Goldman Sachs gave little warning of risk to investors

NEW YORK - When financial titan Goldman Sachs joined some of its Wall Street rivals in late 2005 in secretly 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 Newspapers has obtained documents that provide a closer look at the shadowy $1.3 trillion market since 2002 for complex offshore deals, which Chicago financial consultant and frequent Goldman Sachs critic 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, at the crest of the booming market for subprime mortgages to marginally qualified borrowers.

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 Sachs 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, might 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 Sachs well after the performance of many offshore deals weakened significantly beginning in June 2006.

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

These Cayman Islands deals, which Goldman Sachs assembled through the British territory in the Caribbean, a haven from U.S. taxes and regulation, became key links in a chain of exotic insurance-like bets called credit-default swaps. These swaps worsened the global economic collapse by enabling major financial institutions to take bigger and 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 their houses, cars and college educations, said Gary Kopff, a financial services consultant and the president of Everest Management Inc. in Washington, D.C. The offshore deals, he lamented, "became the biggest contributors to the trillions of dollars of losses" in 2008's global meltdown.

While Goldman Sachs wasn't alone in the offshore deal-making, it was the only big Wall Street investment bank to exit the subprime mortgage market safely, and it played a pivotal role, hedging its bets earlier and with more parties than any of its rivals did.

McClatchy reported on Nov. 1 that in 2006 and 2007, Goldman Sachs 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 secretly 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 Caymans deals.

At the time, Goldman Sachs' chief spokesman, Lucas van Praag, dismissed as "untrue" any suggestion that the firm had misled the pension funds, insurers, foreign banks and other investors that bought those bonds. Two weeks later, however, Chairman and CEO Lloyd Blankfein publicly apologized -- without elaborating -- for Goldman Sachs' role in the subprime debacle.

Goldman Sachs' 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. Spokesmen for Goldman Sachs and the SEC declined to comment on the inquiry.

Goldman Sachs' defenders argue that the legendary firm's relatively unscathed escape from the housing collapse is further evidence that it's smarter and quicker than its competitors. 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 Sachs 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 Sachs deals in that period involved mortgages and other consumer loans and are still sheltered by the Caymans' opaque regulatory apparatus.

Tavakoli, an expert in these types of securities, said it's time to start discussing "massive fraud in the financial markets" that she said stemmed from these offshore deals.

"I'm talking about hundreds of billions of dollars in securitizations," she said, without singling out Goldman Sachs or any other dealer. "We nearly destroyed the global financial markets."