December 2, 2007

EVERYBODY’S BUSINESS

The Long and Short of It at Goldman

Sachs
By BEN STEIN

FOR decades now, as a writer, economist and scold, I have been receiving letters from
thoughtful readers. Many of them have warned me about the dangers of a secret
government running the world, organized by the Trilateral Commission, or the Ford
Foundation, or the Big Oil companies or, of course, world Jewry.

I always scoff at these letters. The world is far too complex a place to be run by any one
group. But the closest I have recently seen to such a world-running body would have to be
a certain large investment bank, whose alums are routinely Treasury secretaries, high
advisers to presidents, and occasionally a governor or United States senator.

This all started percolating in my fevered brain last week when a frequent correspondent,
a gent in Florida who is sure economic disaster lies ahead (and he may be right, but he’s
not), forwarded a newsletter from a highly placed economist at Goldman
Sachs named Jan Hatzius.

That worthy scholar recently wrote a detailed paper about how he thought the subprime
mess would get worse and worse. It would get so bad, he hypothesized, that it would affect
aggregate lending extremely adversely and slow down growth.

Dr. Hatzius, who has a Ph.D. in economics from “Oggsford,” as they put it in “The Great
Gatsby,” used a combination of theory, data, guesswork, extrapolation and what he recalls
as history to reach the point that when highly leveraged institutions like banks
lost money on subprime, they would cut back on lending to keep their capital
ratios sound — and this would slow the economy.
This would occur, he said, if the value of the assets that banks hold plunges so
steeply that they have to consume their own capital to patch up losses. With
those funds used to plug holes, banks’ reserves drop further. To keep
reserves in accordance with regulatory requirements, banks then have to rein
in lending. What all of this means — or so the argument goes — is that losses
in subprime and elsewhere that are taken at banks ultimately boomerang
back, in a highly multiplied and negative way, onto our economy.

As the narrator in the rock legend “Spill the Wine” says, “This really blew my mind.”

So I started an e-mail correspondence with Dr. Hatzius, pointing out what I believed were
a few flaws in his paper. Among them were his hypothesis that home prices would
fall an average of 15 percent nationwide (an event that has never happened
since the Depression, although we surely could be headed in that direction),
and that this would lead to a drastic increase in defaults and losses by
lenders.

This, as I see it, is a conclusion that is an estimation based upon a guess. I found especially
puzzling the omission of the highly likely truth that the Fed would step in to
replenish financial institutions’ liquidity if necessary. In a crisis like that
outlined by the good Dr. Hatzius, the Fed — any postwar Fed except perhaps
that of a fool — would pump cash into the system to keep lending on track.

I mentioned this via e-mail to Dr. Hatzius. He generously agreed that there was some
slight merit to my arguments and that he was merely pointing out tendencies and
possibilities (if I understand him correctly).

BUT forecasting is tricky, and I have a hard time believing that financial events to come
will be qualitatively different from those that have already happened.

I do want to emphasize Dr. Hatzius’s gentlemanliness and intelligence. But I also want to
emphasize that, as I see it, his document was mostly about selling fear. A spokesman for
Goldman Sachs categorically denies this point and says that the firm’s economic research
is held to the highest levels of objectivity and that its economists’ views are completely
independent.

As I interpret it, Dr. Hatzius was saying that the financial system would possibly
not be able to adjust to a level of financial losses that are large on an absolute
scale but small compared with aggregate credit or the gross domestic
product. He is also postulating that lenders would have to retrench so deeply
that lending would stall and growth would falter — an event that, again, has
not happened on any scale in the postwar world, except when planned by the
central bank.

In other words, with the greatest possible respect to Dr. Hatzius, his paper is not really
what I would call a serious overview of the situation. It is more a call to be afraid and
cautious based on general principles that he embraces and not on the lessons of history.
(In this respect, he is much like many economic journalists and commentators who sell
newsprint by selling fear. The common cause of journalists and Wall Streeters in this
regard is a subject I will address in the future.)

Now, let me make a few small points here and then get to my own big point.

Goldman Sachs is a huge name in terms of moneymaking and prestige. I

totally understand the respect it receives for its financial dexterity. The firm
is a superstar in that regard, and I, a small stockholder, am grateful. But it
has never been clear to me exactly why its people are considered rocket
scientists in any other area than making money.

Dr. Hatzius’s paper is a prime example of my puzzlement. It shows extreme intelligence

but basically misses the point: yes, there are possible macro dangers, but you have to go all
the way around Robin Hood’s barn to get to them, and you have to use what I think are
extremely far-fetched hypotheticals to get to a scary situation. (This is not to diminish the
real risks in today’s economy, I’m just not as gloomy about them as Dr. Hatzius.)

Why, then, is his document circulating? Perhaps as a token of Dr. Hatzius’s genuine
intelligence, which is fine. But to me, his paper seemed like a selling document in the real
Wall Street sense of selling — namely, selling short. (Dr. Hatzius notes that he has long
been bearish on housing, since faraway 2006, but I respectfully note that that is a lot
different from predicting a credit catastrophe. The spokesman for Goldman also noted the
company’s bearishness on housing since 2006. He also noted that in the recent past,
Goldman Sachs has moved to a considerably larger short posture and that the firm is net
short.)

More thoughts came to me as I read a recent piece in Fortune by my colleague Allan Sloan
(article follows), a veteran financial writer. Mr. Sloan traces the life and death throes of a
Goldman Sachs-arranged collateralized mortgage obligation. He shows how truly toxic
waste was sold to overly eager investors who now have major charge-offs,
and he also points out that some parts of the C.M.O. were indeed safe and
were either current or had been paid off.

But what leaps out at me from this story is that Goldman Sachs was injecting
dangerous financial products into the world’s commercial bloodstream for
years.

My pal, colleague and alter ego, the financial manager Phil DeMuth, culled data from a
financial Web site, ABAlert.com (for “asset-backed alert”), that Goldman Sachs was
one of the top 10 sellers of C.M.O.’s for the last two and a half years. From the
evidence I see, Goldman was doing this for years. It might have sold very
roughly $100 billion of the stuff in that period, according to ABAlert.
Goldman was doing it on a scale of billions even when Henry M. Paulson Jr.,
the current Treasury secretary, led the firm.
The Goldman spokesman would not comment on this except to note that other firms sold
C.M.O.’s too.

The point to bear in mind, as Mr. Sloan brilliantly makes clear, is that as Goldman was
peddling C.M.O.’s, it was also shorting the junk on a titanic scale through
index sales — showing, at least to me, how horrible a product it believed it
was selling.

The Goldman Sachs spokesman said that the company routinely shorts the securities it
underwrites and said that this is disclosed. He noted candidly that Goldman is much more
short in this sector than usual.

Here is my humble hypothesis, even after talking to Goldman: Is it possible that Dr.
Hatzius’s paper was a device to help along the goal of success at bearish trades in this
sector and in the market generally? His firm says his paper, like all of its economists’
work, was not written to support any larger short-trading strategy. But economists, like
accountants, are artists. They have a tendency to paint what their patrons, who pay
them, want to see.

From what I have observed over the years, Goldman has a fascinating culture. It is
sort of like what I imagine the culture of the K.G.B. to be. You always put the
firm first. The long-ago scandal of the Goldman Sachs Trading Corporation,
which raised hundreds of millions just before the crash of 1929 to create a
mutual fund, then used the fund’s money to prop up stocks it owned and
underwrote, was a particularly sad example. The fund, of course, went bust.

Now, obviously, Goldman Sachs does many fine deals and has many smart, capable people
working for it. But it’s not the Vatican. It exists to make money for the partners and (much
farther down the line) the stockholders. The people there are not statesmen. They are
salesmen.
To my old eyes, the recent unhappiness about mortgages and Goldman’s connection with
them are not examples of sterling conduct. It is bad enough to have been selling this stuff.
It is far worse when the sellers were, in effect, simultaneously shorting the stuff they were
selling, or making similar bets.

Doesn’t this bear some slight resemblance to Merrill selling tech stocks during the bubble
while its analyst Henry Blodget was reportedly telling his friends what garbage they were?
How different would it be from selling short the junky stock that your firm is
underwriting? And if a top economist at Goldman Sachs was saying housing was in
trouble, why did Goldman continue to underwrite junk mortgage issues into the market?

HERE is a query, as we used to say in law school: Should Henry M. Paulson Jr., who
formerly ran a firm that engaged in this kind of conduct, be serving as
Treasury secretary? Should there not be some inquiry into what the invisible
government of Goldman (and the rest of Wall Street) did to create this
disaster, which has caught up with some Wall Street firms but not the nimble
Goldman?

When the Depression got under way, the government created the Temporary
National Economic Committee to study just what had happened on the Street
to get the tragedy going. Maybe it’s time for an investigation of just what Wall
Street and Goldman did to make money as they pumped this mortgage mess
into the economic system, and sometimes were seemingly on both sides of the
deal.

Or is Goldman Sachs like “Love Story”? Does working there mean never
having to say you’re sorry?

Ben Stein is a lawyer, writer, actor and economist. E-mail: ebiz@nytimes.com.

Junk mortgages under the microscope
A close-up of one deal shows how subprime mortgages went bad,
says Fortune's Allan Sloan.

By Allan Sloan, Fortune senior editor-at-large

October 16 2007: 9:21 AM EDT
(Fortune Magazine) -- It's getting hard to wrap your brain around subprime mortgages, Wall
Street's fancy name for junk home loans. There's so much subprime stuff floating around -
more than $1.5 trillion of loans, maybe $200 billion of losses, thousands of families facing
foreclosure, umpteen politicians yapping - that it's like the federal budget: It's just too big to be
understandable.

So let's reduce this macro story to human scale. Meet GSAMP Trust 2006-S3, a $494 million
drop in the junk-mortgage bucket, part of the more than half-a-trillion dollars of mortgage-
backed securities issued last year. We found this issue by asking mortgage mavens to pick
the worst deal they knew of that had been floated by a top-tier firm - and this one's pretty bad.

It was sold by Goldman Sachs (Charts, Fortune 500) - GSAMP originally stood for Goldman
Sachs Alternative Mortgage Products but now has become a name itself, like AT&T and 3M.

This issue, which is backed by ultra-risky second-mortgage loans, contains all the elements
that facilitated the housing bubble and bust. It's got speculators searching for quick gains in
hot housing markets; it's got loans that seem to have been made with little or no serious
analysis by lenders; and finally, it's got Wall Street, which churned out mortgage "product"
because buyers wanted it. As they say on the Street, "When the ducks quack, feed them."

Alas, almost everyone involved in this duck-feeding deal has had a foul experience. Less
than 18 months after the issue was floated, a sixth of the borrowers had already defaulted on
their loans. Investors who paid face value for these securities - they were looking for slightly
more interest than they'd get on equivalent bonds - have suffered heavy losses.

That's because their securities have either defaulted (for a 100% loss) or been downgraded
by credit-rating agencies, which has depressed the securities' market prices. (Check out one
of these jewels on a Bloomberg machine, and the price chart looks like something falling off a
cliff.)

Even Goldman may have lost money on GSAMP - but being Goldman, the firm has more
than covered its losses by betting successfully that the price of junk mortgages would drop.
Of course, Goldman knew a lot about this market: GSAMP was just one of 83 mortgage-
backed issues totaling $44.5 billion that Goldman sold last year.

Now let's take it from the top.

In the spring of 2006, Goldman assembled 8,274 second-mortgage loans originated by

Fremont Investment & Loan, Long Beach Mortgage Co., and assorted other players. More
than a third of the loans were in California, then a hot market. It was a run-of-the-mill deal,
one of the 916 residential mortgage-backed issues totaling $592 billion that were sold last
year.

The average equity that the second-mortgage borrowers had in their homes was 0.71%. (No,
that's not a misprint - the average loan-to-value of the issue's borrowers was 99.29%.)

It gets even hinkier. Some 58% of the loans were no-documentation or low-documentation.
This means that although 98% of the borrowers said they were occupying the homes they
were borrowing on - "owner-occupied" loans are considered less risky than loans to
speculators - no one knows if that was true. And no one knows whether borrowers' incomes
or assets bore any serious relationship to what they told the mortgage lenders.

You can see why borrowers lined up for the loans, even though they carried high interest
rates. If you took out one of these second mortgages and a typical 80% first mortgage, you
got to buy a house with essentially none of your own money at risk. If house prices rose,
you'd have a profit. If house prices fell and you couldn't make your mortgage payments, you'd
get to walk away with nothing (or almost nothing) out of pocket. It was go-go finance, very
21st century.

Goldman acquired these second-mortgage loans and put them together as GSAMP Trust
2006-S3. To transform them into securities it could sell to investors, it divided them into
tranches - which is French for "slices," in case you're interested.

There are trillions of dollars of mortgage-backed securities in the world for the same reason
that Tyson Foods offers you chicken pieces rather than insisting you buy an entire bird. Tyson
can slice a chicken into breasts, legs, thighs, giblets - and Lord knows what else - and get
more for the pieces than it gets for a whole chicken. Customers are happy, because they get
only the pieces they want.

Similarly, Wall Street carves mortgages into tranches because it can get more for the pieces
than it would get for whole mortgages. Mortgages have maturities that are unpredictable, and
they require all that messy maintenance like collecting the monthly payments, making sure
real estate taxes are paid, chasing slow-pay and no-pay borrowers, and sending out annual
statements of interest and taxes paid. Securities are simpler to deal with and can be
customized.
Someone wants a safe, relatively low-interest, short-term security? Fine, we'll give him a nice
AAA-rated slice that gets repaid quickly and is very unlikely to default. Someone wants a risky
piece with a potentially very rich yield, an indefinite maturity, and no credit rating at all? One
unrated X tranche coming right up. Interested in legs, thighs, giblets, the heart? The butcher -
excuse us, the investment banker - gives customers what they want.

In this case, Goldman sliced the $494 million of second mortgages into 13 separate tranches.
The $336 million of top tranches - named cleverly A-1, A-2, and A-3 - carried the lowest
interest rates and the least risk. The $123 million of intermediate tranches - M (for
mezzanine) 1 through 7 - are next in line to get paid and carry progressively higher interest
rates.

Finally, Goldman sold two non-investment-grade tranches. The first, B-1 ($13 million), went to
the Luxembourg-based UBS (Charts) Absolute Return fund, which is aimed at non-U.S.
investors and thus spread GSAMP's problems beyond our borders. The second, B-2 ($8
million), went to the Morgan Keegan Select High Income fund. (Like most of this article, this
information is based on our reading of various public filings; UBS and Morgan Keegan both
declined to comment.)

Goldman wouldn't say, but it appears to have kept the 13th piece, the X tranche, which had a
face value of $14 million (and would have been worth much more had things gone as
projected), as its fee for putting the deal together. Goldman may have had money at risk in
some of the other tranches, but there's no way to know without Goldman's cooperation, which
wasn't forthcoming.

How is a buyer of securities like these supposed to know how safe they are? There are two
options. The first is to do what we did: Read the 315-page prospectus, related documents,
and other public records with a jaundiced eye and try to see how things can go wrong.

The second is to rely on the underwriter and the credit-rating agencies - Moody's and
Standard & Poor's. That, of course, is what nearly everyone does.

In any event, it's impossible for investors to conduct an independent analysis of the
borrowers' credit quality even if they choose to invest the time, money, and effort to do so.
That's because Goldman, like other assemblers of mortgage-backed deals, doesn't tell
investors who the borrowers are.

One Goldman filing lists more than 1,000 pages of individual loans - but they're by code
number and zip code, not name and address.

Even though the individual loans in GSAMP looked like financial toxic waste, 68% of the
issue, or $336 million, was rated AAA by both agencies - as secure as U.S. Treasury bonds.
Another $123 million, 25% of the issue, was rated investment grade, at levels from AA to
BBB--.

Thus, a total of 93% was rated investment grade. That's despite the fact that this issue is
backed by second mortgages of dubious quality on homes in which the borrowers (most of
whose income and financial assertions weren't vetted by anyone) had less than 1% equity
and on which GSAMP couldn't effectively foreclose.
It's all in the math
How does toxic waste get distilled into spring water? Watch. It's all in the math - and the
assumptions about how borrowers will behave.

These loans, which are fixed-rate, carried an average interest rate of 10.51%. After paying
the people who collected the payments and handled all the other paperwork, the GSAMP
Trust had ten percentage points left. However, the interest on the securities that GSAMP
issued ran to only about 7%. (We say "about" because some of the tranches are floating-rate
rather than fixed-rate.)

The difference between GSAMP's interest income and interest expense was projected at
2.85% a year. That spread was supposed to provide a cushion to offset defaults by
borrowers. In addition, the aforementioned X piece didn't get fixed monthly payments and
thus provided another bit of protection for the 12 tranches ranked above it.

Remember that we're dealing with securities, not actual loans. Thus losses aren't shared
equally by all of GSAMP's investors. Any loan losses would first hit the X tranche. Then, if X
were wiped out, the losses would work their way up the food chain tranche by tranche: B-2,
B-1, M-7, and so on.

The $241 million A-1 tranche, 60% of which has already been repaid, was designed to be
supersafe and quick-paying. It gets first dibs on principal paydowns from regular monthly
payments, refinancings, and borrowers paying off their loans because they're selling their
homes. Then, after A-1 is paid in full, it's the turn of A-2 and A-3, and so on down the line.

Moody's projected in a public analysis of the issue that less than 10% of the loans would
ultimately default. S&P, which gave the securities the same ratings that Moody's did, almost
certainly reached a similar conclusion but hasn't filed a public analysis and wouldn't share its
numbers with us. As long as housing prices kept rising, it all looked copacetic.

Goldman peddled the securities in late April 2006. In a matter of months the mathematical
models used to assemble and market this issue - and the models that Moody's and S&P used
to rate it - proved to be horribly flawed. That's because the models were based on recent
performances of junk-mortgage borrowers, who hadn't defaulted much until last year thanks
to the housing bubble.
The fallout
Through the end of 2005, if you couldn't make your mortgage payments, you could generally
get out from under by selling the house at a profit or refinancing it. But in 2006 we hit an
inflection point. House prices began stagnating or falling in many markets. Instead of HPA -
industry shorthand for house-price appreciation - we had HPD: house-price depreciation.

Interest rates on mortgages stopped falling. Way too late, as usual, regulators and lenders
began imposing higher credit standards. If you had borrowed 99%-plus of the purchase price
(as the average GSAMP borrower did) and couldn't make your payments, couldn't refinance,
and couldn't sell at a profit, it was over. Lights out.

As a second-mortgage holder, GSAMP couldn't foreclose on deadbeats unless the first-

mortgage holder also foreclosed. That's because to foreclose on a second mortgage, you
have to repay the first mortgage in full, and there was no money set aside to do that. So if a
borrower decided to keep on paying the first mortgage but not the second, the holder of the
second would get bagged.

If the holder of the first mortgage foreclosed, there was likely to be little or nothing left for
GSAMP, the second-mortgage holder. Indeed, the monthly reports issued by Deutsche
Bank (Charts), the issue's trustee, indicate that GSAMP has recovered almost nothing on its
foreclosed loans.

By February 2007, Moody's and S&P began downgrading the issue. Both agencies dropped
the top-rated tranches all the way to BBB from their original AAA, depressing the securities'
market price substantially.

In March, less than a year after the issue was sold, GSAMP began defaulting on its
obligations. By the end of September, 18% of the loans had defaulted, according to Deutsche
Bank.

As a result, the X tranche, both B tranches, and the four bottom M tranches have been wiped
out, and M-3 is being chewed up like a frame house with termites. At this point, there's no
way to know whether any of the A tranches will ultimately be impaired.

"[In hindsight,] I think we would not have rated it" had Moody's realized what was going on in
the junk-mortgage market, says Nicolas Weill, the firm's chief credit officer for structured
finance. Low credit scores and high loan-to-value ratios were taken into account in Moody's
original analysis, of course, but the firm now thinks there were things it didn't know about.

Weill doesn't lay blame on any particular party, although in a Sept. 25 special report posted
on Moody's website, he called for "additional third-party oversight that reviews the accuracy
of the information provided by borrowers, appraisers, and brokers to originators" when it
comes to junk issues. Or, as he calls them, "non-prime."
S&P, by contrast, says that it considers both its original rating and subsequent downward
revisions correct. "We used the best information available at the time," says Vickie Tillman,
S&P's chief rating officer.

If you read documents that Goldman filed with the SEC in connection with this offering, you
discover that they warn about pretty much everything we've discussed so far and some things
we haven't: the impact of falling house prices, the difficulty of foreclosing, the possible
changes in credit ratings, the fact that more than half the mortgages were in California,
Florida, and New York, all of which were overheated markets.

It's all disclosed. In capital letters. So no buyer - and this is aimed at sophisticated investors -
can say he wasn't warned.

Goldman said it made money in the third quarter by shorting an index of mortgage-backed
securities. That prompted Fortune to ask the firm to explain to us how it had managed to
come out ahead while so many of its mortgage-backed customers were getting stomped.

Goldman's profits came from hedging the mortgage securities it keeps in inventory in order to
make trading markets. It said in a recent SEC filing, "Although we recognized significant
losses on our non-prime mortgage loans and securities, those losses were more than offset
by gains on short mortgage positions."

As we interpret this - the firm declined to elaborate - Goldman made more on its hedges than
it lost on its inventory because junk mortgages fell even more sharply than Goldman thought
they would.

What is there to take away from our course in Junk Mortgages 101? Two things. First, you
have to pay at least some attention to all those "risk factors" that issuers forever warn you
about - especially when you're dealing with a whole new thing like junk mortgages issued en
masse instead of by specialists.

Second, when you rely on the underwriter and the rating agencies to do all your homework
for you, you don't have safety. You have only the illusion of safety.

Reporter Associate Doris Burke contributed to this article.

IN TE RN ATIO NAL
How Goldman Sachs made money from US subprime mortgages on
the way up and down
By Michael Hennigan
Dec 3, 2007 - 5:19:00 AM

US Treasury Secretary Hank Paulson had thought that the subprime crisis would be contained last
spring and since August, with the onset of the subprime-related credit crisis, he has been involved
in various proposals to rescue the financial sector from a trauma of its own making and also some
of the at-risk of foreclosure householders.
Meanwhile, the top US investment bank Goldman Sachs has been on a roll as rivals such as Merrill
Lynch have been mired in the subprime fallout. The funny thing is that when Paulson headed
Goldman Sachs, until the summer of 2006, the bank was as active in the packaging/securitization
of subprime debt as its rivals.
According to the website ABAlert.com (asset-backed alert), Goldman Sachs was one of the top 10
sellers of CMO's (Collateralized Mortgage Obligation - a financial debt vehicle that was first created
in 1983 by investment banks Salomon Brothers and First Boston. Legally, a CMO is termed a special
purpose entity that is wholly separate from the institution(s) that create it) for the last two and a
half years and it may have sold about $100 billion in CMO's in that period, according to ABAlert.

Goldman Sachs CEO Lloyd Blankfein said last June that low interest rates and narrow yield
premiums on riskier debt fueled economic growth for the past four years by boosting investment in
real estate, emerging markets and LBOs (Leveraged Buy-outs).
``The biggest risk we face, and there are a lot of things that contribute to this risk, would be a
very big crisis in the credit markets,'' he said. ``Some of that is supply-demand fundamentals, but
a lot of it is sentiment.''

Goldman Sachs recorded $1.48 billion in charges for the third quarter but its trading income was up
a massive 70% on the year-earlier quarter. By contrast, Merrill Lynch & Co. disclosed a $7.9 billion
write-down just three weeks after the bank estimated a $4.5 billion charge. Citigroup Inc. has
recorded nearly $6 billion in credit losses and warned it may have to record as much as $11 billion
in further losses. Investment bank Morgan Stanley is expected to take a charge of $4.9 billion in its
third quarter, which ended last Friday.

Blankfein told a Merrill Lynch banking conference in November that his firm is no more prescient
than anyone else. Rather, the bank's success is a function of an aspiration "to be the most nimble
when the changes actually happen, and to see quicker and respond quicker because we did a
certain amount of war-gaming."
"To be out of it the day before the credit cycle changes, that's not going to happen a lot," he
said. "It's really not of this Earth to step into a place five minutes before it's the right place."

As the credit markets imploded and triggered ripples across the globe, Goldman Sachs had
protected itself from the junk it had sold and was positioned to profit massively from a decline in
those securities.
In a report from northern Norway last week, north of the Arctic Circle, the New York Times
said that the sun does not rise at all this far but Karen Margrethe Kuvaas said she has not been
able to sleep well for days.

What is keeping her awake are the far-reaching ripple effects of the troubled housing market in
sunny Florida, California and other parts of the United States.

Kuvaas is the mayor of Narvik, a remote seaport where the season's perpetual gloom deepened
even further in recent days after news that the town along with three other Norwegian
municipalities had lost about $64 million, and potentially much more, in complex securities
investments that went sour.

"I think about it every minute," Ms. Kuvaas, 60, said in an interview, her manner polite but harried,
according to the report. "Because of this, we can't focus on things that matter, like schools or care
for the elderly."
The New York Times said that Norway's unlucky towns are the latest victims and perhaps the least
likely ones so far of the credit crisis that began last summer in the American subprime mortgage
market and has spread to the farthest reaches of the world, causing untold losses and sowing fears
about the global economy.
Where all the bad debt ended up remains something of a mystery, but to those hit by the collateral
damage, it hardly matters.
The Times said that tiny specks on the map, these Norwegian towns are links in a chain of misery
that stretches from insolvent homeowners in California to the state treasury of Maine, and from
regional banks in Germany to the mightiest names on Wall Street. Citigroup, among the hardest
hit, created the investments bought by the towns through a Norwegian broker.
Also in the New York Times, columnist Ben Stein wrote on Sunday that "economists, like
accountants, are artists. They have a tendency to paint what their patrons, who pay them,
want to see."

Financial service economists are usually the optimists supporting their firms' sales strategies but
Stein charges Jan Hatzius, Chief Economist for Goldman Sachs in the US, with producing a report
on the US housing market last month that was "mostly about selling fear," because it dovetailed
with his firm's bearish strategy.

Goldman Sachs in September reported a blowout third quarter reporting a 79 percent

increase in net income and had chalked up its huge gains in part due to its bets against
mortgage-backed securities.
Fortune Magazine said in October that a large proportion of its third quarter profits
were 'unrealized' - i.e. paper gains, and not hard cash payments from fully closed out trades - and
came from financial instruments that Goldman values largely according to its own estimates.
The magazine said that much of the focus was on Goldman's trading revenue, which totaled a
spectacular $8.23 billion, up 70% on the year-earlier quarter. Part of that increase was due to a
bold bet that made money if mortgage-backed bonds and financial instruments tied to mortgage
values fell in price. Because of the credit crunch, they did plunge in value, netting gains for
Goldman that the banks said "more than offset" the losses it saw on the mortgages it was holding.
Allan Sloan, Fortune Senior Editor-at-Large wrote in October that it's getting hard to wrap your
brain around subprime mortgages, Wall Street's fancy name for junk home loans. There's so much
subprime stuff floating around - more than $1.5 trillion of loans, maybe $200 billion of
losses (Goldman's Jan Hatzius, wrote in a client report in November that losses related to record
US home foreclosures using a``back-of-the-envelope'' calculation may be as high as $400 billion for
financial firms), "thousands of families facing foreclosure, umpteen politicians yapping - that it's
like the federal budget: It's just too big to be understandable."

Sloan wrote that in the spring of 2006, Goldman assembled 8,274 second-mortgage loans originated
by home loan firms Fremont Investment & Loan, Long Beach Mortgage Co., and assorted other
players. More than a third of the loans were in California, then a hot market. It was a run-of-the-
mill deal, one of the 916 residential mortgage-backed issues totaling $592 billion that were sold
last year.
The average equity that the second-mortgage borrowers "had in their homes was 0.71%. (No,
that's not a misprint - the average loan-to-value of the issue's borrowers was 99.29%.)"
"It gets even hinkier. Some 58% of the loans were no-documentation or low-documentation. This
means that although 98% of the borrowers said they were occupying the homes they were
borrowing on - "owner-occupied" loans are considered less risky than loans to speculators - no one
knows if that was true. And no one knows whether borrowers' incomes or assets bore any serious
relationship to what they told the mortgage lenders.

You can see why borrowers lined up for the loans, even though they carried high interest rates. If
you took out one of these second mortgages and a typical 80% first mortgage, you got to buy a
house with essentially none of your own money at risk. If house prices rose, you'd have a profit. If
house prices fell and you couldn't make your mortgage payments, you'd get to walk away with
nothing (or almost nothing) out of pocket. It was go-go finance, very 21st century," Sloan wrote.
How does toxic waste get distilled into spring water, Sloan asked?

The mortgages were packaged into various classes of securities with the level of interest payable
to the purchaser related to a level of risk tied to the maturity periods, but suckers in Arctic Circle
and elsewhere didn't appreciate the risk that they were buying into and the shambolic standards, if
they could be termed that, that applied to the underlying loans. Besides, the likes of Goldman
Sachs, a top Wall Street name, would hardly be expected to be peddling junk and while caveat
emptor(Latin for "Let the buyer beware") should have applied, the modern economy would grind
to a halt without some level of trust. Big established firms get lots of business e.g Mergers &
Acquisitions work; IT projects, because the risk is assumed to be lower and the staff are expected
to be among the best in the market compared with dealing with smaller firms. There is also the
level of resources available and the assumed inclination to protect a reputation if something goes
wrong.
By the end of September, 18% of the underlying home loans had defaulted and will inevitably get
worse as borrowers are hit with higher interest payments after the expiration period of the
initial"teaser"/discounted mortgage rates expire.
Goldman made money because it hedged it bets and said in a Securities & Exchange Commission
filing: "Although we recognized significant losses on our non-prime mortgage loans and securities,
those losses were more than offset by gains on short mortgage positions."

Allan Sloan wrote that Goldman made more on its hedges than it lost on its inventory because junk
mortgages fell even more sharply than Goldman thought they would.

It's indeed an ill wind that doesn't blow somebody good and Goldman reported profits on both the
bull and bear housing markets.

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