Goldman's Blankfein: 'We Certainly Did Not Bet Against Our Clients'

The day the Securities and Exchange Commission brought fraud charges against The Goldman Sachs Group (GS) "was one of the worst days in my professional life," Goldman Sachs Chairman and CEO Lloyd Blankfein said Tuesday in prepared testimony to a Senate subcommittee.

"We believe deeply in a culture that prizes teamwork, depends on honesty and rewards saying no as much as saying yes," according to the prepared remarks that will be delivered before the Senate Homeland Security and Governmental Affairs Permanent Subcommittee on Investigations Tuesday. Blankfein and other Goldman executives are being grilled by lawmakers on the role Goldman Sachs played in the financial crisis.

"We have been a client-centered firm for 140 years and if our clients believe that we don't deserve their trust, we can not survive," Blankfein said.

Goldman Sachs "strongly" disagrees with the SEC complaint, he said, but added, "I also recognize how such a complicated transaction may look to many people. To them, it is a confirmation of how out of control they believe Wall Street has become, no matter how sophisticated the parties or what disclosures were made. 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."

Documents Shows Goldman Bet Against the Housing Market

On April 16, the SEC charged Goldman Sachs with securities fraud for its role in offering collateralized debt obligations based on mortgages -- securities the firm itself bet against. The deal cited in the SEC case was with a German bank.

In a press conference Monday, Sen. Carl Levin (D-Mich.) outlined more than 500 pages of evidence compiled by the subcommittee he chairs that show, contrary to the firm's public statements, starting in late 2006 and continuing through 2007, Goldman Sachs moved away from investing in the mortgage market to betting against that market by shorting securities backed by subprime mortgages.

But Blankfein said his company "didn't have a massive short against the housing market and we certainly did not bet against our clients." He said the company was not consistently or significantly net short in its residential mortgage-related products in 2007 and 2008.

During the two years of the financial crisis, while Goldman was profitable, it lost about $1.2 billion from its activities in the residential housing market, he said.

The chief mistake of investment banks, rating agencies and regulators in the financial crisis was that they failed to "sound the alarm that there was too much lending and too much leverage in the system," and that credit had become too cheap, Blankfein said. "One consequence of the growth of the housing market was that instruments that pooled mortgages and their risk became overly complex. That complexity and the fact that some instruments couldn't be easily bought or sold compounded the effects of the crisis," he said.

Goldman's Hedges Were Designed to Reduce Firm's Overall Risk

Blankfein claimed that "until recently, most Americans had never heard of Goldman Sachs or weren't sure what it did." He stressed that his company employs 35,000 people, most of whom work in the United States, that it helps "governments raise capital to fund schools and roads," and provides funds to companies "to invest in their growth." Goldman works with pension funds, labor unions and university endowments, and it contributes to liquidity in the financial system, he said.

"I recognize, however, that many Americans are skeptical about the contribution of investment banking to our economy and understandably angry about how Wall Street contributed to the financial crisis," he said. "As a firm, we are trying to deal with the implications of the crisis for ourselves and for the system."

He also insisted that "strong, conservative risk management is fundamental and helps define Goldman Sachs." But he said that the company's risk management processes "did not, and could not, provide absolute clarity. They highlighted uncertainty about evolving conditions in the housing market. That uncertainty dictated our decision to attempt to reduce the firm's overall risk."

The financial system today "is still fragile but it is largely stable," he said, and that stability "is a result of decisive and necessary government action during the fall of 2008," when the government began propping up troubled financial institutions with $700 billion in backing under the Troubled Asset Relief Program. Goldman Sachs had government money for about eight months, and it repaid it with a 23% annualized return, Blankfein said.

Derivatives, which played a major role in causing the financial crisis, are an important tool to help companies and financial institutions manage their risk, Blankfein said, "We need more transparency for the public and regulators as well as safeguards in the system for their use." He said Goldman Sachs supports proposals in financial service regulatory reform legislation to set up clearinghouses for standardized derivatives and higher capital requirements for nonstandard instruments.