When the Patina Fades... The Rise and Fall of Goldman Sachs???
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...
Mr. President, last Thursday, the bankruptcy examiner for Lehman
Brothers Holdings Inc. released a 2,200 page report about the demise of
the firm which included riveting detail on the firm’s accounting
practices. That report has put in sharp relief what many of us have
expected all along: that fraud and potential criminal conduct were at
the heart of the financial crisis.
... Only further investigation will determine whether the individuals
involved can be indicted and convicted of criminal wrongdoing.
... Lehman structured its repo agreements so that the collateral was
worth 105 percent of the cash it received – hence, the name “Repo
As explained by the New York Times' DealBook, “That meant that for a
few days – and by the fourth quarter of 2007 that meant end-of-quarter –
Lehman could shuffle off tens of billions of dollars in assets to
appear more financially healthy than it really was.” [Hey,
name several banks that are doing that right now. One might even rhyme
with the name Max]
... Even worse, Lehman’s management trumpeted how the firm was
decreasing its leverage so that investors would not flee from the
But inside Lehman, according to the report, someone described the Repo
105 transactions as “window dressing,” a nice way of saying they were
designed to mislead the public.
... Mr. President, the SEC and Justice Department should pursue a
thorough investigation, both civil and criminal, to identify every last
person who had knowledge that Lehman was misleading the public about
troubled balance sheet – and that means everyone from the Lehman
executives, to its board of directors, to its accounting firm, Ernst
& Young. Moreover, if the foreign bank counterparties who
the now infamous "Repo 105s" were complicit in the scheme, they should
be held accountable as well.
... Mr. President, it is high time that we return the rule of law to
Wall Street, which has been seriously eroded by the deregulatory
that captured our regulatory agencies over the past 30 years [Preach
on my brother from another mother...]
The allure of deregulation, instead, led to the biggest financial
crisis since 1929. And now we’re learning, not surprisingly, that
and lawlessness were key ingredients in the collapse as well. Since
the fall of 2008, Congress, the Federal Reserve and the American
taxpayer have had to step into the breach – at a direct cost of more
than $2.5 trillion – because, as so many experts have said: "We had to
save the system."
But what exactly did we save? [Don't get me started...]
First, a system of overwhelming and concentrated financial power that
has become dangerous. It caused the crisis of 2008-2009 and threatens
cause another major crisis if we do not enact fundamental reforms.
Only six U.S. banks control assets equal to 63 percent of the nation’s
gross domestic product, while oversight is splintered among various
regulators who are often overmatched in assessing weaknesses at these
... a system in which the rule of law has broken yet again. Big banks
can get away with extraordinarily bad behavior – conduct that would not
be tolerated in the rest of society.
Mr. President, what lessons should we take from the bankruptcy
examiner’s report on Lehman, and from other recent examples of
misleading conduct on Wall Street? I see three.
First, we must undo the damage done by decades of deregulation. That
damage includes financial institutions that are “too big to manage and
too big to regulate” (as former FDIC Chairman Bill Isaac has called
them), a “wild west” attitude on Wall Street, and colossal failures by
accountants and lawyers who misunderstand or disregard their role as
gatekeepers. The rule of law depends in part on manageably-sized
institutions, participants interested in following the law, and
gatekeepers motivated by more than a paycheck from their clients. [Amen!!!!!!!
Ladies and gentlemen, Reggie brings you:
objective review shows that the big banks are simply too big for the
safety of this country
Doesn't the Media Take a Truly Independent, Unbiased Look at the Big
Banks in the US?
the markets climb on top of one big, incestuous pool of concentrated
hasn't anybody questioned those rosy stress test results now that the
facts have played out?
Independent Look into JP Morgan
When considering the staggering level of derivatives employed by JPM,
it is frightening to even consider the fact that the quality of JPM's
derivative exposure is even worse than Bear Stearns and Lehman‘s
derivative portfolio just prior to their fall. Total net derivative exposure
rated below BBB and below for JP Morgan currently stands at 35.4%
the same stood at 17.0% for Bear Stearns (February 2008) and 9.2% for
Lehman (May 2008). We all know what happened to Bear Stearns and
Brothers, don't we??? I warned all about Bear Stearns (Is
this the Breaking of the Bear?: On Sunday, 27 January 2008, three
months before their collapse) and Lehman ("Is
Lehman really a lemming in disguise?": On February 20th, 2008,
months before their collapse) by taking a close, unbiased look at
balance sheet. Don't let anyone tell you that these companies'
couldn't have been seen coming. I saw them coming and I
articulated it in BoomBustBlog
just as I
am warning YOU, NOW! And now, back to the esteemed Senator's
Second, we must concentrate law enforcement and regulatory resources on
restoring the rule of law to Wall Street. We must treat financial
crimes with the same gravity as other crimes, because the price of
inaction and a failure to deter future misconduct is enormous.
Third, we must help regulators and other gatekeepers not only by
demanding transparency but also by providing clear, enforceable “rules
of the road” wherever possible. That includes studying conduct that
not be illegal now, but that we should nonetheless consider banning or
curtailing because it provides too ready a cover for financial
wrongdoing. [My dear Senator, might I suggest allowing accountants to
return to making accounting rules rather than lobbyists and
A clear and quick reinstatement of the mark to market rules (and
insuring that they are aptly enforced) will go a very long way with
practically no legislation. Please, please see "About
the Politically Malleable FASB, Paid for Politicians, and Mark to Myth
Accounting Rules". Of course, a practical action such as this may
very well force the market to return to being valued off of
versus rumors, innuendo, gossip and 5 SPARC servers arguing with each
other through high frequency trading algorithms...
If the engineered bear market rally is running off of the FASB
generated lies, then we certainly do have another crash coming, don't
The bottom line is that we need financial regulatory reform that is
tough, far-reaching, and untainted by discredited claims about the
efficacy of self-regulation...
We wanted to make certain that the Department of Justice and other law
enforcement authorities had the resources necessary to investigate and
prosecute precisely the sort of fraudulent behavior allegedly engaged
by Lehman Brothers...
Many have said we should not seek to "punish" anyone, as all of Wall
Street was in a delirium of profit-making and almost no one foresaw the
sub-prime crisis caused by the dramatic decline in housing values. [HA!
I think the technical term for this statement is.....
Commercial Real Estate Crash Cometh, and I know who is leading the
(a year before the CRE crash) It wasn't hard to see that commercial
real estate was ready to implode and that GGP was about to collapse
under its own weight. Why didn't our regulators see what I saw?
Countrywide is pretty bad, but it ain’t the only one at the subprime
party… Comparing Countrywide Countrywide and Washington Mutual's
collapse were visible AT LEAST a year in advance!
I see it, 32 commercial banks and thrifts may see the feces hit the
blades (a year before they started to fall) It wasn't hard to see
that nearly all of these 32 banks would be facing the threat of
insolvency. Why didn't our regulators see what I saw?
Next Shoe to Drop: Credit Default Swaps (CDS) and Counterparty Risk -
Beware what lies beneath! Warned a year ahead. 'Nuff said...
Another "I Told 'ya So" for the Muni Buyers: Two years ago I
that our municipalities will probably start defautling
this the Breaking of the Bear?: On Sunday, 27 January 2008, three
months before their collapse
Lehman really a lemming in disguise?": On February 20th, 2008,
months before their collapse
A Super Scary Halloween Tale of 104 Basis Points Pt I & II, by
Reggie Middleton -11/13/2007
is Effectively Insolvent & Will See More than $8 Billion of Losses
with Just a $2.26 Billion in Equity 11/29/2007 I made it clear
not only are these companies insolvent with business models based upon
near fraudulent relationships with ratings agencies, but the entire
business will come crashing down - 3 years ago.]
This is about addressing the continuum of behavior that took place –
some of it fraudulent and illegal -- and in the process addressing what
Wall Street and the legal and regulatory system underlying its behavior
As part of that effort, we must ensure that the legal system tackles
financial crimes with the same gravity as other crimes. When crimes
happened in the past (as in the case of Enron, when aided and abetted
by, among others, Merrill Lynch, and not prevented by the supposed
gatekeepers at Arthur Andersen), there were criminal convictions. If
individuals and entities broke the law in the lead up to the 2008
financial crisis (such as at Lehman Brothers, which allegedly deceived
everyone, including the New York Fed and the SEC), there should be
and criminal cases that hold them accountable...
If we uncover bad behavior that was nonetheless lawful, or that we
cannot prove to be unlawful (as may be exemplified by the
reports of actions by Goldman Sachs with respect to the debt of Greece),
then we should review our legal rules in the US and perhaps change them
so that certain misleading behavior cannot go unpunished again. [Oh,
I will assist you on expounding on Goldman a few paragraphs below. I
hope you are reading this blog!] This will not be easy.
Wall Street Journal’s “Heard on the Street” noted last week, “Give Wall
Street a rule and it will find a loophole.”
Systemic issues in Uncovering and Prosecuting Fraud This confirms what I
heard On December 9 of last year, when I convened an oversight hearing
on FERA. As that hearing made clear, unraveling sophisticated
fraud is an enormously complicated and resource-intensive undertaking,
because of the nature of both the conduct and the perpetrators. [My
Senatorial Friend, you should more time in the blogosphere. Not only
would you have realized that it was quite possible to see the crash of
2008 coming, but it is also quite possible to see the crash of 2010
coming as well as unraveling financial fraud. Our system is wrought
regulatory capture. If someone is paid (either directly or subvertly)
not to see something, they probably will not see it - reference How
Regulatory Capture Turns Doo Doo Deadly and Lehman
Brothers and Its Regulators Deal the Ultimate Blow to Mark to Market
Rob Khuzami, head of the SEC’s enforcement division, put it this way
during the hearing:
“White-collar area cases, I think, are distinguishable from terrorism
or drug crimes, for the primary reason that, often, people are plotting
their defense at the same time they're committing their crime. They are
smart people who understand that they are crossing the line, and so
are papering the record or having veiled or coded conversations that
make it difficult to establish a wrongdoing.”
In other words, Wall Street criminals not only possess enormous
resources but also are sophisticated enough to cover their tracks as
they go along, often with the help, perhaps unwitting, of their lawyers
and accountants. [Listen, a thief is a thief. Some are smart,
are not. Wall Street comes nowhere near having a monopoly on craftiness
nor intelligence. I have given many instances in the paragrahp above
where I have caught companies in many a shenanigan and anticipated in
illustrious detail the biggest crashes of this lifetime that no one
apparently saw coming. I did this with a small cadre of analysts and an
unbiased eye. It had nothing to do with my being smart! Imagine if I
paid to do this and more without outside influences and biases!]
Is Lehman Brothers an Isolated Example?
Mr. President, I’m concerned that the revelations about Lehman Brothers
are just the tip of the iceberg. We have no reason to believe that the
conduct detailed last week is somehow isolated or unique. Indeed, this
sort of behavior is hardly novel. Enron engaged in similar deceit with
some of its assets. And while we don’t have the benefit of an
examiner’s report for other firms with a business model like Lehman’s,
law enforcement authorities should be well on their way in conducting
investigations of whether others used similar “accounting gimmicks” to
hide dangerous risk from investors and the public. [I don't
about the government, but I definitely have my guys digging deep holes.]
The Case of Greece
At the same time, there are reports that raise questions about whether
Goldman Sachs and other firms may have failed to disclose material
information about swaps with Greece that allowed the country to
effectively mask the full extent of its debt just as it was joining the
European Monetary Union (EMU). We simply do not know whether fraud
involved, but these actions have kicked off a continent-wide
controversy, with ramifications for U.S. investors as well.
In Greece, the main transactions in question were called cross-currency
swaps that exchange cash flows denominated in one currency for cash
flows denominated in another. In Greece’s case, these swaps were
“off-market,” meaning that they didn’t use prevailing market exchange
rates. Instead, these highly unorthodox transactions provided Greece
with a large upfront payment (and an apparent reduction in debt), which
they then paid off through periodic interest payments and finally a
large “balloon” payment at the contract’s maturity. In other words,
Goldman Sachs allegedly provided Greece with a loan by another name.
The story, however, does not end there. Following these transactions,
Goldman Sachs and other investment banks underwrote billions of Euros
bonds for Greece. The questions being raised include whether some of
these bond offering documents disclosed the true nature of these swaps
to investors, and, if not, whether the failure to do so was material.
(QIBs) in the U.S. are able to purchase bonds (like the ones issued by
Greece) and other securities not registered with the SEC under
Securities Act of 1933, the sale of these bonds would still be governed
by other requirements of U.S. law. Specifically, they presumably would
be subject to the prohibition against the sale of securities to U.S.
investors while deliberately withholding material adverse information.
The point may be not so much what happened in Greece, but yet again the
broader point that financial transactions must be transparent to the
investing public and verified as such by outside auditors. AIG fell in
large part due to its credit default swap exposure, but no one knew
until it was too late how much risk AIG had taken upon itself. Why do
some on Wall Street resist transparency so? Lehman shows the answer:
everyone will flee a listing ship, so the less investors know, the
better off are the firms which find themselves in a downward spiral.
least until the final reckoning.
As I said more than a year ago: "At the end of the day, this is a test
of whether we have one justice system in this country or two. If we
don’t treat a Wall Street firm that defrauded investors of millions of
dollars the same way we treat someone who stole 500 dollars from a cash
register, then how can we expect our citizens to have faith in the rule
of law? For our economy to work for all Americans, investors must have
confidence in the honest and open functioning of our financial markets.
Our markets can only flourish when Americans again trust that they are
fair, transparent, and accountable to the laws."
The American people deserve no less.
Whoa! That was some speech coming out of a the senate. You see, it is
admirable that Senator Kaufman, and even Senator Dodd are trying to
reign in entities that are distorting the financial landscape, but I
feel they could accomplish so much more if they really knew how to pick
apart these companies to see what is beneath the hood, how it works, and
how it has been applied to transactions in the past.
In the post, "Smoking
Guns Are Beginning to Litter EuroLand, Sovereign Debt Buyer
Beware!" I illustrated the swap deal that appears to be at the
center of one of Senator Kaufman's issues:
According to people familiar with the matter interviewed by China
Securities Journal, Goldman Sachs Group Inc. did as many as 12
swaps for Greece from 1998 to 2001, while Credit Suisse was also
involved with Athens, crafting a currency swap for Greece in the same
Under its "off-market" swap in 2001, Goldman agreed to convert yen and
dollars into euros at an artificially favorable rate in the future.
helped Greece to use that "low favorable rate" when it recorded its
debt in the European accounts-pushing down the country's reported debt
Moreover, in exchange for the good deal on
had to pay Goldman (the
amount wasn't revealed). And since the
payment would count
against Greece's deficit, Goldman and Greece came up with another
twist: Goldman effectively loaned Greece the money for the payment, and
Greece repaid that loan over time. And the two sides structured the loan
another kind of swap. So, the deal didn't add to Greece's debt under EU
rules. Consequently, Greece's total debt as a percentage of GDP fell
from 105.3% to 103.7%, and its 2001 deficit was reduced by a tenth of a
percentage point in GDP terms, according to people close to Goldman.
Another action that smacks of Hellenic manipulation, at least to the
staff of BoomBustBlog: for years it apparently and simply omitted
portions of its military-equipment spending from its deficit
calculations. Though, European regulators eventually prevailed on
to count everything and as a result, in 2004, there was a massive
revision of Greek deficit figures from 2000 (a budget deficit of 2.0%
GDP in 2000 to beyond the 3% deficit limit in 2004), by then Greece had
already gained entrance to the euro. As in my trying to prepare for the
coming sovereign debt crisis, timing is everything, isn't it???
This is far, far from the only instance where it appears Goldman may
have not given full disclosure to its prospective and actual clients.
Before we get to a few other anecdotal instances, let's review exactly
how profitable this company really is if we were to take an objective,
risk-adjusted view. After all, the apparent shenanigans that are
mentioned throughout this post and by Senator Kaufman are quite risky,
Goldman is a very, very well run company. It is loved by some, reviled
by others, but in the end it is respected for something that it truly
does not deserve. That something is the ability to make an above average
return on risk adjusted capital. Goldman takes gobs of risk! From an
economic income perspective, it is mediocre to average at best. See " For
Who Chose Not To Heed My Warning About Buying Products From Name
Brand Wall Street Banks, "
GS return on equity has declined substantially due to deleverage and
is only marginally higher than its current cost of capital. With ROE
down to c12% from c20% during pre-crisis levels, there is no way a
with high beta as GS could justify adequate returns to cover the
inherent risk. For GS to trade back at 200 it has to increase its
leverage back to pre-crisis levels to assume ROE of 20%. And for that
has to either increase its leverage back to 25x. With curbs on banks
leverage this seems highly unlikely. Without any increase in leverage
and ROE, the stock would only marginally cover returns to shareholders
given that ROE is c12%. Even based on consensus estimates the stock
should trade at about where it is trading right now, leaving no upside
potential. Using BoomBustBlog estimates, the valuation drops
considerably since we take into consideration a decrease in trading
revenue or an increase in the cost of funding in combination with a
limitation of leverage due to the impending global regulation coming
down the pike. Using your method, our valuation would drop from where
is to an even lower point.
Second, it still has a bunch of trash on its balance sheet, see Reggie
vs Goldman Sachs, Round 2.
If you look at the period of the most recent credit bubble,
Goldman did everything that the other failed and bailed out banks did:
leveraged up on trash assets, invested in and sold the worthless junk,
and ran to the government for aid and bailouts:
So, what is GS if you strip it of its government protected, name- 131 pages). I believe
branded hedge fund status. Well, my subscribers already know. Let' take
peak into one of their subscription documents ( Goldman Sachs Stress Test
Professional 2009-04-20 10:06:45 4.04 Mb
many with short term memory actually forgot what got this bank into
trouble in the first place, and exactly how it created the perception
that it got out of trouble. The (Off) Balance Sheet!!!
Contrary to popular belief, it does not appear that Goldman is a
superior risk manager as compared to the rest of the Street. They may
the same mistakes and had to accept the same bailouts. They are
apparently well connected though, because they have one of the riskiest
balance sheet compositions around yet managed to get themselves insured
and protected by the FDIC like a real bank. This bank's portfolio
quite scary at the height of the bubble.
As a matter of fact, it looks just as scary today as it does at the
height of the bubble, but since very few people read balance sheets, no
one really notices.
You know what most people don't realize is that it looks quite scary
now as well.
Senator Kaufman justifiably takes issue with Goldman selling European
sovereign debt securities without full disclosure. If the honorable
Senator were to dig a little deeper, he would find that there may be a
lot more to that theory than he initially believed...
In April of 2006, a Goldman Sachs formed "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
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
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 below 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
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
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
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.
Just one month later from Bloomberg:
Feb. 23 (Bloomberg)
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
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
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!]
“It’s almost too uncanny,” Calacci says. “If these banks had
insight into the
underlying loans because they had relationships with banks,
or servicers, that’s at the least unethical.”[At the very
least. I think it's
The identification of securities in the document, known as Schedule A,
and data compiled by Bloomberg show that Goldman
Sachs underwrote $17.2 billion of the $62.1 billion in
CDOs that AIG insured -- more than any other investment bank. Merrill
Lynch & Co., now part
of Bank of America Corp., created $13.2 billion of the CDOs, and
Deutsche Bank AG underwrote $9.5 billion.
suggest a possible reason why the New York Fed kept so much under
Cox of Duke University School of Law
says: “They may
have been trying to shield Goldman -- for
Goldman’s sake or out of
macro concerns that another investment bank would be at risk.”
This is all gathered from anecdotal, occasional blogging. If someone
such as myself were to really dig in and search for
smoking guns, I am confident smoldering canons will be revealed. I
think the electorate should stand be behind Senator Kaufman for his
willingness to clean up a system which has become too one--sided, too
political, and (darest I say it), too corrupt.
More of Reggie on Goldman Sachs
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