The Tycoon Report

A Wall Street Saga: A 'Goldman' Opportunity (Part 1)

Thursday, August 6, 2009 | Bob De Dea




On Monday, the Securities and Exchange Commission (SEC) hit Bank of America with a (measly) $33 million penalty for paying nigh unto $6 billion of bonuses to Merrill Lynch execs in 2008.

The bailout of American banks was supposed to provide money for loans. But -- according to a report released last week by a watchdog agency overseeing the financial rescue program -- instead of boosting lending, banks have used the funds provided by the government (read: "you and me") to pay down debt or, believe it or not, buy other banks.

So today, I won't be asking you to look at the market or at a sector or a stock. Instead, I'm going to tell you a story. It's a fairly involved story, with lots of intrigue; as such I'll tell it in two parts.

It's a story with many lessons. And it's a story that is not, unfortunately, unique, in that there are others who could also be placed under a similar revealing lens (see B-of-A mention above).

Today we're going to turn our attention to Part 1 of "A Wall Street Saga." Today's installment is "A 'Goldman' Opportunity."

Let's Start at the Very Beginning ...

In 1869, a German immigrant named Marcus Goldman, along with his son-in-law Samuel Sachs, founded a company that led the way in propagating the use of commercial paper.

In other words, they loaned short-term IOUs to small businesses (vendors, really) in New York City. The company’s name, as you’ve probably guessed, is Goldman Sachs.

There are many interesting things about the history of Goldman Sachs that are worth knowing about:

• The investment trust game it played during the Great Depression.
   
• Its pioneering role in the introduction of IPOs, the firm’s adoption of the ethical mantra “long-term greedy” in the '70s and '80s.
   
• Robert Rubin’s relaxing of financial-market regulations that led to the complete disregard for underwriting standards (established in the '30s) and the subsequent dot-com bust (because only "insiders" knew about the changing of the rules, investors were left out in the cold).  ¹
  
  
• Its practice of laddering while introducing Internet IPOs, for which it paid a paltry settlement of $40 million in 2005 (Google “Nicholas Maier” and “Jim Cramer” -- yes, that Jim Cramer, a former GS employee) and its practice of spinning, which earned it another meager settlement of $110 million, prompted by a 2002 House Financial Services Committee report. (Google GS and “special stock offerings,” along with eBay and Enron).

Between 1999 and 2002, GS paid an average of $7 billion a year in comps and "bennies," about $350,000 a year per employee. ²

Now last year, during the financial crisis with which we all have become intimately acquainted (through no desire of our own), Goldman Sachs Group Inc. became a bank holding company (BHC).

The trouble is, after more than half a year as a BHC, several analysts at CreditSights (an independent fixed-income research firm) have noted that Goldman is still "not reporting like a bank and not acting like one, either."

In a note to investors after the latest earnings report, they wrote, “The company has basically been given a green light to continue operating in a 'business as usual' fashion.” In fact, at the end of 2008, CEO Lloyd Blankfein reiterated that the firm would continue "to be an adviser, financier, co-investor and asset manager." No talk of ATMs there, is there?

With more banks continuing to fail, regulators have their hands full and are apparently ignoring Goldman’s unchanging behavior. For instance, say the analysts, the firm doesn't disclose a full balance sheet in its earnings release.

Hmm.

The 'Thought Plickens'

Goldman was a big player in the bundling of mortgages into Collateralized Debt Obligations (CDO), which mixed the good with the bad (and garnered its AAA rating). Companies like AIG provided the insurance on the CDOs in an instrument known as credit-default swaps.

Old news, I know.

Now, I'm not a conspiracy-theorist sort. I am a rationalist, and most conspiracy theories seem to me to be a linking of disparate facts by coincidence in the fashion of "The Da Vinci Code." But I started to wonder just how far Goldman Sachs' influence spread, and by what means.

I first found out that back in 2000, AIG asked the New York State Insurance Department (NYSID) whether default swaps would be regulated as insurance. The head of the NYSID ruled that swaps were not to be regulated. This was Neil Levin, a former Goldman Sachs V.P.

Now, we all know that Henry Paulson was a former GS CEO, and that former Clinton administration Treasury Secretary Robert Rubin was a 26-year veteran of the company. But the list goes on:

• John Thain of Merrill Lynch ("who bought an $87,000 area rug for his office as his company was imploding" ³)
   
• Robert Steel of Wachovia (received $225 million as Wachovia disintegrated, only to rise from the ashes as a Wells Fargo subsidiary)
   
• Joshua Bolten, GW's chief of staff, and Mark Patterson, Obama's Treasury chief of staff (former GS lobbyists)
   
• Ed Liddy, former GS director placed in charge of AIG by Paulson

There, of course, are more. But you get the picture.

Something you may not have known, however, is that -- in addition to the $10 billion in TARP funds that GS recently paid back to the government -- it received $13 billion from AIG when Liddy was put in charge.

"By the peak of the housing boom in 2006, Goldman was underwriting $76.5 billion worth of mortgage-backed securities -- a third of which were subprime. ... But even as it was doing so, it was taking short positions in the same market ... and that net short position was profitable." ⁴

So Goldman was hedging its bets, and making more money doing so than from the mortgage CDOs themselves.

Is there no justice?

Well, of course there is. Sort of.

Lawsuits came. Some are still there. Massachusetts won a humungous settlement from GS of $60 million.

Black Gold, Texas Tea

Where to go?

Well, as Barbara Cohen has so poignantly pointed out in her Monday columns in The Tycoon Report, futures can make a world of difference in the market.

We saw what happened to the price of oil in the last year, even though production was increasing while demand was decreasing. (A classic scenario for a reduction in the price of a commodity. Even now, we're at a 20-year high in supply and a 10-year low in demand.)

How did we get here? Guess who had a dipstick in the oil tank. ...

Goldman Sachs got big, big investors to start buying oil futures, transforming the commodity into a gambler's dream. No longer dependent upon supply and demand, by 2008, "a barrel of oil was traded 27 times, on average, before it was actually delivered and consumed. ...

"(I)n fact, commodities speculators had bought and stockpiled enough oil futures to fill 1.1 billion barrels of crude, which meant that (they) owned more future oil on paper than there was real, physical oil stored in all of the country's commercial storage tanks and the Strategic Petroleum Reserve combined." ⁵

(Google "Bona Fide Hedging exemption" for more insight into GS' dealings with the Commodity Futures Trading Commission, the body that tried and failed to regulate credit-default swaps.)

That's enough to chew on for this week, but the best on this topic is yet to come. Next week, we'll talk about how Goldman Sachs gets its grubby little fingers into taxpayer money, global warming, and programmed trading.

______

¹ "In the early '80s, the major underwriters insisted on three years of profitability. Then it was one year; then it was a quarter. By the time of the Internet bubble, they were not even requiring profitability in the foreseeable future." -- Jay Ritter, University of Florida Professor of Finance and specialist in IPOs

² Matt Taibbi, "The Great American Bubble Machine." I am indebted to Mr. Taibbi for much of the information presented here.

³ Ibid.

⁴ According to David Viniar, GS' CFO

⁵ Taibbi






Bob De Dea
Guest Contributor
The Tycoon Report