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The Honolulu Advertiser
Posted on: Sunday, January 3, 2010

Goldman off-shore deals deepened global crisis


By Greg Gordon
McClatchy-Tribune News Service

NEW YORK When Goldman Sachs joined some of its rivals in 2005 in packaging a new breed of offshore securities, it gave prospective investors little hint that many of the deals were so risky that they could end up losing hundreds of millions of dollars.

McClatchy-Tribune News Service has obtained previously undisclosed documents that provide a closer look at the $1.3 trillion market since 2002 for complex offshore deals, which Chicago financial consultant Janet Tavakoli said at times met "every definition of a Ponzi scheme."

The documents include the offering circulars for 40 of Goldman's estimated 148 deals in the Cayman Islands over a seven-year period, including a dozen of its more exotic transactions tied to mortgages and consumer loans that it marketed in 2006 and 2007, the crest of the market for subprime mortgages.

In some of these transactions, investors not only bought shaky securities backed by residential mortgages, but also took on the role of insurers by agreeing to pay Goldman and others massive sums if risky home loans nose-dived in value as Goldman was effectively betting they would.

Some of the investors, including foreign banks and even Wall Street giant Merrill Lynch, may have been comforted by the high grades Wall Street ratings agencies had assigned to many of the securities. However, some of the buyers apparently agreed to insure Goldman well after the performance of many offshore deals weakened significantly beginning in June 2006.

Goldman said those investors were fully informed of the risks they were taking.

These Cayman Islands deals, which Goldman assembled through the British territory in the Caribbean, a haven from U.S. taxes and regulation, became key links in a chain of exotic insurancelike bets called credit-default swaps that worsened the global economic collapse by enabling major financial institutions to take bigger risks without counting them on their balance sheets.

The full cost of the deals, some of which could still blow up on investors, may never be known.

Before the subprime crisis, the U.S. financial system had used securities for 40 years to generate $12 trillion to help Americans finance houses, cars and college educations, said Gary Kopff, a financial services consultant and the president of Everest Management Inc. in Washington. The offshore deals, he lamented, "became the biggest contributors to the trillions of dollars of losses" in 2008's global meltdown.

While Goldman wasn't alone in the offshore deals, it was the only big Wall Street investment bank to exit the subprime mortgage market safely and played a pivotal role. McClatchy reported on Nov. 1 that in 2006 and 2007, Goldman peddled more than $40 billion in U.S.-registered securities backed by at least 200,000 risky home mortgages, but never told the buyers it was betting that a sharp drop in U.S. housing prices would send the value of those securities plummeting. Many of those bets were made in the Cayman deals.

At the time, Goldman's chief spokesman, Lucas van Praag, dismissed as "untrue" any suggestion that the firm had misled the investors that bought those bonds. Two weeks later, however, Chairman and Chief Executive Lloyd Blankfein publicly apologized for Goldman's role in the subprime debacle.

Goldman's wagers against mortgage securities similar to those it was selling to its clients are now the subject of an inquiry by the Securities and Exchange Commission, according to two people familiar with the matter who declined to be identified. Spokesmen for Goldman and the SEC declined to comment on the inquiry.

Goldman's defenders argue that the firm's escape from the housing collapse is further evidence that it's smarter and quicker than its rivals. Its critics, however, say that the firm's behavior in recent years shows that it has slipped its ethical moorings; that Wall Street has degenerated into a casino in which the house constantly invents new games to ensure that its profits keep growing; and that it's high time for tougher federal regulations.

In 2006 and 2007, as the housing market peaked, Goldman underwrote $51 billion of deals in what mushroomed into an under-the-radar, $500 billion offshore frenzy, according to data from the financial services firm Dealogic.

At least 31 Goldman deals in that period involved mortgages and other consumer loans and are still sheltered by the Caymans' opaque regulatory apparatus.