Wall Street Compensation Is Much More Complex Than It Needs To Be. Let’s Take Goldman For Example…

The Wall Street Compensation issue is being made much more complex
than it needs to be. Let’s take Goldman for example. – Bloomberg: Self-Evaluations
Seen as New Source of Concern After Goldman Sachs Hearing

April 28 (Bloomberg) — Wall Street
employers, long concerned that their staff’s e-mails may be used
against them, now have another thing to worry about: the
self-evaluations employees fill out.

At a 10-hour congressional hearing
yesterday, senators pointed to Goldman
Sachs Group Inc. employees’ self-evaluations, which included boasts
about making “extraordinary profits” by betting against the subprime
market, as proof the company misled investors into a mortgage-linked
investment. [If they made "extraordinary profits", then the
transactions shouldn't be considered an economic hedge]

The fact that self-evaluations were used against Goldman
employees could keep companies from being open in their own review
process, hampering feedback that makes evaluations productive, said Gary
Hayes, co-founder of management consulting firm Hayes Brunswick &
Partners in New York. [Or they could just be more open with their
clients, and wouldn't have to worry about being secretive in their self
reviews - duhh!]

“That’s fairly chilling,” Hayes said. “It
would make many senior executives very cautious, if not guarded in
what they say in evaluations. You’ll hinder the kind of dialogue that’s
necessary.” Such evaluations are “a standard part of corporate
America,” he said. [Again, why doesn't this guy say "It would make
many senior executives very cautious, if not guarded in how they treat
their clients"!!!!????? It's as if it is expected that GS will screw
their clients, and the hurdle is how to conduct a review without getting
busted for it!]

Senators used e-mails and
self-evaluations produced by Goldman, which is being sued by the U.S.
Securities and Exchange Commission, to attack the firm. Goldman denies
the charges.

In his 2007 self-evaluation, Michael
Swenson, a managing director in the structured-products
group, said he earned the firm “extraordinary profits” after he
recognized the subprime mortgage market was going to crumble and
“aggressively capitalized” on betting against it.

‘Enormous Opportunity’

“It should not be a surprise to anyone
that the 2007 year is the one I am most proud of to date,” Swenson
wrote. “I can take credit for recognizing the enormous opportunity for
the ABS synthetics business 2 years ago. It was clear that the market
fundamentals in subprime and the highly levered nature of CDOs was
going to have a very unhappy ending.” [And consequently, the GS
bankers and analysts created CDO product inventory and the GS sales
force was instructed to dump this inventory onto the patsy as GS shorted
it into oblivion. Hey, I was heavily short during that period too. It
was obvious, but I didn't have to mislead a patsy to make a profit!
Those who are defending GS in this regard are being far from objective!]

In his own self-review that year, Joshua
Birnbaum, a former managing director in the same group, wrote, “I
concluded that we should not only get flat, but get VERY short_Much of
the plan began working by February as the market dropped 25 points and
our very profitable year was under way.” [The easiest and most
profitable way to do that is to get our patsies clients
long our product!]

Self-evaluations became popular after
World War II, as corporations expanded, Hayes said. The more thorough
“360” reviews — where employees are evaluated by themselves, their
bosses, their peers and their subordinates — became more popular at
Wall Street firms about 10 years ago, he said.

// // // // // //

I was wondering when, and if the GSAMP slide would gain some
traction. I wrote about this numerous times (see below). As for a
solution, I have also come up with a very simple solution that will end
this entire charade in about a fiscal quarter – tie the GS
compensation directly to risk adjusted return, with deferral and
clawbacks. That is RISK ADJUSTED returns, not revenues!

The
Solution to the Goldman (and by Extension, the Securities Industry)
Compensation Dilemma

Add to this the requisite Client’s best interests/bank as a fiduciary
standard (which will make the banks think twice before fornicating the
patsy) and we have a recipe for a near instantly reformed financial
system. More must read opinion on Goldman Sachs…

I huffed and puffed about how overvalued GS is, particularly
considering the amount of risk that it faced, I got a lot of blow back.
The same blow back I got in early 2008 when I shorted GS from $180 to
$75 (see Reggie
Middleton on Risk, Reward and Reputations on the Street: the Goldman
Sachs Forensic Analysis). Well, I guess we can all see the risk that
I was referring to, right??? It was obvious that Goldman played the
client as the patsym R.eggie
Middleton vs Goldman Sachs, Pt. Deux: Buy into a Collapsing Market
to Fund Bonuses, PLEASE!!!. Read through these excerpts of past
posts on patsyism and overvaluation on a risk adjusted (not accounting
revenue) basis…

When
the Patina Fades… The Rise and Fall of Goldman Sachs??? Tuesday,
16 March 2010

I have warned my readers about following myths and
legends versus reality and facts several times in the past, particularly
as it applies to Goldman Sachs and what I have coined “Name Brand
Investing”. Very recent developments from Senator Kaufman of Delaware
will be putting the spit-shined patina of Wall Street’s most powerful
bank to the test. Here is a link to the speech that the esteemed Senator from
Delaware (yes, the most corporate friendly state in this country). A few
excerpts to liven up your morning…

Reggie
Middleton vs Goldman Sachs, Round 1Tuesday, 08 December 2009 and Reggie
Middleton vs Goldman Sachs, Round 2 Sunday, 31 January 2010

On December 8th of last year, I penned “Reggie
Middleton vs Goldman Sachs, Round 1″ wherein I challenged all to
take a critical look at exactly how much money was lost by Goldman
Sachs’ clients. Well, here comes round 2, which is directed at Goldman
(over)valuation.

For
Those Who Chose Not To Heed My Warning About Buying Products From Name
Brand Wall Street Banks, Wednesday, 24 February 2010 -Those CDO
buyers shoudl really heed this article. Not only did the GSAMP investors
lose over 80%, but the real estate investors lost 98%
(see Wall
Street Real Estate Funds Lose Between 61% to 98% for Their Investors
as They Rake in Fees!).

First a little background info. Goldman is supremely
overvalued in my opinion. It is even more so considering much of its
profit is generated solely from the raping of its clients. I say this
holding absolutely no ill will towards Goldman. This is strictly
factual. Let’s walk through the evidence, of profit potential,
valuation, and the stuff behind some of the value drivers in their
business model, like brokerage and investment banking…

But wait! There’s
more, and it get’s quite interesting…

Reference “Blog
vs. Broker, whom do you trust!” and you will be able to track the
performance of all of the big banks and broker recommendations for much
of the year 2008 for the companies that I covered on my blog. Since
the concept of sell is rather remote to any big broker whose trading
desk is not net short a particular position, it would be safe to assume
that if the market turns the broker’s recommendations will also turn
in a similarly abysmal year as well. Just to be clear, this is not
about ability, or who is the smartest. It is about marketing and
conflicts of interest. Brokers do not charge for their research. Thus
it should be obvious to anyone with even the slightest modicum of
business savvy that the sunk costs that is freely disseminated research
is most likely a loss leader (with the losses being born by the
consumers of said research) otherwise known as the marketing arm for
underwriting, sales and trading.

The
blind following of Wall Street marketing
research, and the abject worshipping of Goldman marketing,inventory dumping,
sales research allows them to
rake billions of dollars off of their clients backs, yet clients still
come back for more pain. A fascinating, Pavlov’s dog’s/Stockholm
Syndrome style phenomena. Have you, as a Goldman client, performed as
well as their employees receiving $19 billion in bonuses? Don’t get me
wrong. I’m not hating Goldman, but now they are actually raping raking billions of dollars off of the tax
payers backs as well. I do not do business with them, hence I do not
want get my back raked – but it appears that as a US taxpayer I have no
choice. A company that nearly collapsed a year ago, receives
mysteriously generous government assistance (AIG full payout during its
near collapse as an insolvent company) with the help of highly ranked
government officials (many of which are ex-Goldman employees) and then
pays out record bonuses on top of so many tens of billions of dollars of
taxpayer aid with taxpayers facing high unemployment and sparse credit
is not necessarily a company that should be looked upon as a scion of
Wall Street. There is no operational excellence here. The only reason
such an aura exists is because main street and Wall Street clients have
an amazingly short memory, as I will demonstrate in the paragraphs
below. This goes for the big Wall Street banks in general, and Goldman
in particular.

As stated above, Goldman is now underwriting CMBS under a
broad fund our $19 billion bonus pool
“buy” recommendation in the CRE REIT space. Let’s take a look at another
big bonus development exercise,
marketing push they made into MBS a few years ago…

In April of 2006, a Goldman Sachs forced “Goldman Sachs Alternative
Mortgage Products”, an entity that pushed residential mortgage backed
securities to its victims clients through
GSAMP Trust 2006-S3 in a similar fashion to the sales and marketing of 
the CRE CMBS that is being pushed to its victimsclients
as described in the links above. The residential real estate market
faced very dire fundamental and macro headwinds back then, just as the
commercial real estate market does now. I don’t think that is the end of
the similarities, either.

Less then a year and a half after this particular issue was
floated, a sixth of the borrowers defaulted on the loans behind this
product, according to CNN/Fortune, where the graphic to the right was
sourced from. Here’s an excerpt from the article of October 2007 (less
than a year after the issue was sold to Goldman clients, clients who
probably didn’t know that Goldman was short RMBS even as Goldman peddled
this bonus bulging trash to them):

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…

,,, 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.

The party line answer to the bolded phrase above is “risk
management”. Goldman is prone to say, “We were just hedging out client
positions”. Well, I wonder, were they net short or net long RMBS. You
want to know what my guess is??? Looking back to there CMBS offerings of
late, clients and bonus pool enhancement customers should inquire, “Is
Goldman net short the trash, bonus pool
enhancement CMBS products that they are peddling to me???”

Now, fast forwarding to the present day, we look into “GSAMP
Trust 2006-S3″ and we find (courtesy of a follow-up CNN/Fortune article):

…the formulas used by Moody’s and S&P allowed
Goldman to market the top three slices of the security — cleverly called
A-1, A-2 and A- 3 — as AAA rated. That meant they were supposedly as
safe as U.S. Treasury securities.

But of course they weren’t. More than a third of the
loans were on homes in California, then a superhot market, now a frigid
one. Defaults and rating downgrades began almost immediately. In July
2008, the last piece of the issue originally rated below AAA defaulted —
it stopped making interest payments. Now every month’s report by the
issue’s trustee, Deutsche Bank, shows that the old AAAs — now rated D by
S&P and Ca by Moody’s — continue to rot out.

As of Oct. 26, date of the most recent available
trustee’s report, only $79.6 million of mortgages were left, supporting
$159.9 million of bonds. In other words, each dollar of bonds had a
claim on less than 50¢ of mortgages.

All the tranches of this issue, GSAMP-2006 S3, that were
originally rated below AAA have defaulted. Two of the three original
AAA -rated tranches (French for “slices”) are facing losses of about
90%, and even the “super senior,” safer-than-mere-AAA slice is facing
losses of 25%.

As of Oct. 26, date of the most recent available
trustee’s report, only $79.6 million of mortgages were left, supporting
$159.9 million of bonds. In other words, each dollar of bonds had a
claim on less than 50¢ of mortgages.

… ABSNet valued the remaining mortgages in our issue at a
tad above 20% their face value. Now, watch this math. If the mortgages
are worth 20% of their face value and each dollar of mortgages
supports more than $2 of bonds, it means that the remaining bonds are
worth maybe 10% of face value.

…If all the originally AAA -rated bonds were the same,
they’d all be facing losses of 90% or so in value. However, they weren’t
the same. The A-1 “super senior” tranche was entitled to get all the
principal payments from all the borrowers until it was paid off in full.
Then A-2 and A-3 would share the repayments, then repayments would
move down to the lower-rated issues.

But under the security’s rules, once the M-1 tranche —
the highest-rated piece of the issue other than the A tranches —
defaulted in July 2008, all the A’s began sharing in the repayments. The
result is that only about 28% of the original A-1 “super seniors” are
outstanding, compared with more than 98% of A-2 and A-3. If you apply a
90% haircut, the losses work out to about 25% for the “super seniors,”
and about 90% for A-2 and A-3.

So, after reminiscing about the GSAMP Slide, we get to a news story
in Bloomberg released just this morning…

Secret AIG Document Shows
Goldman Sachs Minted Most Toxic CDOs

From Bloomberg:

Feb. 23 (Bloomberg)

Representative Darrell
Issa, the ranking Republican on the House Committee on Oversight
and Government Reform, placed into the hearing record a five-page
document itemizing the mortgage securities on which banks such as Goldman Sachs
Group Inc. and Societe Generale SA had bought $62.1 billion in
credit-default swaps from AIG…

The public can now see for the first time how poorly the
securities performed, with losses exceeding
75 percent of their notional value in some cases.
Compounding this, the document and Bloomberg data demonstrate that the banks that bought the swaps from AIG are mostly
the same firms that underwrote the CDOs in the first place.

The
banks should have to explain how they managed to buy protection from AIG
primarily on securities that fell so sharply in value,
says Daniel
Calacci, a former swaps trader and marketer who’s now a
structured-finance consultant in Warren, New Jersey. In some cases,banks also owned mortgage lenders, and they should
be challenged to explain whether they gained any insider knowledge about
the quality of the loans bundled into the CDOs, he
says. [Let's not play games here. The banks knew what trash was hidden
where!]

More of Reggie on Goldman Sachs

Reggie
Middleton vs Goldman Sachs, Round 2

Reggie
Middleton Personally Contragulates Goldman, but Questions How Much
More Can Be Pulled Off

Get Your Federally
Insured Hedge Fund Here, Twice the Price Sale Going on Now!

Reggie
Middleton on Goldman Sachs’ fourth quarter, 2008 results

Goldman
and Morgan losses in the news, about 11 months late

Blog
vs. Broker, whom do you trust!

Monkey
business on Goldman Superheroes

Reggie
Middleton asks, “Do you guys know who you’re messin’ with?”

Reggie
Middleton on Risk, Reward and Reputations on the Street: the Goldman
Sachs Forensic Analysis

Reggie
Middleton on Goldman Sachs Q3 2008

§  As
Reality hits, the Masters of the Universe are starting to look like
regular bank employees

Reggie
Middleton’s Goldman Sach’s Stress Test: Breaking Ranks with the Crowd
Once Again!

Who
is the Newest Riskiest Bank on the Street?

More
premium Stuff!

Goldman Sachs Report June 21, 2008 2008-10-20
16:48:01 361.18 Kb

Reggie
Middleton on Goldman Sachs’ fourth quarter, 2008 results

Goldman Sachs – Buffet’s strategic
investment and public offering 2008-09-26 02:29:15
895.36 Kb

Goldman Sachs’ Bank Holding Company Fundamental Valuation and Forensic
Analysis – Professional 2008-12-18 10:12:37
267.49 Kb

Goldman
Sachs’ Bank Holding Company Fundamental Valuation and Forensic Analysis –
Retail 2008-10-20 15:45:05 348.99 Kb

GS ABS
Inventory 2008-02-25 06:48:56 1.22 Mb

Goldman Sachs Valuation Model updated
for PPIP – Retail 2009-04-04 19:50:51
388.04 Kb

Goldman Sachs’ Bank Holding Company Fundamental Valuation and Forensic
Analysis – Professional 2008-12-18 10:12:37
267.49 Kb

Subscribe Goldman Sachs Stress Test Retail2009-04-20 10:08:06 720.25 Kb – 17 pages Goldman Sachs Stress Test Professional 2009-04-20 10:06:45 4.04 Mb – 131 pages

Comments

[downrodeo]

Taxpayer dollars should never come into the equation.

Correct me if I'm wrong, but there is no principal within the theory of capitalism or any type of free market that allows for tbtf or bailouts with public funds (before you rip me a new one: I know, we don't use capitalisim in this country, but we/our leaders pretend to and so will I to make this point->) .

[LeBalance]

/Alternate to thesis statement/:

"Temptation in the form of compensation and a bonus structure, which along with a deregulated environment and encouragement from on high, caused a criminogenic culture to emerge and deal the decisive blow to the financial house of cards."

[bchbum]

Bonuses should be paid in cash or stock that vests over a 4 or 5 yr period.  Each of the tbtf banks should be forced to put vested and unvested employee compensation into a pool/fund that could be withdrawn from by an employee as they see fit. But, if a tbtf bank failed or a bailout was needed, this fund would be used first (whether or not the stock is vested yet).  In other words, before any taxpayer dollars.

[anony]

A cirumlocutionary way to say:

INCENTIVES must not reward failure, and failure must not be rewarded with bonuses paid for by taxpayers whose only option is to assassinate a Paulson or a Bernanke or anyone of their ilk.

[Leo Kolivakis]

LOL, they should follow the example of Canadian public pension funds and get compensated on four-year rolling returns. this way, even when they get slammed in a bad year, they can "smooth" things out and still get big bonuses.

Time to align interests in all these shops. Use the hedge fund and PE models, with skin in the game, clawbacks, high water marks. Better yet, just do away or seriously curtail bonuses at banks and public pension funds. Let risk-takers innovate with their own capital, not other people's money.

[Steroid]

Leo, I agree. And even better, they should be paid with the paper they generate.