As the subprime crisis was emerging on Wall Street, Goldman Sachs sold a client a slice of a complex security at a price nearly 50 percent higher than what the firm valued at for itself, according to a new Senate report on the origins of the financial crisis. Last week, another bank settled a similar case with securities regulators who accused it of "violating basic investor protection rules."
In July 2007, Goldman sold Bank Hapoalim a $9 million slice of Timberwolf, a $1 billion instrument linked to subprime mortgages, at about 78 cents on the dollar. The Israeli-based bank did not know that Goldman's internal valuations at the same time pegged the slice at just 55 cents on the dollar.
The purchase -- the Israeli lender bought it at a 42 percent premium -- is similar to one made by the Zuni Indian Tribe, which bought a comparable financial instrument from Wachovia in 2007 at 90-95 cents on the dollar even though the seller of the instrument, Wachovia, valued it on its own books before the sale at just 52.7 cents on the dollar.
In that case, Wells Fargo, which took over Wachovia, was ordered to pay an $11 million fine by the Securities and Exchange Commission. In announcing the settlement, SEC director of enforcement Robert Khuzami said the lender violated a basic rule: "Don't charge secret excessive markups, and don't use stale prices when telling buyers that assets are priced at fair market value."
In this case, the SEC declined to comment, though it's been widely reported to be investigating such cases. Goldman Sachs declined to comment. Bank Hapoalim did not return a call seeking comment.
The revelations are among a trove of findings discovered by the Senate Permanent Subcommittee on Investigations after a two-year probe into Wall Street's role in causing the crisis. The panel accused Goldman of deceiving clients, betting against them and profiting off their losses.
In the case involving the Israeli lender, Goldman withheld its internal valuations showing the securities were losing value, declined to tell the bank and other customers that it was betting the security would lose value and profited at the expense of its clients, who didn't know they were buying "poor quality assets at inflated prices," according to the report.
In the SEC's case against Wells Fargo, the regulator charged that the lender sold the securities knowing the prices it charged were excessive, according to the regulatory order describing the scheme.
Whether Goldman will face sanctions for its dealings with Bank Hapoalim is another matter.
"If someone has a security on their books at 50 cents on the dollar, then is marking it up to 90 cents on the dollar, well that just sounds like they're taking advantage of the person, and it's excessive," said Allen D. Madison, a visiting professor at the University of Idaho College of Law who studies securities law.
Goldman's alleged mark-up was smaller, though.
"It's very subjective," Madison acknowledged.
Wall Street veterans, though, say Goldman's behavior is to be expected. There's no price transparency, and firms are at the mercy of the biggest banks.
"If there had been a transparent valuation paradigm ... this never would have happened," said Sylvain Raynes, a founding principal of R&R Consulting in New York and a structured finance expert. "You could never sell something worth 55 for 78 with full symmetry of information. If you could, I have a bridge for sale."
Raynes said firms like Goldman likely value securities based on the conditions in the market, "but only a few people are privy to these conditions in real time," he added.
Thus, investors and traders at smaller firms can often lose out. "This can only exist in a world like finance where reality is what a few people say it is," Raynes said.
A few weeks before the Israeli bank bought a slice of Timberwolf, Thomas Montag, a top Goldman executive, referred to the security as "one shitty deal," according to an internal email obtained by Senate investigators.
Goldman kept marketing Timberwolf to its clients after that comment.
This story was updated to reflect the following correction: Goldman sold the Timberwolf slice to Bank Hapoalim in July, not May. Montag's comments therefore came a few weeks before the sale, not after.