Institute for Financial Transparency

Shining a light on the opaque corners of finance


Goldman using opacity to screw its clients shows why Transparency Label Initiative needed

To great fanfare, Obama’s Justice Department announced a $5 billion settlement with Goldman Sachs over how it sold mortgage-backed securities in the run-up to the financial crisis.  In short, Goldman designed securities to fail and didn’t bother to tell this fact to the buyers.

But how was Goldman able to design these securities to fail without the buyers being able to figure this out?  Buried at the very end of the statement of facts is the answer.

Goldman also received information about risks in the mortgage market from Senderra, a tiny regional originator in which Goldman had previously acquired a 12.5 percent stake. On December 10, 2006, the Chief Executive Officer of Senderra sent an email to, among others, a Goldman mortgage department manager, with observations regarding the “dramatic shifts and disruption in the industry.” Senderra’s CEO noted that credit quality had become a “major crisis” across the subprime market, and that “[i]nvestors ha[d] taken a strong stand” in response to “unprecedented defaults and fraud in the market” and were “pushing loans back to originators/lenders in record numbers.” The Senderra executive noted that some originators had announced publicly that they were shutting down due to increasing EPD [early payment defaults] claims. The Senderra executive also reported seeing increasing numbers of loans in the market with “inflated appraisals, inflated income and occupancy fraud.”

Readers of Transparency Games know the Justice Department has selectively edited both Senderra’s business model and the CEO’s email.  In doing so, it has grossly understated both.  Senderra wasn’t just a regional originator of subprime mortgages.  It bought loans from mortgage brokers nationally.  It didn’t just originate.  It was also a servicer.  It billed and collected the mortgage payments on the mortgages it underwrote.  Finally, the CEO didn’t send emails to a random low level Goldman mortgage department manager.  Rather the emails went to the senior mortgage department manager responsible for trading subprime mortgaged-backed securities.  A manager the top two executives of Goldman met with to discuss the emails and what Goldman should do with its then current exposure to subprime mortgages.

Through Senderra, Goldman had access to the information it needed to create a security that would fail spectacularly.  And it did.  The security was a collection of bets on the performance of several subprime mortgage-backed deals.  Using the insights gained from Senderra, Goldman assisted a hedge fund manager in selecting deals that were likely to fail.  The fact 90+% of these deals did fail, shows how well Goldman was able to apply these insights.

But what about the buyer?  Didn’t they have access to the necessary information to know the deal was designed to blow up?  No.  By design, the subprime mortgage-backed deals were opaque.  Without an ownership interest in a subprime mortgage servicing company, there was no way to know what the current performance of the underlying mortgages was.  Without this information, there was no way to tell how truly junky the deals Goldman helped to select truly were.

Now, imagine the Transparency Label Initiative had been in existence before the financial crisis.  Without a label, most of the opaque subprime mortgage-backed securities would never have been sold.  A vast improvement over what happened.