WASHINGTON - Traders for Morgan Stanley gnashed their teeth for weeks in early 2008, watching helplessly as their $1.2 billion investment in an exotic mortgage securities deal, which was marketed by Wall Street rival Goldman Sachs, began to shrivel.
With the housing market deteriorating rapidly, Morgan Stanley traders wanted to sell off hundreds of millions of dollars in securities positions that had been downgraded by credit-ratings agencies and recover what money they could.
But Goldman Sachs Group Inc., the deal's liquidation manager, held sole control over the disposal of any of the securities contracts - and it was resisting.
On Feb. 6, 2008, Morgan Stanley trader John Pearce wrote a colleague that he got so exasperated with a Goldman representative that "I broke my phone." A day later, he wrote to a Goldman Sachs counterpart: "One day I hope I get the real reason why you are doing this to me."
It turns out, Senate investigators revealed this week, Goldman had plenty of reasons to delay a selloff. The investment-banking giant had secretly wagered on the default of the securities around which the $2 billion deal was structured.
In other words, it had bet against the securities. The more their value dropped, the bigger Goldman's profits would be.
Ultimately, a Morgan Stanley lawyer lodged a formal protest, charging that Goldman Sachs had breached its contractual duty to sell off downgraded securities and that the delays had already cost Morgan Stanley $150 million.
Known as Hudson-Mezzanine-2006-1, the deal collapsed in November 2008, about two years after its creation. Goldman Sachs reaped $1.35 billion. Morgan Stanley lost $930 million.
A Goldman spokesman declined to comment on the Hudson deal.
The story of the deal, which drew outrage from Sen. Carl Levin (D., Mich.) at a news conference Wednesday, is unveiled among hundreds of newly disclosed documents released by his Senate Permanent Investigations Committee, culminating a two-year inquiry into the financial crisis.
It provides a close-up glimpse of how Goldman Sachs deftly scaled back its risks as the housing market crested in late 2006 - and then, at the expense of its investor clients, earned billions of dollars from a full-scale blitz of secret bets that the value of home-mortgage securities would crash.
Goldman Sachs was the only major Wall Street firm to escape relatively unscathed from the nation's economic meltdown.
The subcommittee reported that Goldman packaged at least four securities deals with total value of $4.5 billion that were rife with conflicts of interest, including one for which the firm paid $550 million in fines to the Securities and Exchange Commission last summer to settle a civil fraud suit.
Levin charged that Goldman Sachs deceived investors on the Hudson deal by failing to disclose that it was betting the other way. And, he alleged, the company misled the subcommittee during a marathon hearing last year in which he repeatedly pressed Goldman chief executive officer Lloyd Blankfein and a half-dozen other current and former company executives to acknowledge that the firm bet massively on a housing downturn in 2006 and 2007.
Goldman says its executives testified truthfully.