All the Devils Are Here [170]
If the job of a market maker is to sit between two investors, each of which affirmatively wants to take a different view, the Hudson deal didn’t come close to that definition. Nor is it possible to argue that Goldman was doing something its clients were clamoring for. Rather, it was a deal Goldman had to sell, and sell hard, to reluctant clients. Swenson would later write about such deals, “[W]e aggressively capitalized on the franchise to enter into efficient shorts....”
Later, as Hudson and other deals went sour, Goldman’s clients were furious at how they had been taken in. “Real bad feeling across European sales about some of the trades we did with clients,” wrote Yusuf Aliredha, Goldman’s head of European fixed-income sales, in an e-mail to Sparks. “The damage this has done to our franchise is very significant.”
On December 5, 2006, just before noon, Dan Sparks sent an e-mail to his bosses, Tom Montag, head of sales and trading in the Americas, and Rich Ruzika, co-head of global equity trading. “Subprime market getting hit hard—hedge funds hitting street, wall street journal article.” (He was referring to a Wall Street Journal story published that morning about how subprime borrowers were increasingly falling behind on their mortgages.) “At this point we are down $20 mm today. Structured exits are the way to reduce risk.”
More and more traders on the mortgage desk were getting increasingly uncomfortable being on the long side of the mortgage markets—the Hudson deal had shown that. Individual traders were even shorting mortgage securities. Yet as a firm, Goldman still had a large overall long position. At the end of November, the firm had $7.8 billion in subprime mortgages on its balance sheet, and another $7.2 billion in subprime mortgage-backed securities. Goldman also had a big long position in the ABX index, as well as warehouse lines extended to New Century, among others. The gossip among traders at other firms was that Goldman Sachs was heavily exposed to the mortgage market—and they were right. But they couldn’t see inside Goldman Sachs.
Roughly a week after Sparks’s e-mail, CFO David Viniar convened a meeting in his office. Even though Goldman’s internal risk measures, such as VaR, suggested that everything was okay, the mortgage desk had nonetheless suffered losses ten days running. Gary Cohn, as president, would later testify that the firm’s internal risk models had “decoupled” from the actual results in December 2006. Goldman’s top executives were sensitive to the losses because the firm was fanatical about using mark-to-market accounting, valuing the securities it held daily, based on the price they would get if they sold the securities in the market that day. They reflected any gains or losses on the firm’s books, and reported this information to Viniar and Goldman’s other top executives. Unlike every other firm on Wall Street, in other words, Goldman had no illusions about how its mortgage-related securities were performing.
The group that met that day included Viniar, Sparks, and various members of “the Federation,” the back office risk managers and accounting people. They reviewed Goldman’s exposures, including that ABX position, the securities, the warehouse lines—and the bad loans that Goldman was trying to get New Century and other originators to repurchase. Out of that meeting came a mandate from the top that the firm needed to “get smaller, reduce risks, and get closer to home,” as Birnbaum later put it. It was agreed that Goldman would pull back from its long position so that the firm wouldn’t get caught if the mortgage market continued to sink, as the firm now expected. In an e-mail, Sparks listed his follow-ups, which included “Reduce exposure, sell more ABX index outright,” and “Distribute as much as possible on bonds created from new loan securitizations and clean previous positions.” The next day, Viniar chimed in: “[L]et’s be very aggressive distributing things because there will be