We've Been Here Before: Goldman Sachs, 1929 & 2009

The distinguished economist John Kenneth Galbraith wrote a definitive study of the last great market implosion titled The Great Crash, 1929. In it, he discusses the root causes, both financial and psychological, for the crash.

It is a comprehensive work that ranges far and wide in seeking answers, from the “easy money” made in the Florida real estate bubble of the 1920s which he notes established “... the conviction that God intended the American middle classes to be rich," to the flow of funds from a war-devastated Europe to the US, to the “escape into make believe” that led to an unparalleled increase in trading on margin. Hmmm. Real estate that only goes up, US government debt being financed by foreign inflows of capital, and the use of leverage to increase return – and risk. That does sound vaguely familiar...

In addition to these, Galbraith devotes an entire chapter titled “In Goldman, Sachs, We Trust,” specifying what he called “large-scale corporate thimblerigging” that Goldman (GS) and other Wall Street firms practiced in the 1920s (though none quite as aggressively as Goldman). Primarily he talks about the “investment trusts” foisted upon the public by Goldman and others – effectively, the hedge funds of their day. These trusts never divulged what it was they did or didn’t own – sort of like Bernie Madoff.

As Galbraith writes:

To reveal the stocks they were selecting might, it was said, set off a dangerous boom in the securities they favored. Historians have told with wonder of one of the promotions at the time of the South Sea Bubble. It was 'For an Undertaking which shall in due time be revealed'. The stock is said to have sold exceedingly well.

As promotions the investment trusts were, on the record, more wonderful. They were undertakings the nature of which was never to be revealed, and their stock also sold exceedingly well.

And if one hedge fund from the same company was good, then three or 10 or 50 must be better. Again, Galbraith:

[Goldman’s] ...nearly simultaneous promotion of Shenandoah and Blue Ridge was to stand as the pinnacle of new era finance... Goldman Sachs & Company organized and sold nearly a billion dollars’ worth of securities in three interconnected investment trusts – Goldman Sachs Trading Corporation; Shenandoah Corporation; and Blue Ridge Corporation... All eventually depreciated virtually to nothing.

In today’s dollars, the losses from these investment trusts would equal about $475 billion.

A la today’s latest iteration of hedge fund managers, the investment trust promoters almost never disclosed their holdings. They maintained that that their investment trusts had tangible assets in their portfolio but, more importantly, intangible assets in the experience and singular brilliance of the managers. No mere mortals they! If that sounds suspiciously like today’s hedge fund managers, well, next time study your history before handing your life savings to the smartest guy your second cousin’s maid, whose sister works for this really rich guy, who knows a guy who knows the manager, knows.

Like their current hedge fund successors, they argued that if a trust revealed its portfolio, other investors could replicate the fund’s portfolio without paying its management fee. Stock returns were nice if you could get them but underwriting and continuing management fees were so much more dependable.

A subsidiary of Goldman, The Goldman Sachs Trading Company (GSTC), was the largest promoter of these trusts (effectively the first “closed end funds,” though today such funds are regulated, must fully disclose their holdings, and may be excellent investments if purchased at the right time and the right discount to NAV). Controlling GSTC, Goldman then launched the Shenandoah Corporation and sold a chunk to the public. This established a leveraged fund of funds. Then, Shenandoah set up the Blue Ridge Corporation, selling a chunk to the public, instituting a fund of funds of funds with at least double leverage.

They sold Shenandoah Corp at a 103% premium. (That’s 103%, not 3%! They sold it for more than double the amount of cash and securities it owned...) Flush with success / hubris / greed (choose one) they then sold shares in Blue Ridge at a 46% premium to the actual amount of money in this trust with unknown assets. As a result of this early experiment with secrecy and leverage, GSTC stock soared to $280 a share in 1929 – and subsequently declined to a chastened $1.25 three years later. For every $280,000 you invested at the top, you were left with $1,250. Galbraith cites these investment trusts, rampant greed, weak banks, and the protectionism that followed as the most important factors creating and prolonging the Great Depression.

Whew! Lucky for us none of those factors are present today, huh?

Now fast forward to 2009. Goldman has just declared record first quarter earnings, more than doubling the estimates on the street. You don’t suppose this sudden success would have anything to do with the fact that they are trying to foist $5 billion of its common stock on the public, do you? And where did the money come from that increased earnings exponentially? You don’t suppose it could have come from the sweetheart deal made with AIG to pay Goldman more than any other counterparty, 100% of its CDS obligations, all coming from the pockets of taxpayers, many of whom are now out of work thanks to the shenanigans of outfits like AIG and GS, do you?

Former Treasury Secretary Paulson was CEO of Goldman just before coming to DC. Back in the '90s and the early years of this century, other most-senior executives cum government officials from Goldman like Robert Rubin and Gary Gensler (and Hank Paulson) lobbied hard and contributed well -- GS is the fourth-largest political donor in the nation. ABC News reported recently that since just 1989 Goldman employees have spent more than $43 million dollars on lobbying and campaign contributions to cultivate friends in Washington.

This seems to have held them in good stead. Rubin, Gensler and Paulson, in or out of government, stood fast against derivatives regulation and lobbied hard for higher leverage ratios. When those policies came a-cropper and Wall Street imploded, current Goldman CEO Lloyd Blankfein was reportedly the only bank executive invited to an emergency meeting at the New York Fed (chaired by then-Fed president Tim Geithner, a Rubin protégé, who as Treasury Secretary, chose another Goldman exec, Neel Kashkari, as Assistant Secretary of the Treasury for Financial Stability. He’s the bailout guy who gives your tax dollars to Wall Street).

There are those who might invoke a “Club of Rome” type conspiracy to the revolving door between Goldman and the highest echelons of the Treasury and the Fed. I don’t. (Although it does give them grist for their Roman mill that just-deposed Italian Prime Minister Romano Prodi, Bank of Italy governor Mario Draghi, and recently-resigned Italian Deputy Treasury Massimo Tonomi are all former Goldman employees, and probably still have plenty of stock they’d like to see do well...)

Me, I’m more of an Occam’s Razor kind of analyst. What motivation rests on the fewest assumptions and least irrelevant data? Conspiracy? Or simple greed? I go for greed.

With GM fast joining Stutz and Pierce-Arrow, we can no longer say, “What’s good for GM is good for the nation.” Instead, there will be those on both sides of the revolving door that will whisper “What’s good for Wall Street is good for America.” Don’t you believe them.

DISCLOSURE: No position in GS. Little likelihood of ever having a position in GS. I might short it, though, at the point of maximum hype during their stock offering...

Comments

[Rokjok777:]

Cetin, you need an "r" in your first name...

Apr 15 05:34 PM

[Rokjok777:]

And could you please refrain from commenting on every single post? People don't want to hear your opinion "Ooh I think Goldman guys are soooo smart!" That adds absoluttely nothing to the quality of this site. Bring some insight, or data, or informed commentary....not just random opinions.

Apr 15 05:46 PM

[wobatus:]

Cheap comparison.

Apr 15 05:51 PM

[wobatus:]

He's obviously a short.


On Apr 15 05:46 PM Rokjok777 wrote:

> And could you please refrain from commenting on every single post?
> People don't want to hear your opinion "Ooh I think Goldman guys
> are soooo smart!" That adds absoluttely nothing to the quality of
> this site. Bring some insight, or data, or informed commentary....not
> just random opinions.

Apr 15 09:29 PM

[Jasper M:]

wobatus, do you Really believe that only shorts can see flaws in Goldman? Or see the analogies between this depression and the last?
I am not currently short any bank stocks, at the moment (though I made a Bundle in puts on GS last year). But I can still see the rot, and I can still identify the mongers of excessive leverage when I see them.
And for the record, when the time comes, I will probably buy my puts on MS this time. Just to change things up a bit.
And no doubt I can count on Cetin will sell them to me . . .

Apr 15 11:30 PM

[Tony Daltorio:]

Great article! I also wrote about the similarities with Goldman in an article a few months ago. I still hold that like the investment trusts of the 1920s and 1930s,most hedge funds will simply disappear.

Cetin, I can't believe you read a great article like this with wonderful historical perspective and absorbed nothing. Financial markets history did not start with the bull market of the 1980s and 1990s.

I bet you failed your history classes in school. When they asked you who the first President was, your mind could only go back so far and you would answer Bill Clinton.

Apr 16 10:06 AM

[User 369530:]

Joe,

Great article. I think a lot of people are looking at Goldman with a great deal of suspicion now. The AIG shenanigans really drove it home, especially in comparison to the GM bondholder's deal (don't get me wrong, GM bondholders should lose, but so should Goldman). I think there's somewhat of a populist backlash brewing against the preferential treatment received by Goldman that I hope continues to gain momentum. However as probably 95% of our country's population has never heard of Goldman, and 99% can't describe what they do, it's tough to get this message out. Articles like yours certainly help bring it to light.

Question -- what do we do about it?? Is there a role for government in preventing this kind of corruption/nepotism. What do we say to our congressman?

OT - Those bank preferreds from 2 months ago or so are still looking pretty good. I have sell orders on'm now that are close but haven't executed quite yet. Good call!! I'll take a 40% gain in 2 months any time.

Apr 16 11:59 AM

[Joseph L. S...:]

Well, Sir, I wish I had a brilliant and simple (the two seldom coincide, I fear!) solution / answer to your questions, "What do we do about it?? Is there a role for government in preventing this kind of corruption/nepotism? What do we say to our congressman?"
In my personal opinion, the answer revolves around two key issues: (1) the revolving door between Wall Street and government "service" when that service is performed purely to forge networks and foment laws that make the servicer welcomed back to Wall Street with open arms and open wallet, and (2) how we have allowed many institutions to grow "too big to fail."
I'm writing something right now that I'll try to post on the Instablog shortly on the latter issue. ("Einstein Would Be So Disappointed With Us.") If Congress had insisted the Executive branch enforce laws like the uptick rule, ban on naked short-selling, and Glass-Steagall, instead of gutting them (with Sandy Weill throwing $100 million into the mix to key Congressmen and Senators) we'd never have seen these out-of-control Godzillas.
Most senior executives will push the limit of the law -- but facing criminal penalties involving jail time with a cell-mate named Bubba -- won't go beyond that point. It's up to us as citizens, via our elected representatives, to create laws that keep the playing field even and don't allow behemoths to form that can change the law to fit their liking. Bigger isn't always better and, in the absence of laws (or taxpayer-funded bailouts) favoring one company or one industry, competitive pressure will typically keep one firm from ascending to that dangerous level of "too big to fail."
Finally, fair warning must be given: if you want to get so big that if you screw up, the repercussions could shake our system to its foundations, know that every executive and shareholder, in that order, will lose everything before a single dime of taxpayer money is forthcoming. You took the risks, you have the most to lose. And PS, if you take taxpayer money, you don't exist any more in your current form. We will break you into pieces just as Teddy Roosevelt did in his day. Actions have consequences. And despite John D. Rockefeller's protestations at the time, the world went on and we still extract, process and sell oil products...


On Apr 16 11:59 AM User 369530 wrote:

> Joe,
>
> Great article. I think a lot of people are looking at Goldman with
> a great deal of suspicion now. The AIG shenanigans really drove
> it home, especially in comparison to the GM bondholder's deal (don't
> get me wrong, GM bondholders should lose, but so should Goldman).
> I think there's somewhat of a populist backlash brewing against the
> preferential treatment received by Goldman that I hope continues
> to gain momentum. However as probably 95% of our country's population
> has never heard of Goldman, and 99% can't describe what they do,
> it's tough to get this message out. Articles like yours certainly
> help bring it to light.
>
> Question -- what do we do about it?? Is there a role for government
> in preventing this kind of corruption/nepotism. What do we say to
> our congressman?
>
> OT - Those bank preferreds from 2 months ago or so are still looking
> pretty good. I have sell orders on'm now that are close but haven't
> executed quite yet. Good call!! I'll take a 40% gain in 2 months
> any time.

Apr 17 02:17 PM