If Goldman Is Selling, Are You Buying?

A predator is prowling and the prey is you and your pension fund. An article by Greg Gordon at McClatchy.com (here) describes how Goldman (GS) sold $40 billion in AAA-rated mortgage securities in 2006-07 to unsuspecting buyers.

Here is an excerpt from the McClatchy article:

To piece together Goldman's role in the subprime meltdown, McClatchy reviewed hundreds of documents, SEC filings, copies of secret investment circulars, lawsuits and interviewed numerous people familiar with the firm's activities.

McClatchy's inquiry found that Goldman Sachs:

• Bought and converted into high-yield bonds tens of thousands of mortgages from subprime lenders that became the subjects of FBI investigations into whether they'd misled borrowers or exaggerated applicants' incomes to justify making hefty loans.
• Used offshore tax havens to shuffle its mortgage-backed securities to institutions worldwide, including European and Asian banks, often in secret deals run through the Cayman Islands, a British territory in the Caribbean that companies use to bypass U.S. disclosure requirements.
• Has dispatched lawyers across the country to repossess homes from bankrupt or financially struggling individuals, many of whom lacked sufficient credit or income but got subprime mortgages anyway because Wall Street made it easy for them to qualify.
• Was buoyed last fall by key federal bailout decisions, at least two of which involved then-Treasury Secretary Henry Paulson, a former Goldman chief executive whose staff at Treasury included several other Goldman alumni.

The firm benefited when Paulson elected not to save rival Lehman Brothers from collapse, and when he organized a massive rescue of tottering global insurer American International Group while in constant telephone contact with Goldman chief Blankfein. With the Federal Reserve Board's blessing, AIG later used $12.9 billion in taxpayers' dollars to pay off every penny it owed Goldman.

These decisions preserved billions of dollars in value for Goldman's executives and shareholders. For example, Blankfein held 1.6 million shares in the company in September 2008, and he could have lost more than $150 million if his firm had gone bankrupt.

With the help of more than $23 billion in direct and indirect federal aid, Goldman appears to have emerged intact from the economic implosion, limiting its subprime losses to $1.5 billion. By repaying $10 billion in direct federal bailout money — a 23 percent taxpayer return that exceeded federal officials' demand — the firm has escaped tough federal limits on 2009 bonuses to executives of firms that received bailout money.

Goldman announced record earnings in July, and the firm is on course to surpass $50 billion in revenue in 2009 and to pay its employees more than $20 billion in year-end bonuses.

The McClatchy article is long and there is a lot more to read (here).

Enter Moody's

In a related McClatchy article by Kevin Hall (here), the story is told of how Moody's (MCO) foisted fraudulent ratings on the public for billions in fees. You might say that Moody's sold its triple A soul to the toxic asset devil. Many within Moody's who protested what was going on were punished and downsized. Those who blessed the most garbage were rewarded and promoted. Moody's revenues and profits soared. You might use the metaphor that Goldman (and others) built houses on foundations of sand and were able to sell them because they paid billions to the building inspector who issued certificates of occupancy.

Warren Buffet is not expressing a lot of confidence in Moody's. According to Andrew Fyre at Bloomberg.com (here), Berkshire Hathaway (BRK-A, BRK-B), which still owns more than 38 million shares of MCO, has unloaded over ten million shares since July. MCO has dropped almost 24% from its recent high on May 6. Over the same time span, the S&P 500 has gained more than 12.5%.

How Many Felons Are on the Street?

In another article (here), Kevin Hall asks, "Why haven't any Wall Street tycoons been sent to the slammer?" The short answer is that justice takes time. Kevin states that there are at least 580 FBI investigations of possible felonies in finance underway, including some in the sub-prime mortgage arena. The SEC has brought a civil case against Angelo Mozilo, CEO of mortgage-lending giant Countrywide (now part of Bank of America - BAC), for deliberately misleading investors about the risks involved in his company's business activities. He is also accused of egregious insider trading violations.

When is billion dollar fraud a civil matter, while fuzzily defined perjury and $20,000 gain at the time of transaction a cause for a felony conviction, as in the case of Martha Stewart? Martha served time in a federal penitentiary and actually did not receive a much larger capital gain that would have accrued to her if she had not sold. How much damage did her actions do to society? I'll let others assess that, but I think you have an idea of what I think the damage was on a relative scale.

What Happened and What Is Legal?

This discussion is prompted by comments by Ricard and untrusting investor. I have not done the research to prove what actually occurred, so I will ask questions:

1. Did GS essentially bribe ratings agencies to get AAA ratings on junk?
2. Did GS then buy CDSs (Credit Default Swaps) on the securities they had already sold?
3. Did GS buy CDSs on any companies that bought the AAA rated junk?

Whether this is what actually happened or not, If this is (or would be) legal, then the law is defective.

The Bottom Line

It is not yet clear to me what has actually happened. But I have formed an opinion about how much I would trust a securitized product assembled by GS. If Goldman is selling, are you buying?

Comments

[Tom Armistead:]

Because GS has done so well over the course of the meltdown and recovery, it is apparent that they have a lot of insight into a lot of areas. The ethics and legality of their conduct are widely and correctly criticized and should be the topic of careful regulatory scrutiny.

When they make calls such as sell KBH short, oil is going to 250, GDP will be ???, you know they know something. You just don't know whether they are setting you and other investors up for some kind of a hosing.

My reaction when GS says something about an area I am invested in is I look very carefully at my thinking because I am pretty sure something is moving around under the water or behind the curtain.

Nov 02 07:48 AM

[gmwright:]

This makes me feel ill. Of course I could invest in GS stock and probably make lots of money. After all, they seem to hold all the cards and make all the rules (or at least have free reign to ignore them).

But when I read stories about how they are duping pension funds and sifting money and transactions through off-shore accounts why would I want to invest? Pension funds are for the retirement of hard working americans. If I invest in GS to make money, I might as well just go and beat up an old lady and take her purse. Sure GS does it in a much less personal way, but they are essentially doing the same thing.

This is why I will never invest any of my money in GS (or PM, MO, LO for obviously different reasons).

Nov 02 08:20 AM

[thotdoc:]

"You just don't know whether they are setting you and other investors up for some kind of a hosing."

With all due respect...I like your writings.

And you're thinking they turned a new leaf? Their corporate culture changed? They've all been to church? They have a new leader? They've decided that money is not god? They all went to therapy and are beginning to experience empathy? There is a new pill that gives them character and morals? And hey decided to take the pill, because?


On Nov 02 07:48 AM Tom Armistead wrote:

> Because GS has done so well over the course of the meltdown and recovery,
> it is apparent that they have a lot of insight into a lot of areas.
> The ethics and legality of their conduct are widely and correctly
> criticized and should be the topic of careful regulatory scrutiny.
>
>
> When they make calls such as sell KBH short, oil is going to 250,
> GDP will be ???, you know they know something. You just don't know
> whether they are setting you and other investors up for some kind
> of a hosing.
>
> My reaction when GS says something about an area I am invested in
> is I look very carefully at my thinking because I am pretty sure
> something is moving around under the water or behind the curtain.

Nov 02 08:30 AM

[The shark:]

Hi,

With all the privied information that GS has it is surprising that they got the GDP number, a day before it was announced, so wrong. In the 2 day swing they must have made a small fortune. Given that there must have been counter Parties to their trades - someone lost "heavily"! No questions who - the man on the street and the Pension Funds. Shame on the system that allows such behaviour to go on without some serious enquiry - the whole system is a mess - now an ordinary Investor is tasked not only with understanding the fundamentals which are difficult enough but also what "games are in play". Smoke and mirrors makes it difficult for the small guy to have any long term investement strategy - it forces short term speculation - which ultimately means you lose, GS wins and the Government collect additional taxes (I am not sure how the US Tax works - but in the rest of the world a share sold within 3 years attracts the full income tax - only after 3 years is it deemed CGT and therefore taxed at 20% or if you are structured in a Trust and redistribute to Beneficiaries you get away with 10% - unless the IRS perceive the Trust to be a sham - and then apply the full tax - proof of burben is on you the tax Payer).

Nov 02 09:53 AM

[Ricard:]

Not only are we rewarding failure, it seems we are hell-bent on punishing success as well.

Nov 02 10:49 AM

[Ricard:]

BTW, thanks for the mention.

Nov 02 10:49 AM

[Steven Hansen:]

john,

me thinks gs is doing the government bidding. caveat emptor.

Nov 02 11:38 AM

[John Lounsbury:]

There is a lengthy discussion of this topic today at Zero Hedge www.zerohedge.com/arti...

Nov 02 03:18 PM

[BRUCE E. W.:]

online.wsj.com/article...
Goldman wants Fannie's credits.

www.mcclatchydc.com/22...
Goldman takes on new role: taking away people's homes

www.mcclatchydc.com/go.../ web video

www.mcclatchydc.com/22...
How Goldman secretly bet on the U.S. housing crash

Nov 02 03:33 PM

[DonFurio:]

I thought it was common knowledge at this point that GS did repackage loans from some of the shadier lenders out there along with financial institutions. The difference is that they realized the problems that occurred in housing by early 2007 and made big bets to hedger their exposure. Yes, some of those hedges were made through AIG. GS also hedged their exposure to AIG by buying protection against AIG (which was very expensive, but ultimately a good bargaining chip).

The article asked, Did GS essentially bribe ratings agencies to get AAA ratings on junk?
----No, there were models, there may have been flaws in the models, but the rating agencies did see the models and the way the security was supposed to cash flow and signed off on it. There are criticisms in the way the rating agencies were compensated since the issuer, not the investor paid for the rating. Some say this is a conflict of interest, but the investors had fought to not have to pay for the rating and allowed the issuer to pay for it. The securities were sold as bonds and the investor received a bond indenture, although many didn’t take the time to analyze it properly but they should have since part of the investor’s job is to perform adequate due diligence.

Look securitization will not be going away. Many things I described above are/were the protocol for many years and it worked well for everyone including consumers. What happened was the securities got extremely levered, so the equity returns were great for a couple of years like 30+%, but when the downturn occurred, the underwriting was so lax that not only the equity was hit, but also the top tranches. In my opinion, the securities should not have a rating of AAA like a muni-bond, but a different type of rating that will distinguish the tranches but not use the “AAA” label.

Nov 02 04:06 PM

[DonFurio:]

And if they got it right, you'd say they were front-running... You can't have it both ways. But I know, you're always anti GS and financials and whatever you write will have support your bearish/negative view.


On Nov 02 09:53 AM The shark wrote:

> Hi,
>
> With all the privied information that GS has it is surprising that
> they got the GDP number, a day before it was announced, so wrong.
> In the 2 day swing they must have made a small fortune. Given that
> there must have been counter Parties to their trades - someone lost
> "heavily"! No questions who - the man on the street and the Pension
> Funds. Shame on the system that allows such behaviour to go on without
> some serious enquiry - the whole system is a mess - now an ordinary
> Investor is tasked not only with understanding the fundamentals which
> are difficult enough but also what "games are in play". Smoke and
> mirrors makes it difficult for the small guy to have any long term
> investement strategy - it forces short term speculation - which ultimately
> means you lose, GS wins and the Government collect additional taxes
> (I am not sure how the US Tax works - but in the rest of the world
> a share sold within 3 years attracts the full income tax - only after
> 3 years is it deemed CGT and therefore taxed at 20% or if you are
> structured in a Trust and redistribute to Beneficiaries you get away
> with 10% - unless the IRS perceive the Trust to be a sham - and then
> apply the full tax - proof of burben is on you the tax Payer).

Nov 02 04:10 PM