Goldman Defends Valuations That Helped Put AIG In Bind

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Phil Angelides makes a point at Thursday's hearing. In an interview, he said Goldman 'built the bomb' by developing complex mortgage securities.

Goldman Sachs Group Inc., already under scrutiny from regulators, faced new questions from a congressional commission about whether it aggressively marked down the value of its mortgage-securities positions to benefit a bet Goldman made against the mortgage market.

A bipartisan panel reviewing causes of the financial crisis grilled Goldman executives about valuations of mortgage assets the Wall Street firm provided American International Group Inc. and other trading partners in the mortgage crisis of 2007 and 2008.

Documents released by the panel showed Goldman repeatedly valued these securities lower than rivals did, demanding additional money from AIG, which was insuring against losses in the securities. These and other banks' collateral demands strained AIG, which was bailed out by the U.S. government in September 2008.

At the time, Goldman had placed a trading bet with the firm's money against the mortgage market. Lower valuations, or "marks," would have made that bet more profitable.

Goldman executives defended their practices. "Our marks were based on actionable prices, informed by market information from comparable transactions," David Lehman, a Goldman managing director, told members of the Financial Crisis Inquiry Commission.

In any case, the questions underscored an unnerving reality in the financial world: Investors have no way of knowing with any certainty the value of many securities. Fewer than half of all securities these days trade on exchanges with readily available price information, making large parts of the U.S. financial markets essentially a hall of mirrors.

Phil Angelides, the commission's chairman, said this week that Goldman "built the bomb" by developing complex mortgage securities and "built a bomb shelter" by betting against the mortgage market in 2007. "The question is, did they light the fuse" by lowering the value of mortgage securities, he said.

The questioning comes as Goldman battles civil charges filed in April by the Securities and Exchange Commission alleging Goldman and one of its mortgage traders created a mortgage product secretly designed to fail for the benefit of a hedge-fund client, without disclosing the hedge fund's role in picking investments for the 2007 deal. Goldman says it did nothing wrong.

Back in 2007, when cracks began showing in the U.S. mortgage market, Goldman was one of the first Wall Street firms to determine mortgage-debt pools like the ones AIG had insured were losing value. Goldman executives were aware of the impact, according to documents released by the panel. Documents released in a separate Senate inquiry show that by early 2007, Goldman increasingly believed the housing market was in serious trouble and that it needed to reverse course against bullish mortgage bets and protect itself against losses by hedging its exposure. A May 11, 2007, email from Craig Broderick, Goldman's chief risk officer, informed colleagues Goldman's mortgage group was "in the process of considering making significant downward adjustments to the marks on their mortgage portfolio."

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David Viniar, executive vice president and chief financial officer of Goldman Sachs Group Inc., right, speaks during a Financial Crisis Inquiry Commission hearing on the role of derivatives in the financial crisis.

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"This will potentially have a big [profit and loss] impact on us, but also our clients due to the marks and associated margin calls" on derivatives and other products, Mr. Broderick wrote. He added in the email that Goldman needed to figure out which clients were the most vulnerable and said "this is getting lots of 30th floor attention," referring to Goldman's corporate executive floor at the time.

One of the most vulnerable institutions turned out to be AIG, which had sold Goldman insurance-like derivative contracts on $20 billion in debt pools and had similar contracts on more than $70 billion in U.S. mortgage assets. Between mid-2007 and mid-2008, executives at AIG's derivatives-trading unit sparred with Goldman over market prices of the insured assets and the bank's collateral demands, which often changed. This fierce tug-of-war, first disclosed in a November 2008 Wall Street Journal article, now has become a focus of the panel.

Mr. Angelides, the commission's chairman, asked during Thursday's hearing, why Goldman made a collateral call to AIG of $1.8 billion on July 27, 2007—only to reduce it to $1.2 billion six days later. "It seems to me that's pretty much a stab in the dark. You're in business. You're being aggressive," Mr. Angelides, a former California state treasurer, said.

David Viniar, Goldman's chief financial officer, replied: "For illiquid assets, it's not a science, it's an art, and there is judgment involved. We used our best estimate at all times of what the market was."

AIG didn't believe Goldman's valuations were reasonable, but "we didn't have an internal pricing system at that time" to counter their estimates, Andrew Forster, an AIG executive, told the panel.

Goldman's actions on valuations had a broader impact on AIG. Several other banks used Goldman's marks on mortgage securities to demand collateral from the insurer, heightening the pressure on AIG as the housing crisis deepened.

Mr. Forster struck a more-conciliatory tone Thursday than his former boss, Joseph Cassano, had the previous day. Mr. Forster said that in hindsight, "it would have been prudent to have hedged" AIG's huge exposure to U.S. mortgage debt.

Mr. Forster was, along with Mr. Cassano and another AIG executive, under investigation in connection with the mortgage trades AIG's Financial Products unit made. Criminal and civil authorities several weeks ago closed those probes without bringing charges.

Write to Serena Ng at serena.ng@wsj.com and Fawn Johnson at fawn.johnson@dowjones.com

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