5 November 2007

Paulson's Focus on Subprime 'Excesses' Shows His Goldman Gorged

By Mark Pittman

Nov. 5 (Bloomberg) -- Treasury Secretary Henry Paulson says the U.S. is examining the subprime mortgage crisis to ensure that ''yesterday's excesses'' aren't repeated. He could be talking about himself and his former firm, Goldman Sachs Group Inc.

Paulson, 61, doesn't mention that Goldman still has on the market some $13 billion of almost $37 billion in bonds backed by subprime loans or second mortgages that it created while he was chief executive officer. Those bonds have an average delinquency rate of almost 22 percent, higher than the average of other subprime bonds from the period, according to data compiled by Bloomberg.

Goldman, the most profitable investment bank, was one of 14 primary dealers of U.S. Treasuries who contributed to a three- year binge as $1 trillion of subprime mortgages were packaged and sold to investors. The value of its remaining subprime bonds trails Lehman Brothers Holdings Inc.'s $33 billion, out of $106.8 billion created during Paulson's years at Goldman, and Morgan Stanley's $28.8 billion, out of $82.5 billion.

''He should admit to having been involved in creating the problem that we have now,'' said Representative Brad Miller, a North Carolina Democrat, who introduced a bill Oct. 22 to make firms packaging subprime mortgages liable for bad loans in some circumstances.

The subprime crisis developed earlier this year when falling home prices triggered defaults by homeowners who wouldn't have normally qualified for a mortgage. Many were unable or unwilling to make adjustable-rate payments that were due to rise. Home foreclosures doubled in the third quarter from a year earlier to 635,159, RealtyTrac reported Nov. 1.

'Largely Contained'

Starting in March, Paulson said the damage was ''largely contained'' and was no risk to the larger economy. When other credit markets began to be affected, he and others began pushing for solutions.

''I can't help but notice that when middle-class homeowners were losing their homes to foreclosure, he was pretty nonchalant about it,'' Miller said of Paulson. ''But when Wall Street CEOs start seeing trouble in their absurdly complicated financial instruments built on the mortgages of middle-class homeowners, he feels their pain.''

Paulson declined to comment through spokeswoman Michele Davis, who said, ''he can't talk about Goldman business.'' Spokesman Michael DuVally of New York-based Goldman declined to say how much subprime mortgages contributed to the investment bank's profits, or Paulson's compensation, during his tenure from May 1999 through June 2006.

Goldman paid Paulson $38.5 million for 2005, and he received an $18.7 million bonus for the first half of last year.

Bet Against Subprime

While competitors reported losses from their subprime portfolios in recent months, Goldman said Sept. 20 that it profited from the market's decline by using derivatives to bet that mortgage securities would continue to fall.

Paulson's involvement in the subprime crisis ''points out that there needs to be complete accountability up and down the system,'' said Allen Fishbein, the director of credit and housing policy at the Consumer Federation of America in Washington. ''Goldman wasn't alone. All the brokerages did this.''

Goldman ranks 10th among 118 issuers, based on the amount of subprime loans still on the market. Bonds with a face value of $484.6 billion remain from those created in the years Paulson ran Goldman.

Market leader Countrywide Financial Corp. has $40.7 billion in subprime bonds still on the market, or 8.4 percent of the total. GMAC LLC's Residential Capital LLC has $34.4 billion. Lehman's $33.1 billion leads Wall Street firms.

Calabasas, California-based Countrywide, the nation's biggest home lender; ResCap, the Minneapolis-based home lending arm of General Motors Corp.'s finance subsidiary; and Goldman were among those competing to create pools of mortgages consisting mostly of subprime loans, made to borrowers with poor credit records or high debt.

Citi, Chase

Goldman has more subprime debt outstanding than Credit Suisse, which has almost $10 billion; Citigroup Inc., with $6.8 billion; or JPMorgan Chase & Co., with $7.8 billion.

The data on subprime bonds, compiled by Bloomberg from reports by debt servicing companies, don't include all of the mortgage bond offerings managed by any of the firms. That's because all of them handle offerings by bond issuers outside of Wall Street, including Irvine, California-based New Century Financial Corp., a subprime lender now in bankruptcy.

The House bill Miller introduced is backed by Representative Barney Frank, the Massachusetts Democrat who is chairman of the Financial Services Committee. One provision would make firms that package and sell subprime mortgages liable for damages if loans violate certain minimum standards, including ensuring a borrower's reasonable ability to repay.

Criticized Liability

Paulson criticized the liability idea in an Oct. 16 speech at Georgetown University in Washington.

''We need to ensure yesterday's excesses are not repeated tomorrow,'' Paulson said. Penalizing Wall Street for packaging mortgage loans ''is not the answer to the problem,'' he said.

The House measure would ''potentially paralyze securitization,'' which, Paulson said, has been ''extremely valuable in extending the availability of credit to millions of homeowners nationwide and lowering the cost of financing.''

In New Delhi on Oct. 30, Paulson repeated his pledge to find what went wrong in the financial system. ''We need to shed light on it and make the policy adjustments so this doesn't happen again,'' he said.

When the subprime mortgage issue exploded as an economic and political issue this year, Federal Reserve Board Chairman Ben S. Bernanke was the federal government's point man. He was called before Congress to defend regulators' failure to prevent lending abuses.

Saving SIVs

Paulson's public role increased in the past month as the credit crunch spread to the commercial paper markets and off- balance-sheet structured investment vehicles, known as SIVs. He urged major lenders in a Sept. 12 meeting in Washington to help subprime borrowers keep their homes.

Paulson and Robert Steel, a former Goldman Sachs vice chairman who is the Treasury's undersecretary for domestic finance, helped persuade Citigroup and other banks to set up an $80 billion partnership to buy assets from any SIVs that couldn't refinance their debt.

Goldman under Paulson created 58 mortgage pools branded under the acronym of GSAMP, which originally stood for Goldman Sachs Alternative Mortgage Products, starting in July 2002. The value of the loans at risk of default is almost 50 percent for one Goldman pool, according to Bloomberg data, which includes pools identified as containing home equity financings as well as subprime mortgages.

Delinquency Rates

The average delinquency rate for subprime bonds sold from May 1999 through June 2006 is 19.3 percent as of yesterday, according to data compiled by Bloomberg. Among the top 20 issuers that have more than $5 billion outstanding, Goldman's GSAMP ranks ninth with 21.7 percent for delinquencies of 60 days or more, foreclosures or real estate that has been taken away from borrowers.

That rate is higher than for JPMorgan, with 20.8, and Citigroup, with 19.9 percent, according to data compiled by Bloomberg through October. Goldman's delinquency rate is lower than the 26.2 percent for bonds in Deutsche Bank AG's ACE trust, as well as 25.1 percent for Barclays Capital's SABR and 23.8 percent for Merrill Lynch's MLMI.

One of Goldman's bonds, GSAMP 2006-HE2 B2, is valued at 47 cents on the dollar, to yield 14.5 percent, according to Merrill Lynch. The pool, which was sold March 1, 2006, already has a delinquency rate of 16.4 percent. The bond was cut five levels from investment-grade Baa2 to a junk rating of B1 on Oct. 11 by Moody's Investors Service.

To contact the reporter on this story: Mark Pittman in New York at mpittman@bloomberg.net .

Last Updated: November 5, 2007 00:20 EST


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