Dan Sparks
The FHFA's massive bank lawsuit extravaganza is a reminder of the horrific behavior that took place inside the subprime mortgage machine: fraud.
In it's lawsuit against Goldman Sachs, the FHFA claims that Goldman directly committed common law fraud, and particularly claims that Goldman "aided and abetted fraud."
This is the second time a government agency has accused Goldman of fraud. It's a big deal.
The agency seeks to recover the damages it sustained as a result of Goldman's wrongdoing, including the amount it paid for the securities ($11.1 billion) plus interest, the amount the value of those securities have lost, and legal fees.
The most serious of the FHFA's 10 causes of action against Goldman is for fraud.
And there are two big reasons why the FHFA says Goldman's actions were fraudulent. In short, they are the money it paid to get a window into the mortgage origination process and Dan Sparks.
Here's the first. From a key sentence in the FHFA lawsuit:
Because the information that Goldman provided or caused to be provided [to ratings agencies] was false, the ratings were inflated... [and] also that Goldman Sachs knew, or was reckless in not knowing, that it was falsely representing the underlying process and riskiness of the mortgage loans... because Goldman’s longstanding relationships with the problematic originators, and its numerous roles in the securitization chain, made it uniquely positioned to know the originators had abandoned their underwriting guidelines... [and because] as a result, the GSEs paid Defendants inflated prices for purported AAA (or its equivalent) Certificates, unaware that those Certificates actually carried a severe risk of loss and inadequate credit enhancement.
The big thing here is that Goldman funded mortgage originators, who encouraged property appraisers to inflate home values by firing them if they didn't and gave half million dollar loans to people like hairdressers and gardeners.
The other main reason Goldman is getting sued for fraud is that some of its employees signed the "shelf registration documents" registering the securities for multiple issuance with the SEC.
The FHFA alleges that those employees made false statements and omitted facts such as:
A number of the properties were stated as "owner-occupied" when in fact they were second homes or investment properties. (The FHFA says this is material because a borrower who lives in a mortgaged property is less likely to stop paying their mortgage and thus a better investment.)The mortgage loans' Loan-To-Value (LTV) ratios, key numbers in determining the risk of a mortgage loan, were said in Prospectus Supplements to have ratios of 80% or less (meaning that the borrower got a loan for less than their house is worth -- a much more attractive investment than a borrower who took out a loan for more than their house is worth) when in fact many were higher because the appraised values given to the homes were significantly than the actual value of the homes.And those documents, which were key in determining the value of the securities sold to Fannie and Freddie, are alleged to have been manufactured fraudulently by Goldman and its employees.The reason Goldman the company is sued for manufacturing these documents and not the people named seems to be that Goldman 1) provided money to the mortgage originators so that they would grant more mortgages to borrowers and sell them to Goldman to securitize, 2) incentivized its employees to securitize and sell as many loans as quickly as possible*, and 3) that there was "significant overlap between the management of the Goldman Sachs Group and the directors and officers of GS Mortgage Securities," meaning basically that Goldman made mortgages a big part of its business.
(In fact, in subprime RMBS securitizations, Goldman's deal volume increased from $2.1 billion in 2003 to $9.7 billion in 2004, to $14.5 billion in 2005 to $15 billion in 2006. And in ALT-A RMBS securitizations, Goldman's deal volume increased from $3.8 billion in 2004 to $10.4 billion in 2005 to $20.5 billion in 2006, according to the lawsuit.)
Goldman is also on the hook because it saw the poor quality of the loans it bought from the mortgage originators it funded (the lawsuit says Goldman received daily updates on how many loans were delilquint), retained third-party due diligence providers to analyze those loans that it considered securitizing regardless of the delinquinces (a smart move considering that it might have absolved Goldman of responsibility for any poor-quality loans in the Securitizations) but Goldman didn't listen to the companies' recommendations to exclude a significant number of loans. Goldman included the loans in its Securitizations anyway. Then it got the ratings agencies to rate them attractively. But it stated in offering documents that the loans had generally met the guidelines of the due diligence review.
Our takeaways: Dan Sparks is full-on attacked in the lawsuit. The FHFA basically blames the rot of Goldman's mortgage business on him and his team's "traveling the world" to "make some lemonade from some big old lemons" (his words).
Of all the Goldman employees named as defendants, Sparks is the bad guy this time. The others are barely mentioned.
It's the FHFA's imperative to encourage the mortgage industry to support a robust housing market. So at first it might seem that the lawsuits are counter-productive for discouraging lending during a time when already, few are lending.
And in a way, it is. But the FHFA lost billions. And they're a regulator that has to disincentivize fraud, which of course makes home buyers wary of the housing market.
This lawsuit, and any others that might follow, help achieve that goal.
Endgame: It seems like a settlement is coming.
It's a hard sell, to us at least, that Goldman can be found directly at fault for Fannie and Freddie's losses because 1) No matter who it paid to do so, Goldman didn't originate most of the loans, and that's where the real fraud took place; 2) Fannie and Freddie should have investigated the quality of the loans before investing in them (although the FHFA says it could not have known); and 3) Much of the blame is on this system that created impossible loans to pay off so that someone would actually invest in those loans (incredible yield) so that it could grant loans to people who couldn't pay them off because discriminating against poor people was litigously discouraged back in 1992.
This lawsuit certainly spells out Goldman's role in each step of that system (Using evidence from the lawsuit, we could probably create a flip book of Sparks blazing the trail for each of them), but Fannie and Freddie remain "sophisticated investors."
* The lawsuit says "Defendants had enormous financial incentives to complete as many offerings as quickly as possible without regard to ensuring the accuracy or completeness of the Registration Statements or conducting adequate and reasonable due diligence... if for no other reason than to quickly get them off Goldman's books."
In reality Goldman and its employees had two incentives:
1. GS Mortgage Securities was paid a percentage of the total dollar amount of the offering whenever the Securitization was complete, if GSMS was the depositor (and it was in most of the relevant instances in this lawsuit regarding securities that Fannie and Freddie invested in).
2. GS, the underwriter, got a commission based on how much it sold the Certificates for.
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