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

| About: Goldman Sachs (GS)

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 (NYSE: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...

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