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My Beef With Goldman Sachs

|Includes:American International Group Inc (AIG), BP, F, GS, KCG, SCHW, XOM

For those of you that have been living on Mars for the last 140 years, Goldman Sachs (NYSE:GS) is an investment banking firm that makes their money through worldwide banking, investment management and multiple other financial services with both individual and corporate clients. in addition, the company acts as a market maker and also performs services in the field of private equity.

Over the last year, Goldman Sachs investors have yielded outstanding returns. Goldman's stock has returned 24.1% since the beginning of 2013 and 50.3% in the last twelve months.

My beef with Goldman Sachs isn't with their investors, nor is it with the people who use the bank; it's primarily the way the bank seems to avoid accountability and potentially have used questionable tactics to move the markets in their favor. My beef with Goldman Sachs started earlier this year over their fiasco of downgrading gold right before they covered their short and before going long. My beef with Goldman, I'm guessing, is going to continue on today's news. But, first a little color on the gold fiasco.

This happened a few months ago, towards early 2013. I had written about Goldman's downgrade of, and then subsequent total change of heart on gold (after they had covered a short). Imagine my surprise on April 23, less than two weeks after Goldman's massive downgrade on gold, I see front page on with the headline "Surprise! Goldman Covers Gold Short":

Goldman Sachs on Tuesday reversed its high-profile call to shortgold, which it made two weeks ago, just before the metal sunk into bear market territory.

The firm's commodities research team said the decline in gold was more rapid than it expected, and it exited the trade with a potential gain of 10.4 percent, below its original target price of $1,450.

Why not use the headline, "Suprise! Goldman Just Pulled the ole' Switcheroo On Retail Investors"? Interesting, nonetheless. Goldman was short gold before issuing a "world is going to end" style downgrade on gold and then covered their entire short after the market and the common folk sold off to bring gold down about 15%? Folks, I'm not saying its market manipulation, rather just a series of coincidences. Yeah, let's call it that.

For our visual learners, here's a picture version of all that pesky text you might not want to read through:

And so my recent disdain for Goldman Sachs was born. Things had remained relatively quiet in the world of sneaky banking tricks, with the exception of Schwab (NYSE:SCHW) screwing up royally with some naked shorting issues since then. I wrote about this in my article "Naked Short Selling : The SEC's Tall Task Ahead". In another non-surprise to Wall Street Insiders and massive surprise to the common investor, the SEC handed out several naked short selling fines about two months ago, to prove to casual investors that they are still "looking out for the little guy". More shenanigans.

I even gave Goldman a mulligan on their government bailout from the get-go. I mean, from a fundamental and ideological point of view, I hated it. But, being an Austrian economics guy stuck in the Keynesian world of how we do things, I guess I've just become comfortably numb to the "normal" of not letting companies that big fail. It's a sad day for me. The one company I respect now (that I absolutely hated going into the crisis) continues to be Ford (NYSE:F). The fact that they did not take any bailout money and continued to turn their brand and vehicle line around is an inspiring story; one that'll likely not only make me an investor, but a future customer.

So, again, things had remained quiet in the world of "behind the curtain", until it was announced this morning that Goldman Sachs had a "trading glitch" involving part of the market that they made for options traders.

The report on Goldman's "incident" stated the following:

Goldman Sachs experienced a trading glitch Tuesday that resulted in a large number of erroneous single stock and ETF options trades. Many of the trades may wind up being erased but the error could still cost the firm upwards of $100 million, according to a person familiar with the situation.

"The exchanges are working to resolve the issue," a Goldman spokesman said in a statement. "Neither the risk nor the potential loss is material to the financial condition of the firm."

The trades involved NYSE Euronext, CBOE and Nasdaq OMX, according to reports.

A CBOE spokesperson said erroneous trades were being adjusted and busted up until 7pm CT Tuesday.

NYSE officials sent a notice to traders that they "anticipate that most of the impacted trades will be busted," the Wall Street Journal reported.

A person familiar with the situation said the losses for Goldman could be in the millions, or even upwards of $100 million, depending on how many trades were busted.

The botched trades occurred when Goldman's internal computer system that helps to determine where to price options mistakenly ended up sending orders at errant prices. Goldman is a market maker in the options market.

Is Goldman Going the Way of J.P. Morgan?

This is the first obvious comparison a lot of people are bringing up between Goldman's glitch and recent news. I'd contend that Goldman, while likely participating in some of the same style of trades, isn't necessarily going down the JPM road simply due to this incident. The reported on the ongoing saga of the London Whale, where a J.P. Morgan trader botched a major CDS trade that cost the bank billions:

Authorities are reportedly closing in on former JPMorgan employees Javier Martin-Artajo and Julien Grout - two of the three traders allegedly responsible for a bad derivatives bet that lost the bank an estimated $6.2 billion, then trying to hide the amount of the loss from their bosses in New York. Meanwhile, Bruno Iksil, the London Whale himself, is reportedly cooperating with the authorities in exchange for possible leniency.

And then there's the fallout for JPMorgan Chase itself. Historically, the SEC has allowed banks to pay a fine and "neither admit nor deny" wrongdoing in similar cases of employee misbehavior. In the case against former Goldman Sachs trader Fabrice Tourre earlier this summer, for example, Goldman was able to settle for $550 million - and no admission of guilt.

But after fielding criticism for this policy, the SEC may well require JP Morgan to acknowledge some wrongdoing as part of a settlement. "Making JPMorgan the first example of the SEC's new policy would send a clear message to Wall Street that no financial institution, even one of its largest and most profitable, is immune from being required to admit to a violation," said Peter J. Henning in The New York Times.

The J.P. Morgan case is one in which an actual investor knowingly tried to cover up a poor trade. Goldman's issue, for the time being, revolves around automated trading glitches, similar to the algorithm trading error by Knight earlier in the year. The potential losses sustained by GS are also significantly less (max 100 MM vs. billions) than JPM.

The one common ground in the Venn diagram of these two instances is going to be that these events are both likely to act as catalysts to spur new trading regulations - but with the SEC running the show, it's anyone's guess as to how quickly they come along.

Is There a Threat of Losses to Goldman Investors?

The reality of this situation is that due to the potential amount Goldman can lose, versus what I think they're likely to lose after getting everything sorted out with the exchanges and regulatory agencies means that, to me, there's no real threat of this effecting trading for current and potential Goldman investors.

The fact of the matter is that Goldman is a company with a $71 billion market cap that did $34 billion in revenue in 2012. The maximum predicted loss of $100 million is what Goldman executives are likely to be spending on landscaping at their homes. In all seriousness, there's little to zero chance of this incident negatively effecting the average investor in Goldman Sachs.

With that, the headlines on this "incident" have already disappeared from most online news sites. Soon, it'll be swept under the rug and forgotten about, as the market chugs further along and we await the next trading SNAFU to eventually come down the pipeline.

I Predict Goldman Not Likely to Lose $100 MM

From reading the above piece on Goldman, we can already see that the "damage control" wheels appear to already be spinning. It almost sounds as if some of the exchanges plan on giving Goldman Sachs a mulligan here, "adjusting and busting" some of the trades that took place. In other words, there's a good chance Goldman will get another "do over".

Something about this stinks, and no doubt someone is getting the short end of the stick here with this "glitch", and I'm likely to contend that it's not going to be Goldman that comes out screwed in the end. Goldman already took $10 billion of the taxpayers money, so why should they have to pay for this "glitch"? As a taxpayer, you know you're lining up for the big hurt here, and by this point I can't even say I'm surprised.

Have we learned nothing from what happened to Knight Capital Group (NYSE:KCG) at the beginning of the year? Here's a quick well-worded refresher from the folks at the Register:

Knight Capital, a firm that specialises in executing trades for retail brokers, took $440m in cash losses Wednesday due to a faulty test of new trading software. This morning reports were calling it a trading "glitch", which isn't nearly as accurate as the term I'd use: "f**king disaster".

I knew something was wrong at Knight Capital the day of their algorithm error, because the stock was getting crushed down to $9 on massive volume almost an hour before the story ever even hit the newswire. After investing long enough, I've started to learn, "there are no coincidences". I was able to trade the Knight disaster accordingly just by watching the volume. I took my short position, they released the news, the rest is history. The pre-news trading tipped me off. If you don't think there were insiders that dumped into that news, then I have some real estate in rural Alaska to sell you.

After Knight's collapse, the company's valuation to the market was crushed to the tune of about 70%, screwing many retail shareholders that had bought into the company. The CEO eventually fixed Knight for a buyout at a price that was 55% lower than it's trading price before the error. He collected his salary and bonuses, and quickly resigned thereafter. Lack of regulation and accountability cost tons of retail investors lots of money - and that's what it looks like we're heading for again with Goldman. $100 million means diddily to Goldman, but I'd bet dollars to donuts that they're still going to find a way out of being accountable for this.

There was supposed to be regulations and things put in place to stop this. Remember after Knight's collapse? The SEC was going to convene and put things in place to stop this. Looks like that's going the way of the buffalo.

How This Translates to Your Investing

So, it's just another day on Wall Street folks, where the big corporations remain untouchable and the retail commonfolk wind up being the ones who foot the bill. As I noted in a previous article, the sooner you realize that no matter what you think, you're one of the sheep - and the sooner that you realize banks and oil & gas are so tied into the state of the world in general that they can do whatever they want - the sooner you can make money off of them.

The "untouchables", companies that are deemed too big to fail by the government are the companies that are invested in by the smart money. There's a reason that AIG (NYSE:AIG) is the most widely held stock in current hedge funds even despite it's horrific track record and government bailout - that reason is it's an "untouchable".

Companies like BP (NYSE:BP) and Exxon (NYSE:XOM), while posing risks to the environment, continue to push forward and earn investors money due to their close ties and lobby with the government. From an ideological standpoint, they may not always feel great to invest in, but you're money is backed by the government's assure that "everything will be OK" - and they're running the show for the foreseeable future.

Likewise, while Knight investors weren't close enough to prevent them from going under, there's no doubt that there were a substantial amount of people holding KCG short that were able to clean up. Goldman, I contend, is extremely close to the government. How close? Robert Rubin, Henry Paulson, Bill Clinton, George W. Bush, Mario Draghi and Mark Carney - all former Goldman execs.

Ideologically, I'd love to short GS, but I know at the end of the day it'd be me versus the world on this one, so I won't be taking a position - but my beef with Goldman will carry on.

If you can stomach it, investing in the companies that are in bed with the government is likely to be a profitable endeavor.

Best of luck to all investors.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Stocks: AIG, BP, F, KCG, SCHW, XOM, GS