Goldman Steels Itself for a Senate Grilling

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Lloyd C. Blankfein, chairman and chief executive officer of Goldman Sachs Group Inc., center, walks with Gary D. Cohn, Goldman's president and chief operating officer, before a speech by President Barack Obama about financial in New York.

When they appear before the Senate Permanent Subcommittee on Investigations on Tuesday, the bigwigs of Goldman Sachs will try their hardest to scrub away every trace of masters-of-the universe entitlement. As they absorb Senators' barbs, they will likely come off as humble, contrite — and as boring as possible. The hearing, the fourth in a series on the causes and consequences of the financial crisis, will use Goldman as a "case study" to examine the role investment banks played in fueling the sector's near-collapse. With anger over Wall Street bailouts and banker bonuses still bubbling, "case study" is a naked euphemism for "whipping boy," and lawmakers will hurl the usual mix of scripted sound bites, choreographed outrage and probing (often rhetorical) questions at Goldman boss Lloyd Blankfein and his deputies.

"Goldman Sachs was slicing, dicing and selling toxic mortgage-related securities on Wall Street like many other investment banks, but its executives continue to downplay the firm's role in the financial engineering that blew up the financial markets and cost millions of Americans their jobs, homes and livelihoods," Sen. Carl Levin, the Michigan Democrat who serves as subcommittee chairman, said on Monday. "They have a lot to answer for."

Unlike other investment banks, however, Goldman is facing fraud charges filed by the SEC for its role in hawking the synthetic CDO (collaterized debt obligation) known as Abacus 2007-AC1. In this fraught context, the first objective for the seven current and former Goldman employees testifying will be to say nothing that could be potentially incriminating. Peter Henning, a law professor at Wayne State University and former SEC attorney, predicts the witnesses may invoke the pending SEC charges as a way to skirt specifics. "The senators can yell and scream, but there's not much they can do," he says. "To the extent this hearing focuses on the past, it's a waste of time."

Perhaps. But after 18 months exhuming information about Goldman's mortgage-related positions in 2006 and 2007, the subcommittee isn't about to pass up an opportunity to savage the firm for zeroing in on profits even at the cost of its clients' well-being. Marshaling internal e-mails, presentations to the firm's board of directors and employee performance-reviews, the bipartisan investigation claims that Goldman ran a "conveyer belt" of toxic assets that "spread the poison throughout the system" — facilitating risky mortgage loans, inflating the housing bubble, and then capitalizing as it burst by heavily shorting assets it was selling to clients. "The evidence shows Goldman repeatedly put its own interest and profit ahead of the interests of its clients," Levin said on Monday.

Blankfein's prepared testimony, released Monday afternoon, telegraphs the firm's approach to combating the explosive charges. "While we strongly disagree with the SEC's complaint, I also recognize how such a complicated transaction may look to many people. To them, it is confirmation of how out of control they believe Wall Street has become, no matter how sophisticated the parties or what disclosures were made," he is expected to say. "We have to do a better job of striking the balance between what an informed client believes is important to his or her investing goals and what the public believes is overly complex and risky."

The embattled Goldman chief will deny one of the central findings of the subcommittee: that after hedging its long position in late 2006 to limit its exposure to mortgage-related assets, Goldman adopted a substantial short position in early 2007 — one that became hugely lucrative when the market cratered. In a November 2007 e-mail released by the subcommittee, Blankfein wrote, "Of course we did not dodge the mortgage mess. We lost money, then made more than we lost because of shorts. Also, it's not over, so who knows how it will turn out ultimately." The embattled chief will say the firm lost $1.2 billion from its exposure to the housing market: "We didn't have a massive short against the housing market, and we certainly did not bet against our clients." Levin dismissed that contention as a ruse designed to mollify those who got burned. "Were they big-time short in 2007? You betcha," Levin said.

Blankfein is also expected to say that without the trust of its clients, Goldman "cannot survive." The subcommittee, however, makes the case that the firm breached that trust, whether or not it violated the law. The documents it highlighted were plucked from a phonebook-sized tome, and there's little way of knowing how much of the material corroborates Blankfein's statements. But the damaging excerpts, which Levin brandished Monday like an indictment — with text underlined and marked up heavily in green ink — reveal no small amount of backslapping over the firm's shrewd shorts. Among the money quotes are CFO David Viniar wondering "what might be happening to people who don't have the big short"; a 2007 self-evaluation penned by former managing director Joshua Birnbaum in which he credits his influence in positioning Goldman "VERY short" as a key to "our very profitable year"; and a September 2007 board of directors meeting summary that indicates Goldman was "overall net short the mortgage market and thus had very strong results."

Apart from Blankfein, however, the most anticipated witness will be Fabrice Tourre, the lone employee specifically implicated in the SEC's charge. Much of the evidence that Tourre and Goldman misled investors stems from a series of e-mails the young trader, now an executive director in the firm's London office, wrote to a girlfriend. The messages are a riveting amalgam of financial jargon, smug braggadocio and cheesy pillow talk punctuated by way too many exclamation points. "The whole building is about to collapse anytime now ... Only potential survivor, the fabulous Fab ... standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstruosities [sic] !!!" Tourre noted in one widely circulated e-mail. In another, from January 2007, he soldiers through a bout of self-awareness: "Not feeling too guilty about this, the real purpose of my job is to make capital markets more efficient and ultimately provide the US consumer with more efficient ways to leverage and finance himself, so there is a humble, noble and ethical reason for my job. . amazing how good I am in convincing myself!!!"

If Blankfein will attempt to navigate the tightrope between aggressively defending the firm and acknowledging the public's concern, Tourre will likely cite the SEC suit in declining to provide any substantive information, Henning says. "It's a little bit like being yelled at by a teacher," he notes. "You take it, and the next day you move on." The gnawing question for Goldman execs is whether their clients are ready to do the same.