WASHINGTON -- In 2006 and 2007, Goldman Sachs Group peddled more than $40 billion in securities backed by at least 200,000 risky home mortgages, but never told the buyers it was secretly betting that a sharp drop in U.S. housing prices would send the value of those securities plummeting.
Goldman Sachs' sales and its clandestine wagers on falling home prices, completed at the brink of the housing market meltdown, enabled one of the nation's premier investment banks to pass most of its potential losses to others before a flood of mortgage loan defaults staggered the U.S. and global economies.
Only later did investors discover that what Goldman Sachs promoted as triple-A investments were closer to junk.
Now, pension funds, insurance companies, labor unions and foreign financial institutions that bought those dicey mortgage securities are facing large losses. A five-month McClatchy Newspapers investigation has found that Goldman Sachs' failure to disclose that it made secret, exotic bets on an imminent housing crash may have violated securities laws.
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"The Securities and Exchange Commission should be very interested in any financial company that secretly decides a financial product is a loser and then goes out and actively markets that product or very similar products to unsuspecting customers without disclosing its true opinion," said Laurence Kotlikoff, a Boston University economics professor who's proposed a massive overhaul of the nation's big banks. "This is fraud and should be prosecuted."
John Coffee, a Columbia University law professor who served on an advisory committee to the New York Stock Exchange, said investment banks have wide latitude to manage their assets, and so the legality of Goldman Sachs' maneuvers hinges on what its executives knew at the time.
"It would look much more damaging," Coffee said, "if it appeared that the firm was dumping these investments because it saw them as toxic waste and virtually worthless."
Lloyd Blankfein, Goldman Sachs' chairman and chief executive, declined to be interviewed for this article.
A Goldman Sachs spokesman, Michael DuVally, said the firm decided in December 2006 to reduce its mortgage risks and did so by selling subprime-related securities and making myriad insurancelike bets, called credit-default swaps, to hedge against a housing downturn.
Although the company had secretly bet on a downturn, DuVally said Goldman Sachs "had no obligation to disclose how it was managing its risk, nor would investors have expected us to do so. ... Other market participants had access to the same information we did."
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In piecing together Goldman Sachs' role in the subprime meltdown, McClatchy reviewed hundreds of documents, SEC filings, copies of secret investment circulars and lawsuits, and interviewed numerous people familiar with the firm's activities.
McClatchy's inquiry found that Goldman Sachs:
Bought and converted into high-yield bonds tens of thousands of mortgages from subprime lenders that became the subjects of FBI investigations into whether they'd misled borrowers or exaggerated applicants' incomes to justify making hefty loans.
Used offshore tax havens to shuffle its mortgage-backed securities to institutions worldwide, including European and Asian banks, often in secret deals run through the Cayman Islands, a British territory in the Caribbean used by companies to bypass U.S. disclosure requirements.
Has dispatched lawyers across the country to repossess homes from bankrupt or financially struggling owners, many of whom lacked sufficient credit or income but got subprime mortgages because Wall Street made it easy for them to qualify.
With the help of more than $23 billion in direct and indirect federal aid, Goldman Sachs appears to have emerged intact from the economic implosion, and by repaying $10 billion in direct federal bailout money -- a 23 percent taxpayer return that exceeded federal officials' demand -- the firm has escaped tough federal limits on 2009 executive bonuses that accompanied bailout money.
It announced record earnings in July, and is on course to surpass $50 billion in revenue in 2009 and pay its employees more than $20 billion in year-end bonuses.
From 2001 to 2007, Goldman Sachs hawked at least $135 billion in bonds keyed to risky home loans, according to analyses by McClatchy and the industry newsletter Inside Mortgage Finance.
Its financial panache made its sales pitches irresistible to policy-makers and investors alike, and helps explain why so few of them questioned the risky securities Goldman Sachs sold off in a 14-month period that ended in February 2007.
Since the collapse of the economy, however, some investors have changed their views of Goldman Sachs.
Several pension funds, including Mississippi's Public Employees' Retirement System, have filed lawsuits, seeking class-action status, claiming that Goldman Sachs and other Wall Street firms negligently made "false and misleading" representations of the bonds' true risks.
Mississippi Attorney General Jim Hood, whose state lost $5 million of the $6 million it invested in Goldman Sachs' subprime mortgage-backed bonds in 2006, said the state's funds are likely to lose "hundreds of millions of dollars" on those and similar bonds.
California's huge public employees retirement system, known as CalPERS, purchased $64.4 million in subprime mortgage-backed bonds from Goldman Sachs on March 1, 2007. In July, CalPERS listed the bonds' value at $16.6 million, a drop of nearly 75 percent, according to documents obtained through a state public records request.
In May, without admitting wrongdoing, Goldman Sachs became the first firm to settle with the Massachusetts attorney general's office as it investigated Wall Street's subprime dealings. The firm agreed to pay $60 million to the state, most of it to reduce mortgage balances for 714 aggrieved homeowners.
McClatchy Newspapers researcher Tish Wells contributed to this report.