Goldman Sachs: Still Arrogant and Unrepentant

Last week Goldman Sachs (GS) reported record profits for the April through June 2009 quarter. Quite a difference for a firm that was nearly insolvent less than a year earlier. But thanks to the TARP and favorable borrowing terms from the Federal Reserve, Goldman was able to use taxpayers' funds primarily for the benefit of its shareholders and employees.

In announcing its stellar quarterly earnings of $3.44 billion or $4.93 per share, Goldman stated that it was setting aside $11.36 billion for an employee bonus pool, or $386,489 per employee. According to the Wall Street Journal, Goldman is on track to set aside $20 billion for the year or $700,000 per employee. Under any circumstances, such bonus compensation would be considered sensational. But given the actual circumstances under which its profits were "earned", the projected bonuses are reprehensible and unjustified.

The justification for such bonuses should reflect the risk/reward undertaken to achieve them. Unfortunately, that is far from the case in this instance. Rather, Goldman's apparent success is a function of a confluence of events which had very little to do with the adeptness of its management or employees.

As alluded to above, Goldman was in severe financial stress last Fall as the U.S. financial system was under assault. First, Bear Stearns effectively failed and was sold off to J.P. Morgan Chase (JPM) for $10 a share. Second, Lehman Bros. was forced into bankruptcy after the federal government decided not to bail it out. Third, other financial institutions nearly collapsed and were forced to sell for a fraction of their value only months earlier. Consider Washington Mutual, Merrill Lynch and Wachovia for example.

After the Lehman failure, the financial woes of the U.S. financial system worsened rapidly. The Government enacted the TARP to prevent a further avalanche and in the process created a bailout nation mentality, as least among the largest financial institutions.

A huge beneficiary of TARP funds was AIG. As of today, AIG has received approximately $180 billion of government funds and guarantees for other substantial obligations on its books depending on the ultimate value received for the vast inventory of credit-default swaps and related derivatives on its books.

Of the AIG TARP funds, Goldman received nearly $13 billion. Without those funds, Goldman would likely have suffered a significant loss on the counter-party liability due from AIG. Although Goldman claims that it was really never at risk and was substantially collateralized, Goldman showed no hesitancy in accepting the AIG TARP funds as opposed to enforcing its contractual rights. Clearly, if AIG had gone out of business, it is far from certain as to the nature and extent of AIG's total liabilities and of those particularly due to Goldman, and how such obligations would be treated vis-á-vis other creditors of AIG.

Aside from those funds, Goldman also received $10 billion of TARP funds directly. Of course, this was only after Goldman received nearly instantaneous approval to change its status from an investment bank not regulated by the Federal Reserve to a bank holding company that is. Without the change in status, Goldman would not have qualified for TARP funds and it would have had to raise additional capital from private sources.

In fact, before becoming eligible for TARP funds, Warren Buffett invested $5 billion in preferred stock of Goldman in exchange for a cumulative annual dividend of 10% and warrants to purchase 43,478,260 shares of common stock bearing a strike price of $115. In contrast, thanks to Henry Paulson, the then-Treasury Secretary and former CEO of Goldman, the U.S. government only negotiated to receive a cumulative annual dividend of 10% on its preferred stock investment and warrants to purchase only 12,205,045 million share of common stock with a strike price of $122.90. In effect, Buffett received twice the dividend rate of return on his equity investment to that of the government (even though the situation was more dire when the government invested the TARP funds) and 31,273,215 more warrants than the government at a strike price almost $8 lower. Clearly, the government's below-market equity investment terms were a benefit to Goldman, which would have had to pay at least the same terms to a private investor as received by Buffett (which, given the government's investment, would have equated the right to purchase almost 87 million shares at a strike of $115) and likely much more, given the severity of the situation when the government made its TARP investment as the likelihood of repayment was even less certain at that time.

Besides the TARP, as a result of Goldman becoming a bank holding company, it was given access to the Fed Discount Window, meaning that it could borrow billions of dollars from the Fed at rates as low as .10% and then deploy those funds. Now, the original intent of such borrowings was to enable "banks" to make loans to creditworthy borrowers to spur stagnating economic growth. Such borrowings were not intended as a mechanism for Goldman or other banks borrowing such funds to either purchase other government instruments bearing a higher rate of return or to fund a bank's proprietary trading operations.

But that is exactly what Goldman did. They didn't make a single commercial loan, nor did they accept a single customer deposit. They used the funds to make money on the spread between the almost non-existent cost of borrowing from the Fed and government-guaranteed rates on return on U.S. bond instruments (i.e., bonds issued to fund the Fed borrowings and other government obligations) and related instruments and derivatives. Net net, the government loaned money to Goldman so that Goldman could buy the bonds/instruments being sold to loan money to it and other financial institutions.

Goldman profited handsomely as a result of all of this government assistance, TARP and Fed borrowings. They were literally guaranteed a substantial profit merely by borrowing as much money as possible and then buying government-backed securities bearing a higher rate of interest. Additionally, Goldman took advantage of its nearly monopolistic bond trading operations. With the departure of Bearn Stearn and Lehman Bros. and with Merrill Lynch becoming a shadow of itself due to its acquisition by Bank of America (BAC), there were only two of the principal bond trading operations existing from at least five only months earlier, the other being Morgan Stanley (MS).

While there were other firms trading bonds, Goldman had and retained a significant competitive advantage due to the loss of three of its principal bond trading competitors.

As a result of all this, Goldman posted record earnings. Was that due to Goldman's talent? The skill of its management and its employees? Or did Goldman benefit from the TARP and easy Fed money and fewer competitors in the marketplace? To put it bluntly, Goldman did benefit mightily and for its management to now seek to compensate itself and its employees as if its skill and expertise alone were the only or primary reason for its success is arrogant and condescending.

Yet, that is what Goldman appears to be doing. Other than a perfunctory acknowledgment of thanks to the U.S. government for its assistance, Goldman apparently hasn't learned a thing, certainly not about humility or avoiding ostentatiousness. Consequently, the outrage from the public and Congress has been strong. And even President Obama has counseled against payment of out-sized bonuses by those firms that benefitted from the TARP and other government assistance now that they have returned to profitability due in no small part to U.S. financial assistance.

If Goldman and other banks do not take this advice to heart, it is quite likely that new legislation will attempt to rectify this compensation issue or at least to prevent it from occurring again in the future.

Disclosure: Long BAC and no other positions.

Comments

[TradingHelp...:]

"the projected bonuses are reprehensible and unjustified."

Agree. To pay such bonuses when 9.5% are unemployed (soon to be 10%) and the firm borrowed from the tax-payer less than a year ago and apparently and allegedly risked the money for staff and shareholder benefit (with the tax-payer cash at risk), is abhorant.

We live is a morraly corrupt society. Sad but true.

Jul 26 05:04 AM

[AlphaDude:]

Thx, great article spelling out just how disgusting GS are, all of their profits are Gov't derived and so belong to the taxpayer, they should be bankrupt and not have jobs let alone bonuses.

Jul 26 06:09 AM

[BRUCE E. W.:]

URL: www.rollingstone.com/p...
Rollingstone.com
The Great American Bubble Machine
Matt Taibbi on how Goldman Sachs has engineered every major market manipulation since the Great Depression
In Rolling Stone Issue 1082-83
Pretty much says it all about these pirates in finance.

Jul 26 08:55 AM

[john s. gordon:]

let's get crackin on that new legislation (to rectify this compensation issue).
> jack

Jul 26 09:55 AM

[Ferdinand E...:]

I love hearing that the compensation issue will be rectified, and hopefully sooner rather than later. Outside of that however I would feel better if I had not read this article.

I taught finance for about 15 years, and was not averse to perusing the financial newspapers and other publications. It eventually became quite clear in my mind that GS was perhaps the best investment bank in the world, as I mentioned in my finance book (2001). That being the case, I really don't see the point in pretending that the US and the world would be a better place if GS was allowed to go into the can.

Jul 26 10:47 AM

[Chemist29:]

if you think goldman makes too much money for its shareholders, buy the stock.

Jul 26 12:24 PM

[Davewmart:]

Those who live by corrupt legislation can also die by it.
Retrospective taxation on bonuses and 'earnings' by these scam artists, taxed at, say, 95%, and chargeable from the date the grifters extracted it including interest at the highest rate on their banks credit cards, say 30% per annum, would seem to fit the bill.
Meanwhile all their and their families assets should be frozen pending a Rico investigation.
The laws relevant to drug dealers would perhaps be appropriate, as these characters are far more dangerous.

Jul 26 12:45 PM

[AlphaDude:]

@Chemist29

I personally have higher morals than that and would not invest in such a morally repugnant organisation.

Jul 26 12:48 PM

[Michael J. ...:]

Goldman Sachs, AIG and a host of "too big to fail" financial institutions put the entire U.S., if not the World, economy at risk by taking on way too much leverage/risk. But, if you truly believe in capitalism, they should have been allowed to fail due to their lack of risk management. Instead, the U.S. chose which institutions to bail out and which not to. The U.S. did that to prevent unforeseeable adverse consequences to the economy as opposed to doing nothing. But, the government gave these firms trillions of dollars of TARP and guarantees without negotiating proper terms for such assistance. The U.S. should have essentially owned a substantial portion of these firms. Instead, they didn't even get the same type of terms as Warren Buffet. That is part of my argument about why Goldman is arrogant and unrepentant. I assure you if private investors would have given Goldman the same financial terms as the U.S. government, Goldman would have had to give up a lot more ownership, dividends, warrants, etc.

So, to call Goldman the best investment bank on its merits, is a bit ludicrous. Basically, they just got an incredible deal from Uncle Sam and the FED to stay in business and borrow cheap money to generate easy profits. So, it is absurd for Goldman to go around now and act as if their employees with their skill enabled they to make record profits.

In sum, the U.S. screwed up big time in negotiating terms with Goldman and other financial institutions. The result now is that Goldman and those organizations are receiving windfall profits thanks to the American taxpayer.

On Jul 26 10:47 AM Ferdinand E. Banks wrote:

> I love hearing that the compensation issue will be rectified, and
> hopefully sooner rather than later. Outside of that however I would
> feel better if I had not read this article.
>
> I taught finance for about 15 years, and was not averse to perusing
> the financial newspapers and other publications. It eventually became
> quite clear in my mind that GS was perhaps the best investment bank
> in the world, as I mentioned in my finance book (2001). That being
> the case, I really don't see the point in pretending that the US
> and the world would be a better place if GS was allowed to go into
> the can.

Jul 26 01:20 PM

[Michael J. ...:]

So, basically, if Goldman "gamed" they system and was essentially given billions of dollar of free money via direct and indirect TARP and FED borrowings, you think that's just fine.

The earning of a company are not supposed to be based on government assistance. The American taxpayers were duped in the Goldman deal because the U.S. didn't even get comparable terms to Warren Buffet. That's the point.

If Goldman made its profits without government assistance, I would be the first to congratulate them for a job well done and would have no problem with a generous employee bonus pool. But that's not what happened here.


On Jul 26 12:24 PM Chemist29 wrote:

> if you think goldman makes too much money for its shareholders, buy
> the stock.

Jul 26 01:27 PM

[JCC:]

I did - I purchased GS stock after the bailout. My reasoning was that they were in pretty good shape and would soon pay the moneyback. I also felt that after the financial meltdown that they would profit handsomely. It turned out that my logic was correct. Furthermore, I think that they have a year or more of unbelievable earnings in the future.

For the record, GS did nothing illegal. You might not have agreed with the TARP, but it critical last September to stem the financial meltdown. The monetary supply was not flowing, and similar to your vascular system, this would have resulted in an economic heart attack.

No question we need to stengthen the regulatory environment to avoid or mitigate a future meltdown. Also we need to modify the system so that businesses will not be able to jeopardize the future for a near term quarterly report. But in our society, as businessmen, we have an obligation to return earnings to our shareholders providing that we don't break the law.

I have to say that I am amazed at all of the negative chatter from many of you. These views certainly prevent you from making good investments, and they almost sound anti-capitalist.

On Jul 26 12:24 PM Chemist29 wrote:

> if you think goldman makes too much money for its shareholders, buy
> the stock.

Jul 26 01:58 PM

[Michael J. ...:]

Whether something turns out to be a good investment should not depend on government assistance. To suggest that those who oppose government bailouts or at least government bailout where the government negotiates a worse deal than would have occurred in the private sector is not anti-capitalist.

Having said that, I would agree with you that unless the government imposes new restrictions in the future concerning leverage/risk and employee compensation or discontinues Goldman's ability to borrow from the FED, it will continue to "earn" outsized profits. But, the taxpayers got screwed and are still in the process of being screwed by the likes of Goldman.


On Jul 26 01:58 PM JCC wrote:

> I did - I purchased GS stock after the bailout. My reasoning was
> that they were in pretty good shape and would soon pay the moneyback.
> I also felt that after the financial meltdown that they would profit
> handsomely. It turned out that my logic was correct. Furthermore,
> I think that they have a year or more of unbelievable earnings in
> the future.
>
> For the record, GS did nothing illegal. You might not have agreed
> with the TARP, but it critical last September to stem the financial
> meltdown. The monetary supply was not flowing, and similar to your
> vascular system, this would have resulted in an economic heart attack.
>
>
> No question we need to stengthen the regulatory environment to avoid
> or mitigate a future meltdown. Also we need to modify the system
> so that businesses will not be able to jeopardize the future for
> a near term quarterly report. But in our society, as businessmen,
> we have an obligation to return earnings to our shareholders providing
> that we don't break the law.
>
> I have to say that I am amazed at all of the negative chatter from
> many of you. These views certainly prevent you from making good investments,
> and they almost sound anti-capitalist.
>
> On Jul 26 12:24 PM Chemist29 wrote:

Jul 26 02:06 PM

[xpatriot:]

Didn't Bernanke & Paulson say (to paraphrase) "first let's put out the fire, then go after the arsonists?" Did I miss something, or did they go after the arsonists to give them obscene bonuses?

Jul 26 07:01 PM

[Michael J. ...:]

Yeah, whatever happened to the investigation part of the crisis? No one has yet been help accountable and virtually no one has lost his/her job because of excessive risk/leverage, mismanagement, etc.


On Jul 26 07:01 PM xpatriot wrote:

> Didn't Bernanke & Paulson say (to paraphrase) "first let's put
> out the fire, then go after the arsonists?" Did I miss something,
> or did they go after the arsonists to give them obscene bonuses?

Jul 26 08:01 PM

[Jasper M:]

If, in the 30's, I calculated that John Dillinger was the best bank robber around, would I try to join him? If I foresaw the rise of Stalin, or Mao, in their nations, would I hitch my wagon to their star? Speaking strictly for myself, NO. Bad is bad.

GS's business plan was not good enough to survive the collapse of the credit bubble without a(n immoral) federal handout. At which point, any claim of 'being excellently run' evaporates. Now, they are engaged in a pretty blatant (not to mention open-ended) rip-off of the taxpayers. A shareholder in that is an accessory.

Jul 26 09:49 PM

[Helene:]

Who do you think the Goldman Boys, Bernanke, Paulson, and the rest were for. The taxpayer? We foot the bill as usual and they get the bonus. Par for the course. Goldman Sachs was their boss. The worst is yet to come. As far as the shareholders, of course they are happy and will defend Goldman. As far as the morality, that is a different story. The issue is not just Goldman but the way our government is heading. Vote smarter next time.

Jul 26 10:14 PM

[Michael J. ...:]

Yes, they paid the government back by borrowing more money from the government at virtually zero interest and then calling it a profit. Any fool can make money by merely buying government backed instruments if given free money to do so.

Now the latest is that Goldman is essentially front-running the market. The guys are using heavy-duty supercomputers to place and immediately cancel bogus order before the less sophisticated exchange computers and execute the order. In this way, Goldman is able to see limit price offers which is supposed to be private info. Goldman is using this information in a way to prevent the average investor from getting the best fill possible on a limit or market order.

Here is a link to their current game: opinionator.blogs.nyti.../


On Jul 26 11:06 PM dividendmachine1 wrote:

> This may be unpopular but unlike most who have sucked from the teat
> of the government GS has paid them back in full and the Government
> made a 22% profit.
>
> No offense but BOTH political parties and their lobbyists have not
> paid us 1 dime and instead have looted the trasury with their salaries
> and health care and excellent pensions
>
> Is GS perfect ,No of course not
>
> But at least they aren't freeloaders like GM AIG and the politicans
> and lobbyists are.peace

Jul 27 02:47 AM

[LoveShorting:]

Chemist 29 - - from one chemist to another, yes, GS price action has been great but as someone short GS on principle, I have to pay their dividends and they are tiny. Yes, everyone on this site trades stocks
(presumably) but some of us, in spite of our desire to make money, just can't stand the stench of undeserved profits on such a massive scale. We are (most of us anyway) only human after all.

Jul 27 09:33 AM

[ex- bond tr...:]

After reading this great article what stood out to me the most is not only what disgusting pigs GS and their accomplices are but Warren Buffet is just as disgusting by helping prop up, at a large profit, this
dispicable monopoly. I know he tries to comes off as a "I was born in a
small town" Mr. U.S.A. loving mid-westerner slice of apple pie. But he
is no nice guy to me anymore and I hope his beloved GS investment
tanks on any side of the platform he's hedged on. Needless to say I have no good wishes for GS either.

Jul 27 10:16 PM

[DougM:]

Almost as bad as the fact that this company is borrowing taxpayer's money at close to 0% is the fact that the managers of this company are rewarding themselves with an outsized share of profits that come directly out of the shareholders' pockets. Looking at where the winnings - er, I mean earnings, are coming from, it's not a stretch to say that shareholders of GS are more like investors in a publically-traded hedge fund. At least at a real hedge fund investors would only be paying the managers 20% of the profits; what fraction of the profits are GS shareholders being allowed to keep?

On Jul 26 12:24 PM Chemist29 wrote:

> if you think goldman makes too much money for its shareholders, buy the stock.

Oct 22 12:06 AM