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Washington Mutual Inc. and its Long Beach Mortgage Co. subprime-lending unit rang up one of the worst failures in U.S. history. Left in the wake were billions of dollars of soured loans and questionable lending practices.
But when times were better, the two companies had a powerful partner on Wall Street: Goldman Sachs Group Inc.
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.Recently released emails and other documents, including securities filings, show how Goldman, considered one of Wall Street's most elite banks, built its mortgage business by closely working with lenders such as Washington Mutual and Long Beach, two firms that "polluted the financial system" with souring loans, according to a Senate review of Washington Mutual on April 13.
"Long Beach…was not a responsible lender," Sen. Carl Levin (D., Mich.), chairman of the Senate Permanent Subcommittee on Investigations, said in his opening remarks April 13. "Its loans and mortgage-backed securities were among the worst performing of the subprime industry."
Goldman declined to discuss its business with Washington Mutual or the communications in the emails released by the Senate panel.
Goldman was one of several Wall Street firms that helped sell bonds backed by Washington Mutual loans. Over the weekend, the Senate subcommittee released internal Goldman emails, including one showing that the firm made a $5 million trading profit by betting against securities Goldman sold in a Long Beach bond offering that lost money for its investors, raising a potential conflict with its clients. On Tuesday, the panel plans to question Goldman executives in a separate hearing.
The emails and others like them highlight "the importance of transparency, the importance of things being in the open, the importance of it being known who is in a position to benefit from what," senior White House adviser Lawrence Summers said Sunday on CBS's "Face the Nation."
Much has been written about Washington Mutual's failure. In September 2008, the Seattle lender was forced to sell itself to J.P. Morgan Chase & Co. at the height of the crisis in the largest-ever U.S. bank failure. But there has been less scrutiny of the ties between Washington Mutual and Goldman, which emerged stronger than rivals after the mortgage market's collapse.
J.P. Morgan said the Washington Mutual loans and securities being investigated were issued before J.P. Morgan's purchase of Washington Mutual. A lawyer for former Washington Mutual Chief Executive Kerry Killinger couldn't be reached.
At times, executives at Washington Mutual discussed seeking out Goldman for its reputation for excellence, according to Washington Mutual emails. But Washington Mutual executives also were wary of their partner because of concerns about how the Wall Street firm traded.
"We always need to worry a little about Goldman because we need them more than they need us and the firm is run by traders," a Washington Mutual executive wrote in an email released by the Senate panel in its probe of the lender.
Long Beach was founded in 1979 as Long Beach Savings & Loan by Roland Arnall, a Los Angeles developer who got his start in business in Los Angeles selling flowers on a Los Angeles street corner. A unit called Long Beach Financial Corp., based in Orange, Calif., was sold to Washington Mutual in 1999.
Aided by mortgage brokers who channeled loans to Long Beach, Washington
Mutual and Long Beach ended up bundling subprime home loans into $77 billion worth of securities, according to the Senate inquiry.
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.Some Long Beach bonds were ultimately used to allow Wall Street firms and hedge funds to bet against the U.S. mortgage market. Long Beach bonds were among those underpinning subprime-mortgage indexes—assembled by Goldman and other Wall Street firms—that allowed those firms and hedge funds to bet against the housing industry, according to data provided by Markit Group Ltd., which helps run the indexes.
The Long Beach loans ended up being among the worst performing in the indexes, according to a Nomura Holdings report. Separately, some Long Beach bonds also underpinned the Abacus 2007-AC1 debt pool now at the center of a Securities and Exchange Commission securities-fraud case against Goldman, which the firm is fighting.
By 2005, Long Beach was in trouble. According to the Senate report released April 13, Long Beach had to buy back $875 million of nonperforming loans from investors. Problems persisted.
Behind one sale of Long Beach securities was Goldman. In 2006, Goldman teamed with a Washington Mutual unit to sell a debt pool called Long Beach Mortgage Loan Trust 2006-A. Both firms agreed to buy some of the securities with the intention of reselling them or making a secondary market for them, according to a prospectus for them. Of the $496 million deal, Goldman was expected to purchase about $322 million of the securities with the intention of reselling them.
Washington Mutual executives appeared troubled by loans at Long Beach.
In an April 2006 email, a Washington Mutual executive told Mr. Killinger that
Long Beach's "delinquencies are up 140% and foreclosures close to 70% ... It is ugly."
By early 2007, Goldman bankers also were growing anxious about their business dealings with Washington Mutual and Long Beach, according to emails released as part of the Senate investigation into Washington Mutual.
A Goldman banker raised questions about the performance of Long Beach loans that were "performing dramatically worse" than other similar deals in 2006. "As you can imagine, this creates extreme pressure, both economic and reputational, on both organizations," the Goldman banker said.
In May 2007, Goldman executives were discussing problems facing the debt deal it had helped underwrite called Long Beach Mortgage Loan Trust 2006-A, according to emails released by the Senate panel.
Among the Senate documents is an email from a Goldman executive to Michael Swenson, then a Goldman managing director in the firm's mortgage group, about the 2006-A bond deal. In an 8 a.m. email, Goldman executives circulated a securities report that showed loans inside the pool had soured.
Six minutes later, a Goldman executive wrote, "bad news…(the price decline in the bonds) costs us about 2.5 mm," adding, "good news…we make $5mm" on a derivatives bet against the bonds.
The Senate panel, in a statement over the weekend, said the email showed how the soured Long Beach bonds "would bring [Goldman] $5 million from a bet it had placed against the very securities it had assembled and sold."
Mr. Swenson declined to comment through a Goldman spokesman. He is among the Goldman executives set to appear at Tuesday's hearing. A Goldman spokesman said in a statement: "It's our standard, prudent practice to hedge exposures."
Despite the close relationship between Washington Mutual and Goldman, Washington Mutual wondered which side Goldman was on. In October 2007, Mr. Killinger wrote in an email about a situation with Goldman: "I don't trust Goldy on this. They are smart, but this is swimming with the sharks. They were shorting mortgages big time."
Write to Carrick Mollenkamp at [email protected] and Serena Ng at [email protected]
