sell off was large enough and the price low enough, Goldman planned to move in and buy more shorts for itself at the artificially low price.

¶This short-squeeze strategy was later laid out in a 2007 performance self-evaluation by one of the traders on Goldman's ABS Desk who participated in the activity, Deeb Salem. In the self- evaluation he provided to senior management, Mr. Salem wrote:

"In May, while we were remain[ing] as negative as ever on the fundamentals in sub-prime, the market was trading VERY SHORT, and susceptible to a squeeze. We began to encourage this squeeze, with plans of getting very short again, after the short squeezed [sic] cause[d] capitulation of these shorts. This strategy seemed do-able and brilliant, but once the negative fundamental news kept coming in at a tremendous rate, we stopped waiting for the shorts to capitulate, and instead just reinitiated shorts ourselves immediately."1739

¶When interviewed by the Subcommittee, Mr. Salem denied that the ABS Desk ever intended to squeeze the market, and claimed that he had wrongly worded his self-evaluation.1740 He said that reading his self-evaluation as a description of an intended short squeeze put too much emphasis on "words."1741

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¶Mr. Salem's description of an attempted short squeeze by Goldman's Structured Product Group is supported by other evidence. In May 2007, Michael Swenson, the head of both SPG and ABS Desks and Mr. Salem's supervisor, wrote emails that appear to confirm the attempted short squeeze. In the first email, dated May 25, 2007, Mr. Swenson wrote:

"We should be offering sn [single name] protection down on the offer side to the street on tier one stuff to cause maximum pain."1742

¶Four days later, on May 29, 2007, Mr. Swenson followed up with another email:

"We should start killing the sn [single name] shorts in the street – let's pick some high quality stuff that guys are hoping is wider today and offer protection tight – this will have people totally demoralized."1743

¶When asked about these emails, Mr. Swenson also denied that Goldman had attempted to squeeze the CDS short market. He claimed that the cost of single name CDS shorts had gone too high, and the purpose behind Goldman's actions was to restore balance to the market.1744 Mr. Swenson could not explain, however, why in an effort to restore balance to the market, he used the phrases "cause maximum pain," and "this will have people totally demoralized."

¶Goldman documents show there was a plan and an attempt to conduct a short squeeze, despite the harm that might be caused to Goldman's clients. Contemporaneous emails further show that clients were complaining about a sudden markdown by Goldman in the value of their short positions, especially compared to prevailing market prices and the worsening of the subprime market itself.1745

¶On May 18, 2007, a Friday, the ABS Desk marked down the value of many of its clients' CDS short positions. On Monday, May 21, Mr. Salem sent an email to Mr. Swenson and Edwin Chin entitled, "A few things . . . pain-related."1746

"Guys r gonna complain about their marks [hedge fund] already emailed me. I would talk about the recent flow of OWICS [offers] and the levels ... they have been trading as the

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reason we moved marks on Friday. ... [Another customer] lost 6 pct based on fridays moves."1747

¶That same day, a Goldman sales representative sent Mr. Chin a complaint from a hedge fund customer named Stanfield Capital regarding the lower values assigned to its CDS short positions. The sales representative wrote:

"Stanfield feels we are marking them tighter than other dealers with whom they have similar protection. ...

In addition,¹⁴¹⁴ The financial crisis has not reversed this trend; it has accelerated it. By the end of 2008, Bank of America had purchased Countrywide and Merrill Lynch; Wells Fargo had acquired Wachovia Bank; and JPMorgan Chase had purchased Washington Mutual and Bear Stearns, creating the largest banks in U.S. history. By early 2009, each controlled more than 10% of all U.S. deposits. See, e.g., "Banks 'Too Big To Fail' Have Grown Even Bigger: Behemoths Born of the Bailout Reduce Consumer Choice, Tempt Corporate Moral Hazard," Washington PostShow full note of the 25 names below were marked over 100 bps [basis points] tighter week-on-week. That is a massive move and is creating major stress at the clients, as we can't see a similar move in the broader market. ...

Finally, be aware that Stanfield may look for you to offer protection very close to your mark. ... I'm hoping your attention to the marks below will defuse a situation in which they think we're messing with them via our marks on their protection."1748

¶Mr. Chin forwarded the email to Mr. Swenson and Mr. Salem. Mr. Swenson replied: "We are ok with that they do not have much more gun powder."1749 Mr. Swenson's response suggested that Goldman did not have to be concerned about Stanfield's threat to buy CDS shorts at the same low price Goldman had applied to his CDS holdings, since Stanfield did not have the financial resources – the "gun powder" – to make a large purchase.

¶On May 24, 2007, the Stanfield trader wrote to Goldman that he had thought the purchase of the CDS contract signaled the beginning of a partnership between Stanfield and Goldman, but he had lost credibility with his company because of the CDS contracts and expressed concern that he may have been "naive to trust the pitch" from Goldman:

"When we put on the Single A protection trade the underlying names were suppose[d] to have a large similarity to the index. ... The indexes are up only a couple of points since we did the trade. Looking at the mid's on our Single A trades we have tightened roughly 33%. ... I'm just trying to figure out how we can reverse some of the losses we have incurred.

Also, from where our BBB trade was marked last Friday ... [t]his trade is tighter by 35% as well. ...

I had always thought that these trades were meant to be the start of a partnership building of future business between Stanfield and Goldman Sachs. I know we are big boys and we did the trade there is no doubt of that. What I am attempting to do is either cut our losses and

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get out or determine what I can say to keep this trade on .... I've lost a lot of credi[b]ility on the desk with this trade. Maybe I was naive to trust the pitch on the trade. It has cost me a lot."1750

¶A week later, on May 31, 2007, Stark Investments indicated interest in buying a short on certain RMBS securities backed by home equity loans. The Goldman sales representative trying to close the sale emailed SPG personnel that the client was hesitating due to Goldman's valuations which were "drastically different" from other dealers:

"Stark has an interest in looking at this trade; but there is an obstacle we need to address: They feel Goldman is very inconsistent in the single name HEL [Home Equity Loan] CDS marks that we provide them. We are drastically different in marking positions versus other dealers. It is an annoyance that would potentially limit their interest in putting on incremental CDS trades. I can name specific examples if you would like. Please advise."1751

¶Mr. Salem replied: "you couldn't be more wrong," while Mr. Swenson replied:

"Frankly, we believe we are best in class and have numerous data from controllers, collateral posting and markit (the company, not market) that reflect upon this. This process is thoroughly reviewed by all levels of senior management at GS. ...

"Unlike other dealers we stand by our marks and are willing to transact in the context of our marks. ...

We also don't mark our book wide if we are long protection and tight if we are short. [W]e mark to market."1752

¶When the salesman replied: "I am trying to work with you guys," Mr. Swenson chided him: "You need to manage their opinions on marks – that has been fully vetted over here."1753

¶On June 7, 2007, Mortgage Department personnel learned that two Bear Stearns hedge funds specializing in subprime mortgage assets were in financial distress.1754 In response, the ABS Desk immediately decided to buy more shorts at the prevailing market price to take advantage of the possible collapse of the Bear Stearns hedge funds, which would send subprime mortgage prices still lower. To do so meant the ABS Desk had to sacrifice its "short squeeze" play. On June 7, 2007, Mr. Salem emailed Messrs. Swenson and Chin:

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"We need to go to magnetar [a hedge fund] and see if we can buy a bunch of the cdo protection. ... Can tell them we have a protection buyer, who is looking to get into this trade now that spreads have tightened back in."1755

¶Raising no concerns about the proposed deception, Mr. Swenson replied "Great idea."1756 Mr. Salem continued:

"Should we also send an email to select sales people in the mtg [mortgage] sales force saying that we r looking to buy a block of single name protection vs a cdo OUT OF COMP [in a private, off-market transaction]? It's a no lose situation . . . either we get some sn [single name] protection that we want or we gave these guys a chance and nobody can say we aren't working with them."1757

¶Mr. Swenson responded: "We need to be careful." Mr. Chin wrote that he knew of another CDO collateral manager that might also be willing to sell some shorts: "I mentioned there was a hedge fund on the side and he was very axed to do something."1758

¶Having decided to start buying shorts outright, the ABS Desk also stopped offering to sell CDS short positions to Goldman customers, effectively abandoning the attempted short squeeze. On June 8, 2007, Mr. Swenson told his traders: "[w]ant to slow down on protection offers."1759 On June 10, 2007, in response to a customer inquiry about a CDS short, Mr. Salem wrote: "Not sure if we have any to offer any more."1760 Mr. Swenson was less equivocal: "Really don't want to offer any."1761 On June 13, 2007, a Goldman salesman emailed SPG personnel: "[Customer] is looking to buy protection on cdos."1762 Mr. Salem replied: "too late!"

¶Once it began buying CDS shorts, the SPG Desk immediately changed its CDS short valuations and began increasing their value. Clients with long positions began to complain that the marks were too high, and internal Goldman business units also raised questions. For example, on June 11, 2007, a Goldman valuation specialist sent an email to Mr. Swenson, with copies to Compliance and the Controller's Office noting that "Client challenging marks," followed by

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¶"Trading has agreed to change ... marks."1763 The next day, June 12, 2007, a Goldman representative from the Controller's Office sent an email to Mr. Salem, asking: "Given recent gyrations in the ABX and CDS markets, when can I come by to discuss how you are marking the book tonight?"1764 The following week, on June 19, 2007, the Controller's office sent an email to Mr. Swenson raising questions about values assigned to certain CDS contracts: "These levels look quite wide. Do you have any specific market color that points this direction?"1765

¶The May 2007 attempted short squeeze described in Mr. Salem's performance self- evaluation did not succeed in compelling existing CDS holders to sell their short positions. In Subcommittee interviews, Mr. Salem and Mr. Swenson denied that an attempted short squeeze even took place. Any attempt that did take place was apparently abandoned in June 2007, when Goldman stopped offering to sell CDS short positions. Trading with the intent to manipulate market prices, even if unsuccessful, is a violation of the federal securities laws.1766 Given the novelty of credit default swaps and their use in the mortgage field, however, the Subcommittee is unaware of any enforcement action or case applying an anti-manipulate prohibition to the CDS market. Because Goldman is a registered broker-dealer subject to the supervision of the Financial Industry Regulatory Authority (FINRA), the conduct of its ABS traders raises questions about their compliance with FINRA's Rule 2010, which provides: "A member, in the conduct of his or her business, must observe high standards of commercial honor and just and equitable principles of trade."

¶(d) Building the Big Short

¶In the months of June and July 2007, Goldman's Mortgage Department went short again. This time, it built an even larger net short position than earlier in the year, reaching a peak of $13.9 billion in late June,1767 which Mr. Viniar later referred to as "the big short."1768 This net short position included the $9 billion AAA ABX short which had suddenly begun gaining value as the subprime market worsened. In June, two Bear Stearns hedge funds specializing in subprime mortgage assets collapsed. In July 2007, the credit rating agencies began downgrading ratings for hundreds and then thousands of RMBS and CDO securities. Soon after, the subprime mortgage backed securities market froze and then collapsed. Each of these events increased the value of Goldman's net short position.

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¶Bear Stearns Hedge Fund Collapse. The collapse of the Bear Stearns hedge funds in mid-June triggered Goldman's effort to rebuild its net short position. On June 7, 2007, the Mortgage Department learned that the Bear Stearns hedge funds were seeking quietly to sell some of their subprime portfolio to meet client redemption requests, which Goldman interpreted as a signal of serious financial distress.1769 After reviewing the hedge funds' assets, one Goldman employee remarked:

"In total these two portfolios add up to roughly $17bil in total exposure after leverage. It goes without saying that if this portfolio were to be released into the market the implications would be pretty severe."1770

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¶On June 8, 2007, Mr. Sparks received an urgent early morning email from Goldman's Japan office regarding "unprecedented overnight [rates] market volatility," suggesting that he call in the ABX traders early.1771 "Given the recent correlation of risk assume this is not a good sign for RMBS/ABS spreads."1772 Later that day, when another trader complained about "getting crushed" in the ABX market, Mr. Birnbaum replied: "Patience, patience. The CDO unwind has only begun."1773

¶Around June 12, 2007, public news accounts indicated that the two Bear Stearns funds were unable to meet collateral calls on their subprime mortgage backed securities holdings.1774 The funds also devalued their Net Asset Valuations (NAVs) to significantly lower levels, which effectively triggered the funds' total collapse.1775

Mr. Lehman: Told Egol I'm comfortable w/ the prices, especially when u include the 5 pt [percent] HC [haircut.] Don't think mar[k]ing him down 1 or 2 pts makes sense or sends the right message .... I wud run it by Dan [Sparks] and get his take .... [M]y opinion is that the Firm is appropriately protected w/ current HC [haircut] and mark. Mr. Swenson: W e need to mark him he is the biggest elephant by far and it has an impact on the m$arket[.] Mr. Lehman: How much do u [sic] want to mark him by? Mr. Swenson: A lot[.] Mr. Lehman: I disagree on this one ... Let's talk tomorrow[.] Mr. Swenson: He is done[.]

¶6/7/2007 email exchange between Mr. Swenson and Mr. Lehman, "BSAM Post," GS MBS-E-011184213.

¶The next day, Friday, June 8, 2007, Mr. Egol reported he had marked down all four CDO positions by two points. 6/8/2007 email from Jon Egol to Daniel Sparks, "BSAM mark recap," GS MBS-E-001920339. Upon reviewing the marks the following Monday, Mr. Sparks wrote: "The marks look stale." 6/11/2007 email from Daniel Sparks, "BSAM Exposure Summary," GS MBS-E-010798675. A Mortgage Department employee replied: "Marks for everything but the correlation positions are taken from work egol did last thurs. Correlation marks are as of friday's cob [close of business]." Id.

¶On June 12, Bear Stearns announced that it would be changing the hedge funds' Net Asset Valuations (NAVs). 6/12/2007 email to Craig Broderick, "BSAM Bullet Points," GS MBS-E-009967117 ("BSAM is currently in the process of restating their performance figures for April, from down 5% to down 10%. This was due to many dealers changing the way they are marking their Repo positions"). The Mortgage Department later marked down two Timberwolf tranches owned by the Bear Stearns hedge funds by another 2 points and 5 points, respectively, to 95 and 89, before it bought them back from Bear Stearns at 96 and 90 on June 19, 2007, in a negotiated unwind of the Bear funds' positions with Goldman. See 6/22/2007 emails from Mr. Lehman, "BSAM Repo Summary," GS MBS-E-001916435. See also 6/18/2007 email from Mr. Lehman, "Today's Bear Stearns Prices," GS MBS-E- 001919600; 6/27/2007 email from Mr. Sparks to Mr. Viniar, "CDO^2s," GS MBS-E-009747489.

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¶The failure of the Bear Stearns hedge funds triggered another decline in the value of subprime mortgage related assets. The ABX Index, which was already falling, began a steep, sharp decline. The collapse had further negative effects when the hedge funds' massive subprime holdings were suddenly dumped on the market for sale, further depressing prices of subprime RMBS and CDO assets.

¶The creditors of the Bear Stearns hedge funds met with Bear Stearns management in an attempt to organize a "workout" solution to stabilize the funds.1776 While those efforts were underway, Goldman and Bear Stearns agreed to an unwind in which Goldman bought back $300 million of two AAA CDO tranches of Goldman's Timberwolf CDO, which the hedge funds had purchased two months earlier in April 2007. Goldman paid Bear Stearns 96 and 90 cents on the dollar, respectively, for the two Timberwolf tranches.1777 Goldman also bought a few other RMBS and CDO assets, which it immediately sold.1778 The attempt to organize a workout solution for the funds was ultimately unsuccessful. Large blocks of subprime assets from the Bear Stearns hedge funds' inventory began flooding the market, further depressing subprime asset values.1779

¶Goldman's Structured Product Group (SPG) took the collapse of the Bear Stearns hedge funds as the signal to begin rebuilding its net short position. As Joshua Birnbaum, the head ABX trader on the SPG Desk, later wrote:

"[T]he Bear Stearns Asset Management (BSAM) situation changed everything. I felt that this mark-to-market event for CDO risk would begin a further unraveling in mortgage

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credit. Again, when the prevailing opinion in the department was to remain close to home, I pushed everyone on the [SPG] desk to sell risk aggressively and quickly. We sold billions of index and single name risk."1780

¶In a later internal presentation for Goldman senior executives which Mr. Birnbaum drafted for another purpose,1781 Mr. Birnbaum wrote that, after the Bear Stearns funds collapsed, SPG's Trading Desks went net short outright and that the shorts were not a hedge for long positions:

"By June, all retained CDO and RMBS positions were identified already hedged. ... SPG trading reinitiated shorts post BSAM [Bear Stearns Asset Management] unwind on an outright basis with no accompanying CDO or RMBS retained position longs. In other words, the shorts were not a hedge."1782

¶On June 29, 2007, the ABX Index and the value of single name CDS contracts referencing RMBS and CDO securities plummeted in value and continued dropping until mid-July. Mr. Swenson, head of the SPG Trading Desk, exchanged emails with Mr. Lehman and other Goldman executives about that day's trading: "There is absolutely no support at the lower levels from the street. CDOs are wider by 50 bps or more." Mr. Lehman responded: "[W]e r in the middle of a mkt meltdown."1783

¶On July 10, 2007, the two primary ratings agencies, Standard & Poor's and Moody's, began the first of many mass ratings downgrades for subprime RMBS and CDO securities.1784 The downgrades sent another negative shockwave through the subprime mortgage market as investors scrambled to assess the impact of the downgrades on their RMBS and CDO holdings.1785 On July 12, 2007, when still more RMBS and CDO ratings downgrades were announced, Mr. Birnbaum wrote to his colleagues: "Seen massive flows recently. Many accounts 'throwing in the towel'. Anybody who tried to call the bottom left in bodybags."1786

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¶On July 27, 2007, a Goldman senior sales executive summarized the state of the market:

"Whether you remember '94, '98, or '03, the general themes/patterns are consistent. An initial dislocation to the market (in this instance a credit deterioration in sub prime mortgages) acts as a tipping point and leads to spread widening in other sectors. This in turn quickly becomes a liquidity crunch/crisis. It appears this is where the structured product market is now – searching for liquidity. This has produced numerous capitulation/liquidation situations and forced customers to trade. . . . The impact of this week leaves the account base in three camps: The Paralyzed . . . The Wounded (some fatally) . . . The Opportunistic."1787

¶Although the July subprime market meltdown was a disaster for many investors, the value of Goldman's net short positions climbed rapidly. Senior management at all levels were aware of the Mortgage Department's net short and the profits it was generating. On July 20, 2007, CEO Lloyd Blankfein and COO Gary Cohn received a profit and loss report showing that the Mortgage Department was up $72.7 million for the day, across almost every mortgage trading desk. Mr. Cohn wrote to Mr. Blankfein: "There is a net short."1788 On July 24, 2007, the Mortgage Department posted a profit of $83 million for the day, while the firm's overall net revenue for the day was only $74 million.1789 Mr. Viniar forwarded the report to Mr. Blankfein with a note saying: "Mergers, overnight asia and especially short mortgages saved the day." On July 29, 2007, Mr. Sparks reported to Messrs. Montag and Mullen:

"Department-wide P&L [Profit & Loss] for the week was $375mm (this is after adjusting for the $100mm [error] discussed today). Correlation P&L on the week was $234mm, with CMBS, CDOs, and RMBS/ABX shorts all contributing."1790

¶Mr. Birnbaum later recapped the SPG Trading Desk's profits during this period: "[W]hen the [ABX] index dropped 25 pts in July, we had a blow-out p&l month, making over $1Bln that month."1791

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¶Covering the Big Short to Lock in Profits. Starting in July and throughout August 2007, Goldman undertook an intensive effort to cover its $13.9 billion net short and lock in its profits. To do so, the Mortgage Department bought long assets, offered CDS contracts in which it took the long side, and even sold some short positions.

¶The Mortgage Department was particularly focused on purchasing long AAA assets to cover Goldman's $9 billion AAA ABX short, to lock in the unexpected profits on that position. In August 2007, Mr. Lehman, co-head of the SPG Desk, wrote: "[A]s swenny/deeb/josh have done an awesome job sourcing risk, the CDO transition book AAA ABX short decreased from 1.55bb to 250m over the past two weeks – we love covering that trade."1792 On August 23, 2007, Mr. Montag reported to Messrs. Cohn and Viniar: "We ... bought back almost 9 billion of aaa abx over last two weeks."1793

¶From mid-July through the end of August, the Mortgage Department also covered a range of other shorts.1794 On August 5, 2007, Mr. Swenson reported a "phenomenal week":

"In summary, a phenomenal week for covering our Index shorts on the week. The ABS Desk bought $3.3bb of ABX Index across various vintages and ratings over the past week. $1.5 billion was retained by the ABS desk to cover shorts in ABX ($900mm in ABX 06-1 As being the most significant) and $1.0 billion was sold to internal desks across the mortgage department ($925mm in triple-As)."1795

¶Mr. Swenson also reported that the Mortgage Department was still $8.3 billion net short across all subprime asset classes, including $4 billion of AAA ABX assets.1796

¶On August 8, the market rallied for a short period, and the Mortgage Department's net short position suffered a $100 million loss. Mr. Swenson explained: "Market rallied especially at the top end of the capital structure – AAA (up 2 pts), AA (up 3 pts), and A (up 2 pt.)." He reported that the Department still held a $3.1 billion net short in AAA rated subprime mortgage assets.1797 Mr. Montag replied: "now on to the 3 billion short."1798 The next day, August 9, 2007, Mr. Montag reported to his colleagues: "mortgages bought back 1 billion of 3 billion short in AAA indices at ½ to 1 point better than yesterday."1799

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¶On August 11, 2007, reports of firms having to sell CDO securities in Asia prompted Mr. Mullen to ask: "Did we cover to[o] soon? Looks like more selling at the higher end of cap stack"1800 Mr. Lehman replied: "Don't th[in]k so – we haven't covered any CDO risk (we have gone the other way by 1.44bb since June 1st ) and that is where the market still has bad longs – th[in]k AAA rmbs is a very different trade."1801

¶On August 20, 2007, Mr. Sparks reported on the Mortgage Department's progress in covering its net short, telling Mr. Montag: "[L]oan books had been heavily net short (still are some – especially ... in alt a) and I have been forcing them to cover over the past 2 weeks." Mr. Montag responded: "[H]eavily isn't the half of it – we have bought back 4 - 5 billion and still short."1802

¶Buying More AAA RMBS Securities. In August 2007, the Mortgage Department proposed buying $10 billion in AAA rated RMBS securities, but did not receive permission to initiate the investment.

¶By August 2007, AAA rated RMBS and CDO securities were available from many financial firms at a very low price. On August 14, 2007, in summarizing the prior week's trading Mr. Swenson wrote: "Top of the capital structure is where all the action is. AAAs are extremely cheap .... [W]ant to scale into a large long."1803 Mr. Sparks agreed: "[T]he AAA ABX index is a great opportunity and we continue to like it."1804 On August 19, 2007, Mr. Lehman reported that the Mortgage Department had purchased $1.6 billion of the long side of CDS contracts referencing the ABX Index for AAA RMBS securities, and that its value had increased 1.5 percent over the prior week. Given Goldman's dominant market share and recent large purchases, however, Mr. Montag was skeptical: "How much of the aaa outperforming was us buying?"1805 Mr. Birnbaum responded: "On the AAA outperformance question, I think AAAs would have performed similarly without our adding."1806 He also wrote that the "likelihood of loss on 'real' RMBS AAAs (i.e., not AAA CDOs)," was "remote."1807

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¶According to Mr. Birnbaum, a key reason for buying the AAA rated assets was that Mr. Birnbaum and others in the Mortgage Department wanted to maintain a large short position in ABX assets referencing BBB and BBB- rated RMBS securities, because they believed the ABX Index for those securities would fall even further.1808 Mr. Birnbaum told the Subcommittee that covering the BBB/BBB- net short position in August would have amounted to leaving money on the table.1809 He explained that the Mortgage Department thought that buying a proportionate amount of AAA ABX long positions could be used to offset the risks of continuing to hold the BBB/BBB- short until the ABX Index bottomed out.1810

¶On August 14, 2007, Mr. Sparks updated Goldman senior executives on the success of the Mortgage Department's efforts to cover its shorts and added that the Department was interested in increasing its purchase of AAA rated RMBS securities: "we will likely come to you soon and say we'd like to get long billions[.]"1811 Senior executives reacted with skepticism.1812 Mr. Sparks responded: "We're continuing to cover some shorts and we may cover some BBB with AAA, but I got the message clearly that we shouldn't get long without Gary [Cohn]/Tom [Montag]/Don [Mullen] all saying OK."1813

¶On August 20, 2007, Mr. Sparks pitched the idea again to Mr. Montag and other senior executives in an email entitled, "Big Opportunity":

"We are seeing large liquidations – we bought $350mm AAA subprime RMBS from ... SIV unwinds today. ... We think it is now time to start using balance sheet and it is a unique opportunity with real upside – specifically for AAA RMBS. We've sold over $100mm of what we bought today – most up 1-2 points.

That's a great trade – buy and flip up 1-2 points, however, we're not always going to be able to do that – and there's the opportunity for us to make 5-10 points if we have a longer term hold."1814

¶is a significant escalation of the subprime meltdown. ... At its heart, the main shoe to fall will be when the rating agencies downgrade to the aaa level. I don't see as they have much of a choice. Mez[zanine] aaa cdo trade in the 20 and 30s cannot be overlooked even by the agencies." Id.

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¶On August 21, 2007, Mr. Birnbaum presented the Mortgage Department's plan to buy up to $10 billion in AAA rated RMBS securities.1815 The plan had dual objectives, to profit from the intrinsic financial value of the proposed assets and to use those assets to preserve, rather than cover, the Department's existing $3.5 billion BBB/BBB- net short:

"– The mortgage department thinks there is currently an extraordinary opportunity for those with dry powder to add AAA subprime risk in either cash or synthetic form.

– We would like to be opportunistic buyers of up to $10Bln subprime AAAs in either cash or synthetic (ABX) form and run that long against our $3.5Bln in mezzanine subprime shorts.

– Mortgage dept VAR would be reduced by $75mm and Firmwide VAR would be reduced by $25mm.

– At current dollar prices, the implied losses at the AAA level are 2.5x higher than the implied losses at the BBB level where we have our shorts (the ratio is even cheaper for cash due to technicals). If AAAs were priced consistent with BBB implied loss levels, they would be trading 5-10pts higher in synthetics and 10-15 points higher in cash. ...

– On the demand side, we plan to share this trade quietly with selected risk partners. We began doing so yesterday when we sold 1/3 of the AAAs purchased off the [seller] list to [customer] and 100% of the AAAs from [seller] to [customer] and [customer]."1816

¶Mr. Montag responded that he wanted to discuss the concept further.1817 Mr. McMahon wrote: "What are we holding against the 3.5b mezz shorts right now? Why don't we just cover the shorts?"1818 Co-President Gary Cohn emailed Messrs. Mullen, Winkelried, and Montag: "I do like the idea but you[r] call."1819 Before any further discussion took place, however, events overtook the debate.

¶[M cMahon]. W e aren't going crazy with it, just being opportunistic. Before we get large, we are going to lay out a strategy for the four of you.").

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¶(e) "Get Down Now"

¶Despite direction from senior management to cover its $13.9 billion net short position, the Mortgage Department continued to maintain several large net shorts, including at least $3 billion in single name CDS contracts referencing BBB and BBB- rated RMBS securities that it expected to gain in profits. In August 2007, Co-President Gary Cohn finally issued an order to "get down now."1820

¶Excessive VAR. By late August, a combination of the large net short and volatility in the subprime mortgage market had driven the Mortgage Department's VAR to an all-time high. When the AAA ABX short position was far out-of-the-money, it entailed little market risk, as it was not actively traded and had little likelihood of ever paying off. Once the AAA ABX short became profitable, however, the $9 billion position was so large that it had a major impact on the firm's risk measurements. Even a small percentage change in $9 billion can cause substantial changes in a profit and loss statement. As Mr. Sparks explained: "The combination of our large AAA ABX index shorts and the relatively new volatility in the AAA part of the index will result in much larger daily swings in P&L [profit and loss] both ways."1821

¶As predicted, due to the $9 billion short, the Mortgage Department's daily profit and loss reports began to show much larger swings.1822 For example, while the Mortgage Department showed a profit of $71 million on July 21, 2007,1823 it showed a loss of $100 million on August 8.1824 Upon hearing of that loss, Mr. Montag asked "so who lost the hundy?"1825 Mr. Birnbaum wrote to a colleague: "I'm sure the AAA ABX is being blamed as the reason the dept was down 100 yest[erday]."1826 While some in the Mortgage Department disagreed with the use of VAR as a measure of risk,1827 the gyrations in daily profit and loss figures demonstrated that the $9 billion net short posed real risk to Goldman.

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¶VAR depends primarily on the aggregate size of net asset positions and the volatility of the relevant market. Goldman was holding several large net short positions, the subprime market had become extremely volatile, and the Department's efforts to cover its shorts further complicated matters. Although Goldman's covering of its $9 billion net short AAA position would ordinarily be expected to reduce risk, the massive size of the position, combined with unprecedented levels of volatility in the market, the speed of Goldman's covering, and the size of the trades involved, resulted in steep increases in the Department's VAR.

¶The Mortgage Department's VAR had increased from around $13 million in mid-2006, well under the Department's permanent limit of $35 million, to $85 million in February 2007, to a high of around $113 million in August 2007.1828 The $113 million figure exceeded the Department's $35 million permanent VAR limit by more than 350%. Moreover, the Mortgage Department, which had never contributed more than about 2% of firmwide net revenue prior to 2007, was generating some 54% of all the risk incurred by the firm in August 2007. The Mortgage Department's risk level, however profitable, was of increasing concern from a firmwide perspective.1829

¶In an effort to maximize the profit potential from its net short positions, SPG personnel in the Mortgage Department argued against indiscriminately covering all of the Department's shorts.1830 But the Mortgage Department's VAR level proved to be both intractable and highly unpredictable.1831 It also contributed to record high levels of firmwide VAR, a figure carefully monitored by the firm's most senior management. The Mortgage Department and its risk controllers tried unsuccessfully to reduce the Department's VAR, and were discussing new alternatives,1832 when Goldman's Co-President Gary Cohn intervened. On August 15, 2007, the same day that Goldman's firmwide VAR hit a then-record high of $165 million, Mr. Cohn emailed the Mortgage Department's senior managers, risk analysts and controllers: "There is no room for debate – we must get down now."1833

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¶The Mortgage Department took immediate action. To reduce its VAR, the Department had to sell at least some of its BBB/BBB- net short position.1834 On August 23, 2007, Mr. Swenson reported that Harbinger had bought a large block of single name CDS contracts shorting BBB/BBB- rated RMBS securities which allowed Goldman to take the long side: "We just printed $400mm of Singles with Harbinger. 130mm of BBB and 270mm BBB-." Mr. Montag passed the message on to Messrs. Cohn and Viniar: "Finally actuall[y] covering singles." Mr. Cohn responded: "Great."1835

¶But even after that $400 million sale, Mr. Sparks reported to Mr. Montag: "[W]e are short ... about $3BB single names."1836 Mr. Montag responded that the $3 billion net short position was "huge and outsized" and $800 million had to be sold: "[I]f I make you sell a whopping 800 [million] out of 3 billion which is less than 30% how can anyone complain–the position is huge cob 8/10/07," GS M BS-E-009779885. Mr. McM ahon responded: "var can swing between 140 and 160 without any changes in the complexion of our trading books – essentially it is just noise." 8/15/2007 email from Bill McMahon to Gary Cohn and David Viniar, "Trading VaR $165mm," GS MBS-E-009778573.

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¶and outsized."1837 At the end of the trading day on August 23, Mr. Montag asked Mr. Sparks: "How much did we cover–shooting for $1 billion." Mr. Sparks responded: "Not much more today – trying."1838

¶Although the Mortgage Department did not cover its shorts as quickly as Mr. Montag wanted, within days of Mr. Cohn's August 15 order to "get down," Goldman's firmwide trading VAR had dropped by $40 million and the Mortgage Department's VAR had dropped below $100 million.1839 On August 23, 2007, Mr. Cohn forwarded a VAR report to CEO Lloyd Blankfein: "The message got through." Mr. Blankfein responded: "Good job." Mr. Cohn wrote: "Down 40 in 2 days."1840

¶Although the Mortgage Department's VAR measure fell substantially, it remained well above its permanent risk limit of $35 million throughout the rest of 2007.1841 In addition, although Goldman senior executives rejected the Mortgage Department's plan to buy $10 billion in AAA rated RMBS securities,1842 the Department ultimately purchased over $2.2 billion in AAA rated RMBS securities1843 and continued to hold and strategically sell off its BBB and other short positions through the end of 2007.1844

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¶(f) Profiting from the Big Short: Making "Serious Money"

¶Goldman's short positions continued to produce profits for the firm, as mortgage related assets continued to lose value. In September 2007, one of the key traders in the Mortgage Department, Deeb Salem, summarized four key short-side trading strategies that enabled the Mortgage Department to profit from the collapse of the subprime mortgage market:1845

(a) a "dispersion trade," in which Goldman took advantage of "mispriced" single name CDS contracts that referenced very poorly performing RMBS securities, but were not priced much lower than better performing RMBS securities, resulting in profits of $750 million "so far";

(b) a massive purchase of single name CDS contracts referencing a variety of RMBS securities, taking advantage of Goldman's estimated 33% "dominant" market share in single name CDS to make a "HUGE directional bet" against the subprime mortgage market, resulting in profits of $1.7 billion;1846

(c) the purchase "at a discount" of single name CDS contracts referencing Alt A and A rated RMBS securities, which "others don't want/know where to price," resulting in profits of $400 million "so far"; and

(d) the purchase of single name CDS contracts on A, AA and AAA rated CDO securities "in size," amassing an "enormous" market share whose profits had "exceeded all of our high expectations" at $900 million "so far."1847

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¶In October 2007, after the credit rating agencies downgraded hundreds of CDO securities,1848 Mr. Swenson wrote to Mr. Mullen that the downgrades would eventually cause defaults in many CDO securities that Goldman had shorted, meaning that Goldman's "CDS protection premiums paid out will go to zero,"1849 and Goldman would receive substantial CDS payments on those CDOs from the long parties. Mr. Mullen responded: "Looks like we're going to make some serious money." Mr. Swenson replied: "Yes, we are well-positioned."1850

¶Indeed, the Mortgage Department made $110 million the very next day.1851 Mr. Swenson explained: "65mm was from yesterday's downgrades which lead to the selloff." Mr. Mullen replied: "Great day!"1852 By the end of 2007, the Mortgage Department had brought in approximately $3.7 billion in net revenues from its SPG Trading Desk.1853

¶(g) Goldman's Records Confirm Large Short Position

¶In addition to contemporaneous emails, presentations, and reports, Goldman's large net short position is reflected in its own financial records, including its Mortgage Department Top Sheets.1854 Goldman's Mortgage Department kept records of its overall net short positions across

¶"c. W illingness to put on trades that others don't want/know where to price The 2 most successful trades in this regard have been our $70mm long Alt-A protection and our $1-2bb long sub- prime Single-A protection [i.e., being "short risk" or taking short side in a CDS transaction]. W hen CDOs wanted to sell Alt-A and single-A protection ... the rest of the street was tentative. ... W e viewed this as a tremendous opportunity to buy cheap out-of-the-money options at a significant discount to fair-value. Our exit strategy was always that if sub-prime fundamentals got bad enough, and they did, that the contagion would have to spread up the capital structure because cum loss vol/uncertainty has to go up thus. . . .$400mm so far for the desk ....

¶"d. CDO CDS trade: This trade has made $900mm so far, which exceeded all of our high expectations for the trade. I had the confidence and desire for the desk to buy A, AA, and AAA CDO CDS protection in size during the fall of 2006 for several reasons: ... [T]he rating agencies' correlation assumptions were out of whack with the growing concern about the housing market and the remarkable similarity between the bonds in a CDO, the difficulty that GS was having in placing such mezzanine liabilities and the complexity of such securities scared hedge funds from buying the protection themselves. Edwin and I used the same aggressive strategies in purchasing protection that we used to dominate the SN CDS market. Our market share was enormous ... and we did every ... trade possible." Id.

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¶various subprime asset classes on a daily basis throughout most of 2007.1855 Those records indicate that the Mortgage Department had large net short positions in the subprime mortgage market throughout most of 2007. Goldman's documents reveal that it had a $10 billion net short position at the end of February 2007, and a $13.9 billion net short position in mid-June 2007.1856

¶(i) Top Sheets

¶Daniel Sparks told the Subcommittee that, in 2006 and earlier, he was frustrated because he felt Goldman had inadequate systems to track and aggregate the daily positions of the various desks in the Mortgage Department.1857 At the end of each trading day, he had to review up to a dozen separate reports from the desks to develop a composite mental picture of the Mortgage Department's overall positions. To remedy this shortcoming, in February 2007, Mr. Sparks and the Department's strategic analysts, sometimes called "strats," developed a single-page report called the Mortgage Department Top Sheet.1858

¶The Mortgage Department Top Sheet became the primary report through which the Mortgage Department tracked its daily positions in various classes of mortgage related assets. It provided a comprehensive listing of the Mortgage Department's long and short positions in different asset classes across all desks at the end of each trading day. The Top Sheet drew data from up to a dozen separate reports generated by Goldman's electronic systems. Mr. Sparks told the Subcommittee that the Top Sheet evolved over time to become a good tool that provided a comprehensive record of the Department's positions.1859 The Goldman Controller's office told the Subcommittee that Goldman did not maintain any other type of comprehensive daily report regarding the Mortgage Department's net positions in various asset classes.1860

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¶The Top Sheet was literally the top sheet, or cover page, to a comprehensive report distributed daily to Mr. Sparks and other Mortgage Department managers.1861 The top line of the Top Sheet listed the aggregate total amounts held by the Mortgage Department in various asset classes, including AAA, AA, BBB, and BBB- rated assets.1862 During most of 2007, the Top Sheet also provided an overall net short or long figure that summed across the top line totals for each of the respective asset classes, providing an overall figure by which the Mortgage Department was net long or net short across all asset classes each day. By plotting this overall net figure for each daily Top Sheet, the Subcommittee developed a graph of the Mortgage Department's net position during 2007, as indicated on the chart on the following page.1863

[SEE CHART NEXT PAGE: Goldman Sachs Mortgage Department Total Net Short Position, prepared by the Permanent Subcommittee on Investigations.]

¶Goldman Sachs Mo rtgage Department Tot al Net Short Position, February - December 2007 in S Billions

¶(Market Value, Including All Synt hetic and Cash Positions in Mortgage Related Products)

¶5.0

¶0.0

¶2/ /07 3/5/07 4/5/07 5/5/07 6/5/07 7/5/07 8/5/07 9/5/07 10/5/0 11/5/07 12/5/07

¶-5.0

¶-10.0

¶-15.0 Prepared by the U.S. Senate Permanent Subcommittee on Investigat ions, April 2010. Updated Ja nuary, 2011. Derived from Goldman Sachs Mortgage Strategies, Mortgage Dept Top Sheet s provided by Goldman Sachs.

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¶The Subcommittee's net short chart is generally consistent with a Goldman chart that Mr. Birnbaum asked one of the Mortgage Department's analysts to prepare for him in August 2007, which can be seen on the following page.

[SEE CHART NEXT PAGE: RMBS Subprime Notional History, prepared by Goldman Sachs.]1864

¶The "zero" line in the middle of the chart represents a neutral trading position that is neither net long nor net short. To use Mr. Viniar's description, the zero line represents "home." The area below the zero line represents net short positions; the area above the line represents net long positions. The chart shows that the Goldman Mortgage Department was net short throughout 2007, with a total net short position that reached $13.9 billion in July.

¶8/17/2007 Goldman internal chart, "RMBS Subprime Notional History (Mtg Dept - 'Mtg NYC SPG Portfolio')," GS MBS-E-012928391, Hearing Exhibit 4/27-56a. The title of the Goldman chart, "NYC SPG Trading" is confusing, as Mr. Birnbaum asked the analyst, Kevin Kao, for a chart of all synthetic positions across the entire Mortgage Department (including areas other than SPG Trading). In an email to M r. Birnbaum, Mr. Kao confirmed that despite the title, the chart actually included all synthetic positions across the entire Mortgage Department, and not just the SPG Trading Desk positions. 8/17/2007 email from Mr. Kao to Mr. Birnbaum, GS MBS-E-012929469. Mr. Kao explained that his chart did not include cash positions, meaning long positions in mortgage loans or RMBS from any remaining warehouse inventory. Id. That omission was not significant, however, since Goldman had rapidly sold off the vast bulk of its cash inventory starting in November 2006. 4/2010 "Goldman Sachs Long Cash Subprime Mortgage Exposure, Investments in Subprime Mortgage Loans, and Investments in Subprime Mortgage Backed Securities November 24,^20062006 and 2007, but has not issued any new indices since then. Fremont 10-K Statement with the SEC. vs. August 31,^20072007 "Home Loans Product Strategy," WaMu presentation at JPM_WM03097203, Hearing Exhibit 4/13-60a (only Countrywide ranked higher). WaMu Home Loans Product Strategy, "Strategy and Business Initiatives Update," JPM_WM03097217, Hearing Exhibit 4/13-60a [emphasis in original]. Performance Evaluation for Peter D'Erchia, S&P SEN-PSI 0007442; See also April 23, 2010 Subcommittee Hearing at 74-75. annual report filed with the SEC, in particular the Executive Summary of Deutsche Bank's Annual Report and the letter from the Chairman of the Board. See Goldman Sachs response to Subcommittee QFR at PSI_QFR_GS0252, at 0262.Show full note - in $ Billions," chart prepared by the Subcommittee, Hearing Exhibit 4/27-163. In any event, the Subcommittee's net short chart includes the Department's cash positions and demonstrates that any long cash positions were insufficient to offset the shorts, as the Mortgage Department was massively net short throughout most of 2007. See PSI Net Short Chart.

¶In his Supplemental Responses to Questions for the Record from the Subcommittee, Mr. Birnbaum conceded that the Subcommittee's net short chart includes cash positions and therefore fixed the problem of being limited to synthetics as was the case with Goldman's own net short chart. See 8/17/2007 Goldman internal chart, "RM BS Subprime Notional History (Mtg Dept - Mtg NYC SPG Portfolio)," GS M BS-E-012928391, Hearing Exhibit 4/27-56a; Birnbaum responses to Subcommittee QFRs at PSI_QFR_GS0509. Mr. Birnbaum maintained his objection that the Subcommittee's net short chart improperly summed the notional amounts of different asset classes. Id. However, as noted in the text, the Mortgage Department's Top Sheet actually converted the notional amounts of each asset class into their market values, making it fair to sum across all asset classes.

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¶Some Goldman representatives told the Subcommittee that they objected to both the Subcommittee's net short chart, and Goldman's own similar chart, on the grounds that the charts are too simplistic and fail to account for the relative "weight" or value of short positions in differing asset classes.1865 For example, in a 2010 interview with the Subcommittee, Mr. Birnbaum said that because of their differing "weights" or values relative to one another, the notional amounts in each asset class could not simply be summed up together. For example, he said the notional amount of AAA assets cannot be added to the notional amount of BBB assets, because the market assigns each of those positions different weights or values relative to each other.1866 He said that these relative weights or values are often expressed as specific "hedge ratios" which Goldman traders can call up on their computer screens in real time to tell them, for example, the amount of AAA assets they should buy long to hedge a given net short position in BBB assets.1867 Each class also poses a different level of risk than the others. For example, short positions in AAA assets were relatively inexpensive, as the risk of loss in that tier was considered relatively low, while short positions in BBB assets would have higher prices, because the risk of loss was considered high. Mr. Birnbaum said the only chart of Goldman's net short position that he would accept as fairly representative would be one that was "Beta-adjusted" to account for differences in the relative weights, but he admitted that he was unaware of any such charts or reports created by Goldman during 2007.1868 Without considering these relative weights (which continually change based on market price movements in various asset tiers), Mr. Birnbaum said it would be impossible to say that Goldman was ever "net short" at all or in what amount.1869

¶Goldman's own documents provide a different picture, however. The Top Sheet was the primary comprehensive record used by the Mortgage Department to track all net positions across the Mortgage Department. Goldman did not keep any other records that identified the Mortgage Department's net positions in various asset classes,1870 and did not keep any records that used the "Beta-adjustment" method advocated by Mr. Birnbaum. By early March 2007, the Top Sheet generally expressed the market values of positions in different asset classes, rather than the notional amount of the positions.1871 By using the market values of positions in each asset class on a given day, the Mortgage Department did, in fact, create a reasonable method for summing across all asset classes in a single common denominator – the amount of cash the assets would bring in the market that day. Since the Subcommittee's net short chart relies on the Department's daily Top Sheet figures as expressed in market values rather than notional amounts, it does not suffer from the incompatibility defect pointed out by Mr. Birnbaum.

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¶Mr. Birnbaum's position that the notional amounts of each asset class cannot be summed up together is also inconsistent with what Goldman's Mortgage Department did on a day-to-day basis in 2007. Mr. Sparks, the Mortgage Department head who helped design the Top Sheet, used it to measure the Department's daily position. Mortgage Department personnel and other Goldman executives also discussed the Department's being "net short"– either overall or in specific asset classes – on a daily basis.1872

¶Indeed, the phrase "net short" appears more than 3,400 times in the documents produced to the Subcommittee by Goldman.1873 Since Mr. Birnbaum claimed that one could never really say whether Goldman was truly "net short," the Subcommittee asked him why the phrase "net short" appeared so many times in Goldman's documents. Mr. Birnbaum said that the use of the phrase "net short" was a "shorthand" that was used internally in the Mortgage Department.1874 In fact, neither Mr. Birnbaum, Goldman, nor the Subcommittee could identify any specific document or instance from 2007 in which the weighting exercise advocated by Mr. Birnbaum in his September 2010 interview was ever used or suggested.

¶Aside from the Top Sheet that summed up totals across different asset classes to obtain an aggregate total, there are also many documents in which Goldman personnel described the total amounts by which Goldman was net short in respective asset classes. For example, Mr. Swenson, and later Mr. Lehman, compiled an email summary each week that described each Mortgage Department desk's net position in different asset classes. A typical format was as follows:

¶"Current [SPG Trading] Desk Position Summary:

¶
• RMBS Single-As - net short 900mm 100% in single-name CDS

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• RMBS BBB/BBB- - net short 3,000mm (80% in single-name CDS - 50% 2005 vintage
• Correlation Desk - net short $400mm of ABX 06-1 BBB and BBB-
• Mortgage Department short approx $4bb AAA ABX"1875

¶Mr. Swenson's email summaries were forwarded to Mr. Montag and other senior executives to keep them apprised of the Department's positions.1876 While these documents did not provide an aggregate overall net short position for the Mortgage Department, they did establish net short positions in each of the various specific asset classes described, and they were apparently acceptable to and relied upon by various Goldman executives. Throughout most of 2007, these weekly reports clearly show very large net short positions in mortgage related assets.1877

¶Email correspondence among Goldman's senior executives also routinely referred to the Mortgage Department's net short positions in "billions."1878 CFO David Viniar told the Subcommittee that a loss (or gain) in the amount of even $25 million was considered "large" and would immediately be brought to his attention.1879 By that standard, net revenues of $2 billion from the Mortgage Department's net short positions in the third quarter of 2007 would have been considered significant and monitored by senior management, as indeed they were.

¶In testimony before the Subcommittee and other public statements, Goldman attempted to minimize the size of its net short position by suggesting to the Subcommittee that the short positions held by the Mortgage Department were hedges for other, unidentified long assets.1880 Mr. Blankfein even made that argument to his colleagues in September 2007: "The short position wasn't a bet. It was a hedge."1881 But Mr. Birnbaum contradicted that position just a few days later. On October 4, 2007, Mr. Birnbaum prepared on behalf of the SPG Trading Desk a presentation entitled, "SPG Trading – 2007," in which he advocated that SPG Trading Desk personnel should be compensated like hedge fund managers and not as ordinary participants in Goldman's traditional bonus pool system.1882 The presentation, which Mr. Birnbaum prepared to anticipate and refute counter-arguments that might be made by Goldman senior executives, explicitly addressed and rejected the contention that the profitable net short positions managed by the SPG Trading Desk were hedges for long assets held by other desks. Mr. Birnbaum, one of the chief architects of Goldman's big short, stated:

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"By June [2007], all retained CDO and RMBS positions were identified as already hedged. ... SPG trading re-initiated shorts post BSAM [Bear Stearns Asset Management] unwind on an outright basis with no accompanying CDO or RMBS retained position longs. In other words, the shorts were not a hedge."1883 (Emphasis in original).

¶In response to Questions for the Record from the Subcommittee, Mr. Birnbaum once again stated that SPG Trading initiated the "shorts on an outright basis with no accompanying CDO or RMBS retained position longs following the Bear Stearns Asset Management unwind in 2007, and that these positions were not a hedge."1884

¶Mr. Birnbaum's statement that "all retained CDO and RMBS positions were identified as already hedged" by June 2007 is also supported by other documents provided by Goldman's Mortgage Department. On February 28, 2007, for example, David Rosenblum, Co-Head of the CDO/CLO Origination Desk, initiated a project to ensure that all of the CDO Origination Desk's warehouse accounts were "fully hedged."1885 As a result, the CDO Origination Desk initiated new hedges and specifically allocated others to cover all the desk's warehouse risk. Learning of these actions, Mr. Rosenblum responded: "Great. Getting pretty nailed down."1886 In addition, in a February 12,^20072007 "Home Loans Product Strategy," WaMu presentation at JPM_WM03097203, Hearing Exhibit 4/13-60a (only Countrywide ranked higher). WaMu Home Loans Product Strategy, "Strategy and Business Initiatives Update," JPM_WM03097217, Hearing Exhibit 4/13-60a [emphasis in original]. Performance Evaluation for Peter D'Erchia, S&P SEN-PSI 0007442; See also April 23, 2010 Subcommittee Hearing at 74-75. annual report filed with the SEC, in particular the Executive Summary of Deutsche Bank's Annual Report and the letter from the Chairman of the Board. See Goldman Sachs response to Subcommittee QFR at PSI_QFR_GS0252, at 0262.Show full note email, Mr. Sparks reported to senior management: "Loan and residual books flat," and indicated that the Department's long positions were fully hedged with the short ABX positions.1887 In a third example, after conclusion of the CDO valuation project, all of the remaining CDO assets were transferred from the CDO Origination Desk to the SPG Trading Desk in May 2007. Even after the transfer of those long assets, the SPG Trading Desk remained short, suggesting again that the CDO assets may have already been hedged.1888 These Goldman documents all support Mr. Birnbaum's statement that all retained CDO and RMBS positions were identified as already hedged when the SPG desk started rebuilding its net short position in June 2007.

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¶(ii) Risk Reports

¶The Mortgage Department's large net short positions were also demonstrated by the periodic risk reports that recorded Goldman's key risk measure, "Value at Risk" or "VAR," throughout 2007. At a 95% confidence level, VAR represents the dollar amount a business unit, here the Mortgage Department, could expect to make or lose once every 20 trading days – or about once a month.1889

¶The Mortgage Department's VAR skyrocketed during 2007, climbing far beyond the Mortgage Department's permanent VAR limit of $35 million and hitting a record high of $113 million in mid-August 2007.1890 In 2007, with notable exceptions discussed below, whenever the Mortgage Department's trading exceeded its risk limits, Goldman's risk managers simply assigned the department a new, higher "temporary" risk limit to accommodate the Department's trading.1891

¶At the same time, the higher VAR did signal the presence of a large net short position and functioned to limit the size of that position. Twice during 2007, in late February and again in late August, Goldman's senior executives ordered the Mortgage Department to reduce its large short positions in order to bring the firm's overall VAR measure down.1892 The senior executives were aware of the Mortgage Department's large net short positions, in part, because those positions had contributed to increases in Goldman's firmwide or trading VAR.

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¶The firm tolerated the exceptionally high levels of VAR generated by the Mortgage Department, despite the risks reflected in those high VAR levels.1893 On the few days when the market rallied, the Mortgage Department incurred huge losses from its net short position that were immediately reported up the chain to senior management. For example, upon hearing of a $100 million loss in a single day, Mr. Montag asked: "Okay, who lost the hundy?"1894 Mr. Viniar told the Subcommittee that he was notified of even a $25 million loss in a single day.1895 Allowing the Mortgage Department to maintain high VAR levels meant that Goldman's large net short positions left the firm exposed to large losses, which in some instances did occur, though not as often as its VAR predicted they might.1896

¶Risk Management at Goldman. Every business unit and trading desk at Goldman had a counterpart in the firm's risk management area.1897 Risk managers were assigned to "shadow" the relevant business unit and trading desk operations to ensure that their respective trading activities did not exceed pre-determined risk limits.1898 Separate VAR limits were set for the firm as a whole and for each division. The division then allocated its VAR limit among each department or business area within a division. Some trading desks within a department also had assigned risk limits.

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¶At the end of a typical trading day, Goldman's Risk Department prepared risk reports containing some or all of the risk measures used for the Mortgage Department. The Risk Department prepared daily, weekly, and quarterly risk reports, as well as reports for the Board of Directors and various management committees.1899 Goldman's Firmwide Risk Committee (FWRC) was co-chaired by David Viniar and its weekly meetings were often attended by Co- President Gary Cohn and CEO Lloyd Blankfein.1900 In preparation for a meeting with regulators, Goldman senior executives noted that the Mortgage Department was discussed at every meeting of the FWRC throughout 2007.1901 Goldman also noted that risk "[l]imits are set by the FWRC. Decisions regarding, e.g., short positions in mortgages taken by business units but with full knowledge of the 30th floor."1902

¶Goldman executives told the Subcommittee that, in general, risk limits were firm and compliance was mandatory.1903 At the end of each day, department and divisional personnel, their respective risk managers, and other executives were provided with risk reports from which they could readily see whether a trading desk had breached its limits. In the event of a violation, the desk would be directed to curtail its activities or to take whatever steps were necessary to bring its trading within the applicable limits. Once a desk was notified of its breach of a limit, it was generally required to act immediately to comply with the existing limits.1904

¶At times, the Mortgage Department proposed various modifications or alternatives to its existing risk measures. Some of these proposals were adopted and some were not.1905 But from the perspective of the firm's most senior executives, VAR appeared to have been the predominant risk measure by which the Department's activities were judged.1906

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¶VAR Levels Show Net Short. The primary factors that influence VAR are: (1) the relative size and correlation of positions, and (2) the volatility of trading.1907 While VAR is computed by applying a complex algorithm to trading data, the VAR measure directly reflects position size and correlation, and volatility – or a combination of both factors.1908 Changes in VAR levels over time can also provide information about the general magnitude and direction of trading positions.

¶In the fourth quarter of 2006, the Mortgage Department's permanent VAR limit was $20 million, of which it consumed only $13 million.1909 Early the next year, on February 5, 2007, the Mortgage Department exceeded its limit with a VAR of $20.5 million.1910 On February 8, 2007, a senior risk manager recommended that the Mortgage Department's permanent VAR limit be increased to $30 million to accommodate anticipated increased price volatility in the mortgage markets that year.1911 A senior manager concurred and increased the Mortgage Department's permanent VAR limit to $35 million, which remained the Mortgage Department's "permanent" limit throughout 2007.1912

¶Almost immediately, however, the Mortgage Department breached its new limit, and its VAR continued to climb. Over the course of a single quarter, the Mortgage Department's VAR jumped from $13 million at the end of 2006, to $85 million in the first quarter of 2007 – a 550%

¶VaR calculation); 4/23/2007 email from Robert Berry to Daniel Sparks and SPG Trading Desk, "Mortgage VaR," GS M BS-E-009708690 (adjustments to VAR calculations).

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¶increase. Goldman's Chief Risk Officer, Craig Broderick, told the Subcommittee that he would be concerned about any breach of a VAR limit, and would certainly investigate the doubling of a business unit's VAR, but he admittedly took no action when the Mortgage Department's VAR more than quintupled over the course of a single quarter. Mr. Broderick attributed the steep rise in VAR almost exclusively to unprecedented market volatility,1913 although other Goldman officials stated that the VAR levels were being driven by Goldman's large net short positions.1914

¶For the most part, Goldman's risk managers ignored the Mortgage Department's VAR violations and did not demand immediate compliance with the last applicable limit, as would ordinarily be the case.1915 With notable exceptions in late February and late August 2007, Goldman's risk managers continually assigned the Mortgage Department new "temporary" VAR limits large enough to accommodate whatever risk levels resulted from the Department's trading. Mr. Birnbaum later described this pattern as the risk area's "policy to just keep increasing ou[r] limit."1916

¶The first quarter of 2007 is illustrative of the pattern. During that quarter, the Mortgage Department's trading activities exceeded three new VAR limits in as many weeks. The Mortgage Department received its new permanent VAR limit of $35 million on February 8, 2007.1917 Four days later, on February 12, the Department's VAR hit $49 million.1918 On February 14, the

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¶Department was assigned a new "temporary" limit of $50 million that would expire on February 20.1919 By February 20, however, the Department's VAR was $63 million, well in excess of its temporary limit of $50 million.1920 So the Department was assigned a new temporary limit of $60 million – a level it was already exceeding – until February 27.1921 Instead of dropping below the new temporary limit of $60 million, the Mortgage Department's VAR continued to rise until it hit a quarter-high level of $85 million on February 23 and February 26.1922 In response, on February 27, the Department was given yet another temporary limit of $90 million through the end of the month.1923 But the precipitous rise in VAR apparently alarmed Goldman's Operating Committee, which ordered the Department to reduce the size of its net short position to $4.5 billion.1924 The Department responded immediately and, by February 28, had reduced its VAR to $81 million.1925

¶The pattern created by the Mortgage Department's increasing VAR levels, and the lagged reaction of Goldman's risk managers in setting new "temporary" limits over the course of 2007 is shown in the chart on the next page.

[SEE CHART NEXT PAGE: Goldman Sachs Mortgage Department Value at Risk (VaR), prepared by Permanent Subcommittee on Investigations.]

¶The continual increases in the Mortgage Department's VAR also had an impact on VAR for all of Goldman's trading activities, called "Trading VAR" or "Firmwide VAR." Goldman carefully tracked the amount of its trading VAR that was attributable to the activities of each of its trading desks or units. During the first quarter of 2007, its records show that the firm's Trading VAR rose from $119 million in the prior quarter to $154 million.1926 Goldman has stated that its Mortgage Department's activities have historically resulted in only about 2% of the firm's net revenues.1927 At the end of 2006, the Mortgage Department's VAR of $14 million contributed only about 3% of the Firmwide Trading VAR of $119 million, which is roughly consistent with or proportionate to the 2% contribution to firmwide net revenues that Goldman has reported.1928

Goldman Sachs Mortgage Department Value at Risk (VaR) December 2006 - December 2007 (in $ Millions)

¶Mortgage Department VaR

¶20 Mortgage Department Permanent VaR Limit

¶Mortgage Department Temporary VaR Limit

¶Derived from Goldman Sachs Firmwide Risk Committee Appendices and Market Risk End of Day Summaries provided by Goldman Sachs. Prepared by the U.S. Senate Permanent Subcommittee on Investigations, April 2010.

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¶At the end of the first quarter in 2007, however, the Mortgage Department's VAR of $85 million was contributing a total of 23% to the Firmwide VAR.1929 During the rest of 2007, the Mortgage Department's percentage contribution to Firmwide VAR continued to rise until it hit an all-time high of 54% on August 14, 2007, when the Mortgage Department's VAR reached $110 million on a Firmwide VAR of $165 million.1930

¶The 54% contribution rate to Firmwide VAR means that the Mortgage Department's trading alone accounted for a 54% of total firmwide risk, while all of Goldman's other trading activities combined – including all equities, commodities, foreign exchange, and interest rate instruments – accounted for the rest. Given the serious financial ramifications of such a large and highly concentrated position, the decision to allow the Mortgage Department to incur such a high level of firmwide risk would have required approval at the highest levels of firm management. Indeed, it was Goldman's Operating Committee and its Co-President, Mr. Cohn, who decided in February and August 2007, respectively, that the Mortgage Department's VAR had risen too high and had to be brought down.1931

¶Because of the net short's impact on the Mortgage Department and Firmwide VAR levels, Goldman's senior executives not only knew about the "big short," but made frequent inquiries and exercised frequent control over the Mortgage Department's activities.1932 On August 16, 2007, for example, Jon Winkelried, who served as Co-President with Mr. Cohn, asked Mr. Sparks: "Do you still feel we are being conservative with our marks .... Good time to make sure we're conservative." Mr. Sparks replied:

"I try, but it is much harder than you think with all the things we are dealing with – completely dislocated markets with little price transparency, systems/tools that are not where they should be, focused controllers (who I think are doing a very good job in a tough market) and many cooks in the kitchen who like to micro-manage. ... But I hear your message."

¶Mr. Winkelried replied: "I think you should drop the micro manage theme in this environment."1933

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¶Mr. Mullen also expressed concern that the Mortgage Department's practice of skirting the normal decisionmaking channels and communicating directly with the Co-Presidents Gary Cohn and Jon Winkelried, among other very senior officers, could create problems. When Mr. Birnbaum drafted the Mortgage Department's proposal to buy $10 billion in AAA RMBS securities, he sent it directly to Mr. Cohn and Mr. Winkelried, as well as to his more immediate superiors, Messrs. Mullen, Montag, and Sparks, among others. Mr. Mullen wrote to Messrs. Cohn and Winkelried, the Co-Presidents of Goldman: "It would help to manage these guys if u would not answer these guys and keep bouncing them back to Tom and I." Mr. Cohn replied: "Got that and am not answering," but then added: "I do like the idea but you[r] call."1934

¶For his part, Mr. Montag was also aware that he and Mr. Mullen were taking a more active role in the management of the Mortgage Department than they normally would. Mr. Montag, for example, was Global Co-Head of Securities for the Americas, which encompassed both the FICC Division and the Equities Division, and was responsible for numerous departments. Nonetheless, he was involved in management decisions regarding the Mortgage Department on a near-daily basis in 2007. In August of that year, Mr. Lehman reported to Mr. Sparks that Mr. Montag had asked:

"how the desk thought about him and mullen being very involved. I told him we understood the scrutiny on the business given the overall pressure on our market, large P+L [profit and loss] and risk swings, etc."1935

¶Given the scrutiny by senior executives, the fact that the Mortgage Department's VAR was permitted to reach over $113 million in mid-August 2007 – more than three times its permanent limit – suggests that senior management knew and approved of the magnitude of the risk the Department incurred. It also suggests that the net short positions the Mortgage Department took were proprietary.1936 Goldman's senior executives would have no reason to take such large risks if they were seeking only the small spread arbitrage available from market-making activities for customers.

¶On February 26, 2007, the Mortgage Department's VAR reached a quarterly high of $85.4 million.1937 On February 22, Mr. Sparks had told Messrs. Swenson, Lehman, and Birnbaum that they would have to cover $2 billion in subprime mortgage related net short positions that same day.1938 On February 27, 2007, Mr. Ruzika wrote Mr. Sparks and others: "I want to see us getting the short down to 4.5 bil[lion] net."1939 Later that day, Mr. Ruzika forwarded the "OpCom Directive" to Mr. Sparks: "Dan. Directly from the opcom we need to step up the pace of buying back single names even if it costs us some money."1940 Mr. Birnbaum told the Subcommittee that the SPG Trading Desk's actions in February were taken to reduce the level of VAR.1941

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¶On August 9, 2007, Mr. Birnbaum received a note from the Department's risk managers indicating that the Department's temporary VAR limit might not be extended, which would reverse the prior policy of continually extending temporary limits:

"–Temporary MTG [Mortgage Department] SPG VaR limit of $110mm expired on 8/7/2007[.] –MTG SPG is over its permanent VaR limit of $35mm."1942

¶Mr. Birnbaum told the Subcommittee that he read the note as an indication that the temporary trading limit would not be renewed, and he was being directed to reduce his net short positions to bring VAR under the permanent limit of $35 million.1943 On the same day, August 9, Mr. Birnbaum sent an email to the ABS Desk trader, Mr. Salem:

"Are you getting any more heat to cut/cover risk? These VAR numbers are ludicrous, btw. Completely overestimated for SPG trading, underestimated for other mortgage desks."1944

¶Mr. Salem replied that he had "waved in ~120mm in bbb and bbb- protection in the last 2 days," which covered shorts, so he felt no heat about covering.1945 Mr. Birnbaum said:

"I just asked b/c I saw the note about mortgages dropping back down to a permanent limit of 35mm (which we are way over). This would mark a change of their recent policy to just keep increasing ou[r] limit. Makes me a little nervous that we may be told to do something stupid."1946

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¶Mr. Birnbaum continued: "I do think it is a real concern. How quickly can you work with strats to get them to revise our VAR to a more realistic number?"1947

¶Mr. Birnbaum explained to the Subcommittee that by the phrase, "be told to do something stupid," he meant being ordered by senior Goldman leadership to cover all of the desk's lucrative BBB and BBB- short positions immediately.1948 Mr. Birnbaum and others were reluctant to cover all of SPG Trading's BBB/BBB- shorts, because they believed the ABX Index for BBB and BBB- rated RMBS securities would fall further in coming months, so covering the entire short immediately would amount to leaving significant money on the table.1949 The Department's traders, analysts, and risk managers designed and executed specific transactions over the month of August to lower VAR, but they were unsuccessful.1950

¶For a week between August 14 and August 21, 2007, the Mortgage Department's VAR hovered around $100 million.1951 The Department's record-high VAR contributed to a record Firmwide VAR of $167 million on August 17, 20, and 21, all of which exceeded the Firmwide VAR limit of $150 million.1952 On August 15, 2007, Goldman's Co-President Gary Cohn issued his order: "[G]et down now."1953 In response, the Mortgage Department began selling and covering a portion of its BBB/BBB- net short position, and its VAR quickly dropped to $68 million by August 31. The Mortgage Department was allowed to keep a substantial net short in certain assets, and was granted renewed "temporary" VAR limits at levels between $80 and $110 million through the end of Goldman's fiscal year 2007.1954 The Risk Reports recording these VAR levels throughout 2007 further demonstrate Goldman's net short position. By 2010, the Mortgage Department's permanent VAR limit had increased from $35 million to only $40 million.1955

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¶The dates on which Goldman senior executives ordered the Mortgage Department to reduce its VAR – on February 21 and August 21 – were within two weeks before the end of Goldman's fiscal quarters. In each case, the result was an immediate drop in VAR through the end of the quarter. In February 2007, the Department's VAR dropped from $92 million to $81 million by the end of the quarter. In August 2007, the Department's VAR dropped even more sharply, from a record high of over $110 million to $79.7 million by the end of the quarter.1956 The lower Firmwide VAR figures that resulted from the Mortgage Department's VAR reductions were publicly reported in Goldman's quarterly financial reports.1957

¶(h) Profiting From the Big Short

¶In the third quarter of 2007, Goldman posted financial results showing that it had shorted the subprime mortgage market and profited from its net short position. After posting those third quarter financial results, Goldman continued to trumpet its success, both inside and outside the firm.

¶Third Quarter Financials. On September 20, 2007, Goldman announced record net revenues of $12.3 billion for its third quarter.1958 On September 19, 2007, in a conference call with financial analysts on Goldman's third quarter results, Goldman's CFO, David Viniar, highlighted the performance of the Mortgage Department:

"Let me also address Mortgages specifically. The mortgage sector continues to be challenged and there was a broad decline in the value of mortgage inventory during the third quarter. As a result, we took significant markdowns on our long inventory positions during the quarter, as we had in the previous two quarters. However, our risk bias in that market was to be short and that net short position was profitable."1959

¶Goldman also issued a press release about its third quarter earnings that mentioned mortgages:

"Net revenues in mortgages were also significantly higher, despite continued deterioration in the market environment. Significant losses on non-prime loans and securities were more than offset by gains on short mortgage positions."1960

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¶Internal Statements. In September 2007, Goldman summarized its third quarter results for its Board of Directors, highlighting the Mortgage Department's record profits: "[W]e were overall net short the mortgage market and thus had very strong results."1961

¶In early October, the Mortgage Department held an internal Global Townhall to discuss its third quarter profits in detail. In a draft of the presentation he prepared for the Townhall, Mortgage Department head Daniel Sparks reported that global mortgages generated aggregate net revenues of $741 million, a 152% increase over the same quarter in the prior year, while benefitting from a "proprietary short."1962 Under the heading of "Performance Drivers (Net Revenues)," Mr. Sparks wrote:

"SPG Trading: +2.04bn [up] $1.92bn vs. Q3 2006 – The desk benefited from a proprietary short in CDO and RMBS single names – Additionally, we captured P&L [profit & loss] on spread widening [price declines] in various indices"1963

¶To put the SPG Trading Desk's performance in perspective, it had generated $80 million in the third quarter of 2006, a big year for mortgage related products, but in the third quarter of 2007, an exceptionally poor year for mortgage related products, Goldman's SPG Trading Desk generated $2.04 billion in net revenues – nearly 25 times more. SPG Trading's $2.04 billion in net revenues was offset by other mortgage related losses, including losses from the CDO Origination, Residential Credit, and Residential Prime Desks, but left an aggregate net profit of $741 million for the Mortgage Department as a whole – more than twice the comparable quarter net profit of $294 million in the prior year.1964 The $2.04 billion in net revenues from the SPG Desk accounted for over 16% of Goldman's overall net revenues of $12.3 billion in the third quarter of 2007. The $741 million in net revenues for the Mortgage Department as a whole contributed about 6% of the firm's total net revenues of $12.3 billion for the third quarter, which was three times the department's historical average contribution of about 2% to net revenue.1965

¶In his draft presentation, Mr. Sparks wrote that the "desk benefited from a proprietary short in CDO and RMBS single names."1966 In industry parlance, a "proprietary" position is one acquired with the firm's own capital, solely for the benefit of the firm and not related to customer orders or the firm's role as a market maker. In a later version of the presentation, Mr. Sparks revised the line to read that the desk benefitted from "strong results from trading long correlation and net short bias."1967 When asked why he had originally written that "the desk benefitted from a proprietary short," Mr. Sparks told the Subcommittee that the language was inaccurate.1968

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¶Later in October 2007, Goldman's Chief Risk Officer, Craig Broderick, discussed the Mortgage Department's performance before an internal Goldman audience:

"So what happened to us? A quick word on our own market and credit risk performance in this regard. In market risk – you saw in our 2nd and 3rd qtr results that we made money despite our inherently long positions. – because starting early in '07 our mortgage trading desk started putting on big short positions, mostly using the ABX index, which is a family of indices designed to replicate cash bonds. And did so in enough quantity that we were net short, and made money (substantial money in the 3rd quarter) as the subprime market weakened. (This remains our position today)."1969

¶Goldman's net short positions were also featured in the internal self-evaluations that Mortgage Department personnel were required to prepare and which they expected to be read by their supervisors. In these self-evaluations, which were completed in September 2007, two months before Goldman's fiscal year end on November 30, 2007, several Mortgage Department traders who were active in its shorting activities described the profits produced by the Department's net shorts. Mr. Birnbaum, the senior ABX trader, wrote:

"As a co-head of ABS and SPG trading, my performance in 2007 has been my best ever by any objective measure: 1. P&L. YTD: ABS synthetics: $2.5Bln, ABS: $2.0Bln, SPG Trading: $3.0Bln, all #1 on the street by a wide margin, #2 in the world trading subprime risk (behind Paulson Partners)."1970

¶His self-evaluation showed that the SPG Trading Desk alone generated profits of $3 billion.1971

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¶Mr. Swenson, the head of the SPG and ABS trading desks, wrote:

"It should not be a surprise to anyone that the 2007 year is the one that I am most proud of to date. ... I ... [built] a number one franchise that was able to achieve extraordinary profits (nearly $3bb to date). ... The contributions to the $3bb of SPG Trading profits and $2bb of ABS trading p & l are spread out across various trades and strategies."1972

¶Mr. Salem, one of the ABS traders, wrote:

"Obviously the most important aspect of my 2007 and my contribution to the firm has been the desk's P&L. Mike, Josh, and I were able to learn from our bad long position at the end of 2006 and layout the game plan to put on an enormous directional short. The results of that are obvious."1973

¶Mr. Salem went on to outline estimated profits from four specific trading strategies pursued by the ABS Desk that generated profits totaling $3.75 billion.1974

¶In these three internal documents, key Mortgage Department personnel involved in constructing the Department's net short positions describe the profits generated by those net shorts as "#1 on the street by a wide margin," "extraordinary," and "an enormous directional short" that produced $3.7 billion in profits for the firm.

¶Statements to Regulators. Goldman also described its short positions and the profits they produced to its regulators. In October 2007, Goldman sent a letter to the Securities and Exchange Commission answering questions about its trading activities and reporting that it had been "net short" during "most of 2007":

"[W]e are active traders of mortgage securities and loans and . . . we may choose to take a directional view of the market .... For example, during most of 2007, we maintained a net short sub-prime position and therefore stood to benefit from declining prices in the mortgage market."1975

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¶In November 2007, in another letter to the SEC, Goldman explained further:

"During most of 2007, we maintained a net short subprime position with the use of derivatives, including ABX index contracts and single name CDS which hedged [our] long cash exposure."1976

¶Also in November 2007, in talking points prepared for a meeting with the Tri-Lateral Review Group, which included the Federal Reserve Bank, the SEC, and the United Kingdom's Financial Services Authority, Goldman wrote: "[W]e were able to maintain a short throughout the year."1977 Goldman also wrote:

"The press and others have discussed an anticipated Q4 [2007 fourth quarter] write-down for GS. Our remaining long subprime exposure totals $695 million, inclusive of whole loans and CDO positions. However, we're net short – as we have been throughout 2007. Accordingly, we have nothing to write down."1978

¶Public Statements. Goldman also discussed its net short and related profits in public settings. In November 2007, the Bloomberg news service reported that Goldman's CEO, Lloyd Blankfein, told a public audience at a securities industry conference that Goldman was, and would continue to be, net short the subprime markets:

"[Mr. Blankfein] said the firm is still betting that mortgage-backed assets and collateralized debt obligations will drop. ... 'Given that point of view, we continue to be net short in these markets.'"1979

¶In reaction to another November 2007 news report on how Goldman "dodged the mortgage mess,"1980 Mr. Blankfein sent an email to his colleagues stating: "Of course we didn't dodge the mortgage mess. We lost money, then made more than we lost because of shorts."1981

¶Goldman also prepared for public use a corporate statement entitled, "How Did GS Avoid the Mortgage Crisis? Our Response."1982 The statement was prepared for Mr. Viniar's use in responding to questions about the Mortgage Department's performance in a fourth quarter conference call with analysts. Goldman's public statement outlined the steps it took to reduce its subprime mortgage inventory and related subprime risks in late 2006 and early 2007, characterizing these "proactive" steps as part of its ordinary risk management efforts. Goldman went on to state: "[O]ne should not be led to believe that we went through this period unscathed and somehow significantly profited from a 'bet' on the downturn in mortgage markets."1983 After noting that significant writedowns in the value of its long mortgage inventory had resulted in a "weak" second quarter for mortgages, Goldman wrote:

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"[D]uring the third quarter we were able to make money on mortgages as a result of our net short position. As a consequence, we believe that we are well-positioned to opportunistically participate in the inevitable restructuring of the mortgage market."1984

¶Despite denying earlier in its statement that it significantly profited from a "bet" against a downturn in mortgage markets, Goldman wrote that, in the third quarter of 2007, it had profited from a "net short position" on mortgages. A "net short position" is, in essence, a bet on a downturn in the relevant market, and Goldman's bet was "able to make money."^20072007 "Home Loans Product Strategy," WaMu presentation at JPM_WM03097203, Hearing Exhibit 4/13-60a (only Countrywide ranked higher). WaMu Home Loans Product Strategy, "Strategy and Business Initiatives Update," JPM_WM03097217, Hearing Exhibit 4/13-60a [emphasis in original]. Performance Evaluation for Peter D'Erchia, S&P SEN-PSI 0007442; See also April 23, 2010 Subcommittee Hearing at 74-75. annual report filed with the SEC, in particular the Executive Summary of Deutsche Bank's Annual Report and the letter from the Chairman of the Board. See Goldman Sachs response to Subcommittee QFR at PSI_QFR_GS0252, at 0262.Show full note Year-End Results. The SPG Trading Desk's net revenues for the full fiscal year 2007 were approximately $3.7 billion.1985 In fiscal year 2007, Goldman's total net revenues were approximately $46 billion, and its net earnings (after tax) were approximately $11.6 billion.1986

¶At the Subcommittee hearing, Goldman's Chief Financial Officer, David Viniar, stated that the Mortgage Department's net revenue for 2007 was "less than $500 million, approximately 1 percent of Goldman Sachs's overall net revenues."1987 He insisted that its 2007 net short position in the mortgage market "was not a large short,"1988 and was largely offset by its long positions, omitting that, in 2007, the Mortgage Department's SPG Trading Desk generated a record $3.7 billion in net revenues for the Department as a whole from its net shorts.1989 Those profits sustained the Mortgage Department and Goldman through the harsh financial environment of the subprime mortgage market meltdown and the global credit crisis in 2007. While much of those revenues were offset by other losses, they were a bulwark of profitability in what would otherwise have been a disastrous year for Goldman's mortgage business.

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¶In contrast, other major Wall Street banks reported losses in the third quarter of 2007, primarily due to multi-billion-dollar writedowns in the value of their subprime mortgage related assets.1990 Goldman had not only profited from its net shorts, but had also sold off the bulk of its subprime mortgage assets earlier and at higher prices than many other banks. After observing the losses and writedowns suffered by other Wall Street banks, Mr. Viniar wrote: "Tells you what might be happening to people without the big short."1991

¶At one point, Mr. Birnbaum also contrasted Goldman's performance with its competitors:

"Results out of DB, Citi, UBS, Bear, Lehman etc. all bear evidence that we were far ahead of our competition in marking down positions and moving CDO risk before the market cratered and came to a standstill post-BSAM [Bear Stearns Asset Management]."1992

¶All of these explanations point to actions taken by Goldman to transfer the risks of its own subprime mortgage inventory to others, including many of its own customers, before they became fully aware of the risks entailed in the products Goldman was marketing to them.

¶Goldman Denials. In late 2007, Goldman spoke openly of shorting the subprime mortgage market and that its net short position was profitable. Afterward, as mortgage losses erupted into a full blown financial crisis in the United States and abroad, Goldman began to downplay and even deny the size of its short position, its proprietary nature, and the profits it generated for the firm.1993

¶Goldman had not been the only market participant to profit from a large net short position in mortgage related products. Other investors also aggressively shorted the mortgage market and profited from their short positions. A particularly large short position taken by one hedge fund – Goldman's customer, the Paulson Credit Opportunity Fund of Paulson & Co. Inc. – netted billions of dollars in what was later characterized as "the greatest trade ever."1994 Mr. Birnbaum, however, had described Goldman's own massive net short position as the "greatest trade ever" as early as July

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¶2007.1995 Earlier in the year, Mr. Birnbaum had also described Goldman as the market leader in shorting the housing market, but by July 2007, Mr. Birnbaum conceded that Paulson was "definitely the man in this space, up 2-3 bil on this trade. We were giving him a run for his money for a while but now are a definitive #2."1996 When preparing his case for SPG traders to be paid additional compensation for their 2007 efforts, Mr. Birnbaum again made a comparison to Paulson: "RMBS- related revenues: #1 on the street by a wide margin. #2 in the world behind Paulson Partners."1997

¶In the aftermath of the financial crisis, however, Goldman no longer claimed credit for its market-leading performance during the subprime meltdown. After many of its customers suffered major losses, and several had declared bankruptcy during the financial crisis,1998 Goldman began to downplay the size of its short position and the impact on its profits.1999 In particular, Goldman attempted to dispel the perception that it sold its own customers CDOs it knew were destined to fail, and then profited by betting against them, as discussed in the next section.2000

¶In April 2010, Goldman posted a statement on its website entitled, "Goldman Sachs: Risk Management and the Residential Mortgage Market."2001 In the statement's Executive Summary, Goldman made the following assertions, among others:

–"Goldman Sachs did not take a large directional 'bet' against the U.S. housing market, and the firm was not consistently or significantly net 'short the market' in residential mortgage- related products in 2007 and 2008, as the performance of our residential mortgage-related products business demonstrates.

– Goldman Sachs did not engage in some type of massive 'bet' against our clients. The risk management of the firm's exposures and the activities of our clients dictated the firm's overall action, not any view of what might or might not happen to any security or market."2002

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¶On April 7, 2010, Goldman CEO Lloyd Blankfein and Co-President Gary Cohn made similar assertions in a letter to shareholders contained in Goldman's Annual Report:

– "The firm did not generate enormous net revenues or profits by betting against residential mortgage-related products, as some have speculated; rather our relatively early risk reduction resulted in our losing less money that we otherwise would have when the residential housing market began to deteriorate rapidly ....

–Although Goldman Sachs held various positions in residential mortgage-related products in 2007, our short positions were not a 'bet against our clients.' Rather, they served to offset our long positions."2003

¶At the Subcommittee hearing, Mr. Blankfein repeated the same claims. He testified:

"Much has been said about the supposedly massive short Goldman Sachs had on the U.S. housing market. The fact is, we were not consistently or significantly net short the market in residential mortgage-related products in 2007 and 2008. Our performance in our residential market-related business confirms this. During the 2 years of the financial crisis, while profitable overall, Goldman Sachs lost approximately $1.2 billion from our activities in the residential housing market. We didn't have a massive short against the housing market and we certainly did not bet against our clients. Rather, we believe that we managed our risk as our shareholders and our regulators would expect."2004

¶Mr. Viniar, Goldman's Chief Financial Officer, testified:

"[A]cross 2007, we were primarily, although not consistently short, and it was not a large short. ... The short positions themselves made a lot of money in 2007, but they offset long positions that lost a lot of money in 2007."2005

¶Goldman's denials of its net short positions in the subprime mortgage market, and the large profits produced by those net short positions, are directly contradicted by its own financial records and internal communications, as well as its own public statements in 2007, and are not credible.

(5) How Goldman Created and Failed to Manage Conflicts of Interest in its Securitization Activities

¶In the years leading up to the financial crisis, Goldman was an active trader in the mortgage market, buying and selling a variety of mortgage related assets, including RMBS, CDO, ABX, and

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¶CDS instruments, as described in the prior section. In addition, Goldman was one of the leaders in mortgage related securitizations, helping to originate both CDO and RMBS securities. Goldman's 2006 and 2007 securitization activities are the focus of this section.

¶In 2006 and 2007, Goldman originated 27 CDOs and 93 RMBS securitizations with a total value of about $100 billion.2006 Goldman designed the structure of each securitization, including the number of tranches, how the payments would be allocated, and the projected rate of return or "coupon rate" that would be paid to investors. In some, Goldman selected the assets to be securitized; in others, it hired a portfolio selection agent or collateral manager to help select the assets and manage the portfolio. For each securitization, Goldman typically housed all of the assets to be securitized in a "warehouse" account until the transaction was ready to go to market. The assets in the warehouse accounts were then included in Goldman's balance sheet. Goldman also typically worked with one or more credit rating agencies to obtain favorable credit ratings for the proposed securities.

¶In addition, Goldman typically established a domestic and an offshore corporation to act as the nominal owners of the securitization's incoming cash, assets, and collateral securities; to serve as the actual issuers of the securities; and to perform certain administrative services. Goldman also established arrangements for the servicing of any underlying mortgages. In some CDOs, Goldman or its affiliate provided additional services as well, acting in such roles as the collateral securities selection agent, the collateral put provider, or the liquidation agent charged with selling impaired assets. Goldman also used its global sales force to market its securities to investors around the world, typically selling Goldman-issued CDO securities through a private placement and RMBS securities through a public offering.

¶In late 2006, when subprime residential mortgages began to incur higher than expected rates of delinquency, fraud, and default, and its inventory of mortgage related assets began to lose value, Goldman took a number of actions. It sold the mortgage related assets in its inventory; returned poor quality loans to the lenders from which they were purchased and demanded repayment; limited new RMBS securitizations; sold or securitized the assets in its RMBS warehouse accounts; limited new CDO securitizations to transactions already in the pipeline; and sold assets from discontinued CDOs.

¶Throughout this process, Goldman made a concerted effort to sell securities from the CDO and RMBS securitizations it had originated, even when those securities included or referenced poor quality assets and began losing value. Many of the CDO and RMBS securities that Goldman sold to its clients incurred substantial losses. The widespread losses caused by CDO and RMBS securities originated by investment banks are a key cause of the financial crisis that affected the global financial system in 2007 and 2008.

¶The 27 CDOs securitized about $28 billion in assets. See undated chart prepared for Subcommittee by Goldman Sachs, GS M BS 0000004276. The 93 RMBS securitized about $72 billion in home loans. See undated chart prepared for Subcommittee by Goldman Sachs, GS-PSI-00172.

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¶This section of the Report examines how Goldman originated, marketed, and sold its mortgage related securities, in particular CDO securities, during late 2006 and in 2007, as the mortgage market deteriorated and as Goldman was profiting from its own net short positions. The section begins with general information about Goldman's securitization activities, followed by detailed case studies of four Goldman-originated CDOs: Hudson 1, Anderson, Timberwolf I, and Abacus 2007-AC1.

¶The evidence discloses troubling and sometimes abusive practices which show, first, that Goldman knowingly sold high risk, poor quality mortgage products to clients around the world, saturating financial markets with complex, financially engineered instruments that magnified risk and losses when their underlying assets began to fail. Second, it shows multiple conflicts of interest surrounding Goldman's securitization activities, including its use of CDOs to transfer billions of dollars of risk to investors, assist a favored client make a $1 billion gain at the expense of other clients, and produce its own proprietary gains at the expense of the clients to whom Goldman sold its CDO securities.

¶Under Goldman's sales policies and procedures, an affirmative action by Goldman personnel to sell a specific investment to a specific customer constituted a recommendation of that investment.2007 Under federal securities law, when acting as an underwriter, placement agent, or broker-dealer recommending an investment to a customer, Goldman had an obligation to sell investments that were suitable for any investor and were not designed to fail. When acting in those roles and affirmatively soliciting clients to buy securities, Goldman also had an obligation to disclose material information that a reasonable investor would want to know, including material conflicts of interest or adverse interests in connection with its sale of a security.2008

¶In 2006 and 2007, when selling subprime CDO securities to customers, Goldman did not always disclose that the securities contained or referenced assets Goldman believed would perform poorly, and that the securities themselves were rapidly losing value. Goldman also did not disclose that the firm had built a large net short position betting that CDO and RMBS securities similar to the ones it was selling would lose value. In the case of the Hudson, Anderson, and Timberwolf CDOs, Goldman failed to disclose to potential investors that it was shorting the very securities Goldman was selling to them. In the case of the Abacus CDO, Goldman failed to disclose to potential investors that it had allowed an interested party to help select the CDO assets and act as the sole short party, with the expectation that the selected assets would lose value and that party would make money at the expense of the long investors to whom Goldman had sold the securities. Goldman created these and other conflicts of interest with its clients in connection with its CDO activities.

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¶(a) Background

¶To understand Goldman's securitization activities, this section provides general background about its CDO and RMBS business and how Goldman changed its securitization activities when the mortgage market began to deteriorate in late 2006.

¶(i) Goldman's Securitization Business

¶The Goldman Mortgage Department originated CDOs through two different desks within the Department. Approximately half of Goldman's CDOs were originated by its CDO Origination Desk, which assembled the assets, structured the CDOs, and worked with the Goldman sales force to market the resulting securities to a broad range of investors. The CDO Origination Desk was headed by Peter Ostrem from 2006 until May 2007, after which all remaining Goldman-originated CDOs were transferred to the Structured Product Group (SPG) Trading Desk and were overseen by David Lehman.

¶Goldman's other CDOs, which were part of a series issued under the name of Abacus, were originated by the Correlation Trading Desk, which was a sub-desk of the SPG Trading Desk. The Correlation Trading Desk specialized in arranging customized trades for investors and used the Abacus series of CDOs as one of its investment alternatives. The Correlation Trading Desk was headed by Jonathan Egol. The CDO Origination and Correlation Trading Desks were located on the same floor as the other SPG Trading Desks.

¶RMBS securitizations were handled by the Residential Whole Loan Trading Desk, headed by Kevin Gasvoda. Sub-desks within the Residential Whole Loan Trading area oversaw the purchase of residential loan pools, constructed the RMBS securitizations, and worked with the Goldman sales force to sell the resulting securities to investors.

¶After a desk originated a CDO or RMBS securitization and sold the Goldman-originated securities for the first time, all secondary trading of the securities was handled by the Structured Products Group's Asset-Backed Security (ABS) Desk. In mid-2007, Goldman shut down its CDO Origination Desk and directed the ABS Desk to sell all remaining Goldman-originated CDO securities, in addition to conducting the secondary trading it normally handled.

¶Daniel Sparks, as head of the Mortgage Department, oversaw all of Goldman's CDO and RMBS origination activities. Mr. Sparks reported at times to Jonathan Sobel, the prior department head, and Richard Ruzika, then head of Commodities Trading. He also worked with Justin Gmelich, a managing director asked to help him run the Department on a short term basis. Mr. Sparks also had frequent contact with more senior Goldman executives, including Thomas Montag, then global co-head of Securities Trading, and Donald Mullen, then head of Credit Trading. On occasion, he also received directives from Chief Financial Officer David Viniar and Co-Presidents Gary Cohn and Jon Winkelried.

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¶(ii) Goldman's Negative Market View

¶As established earlier in the Report, all of Goldman's securitization activities from 2006 to 2007 took place against the backdrop of a subprime mortgage market that, in Goldman's view, was in distress and worsening.

¶On December 7, 2006, for example, Mr. Sparks sent this gloomy assessment to senior executive Thomas Montag:

"Generally, originators are struggling with EPDs [early payment defaults] which require them to buy back loans and take losses – thinly capitalized firms can't take much of it. Lower margins and volumes are also causing pain. Ownit [a mortgage originator] ... closed Monday. Premiums for these originators – all of whom are for sale – are rapidly falling. ... Likely fall-out – more originators close and spreads in related sectors widen."2009

¶A week later, on December 13, 2006, Mr. Sparks repeated his negative view of the subprime mortgage market before senior Goldman executives on the Firmwide Risk Committee. The committee minutes described his report as follows:

"Dan Sparks: Noted the stress in the subprime market; Concern around '06 originators, as two more failed last week; Concern around early payment defaults, $5BN in loans to subprime borrowers, warehouse lines to 6 subprime lenders, and $16MM in '06 residual positions and alt-a and subprime residual positions from '04-'05; Street aggressively putting back early payment defaults to originators thereby affecting the originator's business. Rumors around more failures are in the market."2010

¶On December 14, 2006, CFO David Viniar held a meeting with senior Mortgage Department executives, reviewed their mortgage related holdings, and directed them to offset the risk posed by declining values.2011 The Mortgage Department then initiated its first multi-billion- dollar net short positions in 2007, essentially betting that subprime mortgage related assets would fall in value.

¶In early 2007, Mr. Sparks made increasingly dire predictions about the decline in the subprime mortgage market and issued emphatic instructions to his staff about the need to get rid of subprime loans and other assets. On February 8, 2007, for example, Mr. Sparks wrote:

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"Subprime environment – bad and getting worse. Everyday is a major fight for some aspect of the business (think whack-a-mole). . . . [P]ain is broad (including investors in certain GS- issued deals)."2012

¶On February 14, 2007, Mr. Sparks wrote some notes to himself:

¶"Bad week in subprime

collateral performance on loans was poor – we took a write-down on second lien deals and on the scratch and dent book last week ...

¶Synthetics market got hammered – around 150 [basis points] wider ...

Originators are really in a bad spot. Thinly capitalized, highly levered, dealing with significant loan putbacks, some with retained credit risk positions, now having trouble selling loans above par when it cost them 2 points to produce.

¶What is the next area of contagion."2013

¶That same day, February 14, 2007, Mr. Sparks exchanged emails with Goldman's Co- President Jon Winkelried about the deterioration in the subprime market:

¶Mr. Winkelried: "Another downdraft?"

Mr. Sparks: "Very large – it's getting messy. ... Bad news everywhere. Novastar bad earnings and 1/3 of market cap gone immediately. Wells [Fargo] laying off 300 subprime staff and home price appreciation data showed for first time lower prices on homes over year broad based."2014

¶On February 26, 2007, when Mr. Montag asked him about two CDO2 transactions being assembled by the CDO Origination Desk, Timberwolf and Point Pleasant, Mr. Sparks expressed his concern about both:

¶Mr. Montag: cdo squared–how big and how dangerous

¶Mr. Sparks: Roughly 2bb, and they are the deals to worry about.2015

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¶On March 3, 2007, Mr. Sparks made notes after a telephone call: "Things we need to do .... Get out of everything."2016 On March 7, 2007, Mr. Sparks again reported to Goldman's Firmwide Risk Committee on accelerating problems in the subprime mortgage market:

"– 'Game Over' – accelerating meltdown for subprime lenders such as Fremont and New Century. – The Street is highly vulnerable . ... Current strategies are to 'put back' inventory and liquidate positions. – The Mortgage business is currently closing down every subprime exposure possible."2017

¶On March 8, 2007, Mr. Sparks emailed several senior executives, including Mr. Viniar and Mr. Cohn about "Mortgage Risk": "[W]e are trying to close everything down, but stay on the short side."2018

¶Other Mortgage Department personnel gave similarly bleak assessments of the subprime mortgage market. As early as January 2007, Jonathan Egol, head of the Correlation Trading Desk, wrote to a colleague expressing his clients' views: "The mkt is dead."2019 In February 2007, when discussing plans to issue an Abacus CDO with a Correlation Desk Trader, Fabrice Tourre, Mr. Egol repeated that assessment as his own:

Mr. Egol: [T]he paulson trade may already be dead (although given it is baa2 it may still have a decent shot).

Mr. Tourre: Don't think the Paulson trade is dead. Supersenior pretty much done with ACA, AAAs could be placed in 2 shots, this is sufficient. Remember we make $$$ per tranche placed. ...

Mr. Egol: You know I love it all I'm saying is the cdo biz is dead we don't have a lot of time left.2020

481

¶On March 8, 2007, in an email to senior management, Mr. Sparks listed a number of "large risks I worry about."2021 At the top of the list was "CDO and Residential loan securitization stoppage – either via buyer strike or dramatic rating agency change." Mr. Sparks was referring to the possibility that Goldman would be unable to securitize and sell its remaining subprime mortgage related inventory by repackaging it into RMBS and CDOs for sale to customers. His concern was either that buyers would refuse to purchase such products ("buyer strike"), or that the ratings agencies might realize the poor quality and high risks associated with these products and downgrade them so they could not be sold with AAA ratings ("dramatic rating agency change"). In essence, Mr. Sparks was worried about Goldman's being left with a large inventory of unsold and unsaleable subprime mortgage related assets when the market finally collapsed.2022

¶At the same time Goldman personnel were expressing these negative views of the securitization business, the Mortgage Department was building its large net short positions in the first and third quarters of the year.

¶(iii) Goldman's Securitization Sell Off

¶In response to the December 14,^20062006 and 2007, but has not issued any new indices since then. Fremont 10-K Statement with the SEC. meeting at which CFO David Viniar ordered the Mortgage Department to offset the risk associated with its mortgage related holdings, the Department initiated an intensive effort to sell off the subprime RMBS and CDO securities and other assets in its inventory and warehouse accounts.2023

¶AA. RMBS Sell Off

¶As described earlier, on the same day as the Viniar meeting, December 14, 2006, Kevin Gasvoda, head of the Mortgage Department's Residential Whole Loan Trading Desk, instructed his staff to undertake an immediate, concerted effort to sell the whole loans and RMBS securities in Goldman's inventory and warehouse accounts, focusing on RMBS securities from Goldman- originated securitizations.2024 By February 9, 2007, the Goldman sales force reported a substantial growth and the market are DEAD if that's the case.") [emphasis in original].

482

¶number of sales,2025 and by the end of February, Goldman's controllers reported that Goldman's inventory of whole loans had "decreased from $11bn to $7bn" with "subprime loans decreased from $6.3bn to $1.5bn," a reduction of more than two-thirds.2026

¶In addition, during the first quarter of 2007, the Mortgage Department drastically slowed its RMBS origination business and its purchase of whole loans and RMBS securities.2027 Those actions meant that Goldman was not only reducing its inventory, but also reducing its intake of what had previously been a constant inflow of billions of dollars in whole loans and RMBS securities purchased as part of its securitization business.

¶In addition to selling whole loans and RMBS securities, the Mortgage Department wrote down the value of its remaining subprime mortgage portfolio. On February 8, 2007, for example, Mr. Gasvoda recommended that certain whole loan pools and RMBS securities be marked down by $22 million.2028 On February 9, 2007, Mr. Sparks reported a $30 million writedown on non performing loans.2029 Mr. Ruzika responded: "Ok, you've been communicating the write down was coming. Let's go through the residual risk and make sure we get to the correct number for the quarter."2030 Residual risk referred to the non rated equity tranches that underwriters like Goldman often retained from the RMBS securitizations they originated; those tranches were also written down in value. Those writedowns not only implemented Goldman's policy of using current market values for its assets, but also effectively reduced the size of Goldman's "long" position in subprime mortgage related assets. As Mr. Ruzika wrote to Mr. Cohn: "working with Dan to uncover exactly what else needs to be written down so that we can pnl [profit and loss] it this quarter and be clean going into next quarter."2031

483

¶Loan Repurchase Campaign. In addition to its sales and writedowns, the Mortgage Department intensified its efforts to identify and return defaulted or otherwise deficient loans to the originating lender from which they had been purchased in exchange for a refund of the purchase price. Altogether in 2006 and 2007, Goldman made about $475 million in repurchase claims for securitized loans, and recovered about $82 million.2032 It also made about $40 million in repurchase claims for unsecuritized loans, and recovered about $17 million.2033

¶In the years leading up to the financial crisis, most subprime loan purchase agreements provided that if a loan experienced an early payment default (EPD), meaning the borrower failed to make a payment within three months of the loan's purchase, or if the loan breached certain representations or warranties, such as representations related to the loan's characteristics or documentation, the loan could be returned or "put back" to the seller which was then obligated to repurchase it. In late 2006, as subprime loans began to experience accelerated rates of EPDs and fraud,2034 Wall Street firms began to intensify their efforts to return those loans for refunds. Some subprime lenders began to experience financial distress due to unprecedented waves of repurchase requests that drained their cashflows.2035

¶Although Goldman, either directly or through a third party due diligence firm, routinely conducted due diligence reviews of the mortgage loan pools it bought from lenders or third party brokers for use in its securitizations, those reviews generally examined only a sample of the loans and did not attempt to identify and weed out all deficient mortgages.2036 Instead, Goldman purchased loan pools with the expectation that they would incur a certain rate of defaults. In late 2006, however, like other Wall Street firms, Goldman began to see much higher than anticipated delinquency and default rates in the loan pools in its inventory and warehouse accounts, and in the subprime RMBS and CDO securitizations it originated.2037 Defaulted loans generally could not be sold or securitized, and had to be terminated through foreclosure proceedings or sold in so-called "scratch and dent" pools that generally produced less money than the loans cost to buy. In addition, defaulted loans meant that the borrowers who took out those loans stopped making loan payments to the securitized loan pool, reducing the cashflow into the related securities. RMBS and CDO securities whose underlying assets incurred high rates of loan delinquencies and defaults experienced reduced cashflows, lost value, and sometimes failed altogether, resulting in substantial losses for investors.

484

¶In early 2007, Goldman's Mortgage Department initiated an intensive review of the loans in its inventory, warehouse accounts, and RMBS and CDO securitizations, to identify deficient loans and return them for refunds. On February 2, 2007, Mr. Sparks reported to senior Goldman executives Messrs. Viniar, Montag, and Ruzika that obtaining refunds from the loan originators would be "a battle":

"The team is working on putting loans in the deals back to the originators (New Century, WAMU, and Fremont – all real counterparties), as there seem to be issues potentially including some fraud at origination, but resolution will take months and be contentious. ... The put backs will be a battle."2038

485

¶To manage its loan repurchase campaign, Goldman expanded an operations center in St. Petersburg, Florida,2039 and made extensive use of third party due diligence firms hired to review its securitized loan pools.2040 Goldman instructed the firms to "re-underwrite" every loan in pools of mortgages purchased from specific lenders, including New Century, Fremont, Long Beach, and later Countrywide.2041

¶By March 2007, the average EPD rate for subprime loans in Goldman's inventory had climbed from 1% of aggregate volume to 5%, a dramatic increase.2042 On March 7, 2007, Mr. Sparks described Goldman's exposure as follows:

"As for the big 3 originators – Accredited, New Century and Fremont, our real exposure is in the form of put-back claims. Basically, if we get nothing back we would lose around $60mm vs loans on our books (we have a reserve of $30mm) and the loans in the [CDO and RMBS] trusts could lose around $60mm (we probably suffer about 1/3 of this in ongoing exposures). ... Rumor today is that the FBI is in Accredited."2043

¶Five days later, on March 12, 2007, Mr. Sparks wrote: "The street is aggressively putting things back, like a run on the bank before there is no money left to fulfill the obligations."2044

¶One of the lenders that was an initial focus of Goldman's loan repurchase effort was New Century, a subprime lender whose loans Goldman had used in many Goldman-originated RMBS securitizations. After completing a review of one New Century loan pool, an analyst recommended "putting back 26% of the pool ... if possible."2045 A putback rate of 26% meant that about one in four of the loans in the New Century pool had EPDs, were fraudulent, or otherwise breached New Century's contractual warranties. It also implied that about 25% of the expected mortgage payments might not be made to the relevant RMBS securitization. Unless the problem loans could be successfully "put back" to New Century in exchange for a refund, a fail rate of that magnitude would likely impair the performance of all of the securities dependent upon that pool of mortgages.

486

¶Goldman made a total of about $67 million in repurchase requests to New Century, which was among the five mortgage originators to whom Goldman directed the most repurchase requests in 2006 and 2007.2046 In March 2007, however, New Century stopped paying Goldman's claims due to insufficient cash, and the loan repurchase team sought advice from Mr. Gasvoda:

"As you know, we have an extensive re-underwrite review underway on 06 NC2 [New Century second lien loans] and also other NC loans in the 2nds deals that are in the pipeline for scrubs. Should we change course at all here given the fact NC can't pay?"2047

¶Mr. Gasvoda responded:

"Yes .... I think priority s/b [should be] on Fremont and Long Beach on 2nd lien deals. Fremont first since they still have cash but may not for long. ... [O]n NC2 we need not halt that entirely but should pull back resources there. We should also move 06FM2 [Fremont second lien loans] up the priority list."

¶Goldman made a total of about $46 million in repurchase requests to Fremont, another subprime lender for whom Goldman had underwritten multiple securities and which was also among the five mortgage originators to whom Goldman made the most repurchase requests in 2006 and 2007.2048 When Goldman personnel reviewed a loan pool purchased from Fremont, the results were even worse than for the New Century loans. Goldman concluded that "on average, about 50% of about 200 files look to be repurchase obligations."2049 Later, Goldman came to a similar

(if 2nd liens). ... – approx 5% of the pool was possibly originated fraudulently based on the dd [due diligence] results. Main findings: possible ID theft, broker misrepresentations, straw buyer, and falsification of information in origination docs. ... "approx 62% of the pool has not made any payments (4% were reversed pymts/nsf [non-sufficient funds]) ... "approx 38% of the loans are out of [loan to value] tolerance."

487

¶conclusion after reviewing certain loans purchased from Countrywide, again finding that about 50% of the loans reviewed were candidates for return to the lender.2050

¶Goldman made a total of about $34 million in repurchase requests to Long Beach, a subprime lender for whom Goldman had underwritten billions of dollars in RMBS securities and which was also among the five mortgage originators to whom Goldman made the most repurchase requests in 2006 and 2007.2051 Goldman pressed both Long Beach and its parent Washington Mutual for repayment of millions of dollars in refunds. At one point, a Goldman executive involved in the repurchase effort sent an email to the head of Washington Mutual Home Loans Division, David Schneider. After noting that Long Beach second lien loans were "performing dramatically worse" than other 2006 RMBS securities, the Goldman executive wrote: "As you can imagine, this creates extreme pressure, both economic and reputational, on both organizations."2052

¶Goldman's loan repurchase campaign recovered substantial funds from some lenders,2053 but little or none from others.2054 Non performing loans that were not repurchased by the lender generally remained in Goldman's inventory or the relevant securitized loan pool. Many other securitizers engaged in similar loan repurchase efforts which continued in 2011.2055

¶Poor Quality RMBS Securities. As a result of its loan repurchase and writedown efforts, the Mortgage Department was keenly aware of the poor quality of many of the loan pools in its warehouse accounts. Nevertheless, during this time period, Goldman continued securitizing many of those loans and selling the resulting RMBS securities to clients.

¶In March 2007, for example, Goldman securitized over $1 billion in subprime loans that it had purchased from Fremont, originating an RMBS securitization called GSAMP Trust 2007- FM2.2056 Goldman underwrote the security in the same month that it was attempting to return millions of dollars in deficient loans to the lender,2057 and regulators ordered Fremont to stop issuing subprime loans.2058 Goldman marketed and sold the RMBS securities to clients. Within seven months, by October 2007, the rating downgrades began; by August 2009, every tranche of the GSAMP securities had been downgraded to junk status.2059

488

¶On March 26, 2007, the Mortgage Department sought permission from Goldman's Mortgage Capital Committee to securitize and underwrite a new RMBS called GSAMP Trust 2007- HE2, which contained nearly $1 billion in subprime mortgage loans in a Goldman warehouse account, over 70% of which had been purchased from New Century.2060 Goldman approved this securitization even though it knew at the time that New Century's subprime loans were performing poorly, many of the New Century loans in Goldman's inventory were problematic, and New Century was in financial difficulty.2061 The securitization was approved for issuance in April 2007, the same month New Century declared bankruptcy.2062 Goldman marketed and sold the RMBS securities to its clients. The securities first began to be downgraded in October 2007, and all of the securities have since been downgraded to junk status.2063

¶Had Goldman not securitized the $2 billion in Fremont and New Century loans, the Mortgage Department would likely have had to liquidate the warehouse accounts containing them and either sell the loan pools or keep the high risk loans on its own books.

¶On April 11, 2007, a Goldman salesman forwarded to Mr. Egol a scathing letter from a customer, a Wachovia affiliate, which had purchased $10 million in RMBS securities backed by Fremont loans and underwritten by Goldman. The client wrote that it was "shocked" by the poor performance of the securities "right out of the gate," and concerned about Goldman's failure to have disclosed information about the poor quality of the underlying loans in the deal termsheet:

489

" As you know, we own $10mm of the GSAMP 06-S3 M2 bond. ... We are shocked by how poorly this bond has performed right 'out of the gate' and had asked [Goldman] to send us the attached ProSupp [Prospectus Supplement]. After having read the ProSupp and compared it to the termsheet we have several concerns:

• According to the Prosupp, approximately $2.2mm ... of loans were delinquent when they were transferred to the trust. However, there is no mention of delinquent loans anywhere in the termsheet that was sent to investors when the deal was priced.

• According to the Prosupp, approximately $3.3mm ... are re-performing loans. However, there is no mention of reperforming loans anywhere in the termsheet.

• Approx. 53.14% of the loans in the deal allow for a Prepayment Premium and that all Prepayment Premiums collected from borrowers are paid to the Class P certificateholders. None of this was disclosed in the termsheet and my concerns are two-fold: (1) The presence of Prepayment Premiums effects prepayment speeds which affects ... [the deal's performance]; (2) Prepayment Premiums are not staying inside the deal for the benefit of all investors but are being earmarked for the Class P holder (which is not mentioned in the termsheet). Note that ... $1.2mm in Prepayment Premiums has already been paid out to the Class P holder.

• ... [T]he servicer must charge off any loan that becomes 180 days delinquent, giving rise to a Realized Loss inside the deal. Currently losses are at 9.71% of the original deal balance, or approximately $48mm despite the fact that the deal is only 11 months old (note that this figure already exceeds Moody's expec[ta]tion for cumulative losses for the deal over the ENTIRE LIFE of the deal). I will also note that there are an additional $57.5mm of loans in the delinquency pipeline. This seems to indicate significant fraud at either the borrower or lender level ....

• ... [A]ny subsequent recoveries on the charged-off loans do not inure to the benefit of all investors in the deal but ONLY to the Class X1 certificateholder. This is not mentioned anywhere in the termsheet. Who owns the Class X1 notes? Is that Goldman or an affiliate? How much has been recovered so far? This is a material fact to me especially considering that loss severities are coming in at around 105% on the charged-off loans."2064

¶Reduced RMBS Business. By the end of 2007, Goldman had substantially reduced its RMBS securitization business. In November 2007, in response to a request, Goldman provided specific data to the SEC about the decrease in its inventory of subprime mortgage loans and RMBS securities. Goldman informed the SEC that the value of its subprime loan inventory had dropped from $7.8 billion on November 24, 2006, to $462 million on August 31, 2007. Over the same time period, the value of its inventory of subprime RMBS securities had dropped from $7.2 billion to

490

¶$2.4 billion, a two-thirds reduction.2065 The graph below, which was prepared by the Subcommittee using the data provided by Goldman to the SEC, illustrates the rapid decline in Goldman's subprime holdings.2066

[SEE CHART NEXT PAGE: Goldman Sachs Long Cash Subprime Mortgage Exposure, prepared by the Permanent Subcommittee on Investigations, Hearing Exhibit 163.]

Goldman Sachs Long Cash Subprime Mortgage Exposure, Investments in Subprime Mortgage Loans, and Investments in Subprime Mortgage Backed Securities November 24,^20062006 and 2007, but has not issued any new indices since then. Fremont 10-K Statement with the SEC. vs. August 31,^20072007 "Home Loans Product Strategy," WaMu presentation at JPM_WM03097203, Hearing Exhibit 4/13-60a (only Countrywide ranked higher). WaMu Home Loans Product Strategy, "Strategy and Business Initiatives Update," JPM_WM03097217, Hearing Exhibit 4/13-60a [emphasis in original]. Performance Evaluation for Peter D'Erchia, S&P SEN-PSI 0007442; See also April 23, 2010 Subcommittee Hearing at 74-75. annual report filed with the SEC, in particular the Executive Summary of Deutsche Bank's Annual Report and the letter from the Chairman of the Board. See Goldman Sachs response to Subcommittee QFR at PSI_QFR_GS0252, at 0262.Show full note - in $ Billions

¶Investments in Subprime

¶12 Mortgage Loans

¶10 Investments in Subprime

¶Mortgage Backed Securities

7.8 Long Cash Subprime Mortgage Exposure (Total of Loans and 7.2

¶6 Securities)

¶2.862

¶2 2.4

¶0.462

¶Prepared by the U.S. Senate Permanent Subcommittee on Investigations, April 2010. Data from Nov. 7, 2007, letter from Goldman Sachs to the Securities and Exchange Commission, GS MBS‐E‐015713460, at 5 (Exhibit 50).

492

¶BB. CDO Sell Off

¶Goldman reduced its inventory of subprime loan pools and RMBS securities through outright sales, writedowns, and its loan repurchase campaign. It was equally aggressive in reducing its subprime CDO warehouse inventory.

¶In January 2007, after the CDO Origination Desk worked to sell securities from a CDO called Camber 7, Mr. Sparks wrote to Mr. Montag: "Need you to send message to peter ostrem and darryl herrick telling them what a great job they did. They structured like mad and traveled the world, and worked their tails off to make some lemonade out of some big old lemons."2067

¶In February 2007, the Mortgage Department conducted a review of the CDOs in its origination pipeline.2068 As part of that review, Mr. Sparks cancelled four pending CDOs that had acquired some but not all of the assets needed for the CDOs to go to market.2069 On February 25, 2007, Mr. Sparks reported to Mr. Montag and Mr. Ruzika:

"The CDO business liquidated 3 warehouses for deals of $530mm (about half risk was subprime related). Business also began liquidation of $820mm [redacted] warehouse – all synthetics done, cash bonds will be sold in the next few days."2070

¶The Mortgage Department rushed several remaining CDOs to market, including Anderson, Timberwolf, and Point Pleasant, which issued their securities in March and April 2007.2071 In May and June 2007, the Mortgage Department began closing all of its remaining CDO warehouse accounts and transferring the assets to the SPG Trading Desk for sale.2072 On June 22, 2007, Mr. Lehman reported that the ABS Desk had just sold another $50 million in RMBS securities from the CDO warehouse accounts for a profit of $1 million, and that: "[o]nly 40mm RMBS A3/A- remain in the WH [warehouse] accounts, ½ of which is Long Beach paper - continue to work."2073

493

¶Throughout 2007, Goldman sought to sell all of its remaining subprime assets from the CDO warehouse accounts as well as the new securities issued by Goldman-originated CDOs.2074

¶Aggressive Sales Efforts. On March 9, 2007, Mr. Sparks emailed a call for "help" to Goldman's top sales managers around the world to "sell our new issues – CDOs and RMBS – and to sell our other cash trading positions."2075 In response, Mr. Sparks and key sales managers had a dialogue about "reaching the next wave of players here and abroad."2076

¶The Goldman sales manager for Europe and the Middle East suggested that Mr. Sparks focus the CDO sales efforts abroad, because the clients there were not involved in the U.S. housing market and therefore were "not feeling pain":

"The key to success in the correlation melt-down 2 years ago was getting new clients/capital into the opportunity quickly. Saved/made us a lot of money. Lots of banks and real money clients in Europe and middle east and lots of macro hedge funds are not involved and not feeling pain. In Europe we need a summary of key opportunities/axes and I will get the team to focus on. 2-3 most important things plus sales talking points rather than laundry list."2077

¶Mr. Ostrem, head of the CDO Origination Desk, agreed with expanding Goldman's CDO sales efforts in Europe and the Middle East: "I agree with [sales manager's] comments on new clients. Middle east, french banks, macro hedge funds could and are making these deals 'work' currently."2078 The following week, Mr. Lehman issued three new sales directives or "axes" to the Goldman sales force placing a priority on selling securities from the Anderson, Timberwolf, and Hudson CDOs:2079

"As per [European/Middle East sales manager's] suggestion last Friday, below are the three main focus areas for SP CDOs/SPG Trading, including Anderson Mezzanine, Timberwolf CDO^2 and secondary CDO positions (Hudson Mezzanine and high grade BBBs)."

¶Goldman's New York sales office forwarded the axe sheet to the European/Middle East sales office saying: "London – this is for you."2080

494

¶In an additional effort to expand Goldman's sales effort, the Mortgage Department's sales syndicate provided a list of "non-traditional buyers" to the CDO and SPG Trading Desks:

"We have pushed credit sales to identify accounts in the credit space that would follow yield into the ABS [asset-backed security] CDO market, and tried to uncover some non-traditional buyers. ... Below is a list of higher delta accounts uncovered so far; and we continue to push for leads. We are working with sales on these accounts to push our axes."2081

¶Goldman personnel worked diligently to pitch CDO securities to various clients, internal documents show. On March 30, 2007, for example, Fabrice Tourre reported to senior Mortgage Department executives about his efforts and plans to sell the CDO securities:

"This transaction [Abacus 2007-AC1] has been showed to selected accounts for the past few weeks. Those selected accounts had previously declined participating in Anderson mezz, Point Pleasant and Timberwolfe. ... Plan would still be to ask sales people to focus on Anderson mezz, Point Pleasant and Timberwolfe, but if accounts pass on these trades, steer them towards available tranches in ABACUS 07-AC1 since we make $$$ proportionately with the notional amount of these tranches sold. Wanted to make sure everyone is comfortable with this plan."2082

¶In April 2007, the Mortgage Department issued a new directive to its sales force with a list of new and old CDO securities in its inventory that it wanted sold, including Timberwolf and Anderson as well as CDOs known as Point Pleasant and Altius.2083 Dissatisfied with the pace of sales, Mr. Sparks suggested issuing a separate axe for each CDO and offering additional sales credits: "Why don't we go one at at a time with some ginormous credits - for example, let's double the current offering of credit for timberwolf."2084 A sales manager responded: "We have done that with timberwolf already. Don't want to roll out any more focus axes until we get some traction there but at the same time, don't want to stop showing inventory."

¶"Gameplan" for CDO Valuation Project. By May 2007, CDO sales had slowed significantly. Goldman executives became concerned about the lack of sales prices to establish the value of its CDO holdings.2085 Goldman needed accurate values, not just to establish its CDO sales prices, but also to value the CDO securities for collateral purposes and to comply with Goldman's policy of using up-to-date market values for all of its holdings. Mr. Sparks expressed concern that the value of the remaining CDO assets were rapidly declining, warning one senior executive: "We are going to have a very large mark down – multiple hundreds. Not good."2086

495

¶On May 11, 2007, Goldman senior executives, including Mr. Cohn and Mr. Viniar, held a lengthy meeting with Mortgage Department personnel, their risk controllers, and others to develop a "Gameplan" for a CDO valuation project.2087 The Gameplan called for the Mortgage Department, over the course of about a week, to use three different valuation methods to price all of its remaining CDO warehouse assets and unsold securities from the Goldman-originated CDOs then being marketed to clients.2088

¶A few days later, on May 14, 2007, while the CDO valuation project was underway, Mr. Montag asked Mr. Sparks for an estimate of how much the firm would need to write down the value of its CDO assets. Mr. Sparks responded that the "base case from traders is down [$]382 [million]." He also wrote:

"I think we should take the write-down, but market [the CDO securities] at much higher levels. I'm a little concerned we are overly negative and ahead of the market, and that we could end up leaving some money on the table."2089

¶The valuation project's results were summarized in a presentation dated Sunday, May 20, 2007, prepared for a 9:00 p.m. conference call that night with Mr. Viniar, in which Mr. Mullen, Mr. Sparks, Mr. Lehman, and others also participated.2090 Using the three valuation methods, the presentation estimated that the loss in value and the total writedowns required for the firm's CDO assets were between $237 and $448 million.2091 The executive summary of the presentation also expressed concern about Goldman-originated CDO securities, especially its two CDO2 transactions, Timberwolf and Point Pleasant, since "[t]he complex structure of these positions makes them difficult to value and distribute."2092 The presentation estimated that the market value of those CDO securities, plus the equity and super senior tranches that had been retained by Goldman, was $4.3 billion. The executive summary also estimated the market value of the remaining assets from the CDO warehouse accounts at $1.5 billion, and expressed particular concern about selling $742 million in CDO securities from non Goldman originated CDOs due to "limited liquidity and price transparency in this space." The executive summary stated that since "securitization is no longer a viable exit, the warehouse collateral will be marked to market on an individual basis."2093

496

¶The presentation also presented "Next Steps." It recommended that Goldman "unwind the warehouses" and use "[i]ndependent teams to continue to value" the CDO securities, equity tranches, and super senior tranches from the Goldman-originated securitizations. It also recommended that sales of the Goldman-originated CDO securities be targeted, first, at four hedge fund customers, Basis Capital, Fortress, Polygon, and Winchester Capital.2094 The presentation also attached a list of 35 other target customers with notes regarding the status of efforts to sell them CDO securities in the past.2095

10787603. The final document, "Mortgages V4.ppt" was emailed to Mr. Sparks and Mr. Mullen, and also messengered to Mr. Mullen's home, at 8:31 p.m. on May 20, immediately before the scheduled call. 5/20/2007 email to Daniel Sparks and Donald Mullen, "Viniar Presentation – Updated," GS MBS-E-010971156.

¶Goldman also produced a similar document prepared the day before, which may have been an earlier draft of the final presentation. 5/19/2007 Goldman presentation, "Mortgages CDO Origination – Retained Positions & W arehouse Collateral, May 2007," GS M BS-E-010951926. This document is identified in the relevant correspondence as "Mortgages CDO Origination," and the file name is "Mortgages V3.ppt." This presentation was forwarded to Mr. Sparks for comment on May 19,^20072007 "Home Loans Product Strategy," WaMu presentation at JPM_WM03097203, Hearing Exhibit 4/13-60a (only Countrywide ranked higher). WaMu Home Loans Product Strategy, "Strategy and Business Initiatives Update," JPM_WM03097217, Hearing Exhibit 4/13-60a [emphasis in original]. Performance Evaluation for Peter D'Erchia, S&P SEN-PSI 0007442; See also April 23, 2010 Subcommittee Hearing at 74-75. annual report filed with the SEC, in particular the Executive Summary of Deutsche Bank's Annual Report and the letter from the Chairman of the Board. See Goldman Sachs response to Subcommittee QFR at PSI_QFR_GS0252, at 0262.Show full note at 12:32 a.m., and Mr. Sparks replied with comments at 5:57 p.m. Mr. Sparks forwarded the file "Mortgages V3.ppt" to himself at home on Sunday, May 20,^20072007 "Home Loans Product Strategy," WaMu presentation at JPM_WM03097203, Hearing Exhibit 4/13-60a (only Countrywide ranked higher). WaMu Home Loans Product Strategy, "Strategy and Business Initiatives Update," JPM_WM03097217, Hearing Exhibit 4/13-60a [emphasis in original]. Performance Evaluation for Peter D'Erchia, S&P SEN-PSI 0007442; See also April 23, 2010 Subcommittee Hearing at 74-75. annual report filed with the SEC, in particular the Executive Summary of Deutsche Bank's Annual Report and the letter from the Chairman of the Board. See Goldman Sachs response to Subcommittee QFR at PSI_QFR_GS0252, at 0262.Show full note at 8:07 a.m.

497

¶The CDO valuation project undertaken in May provided clear notice to Goldman senior management at the highest levels that its CDO assets had fallen sharply in value, and that despite their lower value, the Mortgage Department planned to aggressively market them to customers. In an earlier draft of the presentation, the Mortgage Department had also stated that it expected Goldman's CDO and CDO2 securities "to underperform":

"The complexity of the CDO^2 product and the poor demand for CDOs in general has made this risk difficult to sell and the desk expects it to underperform."2096

¶Mr. Sparks reviewed that draft language and made comments about other items on the same page, but did not change the phrase, "the desk expects it to underperform."2097 The same phrase appeared

¶011057632 (mortgage credit business shared with SPG Trading Desk "a fairly lengthy list of accounts that are considered to be 'key'"). In December 2006, the Correlation Trading Desk drew up a list of target customers for 2007: the "proposed top 20 correlation customer list." 12/29/2006 email from Fabrice Tourre, "Last call–any other comments on the proposed top 20 correlation customer list," GS MBS-E-002527843, Hearing Exhibit 4/27-61. Mr. Tourre issued a "last call" for comments on the list and suggested focusing on "buy-and-hold rating-base buyers" who might be more profitable for the desk than more sophisticated and demanding hedge fund customers:

"[T]his list might be a little skewed towards sophisticated hedge funds with which we should not expect to make too much money since (a) most of the time they will be on the same side of the trade as we will, and (b) they know exactly how things work and will not let us work for too much $$$, vs. buy-and-hold rating- based buyers who we should be focused on a lot more to make incremental $$$ next year."

¶The proposed top 20 list identified a number of European accounts, as well as customers who had purchased asset backed security products from Goldman in the past.

¶The reference to "buy and hold, ratings-based buyers" was to conservative financial institutions, often insurance companies or pension funds, that tended to hold their investments indefinitely or until maturity, some of which were limited to holding investments with AAA or other investment grade credit ratings. Many of these buyers tended to rely on the AAA rating as a "seal of approval" signaling that the rated instrument offered predictable, safe returns. Many viewed the AAA rating as, in effect, all these buyers thought they needed to know about the CDO securities they were purchasing. See, e.g.,11/13/2007 Goldman email, GS MBS-E-010023525 (attachment, 11/14/2007 "Tri-Lateral Combined Comments," GS MBS-E-010135693-715 at 713) ("Investors in subprime related securities, especially higher rated bonds, have historically relied significantly on bond ratings particularly when securities are purchased by structured investing vehicles."). But as one press article explained: "CDO ratings may mislead investors because they can obscure the risk of default, especially compared with similar ratings for bonds, says Darrell Duffie, a professor of finance at Stanford Graduate School of Business in California, who's paid by Moody's to advise the company on credit risk. 'You can't compare these CDO ratings with corporate bond ratings,' Duffie says. 'These ratings mean something else – entirely.'" See 5/31/2007 email to David Lehman and others, "CDO Boom Masks Subprime Losses," GS MBS-E-001865723 at 733. The article pointed out that the lowest grade of corporate bonds rated by Moody's had a default rate of 2.2%, while the default rate for CDOs with the same rating was 24%. Id.

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¶in several earlier versions of the presentation as well, but was removed from the final version sent to Mr. Viniar.2098

¶CDO Desk Shutdown. In May 2007, Goldman decided to stop issuing new CDOs, and the head of its CDO Origination Desk, Peter Ostrem, left the firm.2099 Mr. Sparks named as his replacement David Lehman, who was a senior member of the Structured Product Group (SPG) and head of its CMBS Trading Desk, but had little experience in either underwriting or CDOs.2100 On May 19, 2007, Mr. Lehman received an email from a former Goldman managing director who wrote: "Congratulations, but seems like you have a lot ofwork [sic] ahead of you."2101 Mr. Lehman asked Mr. Egol: "What do u th[in]k he means by 'lot of work to do?'"2102 Mr. Egol responded:

"I know what he means. If you talk to people knowledgeable about cdos, you will find that external perception of GS franchise in this space is much lower than Sparks and Sobel believed. Over the last 2 years, GS [Goldman Sachs] is perceived to be a bottom quartile abs [asset-backed security] cdo underwriter and to have done several poor deals. There is a reason [the CDO desk] didn't sell much paper. The fact that [the CDO desk] was basically giving money away in these no-fee principal deals and could still only get TCW, GSC (both street wh—e managers) and some start up managers to work with GS is a stain that will take time to remove. The HG [high-grade] deals in particular are very poor. I thought the alladin deals had some potential but fortius 2 is going to be a real mess.

"These are not just my views – they are from customers whose views resonate in the market. Sales people have just been too timid internally or not engaged enough with their accounts to provide accurate feedback. It pains me to say it but citi, ubs, db [Deutsche Bank], lehman and ms [Morgan Stanley] have much stronger franchises – among large dealers only ML [Merrill Lynch] is more reviled than [Goldman's] business. ...

¶"I should add altius 3 is a doozy as well. I'll spare you the detailed list."2103

¶That May 19,^20072007 "Home Loans Product Strategy," WaMu presentation at JPM_WM03097203, Hearing Exhibit 4/13-60a (only Countrywide ranked higher). WaMu Home Loans Product Strategy, "Strategy and Business Initiatives Update," JPM_WM03097217, Hearing Exhibit 4/13-60a [emphasis in original]. Performance Evaluation for Peter D'Erchia, S&P SEN-PSI 0007442; See also April 23, 2010 Subcommittee Hearing at 74-75. annual report filed with the SEC, in particular the Executive Summary of Deutsche Bank's Annual Report and the letter from the Chairman of the Board. See Goldman Sachs response to Subcommittee QFR at PSI_QFR_GS0252, at 0262.Show full note email provided Mr. Lehman with additional notice of the poor quality of the CDO securities he was charged with selling.

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¶The CDO valuation project presentation given the next day, May 20, 2007, recommended that all assets from the CDO warehouse accounts be transferred to the SPG Trading Desk for sale. A CDO "transition book" was created to account for profits and losses from some of the assets, and the transfer took place the following week.2104 In addition, by June 1, 2007, Goldman eliminated the CDO Origination Desk as a separate entity, and moved all of the remaining Goldman-originated CDO securities to the SPG Trading Desk, where Mr. Lehman was based.2105 As a result, the SPG Trading Desk, which was a secondary trading desk and had little experience with the greater disclosure obligations involved with selling newly minted securities, became solely responsible for selling all Goldman-originated CDO securities.

¶Renewed Sales Efforts. After the transfer of the CDO assets, the SPG Trading Desk began to work with the Goldman sales force to identify potential customers and sell the CDO products. On May 24, 2007, a Goldman salesperson contacted Messrs. Sparks and Lehman regarding two potential customers interested in Timberwolf and Point Pleasant securities.2106 With respect to one customer, the salesman wrote that it was "[n]ot experts in this space at all but [I] made them a lot of money in correlation dislocation and will do as I suggest." With respect to the second customer, the Goldman salesperson wrote that the customer had "just raised another $1bln for their ABS [asset backed security] fund and they are very short the ABX so are natural buyers of our axe."2107

¶A couple of weeks before the CDO valuation project, Goldman's Australia sales representative, George Maltezos, announced he had found a potential Australian buyer for a Goldman CDO being constructed by the Correlation Desk: "I think I found white elephant, flying pig and unicorn all at once."2108 On the same day the project identified Basis Capital as a primary target for CDO sales, May 20, 2007, Mr. Maltezos sent Mr. Lehman an email saying he would contact the Basis principals as soon as they returned from a business trip the following day.2109

¶On May 24, 2007, the CDO sales dry spell ended, when Paramax Capital Group, a U.S. investment adviser, purchased $40 million in AA Timberwolf securities.2110 On May 30, Mr. Lehman announced the sale of $20 million in AAA Timberwolf securities to Tokyo Star Bank in Japan.2111

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¶CDO Sales in Asia. On June 11, 2007, Mr. Lehman received a note from the Mortgage Department's sales syndicate desk asking whether the directive listing high priority CDO sales could be sent to the Japan sales office, which oversaw sales throughout Asia:

"Know there was sensitivity w/ sending this out, but asia sales management is asking again. Do you want to consider sending more broadly for asia sales or do you want to stick with the more targeted approach?"2112

¶The Japan sales group wrote that the head of the Japan office "is saying that we need it to go more broadly to all Sales at least in Japan. Given her request twice now and her help in getting focus, think we should at least push this in Japan."2113 Mr. Lehman responded: "Fine – let's send to all Japan sales then."2114

¶The Japan sales office responded to the new directive with several quick sales. On June 13, 2007, the Japan sales office sent out this celebratory note:

"We have moved over $250mm of SP CDO axes to account in Japan, Australia and Korea over the past 2+ weeks. These are HUGE orders for the firm as they have helped reduce balance sheet risk and further exhibits the importance of the Asia franchise to the global Structured Products Group business. Note that in line with these trades we have paid out over $14mm of gross credits – this is clearly the top focus for us now in SP [Structured Product] CDO space. ... Call the SPG Asia desk in Tokyo for updated axes and offer levels. We hope to trade another $20mm of CDO^2 risk with a Japanese account in the coming week+. Thanks."2115

¶Mr. Lehman replied: "Thx for sending this out."2116

¶A few days later, Mr. Lehman reported to senior management that the Japan sales office had been successful in selling another $20 million in CDO securities. Mr. Lehman wrote:

"Great job by [Japan sales] (again) on our CDO^2 axes. Tonight we will trade $20mm Point Pleasant A1s @90.7 to Tokyo Star Bank .... We hope to trade another $20mm of these bonds next week w/ this account."2117

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¶Mr. Lehman sent an email to the head of the Japan sales office letting him know that Goldman's senior management was aware of the sales effort: "Montag ve[r]y involved in this fyi." The Japan sales manager responded: "Yes – he made that clear when he spent almost 20 minutes on the desk with me in TKO [Tokyo] last week going through every potential lead."2118 That same day, the Japan sales manager sent out a new email urging the trading team to bring in another $20 million from Tokyo Star Bank and promising them additional sales incentives:

"To reward your strong effort and in hopes of the follow on 20mm order from the client on this deal, we plan on paying you a total bonus GC payment of $40 / bond (double our $20/bond for AAA's on our axes that are not lower mezz AAA). We look forward to additional trades from Tokyo Star Bank on our CDO axes."2119

¶During June and July, additional sales took place in Japan, Korea, Taiwan, and Australia.2120 Goldman also made sales to customers in Europe and the Middle East.2121

¶Despite the sales in June and July, Goldman continued to have a significant inventory of unsold CDO securities. On August 15, 2007, Mr. Mullen even made a casual reference to "our cdo business which remains unsaleable."2122 If Goldman's CDOs remained unsaleable, however, it was not for lack of trying. In August and September 2007, Goldman switched from its targeted customer approach to issuing broad directives to its entire sales force in the United States and abroad urging them to concentrate on its CDO securities. On August 17, 2007, for example, the SPG Trading Desk issued a new directive to certain salespersons asking them to place a priority on selling interests in two Timberwolf super senior tranches.2123 These tranches were first in line to receive payments within the CDO and so had the lowest risk. Super senior CDO positions were often sold through CDS contracts, sometimes called super senior swaps, in which the customer took the long side and the CDO originator took the short side, and that's what Goldman wanted the sales force to market. But the following week, on August 23, 2007, Goldman sent a new directive to the sales force urging them to find customers willing to take the short side of the super senior tranches, so the Mortgage Department could take the long side and cover some of its shorts.2124 When asked his opinion of the directive, the head of Japan sales office expressed skepticism about sales to Asian customers:

"The only question in my mind is that we have not seen many accounts pushing hard to find ways to get short (typically they are long only). That being said, the reality of the current

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market may have finally sunk in and investors may be able to convince their boards [n]ow to put on this sort of trade."2125

¶On September 5, 2007, notwithstanding "the reality of the current market," the SPG Trading Desk issued a "Refresh of Axe Priorities" to its entire sales force.2126 The directive placed a priority on selling Goldman's residual CDO equity tranches as well as a variety of other assets to help Goldman cover and lock in the profits from its big short. Mr. Sparks emailed senior sales executives:

"Please let me know how these are going. I am personally going to work to do a better job making sure you understand the things we are trying to achieve as a business. In addition to this, the super-senior ABX trade [Jonathan] egol sent around and general securities financing trades are priorities for us."2127

¶Mr. Sparks forwarded this email to Mr. Cohn, who responded "Great to see."2128 On September 6, Mr. Sparks emailed the syndicate desk about the "Refresh of Axe Priorities": "Want to get you to send out daily 1-3 priority axes for department – let's discuss."2129

¶Goldman has at times suggested that many of its CDO sales were not the result of affirmative client solicitations and recommendations made by the firm, but were in response to client requests–generally known as "reverse inquiries." In a letter to the Financial Crisis Inquiry Commission, for example, Goldman's General Counsel, Gregory Palm, made the following statement about Goldman's role as an underwriter of synthetic CDOs:

"Goldman Sachs' CDOs containing primarily residential mortgage-related synthetic assets were initially created in response to the request of a sophisticated institutional investor that approached the firm specifically seeking that particular exposure. Reverse inquiries from clients were a common feature of this market. ... These transactions often are initiated by our clients, and when proposed by us are often in response to previously expressed

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investment interests of the client. We are responding to our clients' desires either to establish, or to increase or decrease, their exposure to a position based on their own investment views."2130

¶Mr. Palm's characterization of Goldman as playing only a passive, responsive role is at odds with the firm's documented and concerted efforts to market its CDO securities in the face of investor disinterest and falling values. Throughout 2007, Goldman issued directives to its sales force to sell specific CDO securities on a "first priority" basis. It expanded its selling efforts to "nontraditional buyers" as well as to banks, hedge funds, and other clients in Asia, Europe, and the Middle East. It offered its sales force substantial incentives, such as "ginormous" sales credits, to push the sales to clients.2131 Under its CDO Gameplan, Goldman "targeted" four primary and 35 secondary clients for CDO sales, and celebrated selling CDO securities to several of them. The weight of this evidence demonstrates that Goldman was soliciting sales rather than responding solely to client inquiries.