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Are Goldman's 'Big Short' Denials Short on Persuasiveness?

Goldman Sachs dd nothing illegal in shorting the market, but it has a lot of persuading to do if it expects people to believe it wasn't happy to see the housing market tank.

While all eyes are turned to the grilling that seven current or ex-Goldman Sachs representatives are getting before the Senate investigations subcommittee today, much of the back and forth can be summarized thus:

Members of the subcommittee -- particularly Sen. Carl Levin -- accused investment bank Goldman Sachs of shorting the mortgage market. Goldman -- from CEO Lloyd Blankfein on down -- maintained that it wasn't, and that it lost money in many of the transactions.

Shorting, or betting against the market, is neither illegal nor is it even the focus of the SEC's lawsuit against Goldman, which instead hinges on the issue of disclosure. As we've pointed out in our reporting on Magnetar, short bets can even be helpful, and can keep bubbles from expanding, so long as disclosure is complete and deals are not being created for the purpose of shorting them.

In the court of public opinion, however, bets against desperate homeowners aren't the best PR for companies like Goldman, especially when they're accused of betting against their own clients. The investment bank is still trying to stave off waves of public rage following news of the SEC's fraud charges filed two weeks ago.

Since then, the investigation has broadened. Now it's not just the now-infamous Abacus 2007-AC1 deal -- the one that the SEC is suing over -- at the center of the subcommittee's questioning, nor is it the 25 Abacus CDO deals Goldman struck. The investigations subcommittee has also fingered several other Goldman CDO deals (PDF), arguing that e-mails about those deals show that Goldman was, in fact, net short overall.

In his prepared statement (PDF),  Blankfein maintained that "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."

And yet e-mails released by the subcommittee yesterday appeared to show that Goldman was aggressively trying to sell off its long position in many of these CDOs in 2006 and 2007.

With one deal called Timberwolf, for instance, Dan Sparks -- head of Goldman's mortgage department, and one of the executives testifying today -- sent an e-mail promising "ginormous credits" for selling off the securities in Timberwolf. From a document released by the Senate subcommittee that summarizes the new email exhibits:

A congratulatory email was sent to an employee who sold a number of the securities: "Great job ... trading us out of our entire Timberwolf Single-A position."

The CDO then flunked on investors:

In mid-spring, Goldman Sachs sold about $300 million of Timberwolf securities to Bear Stearns Asset Management, one of the offshore hedge funds that collapsed during the summer. Within five months of issuance, the CDO lost 80 percent of its value, and was later liquidated in 2008. The AAA securities issued in March 2007, were downgraded to junk status in just over a year. The Goldman trader responsible for managing the deal later characterized the day that Timberwolf was issued as "a day that will live in infamy." A senior Goldman executive described the deal as follows: "Boy that timeberwof [sic] was one shi**y deal."

Goldman Sachs, meanwhile, held the short position on many of the securities in Timberwolf. Its effort to offload securities that it knew posed a high risk of going bad is similar to what it did with the Abacus deal, according to this description in The New York Times:

But almost from the start, Goldman tried to unload its stake in the Abacus investment, according to two people with direct knowledge of the matter. The bank suffered losses because it couldn't find investors who would pay what Goldman wanted for the final vestiges of the deal, these people said.

It's unclear whether the subcommittee subpoenaed financial records showing Goldman’s net trading positions, but its questioning of the Goldman representatives today concentrated on the e-mails as evidence.

In their testimony today, many of the Goldman execs stated that the company was trying to stay "close to home," or balance out its short and long positions. Apparently not everyone in the company was on board with the strategy, according to the e-mails in the subcommittee's document:

Two top Goldman mortgage traders, Michael Swenson and Joshua Birnbaum, discussed in their 2007 performance self-evaluations the "very profitable year" and "extraordinary profits" that came from shorting the mortgage market that year. One bragged about "aggressively" entering into "efficient shorts in both the RMBS and CDO space," while the other reported that "contrary to the prevailing opinion" that the firm needed only to "get close to home," he "concluded that we should not only get flat, but get VERY short."

Now, the bank's position seems to be that the same strategy one top executive called "the big short" in 2007 was simply a reasonable effort to manage risk.

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