Goldman Sachs Political Capital Ratio Is Inadequate

The stock market suddenly turned bullish on Monday after Meredith Whitney upped Goldman Sachs (GS) from “Neutral” to “Buy” with a twelve month price target of $186. Appearing on CNBC’s Squawk Box, the normally bearish financial analyst said the recommendation was “a bearish call but a bullish call on the stock.” Whitney said that as the number one underwriter of bonds now that Lehman is gone, Goldman has advantage in this “tsunami of debt issuance” economic environment.

Yesterday, Goldman reported record quarterly net revenues of $13.76 billion; second quarter net earnings were $3.44 billion, or $4.93 per share, which was more than Goldman earned in 2008. Goldman recorded record net revenues from FICC* ($6.80B), Equities ($3.18B), and equity underwriting ($736M). Commissions were up 5%, on higher customer volume. CFO David Viniar said during yesterday’s earnings call that now that the hedge fund redemption cycle “is pretty much through” you should “start seeing money flowing into hedge funds.”

Although Goldman ranked first in global M&A deals this year, the firm hopes that M&A activity begins to pick up as “dialogue has not translated into deals for awhile.” Viniar’s economic outlook was cautious, emphasizing “the world is still not a great place.” When asked during the Q&A if their FICC trading spreads are likely to continue for the near term, Viniar responded that “there is no normal.”

Goldman has managed to execute its business flawlessly and must continue to do so in order to propel the stock back to its 2007 record high of $250.70. (Goldman closed yesterday at $149.66, just shy of its “Whitney Day” close.)

What’s blatantly missing from Goldman’s blowout quarter and year to date earnings is good public relations. Once again Viniar reiterated early on in the earnings call that Goldman has “no exposure to retail consumer business.” Goldman chooses to forget the “missing time” in the autumn of 2008 when it became a bank holding company in order to save its own skin. Goldman might not have needed or wanted $10 billion from the TARP, but TARP money gave Goldman access to something it did take full advantage of: $29 billion** of FDIC-guaranteed debt issuance. And Goldman got more help from the Federal Reserve when the Fed forced AIG to pay Goldman ($13B) and other counterparties the full value of their underlying CDOs instead of negotiating a reduced payout.

Goldman may very well employ the smartest people in the room, but the fact is that Goldman could not have regained its footing – let alone have survived – without taxpayer assistance. Having returned the TARP money and “in discussions with the Treasury on the warrants,” Goldman’s attitude is that it can put the past behind it and continue to accelerate risk taking that by value-at-risk (VAR) has reached record levels. Goldman's only concession to the current financial climate is operating at lower leverage.

Goldman set aside $6.65 billion in compensation and benefits expenses during the second quarter. At this rate, that would work out to a record $770,000 for each of its 29,400 employees.*** And the need to pass healthcare reform to insure all Americans starkly contrasts with Chairman & CEO Lloyd Blankfein’s health insurance valued at $40,543 a year. As unemployment rises and more Americans lose their health insurance or file for “medical bankruptcy,” Goldman would be wise to accrue deferred compensation until overall economic conditions have sustainably improved.

Investors could become fearful of Goldman’s stock if Congress clamps down “AIG-style” on Goldman’s compensation culture. Goldman and Wall Street’s return to “business as usual” increases my conviction that the second act of the financial crisis is a distinct possibility this fall.

*fixed income, currency, and commodities

**Barron’s: “How Do You Spell Sweet Deal?” (4/20/09)

***Of course that amount wouldn’t be evenly distributed!

Disclosure: No positions

Comments

[Shiv Kapoor:]

Dunno why I have a bad feeling about this. Cant see anyone, be it a person or a program beating the markets in perpetuity; buy and hold person like Buffet perhaps, trader unlikely. Am hoping GS is not Enron II in the making. In the meantime, I do hope the auditors are exercising extra due diligence.

Jul 15 01:43 PM

[twitee:]

You are forgetting the fact that Goldman is the "FED" and main member of the mob.

Jul 15 02:32 PM

[RTF 360:]

What Wall Street Owes You (Commentary)

CNN – July 15, 2009

By Janet Tavakoli



Goldman Sachs Group Inc. announced record earnings Tuesday of $3.44 billion for the second quarter of 2009.



Goldman's stock price leapt 77 percent for the first half of 2009, and closed Tuesday at $149.66 a share.



Without an ongoing series of front- and backdoor bailouts financed by U.S. taxpayers, most of Goldman's record profits would not have been possible.



In April 2009, Goldman Sachs' CEO, Lloyd Blankfein, who received record salary and bonus compensation of $68.5 million in 2007, said that bonus decisions made before the credit crisis looked "self-serving and greedy in hindsight." Now, they look self-serving and greedy with foresight.



Goldman set aside $11.4 billion for employee compensation and benefits, up 33 percent from last year. That's enough to pay each employee more than $390,000, just for the first six months of this year.



In June, Goldman bought back its preferred shares, repaying $10 billion it received from the government's Troubled Asset Relief Program, or TARP, and setting it free of limits on executive compensation and dividends.



But pay is not the key issue. U.S. taxpayers deserve a large cut of the profits, not the chump change -- less than a half-billion dollars -- they got from preferred shares in the company and the relatively small amount they could get from warrants in its stock.



U.S. taxpayers should insist that a large part of Goldman's revenues and profits belong to the American public. TARP money was just part of a series of bailouts and concessions that allowed Goldman to prosper at the expense of a flawed regulatory system.



In March 2008, Goldman, a primary dealer in Treasury securities, was among the beneficiaries of a massive backdoor bailout by the Federal Reserve Bank. At the time, Henry Paulson, former CEO of Goldman Sachs, was treasury secretary.



In an unprecedented move, the Fed created a Term Securities Lending Facility, or TSLF, that allowed primary dealers like Goldman to give non-government-guaranteed "triple-A" rated assets to the Fed in exchange for loans. The trouble was that everyone knew the triple-A assets were not the safe securities they were advertised to be. Many were backed by mortgage loans that were failing at super speed.



The bailout of American International Group, or AIG, ballooned from $85 billion in September 2008 to $182.5 billion. Of that money, $90 billion was funneled as collateral payments to banks that traded with AIG. American taxpayers may never see a dime of their bailout money again, but Goldman saw plenty.



Goldman may be the largest indirect beneficiary of AIG's bailout, receiving $12.9 billion in collateral, including securities lending transactions, from AIG after the government bailed out the insurance company.



The key question is whether Goldman asked AIG to insure products that were as dodgy as the doomed deal from Goldman Sachs Alternative Mortgage Products exposed by Fortune's Allan Sloan in his October 16, 2007, Loeb Award-winning article: "Junk Mortgages Under the Microscope."



If the federal government had not intervened and if AIG had gone into bankruptcy, Goldman probably would not have received its $12.9 billion from AIG. U.S. taxpayers and the American economy are owed some of the bailout money passed directly through AIG to Goldman.



Wall Street firms also reaped trading windfalls when AIG needed to close out its derivative transactions. This was the most lucrative windfall business in the history of the derivatives markets. When AIG left money on the table, it was U.S. taxpayer money.



Goldman Sachs was granted bank holding company status in the fall of 2008. It already had the temporary ability to borrow from the Fed through the TSLF, which would have expired in January 2009. Now it has permanent access to lending from the Fed.



Goldman can now compete with the largest U.S. banks and borrow money at interest rates pushed as close to zero as possible by the Fed. Goldman gets a further benefit: favorable accounting rule changes. In addition, Goldman issued $30 billion of debt with a valuable government guarantee that remains outstanding.



Meanwhile, the American public faces a rising unemployment rate, falling housing prices, rising unemployment, higher local taxes and a dismal economic outlook.



Interested men with reputations and fortunes at stake rode roughshod over public interest. The American public is owed part of the profits Goldman was able to make because of the largesse of our Congress.



Wall Street's "financial meth labs," including Goldman's, massively pumped out bad bonds and credit derivatives that have melted down savings accounts, pension funds, the municipal bond market and the American economy. Risky assets, leverage and fraud led to acute distress in the global financial markets.



The biggest crime on the American economy may go unpunished with no consequences to the perpetrators. The biggest crime was not predatory lending, but predatory securitizations, packages of loans that did not deserve the ratings or prices at the time they were sold. They ballooned what should have been a relatively small problem into a global crisis.



Wall Street owes the American public for its key role in bringing the global economy -- and in particular, the U.S. economy -- to its knees. Goldman is not alone in owing the American public. It is not the worst of all of the Wall Street firms. But among all of Wall Street's offenders, it is the most well-connected, and Goldman was the firm that cleaned up the most as the result of government bailouts.



The opinions expressed in this commentary are solely those of Janet Tavakoli.



Janet Tavakoli is the president of Tavakoli Structured Finance, a Chicago-based firm that provides consulting to financial institutions and institutional investors. Ms. Tavakoli has more than 20 years of experience in senior investment banking positions, trading, structuring and marketing structured financial products. She is a former adjunct associate professor of derivatives at the University of Chicago's Graduate School of Business. Author of: Credit Derivatives & Synthetic Structures (1998, 2001), Collateralized Debt Obligations & Structured Finance (2003), Structured Finance & Collateralized Debt Obligations (John Wiley & Sons, September 2008), and

Dear Mr. Buffett: What An Investor Learns 1,269 Miles From Wall Street (Wiley, 2009).





Janet Tavakoli

President

Tavakoli Structured Finance, Inc.

360 E. Randolph St., Suite 3007

Chicago, Illinois 60601 USA

[phone]

e-mail: jt@tavakolistructuredf...

web site: tavakolistructuredfina...

Jul 16 01:15 AM