McClatchy Newpapers has reported that Goldman Sachs sold more than $57 billion of risky, mortgage-backed securities in fourteen months in 2006 and 2007. The bank unloaded its unwanted exposure on unsuspecting foreign investors and avoided major losses that plagued many of its competitors during the financial crisis.
In one $2 billion deal, made in 2006, Goldman offered sophisticated US and European investors an opportunity to purchase shares in a pool of supposedly high-grade bonds. These bonds were backed by residential, commercial, and student loans. The bank avoided regulation by conducting the transaction through a shell company in the Cayman Islands, which was outside the jurisdiction of regulators like the SEC. It was through deals like this Cayman offering that Goldman was able to ditch its subprime mortgage business before that market collapsed.
A bond analyst quoted in a McClatchy article said, “[The offering is] a not so cleverly disguised way for Goldman Sachs & Co. to unload its unwanted exposures to the subprime real estate market onto foreign investors.” In the course of its research, Greg Gordon of McClatchy found at least two instances in which Goldman mislead investors. The firm said that one investment had $65.3 million in securities backed by “prime” mortgages, when in reality those loans were labeled a step below prime. In another instance, Goldman listed $10 million in loans as “midprime”. Those loans actually had been made to subprime borrowers.
This Cayman deal is but one of dozens made in the Caribbean and offers an example of how US financial institutions do business in unregulated, hidden markets to avoid restrictions to protect investors. A Treasury Department report found that as of June 30, 2008, $164 billion in US mortgage-backed securities were held in the Cayman Islands and $22 billion more were held in Luxembourg, another tax-free zone. Many of these subprime securities were eventually sold to Eastern European governments, such as Romania, Bulgaria, Slovakia, and Slovenia.
In addition to exaggerating the quality of the underlying assets and selling these mortgage pools offshore, Goldman subsequently made huge bets that the securities would lose value. The investment bank bought credit-default swaps, which insure against the possibility of the assets defaulting. Every such bet on a London-based subprime exchange was on a basket of bonds that included a bundle of its own subprime-related securities. Thus, Goldman was able to sell misleading mortgage-backed securities, and then make enormous bets that would pay off if the securities lost value.
The 2006 Cayman deal was circulated under the names of Cayman-based Altius III Funding Ltd. and created for the sole purpose of facilitating the transaction. This offering was met with scorn from analysts. One analyst wrote, “[Goldman is] a single underwriter solely interested in pushing its dirty inventory onto unsuspecting and obviously gullible investors’.In this case, it is a foregone conclusion that many relatively senior bondholders will suffer severe losses.”
The bank made another private deal in May 2007 through the Cayman Islands. In it, Goldman sold $44.6 million in bonds related to subprime loans written by New Century Financial. A few weeks earlier, that bank was closed by California regulators and filed for bankruptcy protection.
Foreign and institutional investors were lured by these funds’ AAA rating. A former analyst for the largest US rating firm, Moody’s Investors Service, Sylvain Raynes said hiring a ratings agency was like hiring a “high-class escort service.” Raynes said that the investment banker would meet with analysts, describe the asset, and “propose his dream result’.The agency would call back after the meeting and intimate that they ‘could get there’ sight unseen. Both parties understood what that meant, and the agency would be hired to rate the deal.”
Many US pension funds lost money on subprime mortgage-backed bonds. These institutions have filed suits accusing Goldman, Morgan Stanley, and Merrill Lynch of failing to disclose the true risks associated with investing in the funds. European institutions that invested heavily in these funds have been more conservative in evaluating their alternatives.
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