Pension funds, insurance companies, unions and foreign institutions that bought those dicey mortgage securities are facing large losses. Meanwhile Goldman Sachs was making secret, exotic bets on an imminent housing crash, violating securities laws.

In 2006 and 2007, Goldman Sachs Group peddled more than $40 billion in securities backed by at least 200,000 risky home mortgages, but never told the buyers it was secretly betting that a sharp drop in U.S. housing prices would send the value of those securities plummeting.

Goldman's sales and its clandestine wagers, completed at the brink of the housing market meltdown, enabled one of the nation's premier investment banks to pass most of its potential losses to others before a flood of mortgage loan defaults staggered the U.S. and global economies.

Only later did investors discover that what Goldman promoted as triple-A investments were closer to junk.

Now, pension funds, insurance companies, labor unions and foreign financial institutions that bought those dicey mortgage securities are facing large losses.

A five-month McClatchy Newspapers investigation has found that Goldman's failure to disclose that it made secret, exotic bets on an imminent housing crash may have violated securities laws.

"The Securities and Exchange Commission should be very interested in any financial company that secretly decides a financial product is a loser and then goes out and actively markets that product or very similar products to unsuspecting customers without disclosing its true opinion," said Laurence Kotlikoff.

He's a Boston University economics professor who's proposed a massive overhaul of the nation's big banks. "This is fraud and should be prosecuted."

John Coffee, a Columbia University law professor who served on an advisory committee to the New York Stock Exchange, said that investment banks have wide latitude to manage their assets, and so the legality of Goldman's maneuvers hinges on what its executives knew at the time.

"It would look much more damaging," Coffee said, "if it appeared that the firm was dumping these investments because it saw them as toxic waste and virtually worthless."

Lloyd Blankfein, Goldman's chairman and chief executive, declined to be interviewed for this article.

A Goldman spokesman, Michael DuVally, said that the firm decided in December 2006 to reduce its mortgage risks and did so by selling off subprime-related securities and making myriad insurance-like bets, called credit-default swaps, to "hedge" against a housing downturn.

Although the company had secretly bet on a downturn, DuVally told McClatchy that Goldman "had no obligation to disclose how it was managing its risk, nor would investors have expected us to do so. Other market participants had access to the same information we did."

For the past year, Goldman's been on the defensive over its Washington connections and the billions it received in federal bailout funds. Yet, scant attention has been paid to how it became the only major Wall Street player to extricate itself from the subprime securities market before the housing bubble burst.

In piecing together Goldman's role in the subprime meltdown, McClatchy reviewed hundreds of documents, SEC filings, copies of secret investment circulars, lawsuits and interviewed numerous people familiar with the firm's activities.

McClatchy's inquiry found that Goldman Sachs:

- Bought and converted into high-yield bonds tens of thousands of mortgages from subprime lenders that became the subjects of FBI investigations into whether they'd misled borrowers or exaggerated applicants' incomes to justify making hefty loans.

- Used offshore tax havens to shuffle its mortgage-backed securities to institutions worldwide, including European and Asian banks, often in secret deals run through the Cayman Islands, a British territory in the Caribbean used by companies to bypass U.S. disclosure requirements.

- Has dispatched lawyers across the country to repossess homes from bankrupt or financially struggling individuals, many of whom lacked sufficient credit or income but got subprime mortgages anyway because Wall Street made it easy for them to qualify.

- Was buoyed last fall by several key federal bailout decisions, at least two of which involved then-Treasury Secretary Henry Paulson, a former Goldman chief executive whose staff at Treasury included several other Goldman alumni.

Goldman's financial panache made its sales pitches irresistible to policymakers and investors alike, and helps explain why so few of them questioned the risky securities that Goldman sold off in a 14-month period that ended in February 2007.

Since the collapse of the economy, however, some investors have changed their views of Goldman.

Several pension funds, including Mississippi's Public Employees' Retirement System, have filed suits, seeking class-action status, alleging that Goldman and other Wall Street firms negligently made "false and misleading" representations of the bonds' true risks.

Mississippi Attorney General Jim Hood, whose state lost $5 million of the $6 million it invested in Goldman's subprime mortgage-backed bonds in 2006, said the state's funds are likely to lose "hundreds of millions of dollars" on those and similar bonds.

Hood assailed the investment banks "who packaged this junk and sold it to unwary investors."

California's huge public employees' retirement system, known as CALPERS, purchased $64.4 million in subprime mortgage-backed bonds from Goldman on March 1, 2007.

While that represented a tiny percentage of the fund's holdings, in July CALPERS listed the bonds' value at $16.6 million, a drop of nearly 75 percent, according to documents obtained through a state public records request.

New Orleans' public employees' retirement system, an electrical workers union and the New Jersey carpenters union also are suing Goldman and other Wall Street firms over their losses.

While Goldman was far from the biggest player in the risky mortgage securitization business, neither was it small.

From 2001 to 2007, Goldman hawked at least $135 billion in bonds keyed to risky home loans, according to analyses by McClatchy and the industry newsletter Inside Mortgage Finance.

For investment banks such as Goldman, the trick was knowing when to exit the high-stakes subprime game before getting burned.

New York hedge fund manager John Paulson was one of the first to anticipate disaster.

He told Congress that his researchers discovered by early 2006 that many subprime loans covered the homes' entire value, with no down payments, and so he figured that the bonds "would become worthless."

He soon began placing exotic bets - credit-default swaps - against the housing market. His firm, Paulson & Co., booked a $3.7 billion profit when home prices tanked and subprime defaults soared in 2007 and 2008. (He isn't related to Henry Paulson.)

At least as early as 2005, Goldman similarly began using swaps to limit its exposure to risky mortgages, the first of multiple strategies it would employ to reduce its subprime risk.

DuVally said Goldman has made other bets with hundreds of unidentified counterparties to insure its own subprime risks and to take positions against the housing market for its clients. Until the end of 2006, he said, Goldman was still betting on a strong housing market.

However, Goldman sold off nearly $28 billion of risky mortgage securities it had issued in the U.S. in 2006, including $10 billion on Oct. 6, 2006.

The firm unloaded another $11 billion in February 2007, after the firm had intensified its contrary bets. Goldman also stopped buying risky home mortgages after the December meeting, though DuVally declined to say when.

Despite updating its numerous disclosures to investors in 2007, Goldman never revealed its secret wagers.

The Securities Act of 1933 puts a special disclosure burden on principal underwriters of securities, which was Goldman's role when it sold about $39 billion of its own risky mortgage-backed securities from March 2006 to February 2007. The firm maintains that the requirement doesn't apply in this case.

Coffee, the Columbia University law professor, said that any violations of securities laws would hinge on what Goldman executives knew about the risks ahead.

"The critical moment when Goldman would have the highest liability and disclosure obligations is when they are serving as an underwriter on a registered public offering," he said.

"If they are at the same time desperately seeking to get out of the field, that kind of bailout does look far more dubious than just trading activities."

tags: goldman sachs  swindle  investors  double dealings