Blankfein was the CEO of Goldman Sachs during the financial crisis. In the years leading up to the crisis, groups in Goldman apparently worked with some of their biggest customers, John Paulson for example, to create mortgage bonds that were basically designed to fail. A mortgage bond is a collection of a large number of individual mortgages. The “owner” of a mortgage bond receives the payment of the mortgages that make up the bond. Goldman, along with a few of their most select customers, structured bonds to include enough bad mortgages to virtually guarantee the entire bond would fail. Mortgage bonds were highly leveraged, and if as little as 3-4% of the individual mortgages in a mortgage bond defaulted, the entire bond would often fail.
After a mortgage bond of this type – which had essentially been designed to fail – had been created, these select customers would then purchase “insurance” on the bonds. This “insurance” was purchased through complicated derivative investments. The largest seller of mortgage bond insurance was AIG and they lost more than $60-billion on the mortgage bond insurance they sold. The analogy of these derivative investments as “insurance” only goes so far. When the typical homeowner purchases fire insurance, they are not upset at the end of the year when their house doesn’t burn down. However, the investors who purchased insurance on mortgage bonds were hoping that the mortgage bond would collapse. For perhaps $30-million a year in premium payments, a potential windfall of $1-billion could be produced if the bond went into default. It was this enormous potential return that drove Goldman and some of its largest clients to create mortgage securities designed to fail.
Among the most notorious trades Goldman found itself in during the housing bubble era was one involving a security named ABACUS 2007-AC1. In the “ABACUS” trade, Goldman – working with Paulson – created a mortgage bond designed to fail. The patsies – who took the other side of the trade or “side bet” on whether this mortgage bond would collapse or not – were two European banks straight out of central casting, IKB of Germany and ABN AMRO of the Netherlands. Some hayseed - falling off a turnip truck and spending his first day in New York City - would have better luck buying Rolex watches in a Port Authority bus terminal bathroom than these two European banks would ever have buying mortgage bonds from Goldman on Wall Street. Exactly as planned, when the trade was over Paulson found himself up $1-billion and the banks were out $1-billion. Eventually, the nature of the trade – and the many others like it – began to become known outside Wall Street. As more and more people realized what business as usual amounted to on Wall Street, the outrage was palpable.
In such an environment, the government was forced to do something. However, “something” did not constitute going after any of the senior executives at Goldman. Instead, the only individual to face any type of censure over the ABACUS deal was another European patsy – a mid-level Goldman employee and fall guy, Fabrice “Fabulous Fab” Tourre. Eventually, Goldman did pay a $5-billion fine to the Justice Department in 2016 for all its mortgage related shenanigans. While that sounds like a lot of money, it is dwarfed by the $14-billion Goldman received from the Fed in 2008 when the feckless Tim Geithner (#24) decided to pay AIG’s creditors at par.
Placing the interest of some clients below the interests of other, “more select,” clients is only one part of the problem with the Goldman “culture” under Blankfein. Perhaps the most damning aspect of Goldman’s mortgage trading under Blankfein was its “zero sum gain” nature. If not the most damning aspect, the zero-sum aspect is certainly the most incongruous aspect of Goldman’s culture under Blankfein with the traditional role of finance.
Historically, Wall Street finance was where the accumulated savings of society were allocated to investors needing capital. The allocation of capital from savers to investors is of fundamental importance to capitalism. After all, they don’t call it capitalism for nothing! Finance of this type was a means to an end, not an end in itself. By performing its historic role, Wall Street finance allowed savers, investors and society as a whole to benefit. Banking was an honorable profession, full of honorable people. As Goldman’s trade in mortgage bonds clearly shows, this traditional, mutually beneficial and honorable role of finance is long gone. It has been replaced by a type of finance which has nothing to do with a socially desirable end. In finance today, for every winner there must be a loser. As a direct consequence of this, banking is no longer filled with honorable people. Banking is now filled with hucksters like Lloyd Blankfein.
Since 1990 the following “men” have held the position of Goldman Sachs CEO – Robert Rubin (#41), Steve Friedman (#22), Jon Corzine (#13), Henry Paulson (#38) and Lloyd Blankfein. Rubin (Yale), Friedman (Columbia) and Blankfein (Harvard) are all lawyers and all worked at law firms immediately after graduating Ivy League law schools. As their mortgage bond trades and the legal background of the majority of their CEOs clearly demonstrates, Goldman Sachs isn’t even remotely involved with banking in any sort of traditional, mutually beneficial sense. Like the rest of what passes for finance on Wall Street today, Goldman seems to place a very high premium on parsing the letters of the law to develop new and inventive ways to bilk people. By that standard, Goldman is – far and away – the most successful firm on Wall Street.
For the inexcusable decision to pay AIG’s creditors, like Goldman, full price for their mortgage bond insurance policies, see Tim Geithner (#24). For more information on the trade in mortgage bond insurance, see Gary Gorton (#27). See Mark Rubinstein (#42) for the genesis of how finance lost its way.