Here's some good news if you have a mortgage with Goldman Sachs
Matt Levine
(Bloomberg View) -- Here's some good news if you have a mortgage with Goldman Sachs:
Under the terms of the agreement in principle, the firm will pay a $2.385 billion civil monetary penalty, make $875 million in cash payments and provide $1.8 billion in consumer relief. The consumer relief will be in the form of principal forgiveness for underwater homeowners and distressed borrowers; financing for construction, rehabilitation and preservation of affordable housing; and support for debt restructuring, foreclosure prevention and housing quality improvement programs, as well as land banks.
That agreement in principle will "resolve claims from authorities including the Department of Justice and New York and Illinois attorneys general for the bank’s securitization, underwriting and sale of bonds from 2005 to 2007," and is the latest in a series of gigantic settlements between the government's mortgage task force and the big banks. As with the other settlements, a big chunk of this one consists of consumer relief: Because the banks' mortgage misdeeds hurt homeowners, the banks have to help homeowners to balance out the scales.
But of course you don't have a mortgage with Goldman Sachs. When Countrywide and Washington Mutual and other banks were churning out mortgages to feed the great securitization pipeline, Goldman ... wasn't. You couldn't walk into a Goldman Sachs branch and get a no-money-down stated-income mortgage. Goldman was, and is, an investment bank. Consumer mortgage lending has never really been its core business. It doesdo some mortgage lending -- to its wealthy Private Bank customers -- but I suspect that very little of that is subprime, and that very few of those customers are in much distress. And it did have a mortgage servicing business, Litton Loan Servicing, but it sold that to Ocwen Financial Corporation in 2011, and Ocwen has already had to provide $2 billion of consumer relief, in part for past misdeeds at Litton.
For the most part, though, Goldman's mortgage misdeeds came further down the mortgage-securitization pipeline: It didn't make bad loans to people, but just bought those bad loans from other lenders, packaged them into bad securities, misrepresented the badness of those securities, and sold them to investors who lost money on them. You are not supposed to do that, and Goldman has been fined before for doing that, and now it will be fined again for doing that. Obviously you are not supposed to lie about the securities that you sell to investors, and society has judged that Goldman did, and so now it must pay.
But it is a bit odd that it now has to pay, not the investors (whom it is accused of defrauding), but rather the homeowners (whom it didn't). This oddity existed even for the full-stack mortgage-fraud banks, like Bank of America/Countrywide or JPMorgan/Washington Mutual: JPMorgan's big Justice Department settlement, for instance, was for violations "in connection with the packaging, marketing, sale and issuance of" residential mortgage-backed securities, not for defrauding homeowners, but it nonetheless included $4 billion of consumer relief. There, though, you could at least point to bad stuff that Countrywide or WaMu did in their actual interactions with homeowners, and sort of hand-wavily argue that the settlement was rough justice for those homeowners. Goldman never even had interactions with homeowners.
#pb#
So its consumer relief requirement is a little weird. "It is unclear exactly how Goldman’s consumer relief will be doled out and to whom," says the New York Times; clearly it won't go to Goldman mortgage customers. One obvious answer is that it could go to distressed borrowers whose mortgages are in pools securitized, underwritten, managed or serviced by Goldman. But that too is weird. Goldman doesn't own those loans. We don't know how the Goldman consumer relief will work -- it's just an agreement in principle for now -- but the JPMorgan and Bank of America settlements gave those banks 50 cents of consumer-relief credit for every dollar of mortgage forgiveness that they provided on loans that they serviced but that were owned by other investors. But it would be odd if Goldman's punishment for selling bad loans to investors is that it has to take more money away from those investors, by forgiving principal on those loans, and give it to homeowners. That seems to punish Goldman's victims again, and not to punish Goldman at all. This may be why Thursday's $5.1 billion agreement "will reduce earnings for the fourth quarter of 2015 by approximately $1.5 billion on an after-tax basis."
This is too simplistic -- principal forgiveness could in some cases be good for the loan investors, and it's not hard to imagine Goldman, you know, just finding some consumers and handing them cash -- but the important point is that Goldman has to pay -- or "pay" -- $1.8 billion to consumers, even though no one thinks that Goldman ever directly ripped off, or even met, a consumer.
Of course that makes perfect sense. The theory behind these settlements -- and the mainstream of thinking about the financial crisis -- is that the mis-selling of mortgage-backed securities did not only, or even primarily, harm the investors who bought them. It brought on a financial crisis, crashed banks, cratered the economy, and left people unemployed and out of their homes. That causal chain is not hard to understand, exactly -- there is literally a Hollywood movie about it -- but it's a tough thing to wedge into a lawsuit. It is not what you'd call a proximate cause. It's easy enough to sue a bank for lying about bonds that lost value and caused losses to investors, and to demand that the bank pay back those investors for their losses. It's harder to sue a bank for causing a recession, and to demand that the bank pay back consumers for that recession. The mortgage settlements are a very vague and approximate way to do that. But as a way to adapt the legal system to assign blame and seek compensation for an economic crisis, they're an impressive effort.
Also naked shorting.
Besides the mortgage agreement, on Thursday Goldman also entered into a settlement with the Securities and Exchange Commission over some short-selling violations. This one is barely even noticeable financially -- it's for just $15 million, or 0.3 percent of the mortgage one -- but it is funnier, so I ought to tell you about it briefly.
#pb#
The basic rule is that you're not supposed to do "naked short selling." Short selling is selling stock that you don't own: You borrow the stock, sell it on the exchange, deliver the borrowed stock, and hope that it goes down before you have to buy it back. Naked short selling is selling stock that you haven't even borrowed: You sell stock on the exchange, don't deliver it, and when your broker demands that you deliver it you hang up on him. That's illegal.
Or sort of illegal. The way the rule actually works is that if you want to sell short, you have to tell your broker that you are selling short, and then your broker has to "have reasonable grounds to believe that the security can be borrowed." (This checking with your broker is called a "locate.") You don't have to actually borrow it to sell it short, and neither does your broker. Your broker just has to think he can. If it turns out after the fact that your broker actually can't borrow the stock, you have a "fail," and your broker has to quickly find stock to borrow or, if he can't, close out your short position.
Goldman has a lot of customers who want to do short sales. In fact, it gets at least tens of thousands of requests for locates a day. So it automated the process:
Goldman employed a system where the vast majority of customer short sale locate requests were handled by an automated model that would either grant, in whole or in part (or “fill”), deny, or route (or “pend”) the requests for further review to the Demand Team, a group of ten to twelve individuals who worked on Goldman’s securities lending desk. The automated model would review and fill locate requests based on certain available inventory reported to Goldman by certain lending banks and brokerages that fed into Goldman’s automated model at the start of each day after being reduced by Goldman based on their experience with various lenders (the “start-of-day inventory”). As the automated model processed locate requests, it reduced that start-of-day inventory on a 1:1 basis for all shares that were used to grant locate requests (regardless of whether the client actually used the locate). When the start-of-day inventory was depleted in that manner, the automated model would pend subsequent locate requests to the Demand Team for further review and processing.
Fine. The computer knows how many shares it has, and as it gets requests, it crosses out those shares until it has none left, at which point it sends requests to the humans. But eventually the humans were getting "more than 20,000 locate requests per day," which is too many for humans. So:
#pb#
Instead of manually identifying an alternative source of securities to satisfy these pended requests, the Demand Team processed approximately 98 percent of the pended requests by relying on a function of Goldman’s order management system referred to as “fill from autolocate,” which was activated by the “F3” key. This function enabled the Demand Team to cause Goldman’s automated model to fill locate requests based on the amount of inventory that existed at the start of the day (i.e., the start-of-day inventory level before any locates were granted), even though Goldman’s automated model had already treated the start-of-day inventory as depleted.
I picture the F3 key as sort of a "make it stop" key. The computer already thought those shares were used up. That's why it sent the request to the humans. But the poor harried humans couldn't deal with the requests. So they just hit F3 to say to the computer, in effect, never mind that you used up those shares, just use them again.
This sounds both utterly understandable -- would you want to process 20,000 stock borrow requests a day? -- and obviously wrong: Surely if you had 10,000 shares of borrow at the start of the day, and the computer loaned out 10,000 shares, and then sent you a request to borrow 1,000 more shares, you don't have a reasonable basis for thinking that you can borrow those extra 1,000 shares. Quite the reverse: The computer already used up the shares, so where will you get more from?
And that is the SEC's theory: The Demand Team had no reasonable basis to keep hitting F3. But to be fair to the Demand Team, it's not as dumb as it sounds. The computer model reduced its inventory for every locate it granted, "regardless of whether the client actually used the locate," and many clients didn't. So when the Demand Team kept hitting F3, "they relied on their general belief that Goldman’s automated model was conservative and that the provision of additional locates would not result in failures to deliver the securities if and when due for settlement."
The SEC finds this general belief unreasonable, but it does seem to have been right: As the SEC concedes, "the Demand Team’s belief that the model was conservative was based on their familiarity with their client’s low utilization rates and that Goldman’s rate of failures remained low and did not substantially change between November 2008 and mid-2013." That is not particularly indicative of a vast naked-short-selling conspiracy.
But it's pretty dumb, so eventually Goldman cut it out. The solution that Goldman ultimately came up with is that it "implemented a new automated model with logic that substantially reduced the number of locate requests pended for Demand Team review." The humans were pretty sure that the computer was being too conservative, so they re-programmed the computer to make it less conservative, and to take up less of their time. The computer just started hitting F3 itself.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
The disclosure that I used to work at Goldman Sachs seems relevant here. So: I used to work at Goldman Sachs. Goldman has said in its annual reports that it "was not" (or "has not been") "a significant originator of residential mortgage loans." Incidentally, as of its last 10-Q, Goldman did own about $13.2 billion of "loans and securities backed by residential real estate," which I assume is more about mortgage-backed securities than it is about on-balance-sheet whole loans to rich people. I guess I will throw in an "allegedly" here, though this has been so extensively litigated -- and so accepted in popular culture -- that I don't think anyone will disagree too vocally. In 2010, the Securities and Exchange Commission put out a press release with the headline "Goldman Sachs to Pay Record $550 Million to Settle SEC Charges Related to Subprime Mortgage CDO." That was real money back then! Thursday's agreement in principle is nine times that size, and very far from being a record. Not for doing it again, I mean. It's just, the banks that did bad mortgage stuff get fined multiple times for it. Bank of America's does mention origination though: "violations in connection with the packaging, origination, marketing, sale, structuring, arrangement, and issuance of RMBS and CDOs." Necessarily. See footnote 2, though: It does own some RMBS, and so conceivably some writedowns could come out of its pocket. Or it may not be; maybe the cost of the consumer relief is just too uncertain to be accrued now. Incidentally, if this agreement in principle happened in January, why does it reduce income for the quarter ended last December? Conveniently, I have written before about this very issue. The rule is roughly that if you have a loss that accrued in the past (say, because you did bad mortgage stuff in 2005-2007 and everyone knew about it by certainly 2015 at the latest), and if you become able to reasonably estimate the amount of the loss after a quarter ends but before you issue the financial statements for that quarter, then you can include the loss on the financial statements for that past quarter.
Goldman hasn't put out its fourth-quarter 2015 financials yet, so it gets to include this loss in those financials. None of this matters all that much, incidentally. There are people who believe that everything bad in financial markets is due to naked short selling, and that the big banks are in a massive conspiracy to facilitate illegal short selling to manipulate the stock prices of disfavored companies. But actually existing naked-short-selling conspiracies are usually about saving some money on stock-borrow costs, not about price manipulation, and there is even an argument that allowing naked short selling could be good for markets. Never mind that now, though. The relevant point here is just that, if a customer wants to do a short sale, her broker needs to "have reasonable grounds to believe that the security can be borrowed." That's based on the fact that "Over the course of the relevant period," i.e. November 2008 to mid-2013, "the number of locate requests that pended to the Demand Team grew significantly, reaching more than 20,000 locate requests per day at its peak." That's 20,000 requests per day beyond Goldman's automated system, which handled "the vast majority" of locate requests. It's so efficient! The “fill from autolocate” function enabled Demand Team members to select as many of the locate requests routed to it from Goldman’s automated model as desired (for certain customers, 3,000 to 4,000 locate requests were sometimes selected at one time) and hit the “F3” key to process the selected requests with one keystroke. For example between 6:45 a.m. and 7:45 a.m. each day, on average, the Demand Team filled locate requests for several thousand unique CUSIPs. Additionally, in one instance, a Demand Team member granted over 5,486 locates in a 35-minute period.
(Bloomberg View) -- Here's some good news if you have a mortgage with Goldman Sachs:
Under the terms of the agreement in principle, the firm will pay a $2.385 billion civil monetary penalty, make $875 million in cash payments and provide $1.8 billion in consumer relief. The consumer relief will be in the form of principal forgiveness for underwater homeowners and distressed borrowers; financing for construction, rehabilitation and preservation of affordable housing; and support for debt restructuring, foreclosure prevention and housing quality improvement programs, as well as land banks.
That agreement in principle will "resolve claims from authorities including the Department of Justice and New York and Illinois attorneys general for the bank’s securitization, underwriting and sale of bonds from 2005 to 2007," and is the latest in a series of gigantic settlements between the government's mortgage task force and the big banks. As with the other settlements, a big chunk of this one consists of consumer relief: Because the banks' mortgage misdeeds hurt homeowners, the banks have to help homeowners to balance out the scales.
But of course you don't have a mortgage with Goldman Sachs. When Countrywide and Washington Mutual and other banks were churning out mortgages to feed the great securitization pipeline, Goldman ... wasn't. You couldn't walk into a Goldman Sachs branch and get a no-money-down stated-income mortgage. Goldman was, and is, an investment bank. Consumer mortgage lending has never really been its core business. It doesdo some mortgage lending -- to its wealthy Private Bank customers -- but I suspect that very little of that is subprime, and that very few of those customers are in much distress. And it did have a mortgage servicing business, Litton Loan Servicing, but it sold that to Ocwen Financial Corporation in 2011, and Ocwen has already had to provide $2 billion of consumer relief, in part for past misdeeds at Litton.
For the most part, though, Goldman's mortgage misdeeds came further down the mortgage-securitization pipeline: It didn't make bad loans to people, but just bought those bad loans from other lenders, packaged them into bad securities, misrepresented the badness of those securities, and sold them to investors who lost money on them. You are not supposed to do that, and Goldman has been fined before for doing that, and now it will be fined again for doing that. Obviously you are not supposed to lie about the securities that you sell to investors, and society has judged that Goldman did, and so now it must pay.
But it is a bit odd that it now has to pay, not the investors (whom it is accused of defrauding), but rather the homeowners (whom it didn't). This oddity existed even for the full-stack mortgage-fraud banks, like Bank of America/Countrywide or JPMorgan/Washington Mutual: JPMorgan's big Justice Department settlement, for instance, was for violations "in connection with the packaging, marketing, sale and issuance of" residential mortgage-backed securities, not for defrauding homeowners, but it nonetheless included $4 billion of consumer relief. There, though, you could at least point to bad stuff that Countrywide or WaMu did in their actual interactions with homeowners, and sort of hand-wavily argue that the settlement was rough justice for those homeowners. Goldman never even had interactions with homeowners.
#pb#
So its consumer relief requirement is a little weird. "It is unclear exactly how Goldman’s consumer relief will be doled out and to whom," says the New York Times; clearly it won't go to Goldman mortgage customers. One obvious answer is that it could go to distressed borrowers whose mortgages are in pools securitized, underwritten, managed or serviced by Goldman. But that too is weird. Goldman doesn't own those loans. We don't know how the Goldman consumer relief will work -- it's just an agreement in principle for now -- but the JPMorgan and Bank of America settlements gave those banks 50 cents of consumer-relief credit for every dollar of mortgage forgiveness that they provided on loans that they serviced but that were owned by other investors. But it would be odd if Goldman's punishment for selling bad loans to investors is that it has to take more money away from those investors, by forgiving principal on those loans, and give it to homeowners. That seems to punish Goldman's victims again, and not to punish Goldman at all. This may be why Thursday's $5.1 billion agreement "will reduce earnings for the fourth quarter of 2015 by approximately $1.5 billion on an after-tax basis."
This is too simplistic -- principal forgiveness could in some cases be good for the loan investors, and it's not hard to imagine Goldman, you know, just finding some consumers and handing them cash -- but the important point is that Goldman has to pay -- or "pay" -- $1.8 billion to consumers, even though no one thinks that Goldman ever directly ripped off, or even met, a consumer.
Of course that makes perfect sense. The theory behind these settlements -- and the mainstream of thinking about the financial crisis -- is that the mis-selling of mortgage-backed securities did not only, or even primarily, harm the investors who bought them. It brought on a financial crisis, crashed banks, cratered the economy, and left people unemployed and out of their homes. That causal chain is not hard to understand, exactly -- there is literally a Hollywood movie about it -- but it's a tough thing to wedge into a lawsuit. It is not what you'd call a proximate cause. It's easy enough to sue a bank for lying about bonds that lost value and caused losses to investors, and to demand that the bank pay back those investors for their losses. It's harder to sue a bank for causing a recession, and to demand that the bank pay back consumers for that recession. The mortgage settlements are a very vague and approximate way to do that. But as a way to adapt the legal system to assign blame and seek compensation for an economic crisis, they're an impressive effort.
Also naked shorting.
Besides the mortgage agreement, on Thursday Goldman also entered into a settlement with the Securities and Exchange Commission over some short-selling violations. This one is barely even noticeable financially -- it's for just $15 million, or 0.3 percent of the mortgage one -- but it is funnier, so I ought to tell you about it briefly.
#pb#
The basic rule is that you're not supposed to do "naked short selling." Short selling is selling stock that you don't own: You borrow the stock, sell it on the exchange, deliver the borrowed stock, and hope that it goes down before you have to buy it back. Naked short selling is selling stock that you haven't even borrowed: You sell stock on the exchange, don't deliver it, and when your broker demands that you deliver it you hang up on him. That's illegal.
Or sort of illegal. The way the rule actually works is that if you want to sell short, you have to tell your broker that you are selling short, and then your broker has to "have reasonable grounds to believe that the security can be borrowed." (This checking with your broker is called a "locate.") You don't have to actually borrow it to sell it short, and neither does your broker. Your broker just has to think he can. If it turns out after the fact that your broker actually can't borrow the stock, you have a "fail," and your broker has to quickly find stock to borrow or, if he can't, close out your short position.
Goldman has a lot of customers who want to do short sales. In fact, it gets at least tens of thousands of requests for locates a day. So it automated the process:
Goldman employed a system where the vast majority of customer short sale locate requests were handled by an automated model that would either grant, in whole or in part (or “fill”), deny, or route (or “pend”) the requests for further review to the Demand Team, a group of ten to twelve individuals who worked on Goldman’s securities lending desk. The automated model would review and fill locate requests based on certain available inventory reported to Goldman by certain lending banks and brokerages that fed into Goldman’s automated model at the start of each day after being reduced by Goldman based on their experience with various lenders (the “start-of-day inventory”). As the automated model processed locate requests, it reduced that start-of-day inventory on a 1:1 basis for all shares that were used to grant locate requests (regardless of whether the client actually used the locate). When the start-of-day inventory was depleted in that manner, the automated model would pend subsequent locate requests to the Demand Team for further review and processing.
Fine. The computer knows how many shares it has, and as it gets requests, it crosses out those shares until it has none left, at which point it sends requests to the humans. But eventually the humans were getting "more than 20,000 locate requests per day," which is too many for humans. So:
#pb#
Instead of manually identifying an alternative source of securities to satisfy these pended requests, the Demand Team processed approximately 98 percent of the pended requests by relying on a function of Goldman’s order management system referred to as “fill from autolocate,” which was activated by the “F3” key. This function enabled the Demand Team to cause Goldman’s automated model to fill locate requests based on the amount of inventory that existed at the start of the day (i.e., the start-of-day inventory level before any locates were granted), even though Goldman’s automated model had already treated the start-of-day inventory as depleted.
I picture the F3 key as sort of a "make it stop" key. The computer already thought those shares were used up. That's why it sent the request to the humans. But the poor harried humans couldn't deal with the requests. So they just hit F3 to say to the computer, in effect, never mind that you used up those shares, just use them again.
This sounds both utterly understandable -- would you want to process 20,000 stock borrow requests a day? -- and obviously wrong: Surely if you had 10,000 shares of borrow at the start of the day, and the computer loaned out 10,000 shares, and then sent you a request to borrow 1,000 more shares, you don't have a reasonable basis for thinking that you can borrow those extra 1,000 shares. Quite the reverse: The computer already used up the shares, so where will you get more from?
And that is the SEC's theory: The Demand Team had no reasonable basis to keep hitting F3. But to be fair to the Demand Team, it's not as dumb as it sounds. The computer model reduced its inventory for every locate it granted, "regardless of whether the client actually used the locate," and many clients didn't. So when the Demand Team kept hitting F3, "they relied on their general belief that Goldman’s automated model was conservative and that the provision of additional locates would not result in failures to deliver the securities if and when due for settlement."
The SEC finds this general belief unreasonable, but it does seem to have been right: As the SEC concedes, "the Demand Team’s belief that the model was conservative was based on their familiarity with their client’s low utilization rates and that Goldman’s rate of failures remained low and did not substantially change between November 2008 and mid-2013." That is not particularly indicative of a vast naked-short-selling conspiracy.
But it's pretty dumb, so eventually Goldman cut it out. The solution that Goldman ultimately came up with is that it "implemented a new automated model with logic that substantially reduced the number of locate requests pended for Demand Team review." The humans were pretty sure that the computer was being too conservative, so they re-programmed the computer to make it less conservative, and to take up less of their time. The computer just started hitting F3 itself.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
The disclosure that I used to work at Goldman Sachs seems relevant here. So: I used to work at Goldman Sachs. Goldman has said in its annual reports that it "was not" (or "has not been") "a significant originator of residential mortgage loans." Incidentally, as of its last 10-Q, Goldman did own about $13.2 billion of "loans and securities backed by residential real estate," which I assume is more about mortgage-backed securities than it is about on-balance-sheet whole loans to rich people. I guess I will throw in an "allegedly" here, though this has been so extensively litigated -- and so accepted in popular culture -- that I don't think anyone will disagree too vocally. In 2010, the Securities and Exchange Commission put out a press release with the headline "Goldman Sachs to Pay Record $550 Million to Settle SEC Charges Related to Subprime Mortgage CDO." That was real money back then! Thursday's agreement in principle is nine times that size, and very far from being a record. Not for doing it again, I mean. It's just, the banks that did bad mortgage stuff get fined multiple times for it. Bank of America's does mention origination though: "violations in connection with the packaging, origination, marketing, sale, structuring, arrangement, and issuance of RMBS and CDOs." Necessarily. See footnote 2, though: It does own some RMBS, and so conceivably some writedowns could come out of its pocket. Or it may not be; maybe the cost of the consumer relief is just too uncertain to be accrued now. Incidentally, if this agreement in principle happened in January, why does it reduce income for the quarter ended last December? Conveniently, I have written before about this very issue. The rule is roughly that if you have a loss that accrued in the past (say, because you did bad mortgage stuff in 2005-2007 and everyone knew about it by certainly 2015 at the latest), and if you become able to reasonably estimate the amount of the loss after a quarter ends but before you issue the financial statements for that quarter, then you can include the loss on the financial statements for that past quarter.
Goldman hasn't put out its fourth-quarter 2015 financials yet, so it gets to include this loss in those financials. None of this matters all that much, incidentally. There are people who believe that everything bad in financial markets is due to naked short selling, and that the big banks are in a massive conspiracy to facilitate illegal short selling to manipulate the stock prices of disfavored companies. But actually existing naked-short-selling conspiracies are usually about saving some money on stock-borrow costs, not about price manipulation, and there is even an argument that allowing naked short selling could be good for markets. Never mind that now, though. The relevant point here is just that, if a customer wants to do a short sale, her broker needs to "have reasonable grounds to believe that the security can be borrowed." That's based on the fact that "Over the course of the relevant period," i.e. November 2008 to mid-2013, "the number of locate requests that pended to the Demand Team grew significantly, reaching more than 20,000 locate requests per day at its peak." That's 20,000 requests per day beyond Goldman's automated system, which handled "the vast majority" of locate requests. It's so efficient! The “fill from autolocate” function enabled Demand Team members to select as many of the locate requests routed to it from Goldman’s automated model as desired (for certain customers, 3,000 to 4,000 locate requests were sometimes selected at one time) and hit the “F3” key to process the selected requests with one keystroke. For example between 6:45 a.m. and 7:45 a.m. each day, on average, the Demand Team filled locate requests for several thousand unique CUSIPs. Additionally, in one instance, a Demand Team member granted over 5,486 locates in a 35-minute period.
