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Larry Levin's Nightly Newsletter & Trading Signals
Government Sachs
There has been a great deal of talk in blogs and some media circles recently about Goldman Sachs. The discussions have mainly centered on a few issues; the AIG swindle and the GS role, all of the ex-executives working for the government, and more recently High-Frequency Trading (HFT).
I ran across this article today and decided to forward it to you all. It only mentions HFT in passing. Maybe I can find more on that at another time. The total story is 8-pages long in The New York Magazine and can be found here http://nymag.com/news/business/58094/
On the weekend of September 12, 2008, as the financial system shuddered and appeared to be on the verge of lurching to a halt, two Goldman Sachs men, former CEO Hank Paulson and current CEO Lloyd Blankfein, huddled with other banking heads at the Federal Reserve Bank of New York to consider how to stave off disaster. Bear Stearns was dead. Merrill Lynch, run by another former Goldman man, John Thain, was in desperate need of a savior. And now Lehman Brothers was on the brink. As secretary of the Treasury, Paulson asked the banks to come up with a private-funding solution for Lehman before it imploded from lack of cash. But all the banks had been scrambling for cash reserves or strategic mergers to buffer against a rapid freeze in lending. No one was able, or willing, to help. And Paulson, a free-market purist, had made one thing clear up front: The government would not bail out the firm. Lehman Brothers, a longtime Goldman rival, prepared to declare bankruptcy, ending its 158-year run on Wall Street.
By Sunday night, Paulson realized he had an even bigger problem: the insurance giant AIG. AIG had sold billions in credit-default swaps to several major banks, what amounted to unregulated insurance on risky subprime-mortgage investments, the very ones that were bringing down the economy.
Hank Paulson and then-New York Fed chief Tim Geithner called an emergency meeting for the following Monday morning at the Federal Reserve Bank, ostensibly to discuss whether a private banking syndicate could be established to save AIG-one in which Goldman Sachs and JPMorgan Chase, two of the ailing insurance giant's clients, would play prominent roles.
At the meeting, it was hard to discern where concerns over AIG's collapse ended and concern for Goldman Sachs began: Among the 40 or so people in attendance, Goldman Sachs was on every side of the large conference table, with "triple" the number of representatives as other banks, says another person who was there. The entourage was led by the bank's top brass: CEO Blankfein, co-chief operating officer Jon Winkelried, investment-banking head David Solomon, and its top merchant-banking executive Richard Friedman-all of whom had worked closely with Hank Paulson two years prior. By contrast, JPMorgan CEO Jamie Dimon did not attend.
The Goldman domination of the meetings might not have raised eyebrows if a private solution had been forthcoming. But on Tuesday, Paulson reversed course and announced that the government would step in and save AIG, spending $85 billion in government money to buy a majority stake.
Of the $52 billion paid to AIG's counterparties, Goldman Sachs was the biggest recipient: $13 billion, the entire balance of its claim. The amount was surprising: Banks like Merrill Lynch that had bought credit-default swaps from failed insurers other than AIG were paid 13 cents on the dollar in deals moderated by New York 's insurance regulator. Eric Dinallo, the former New York State insurance commissioner, who was at the AIG meetings, characterizes the decision this way: AIG's counterparties, Goldman being the most prominent, "got to collect on an insurance policy without having the loss."
Somehow not recognizing (or perhaps not caring about) the brewing backlash, Paulson continued to appoint Goldman Sachs alumni to positions of power after the AIG decision-he named Edward C. Forst, a former head of Goldman's investment-management division, to help draft the $700 billion Toxic Asset Relief Program (of which $10 billion went to Goldman Sachs), and then Neel Kashkari, a former Goldman V.P., as the TARP manager. And of course Edward Liddy, former Goldman board member, was already serving as the new CEO of AIG. Suddenly, everywhere you looked, men who had passed through the Goldman gauntlet of loyalty and rewards were now in key positions overseeing the rescue of the financial system. The company was earning its nickname: "Government Sachs."
Both Rogers and Paulson (who's publishing a book this fall that will presumably attempt to justify his decisions and save his damaged legacy) have argued that the AIG decision was about saving the system as a whole, not Goldman in particular.
Similarly, they say, when it came to AIG, the firm was "prudent" in hedging its bets, buying credit-default swaps from Bank of America, JPMorgan, Soci?t? G?n?rale and other banks in case AIG failed to pay the money it owed Goldman-in effect, hedging its hedge against the mortgage market. Goldman Sachs had no "material exposure" to AIG, they argue. One senior executive goes so far as to suggest the firm might even have benefited from AIG's demise. "We might have done very well," he says, "but I wouldn't be so presumptuous as to say that. Who knows?"
Not a single Wall Street executive I spoke with, including several Goldman Sachs alumni, believe those hedges would have survived an overall collapse of the financial system. A large loss would have been inevitable as lending evaporated, and Goldman Sachs would have struggled to shrink the company to a fraction of its size overnight. But the most glaring argument against Goldman is Goldman's own: If AIG's biggest and most important bank customer was hedged against losses in AIG, as it claims, why did the government need to pay Goldman Sachs the full $13 billion?
Lost in the haze of Goldman's recent record profits is the fact that the firm nearly went under even after the AIG bailout last fall. As the market continued to plunge and Goldman's stock price nose-dived, people inside the firm "were freaking out," says a former Goldman executive who maintains close ties to the company.
Salvation came on November 25, a few days after Goldman's stock price plunged to $52 a share, down from the year's high of $200 and the lowest price the company had seen since it went public. Again, the white knight was the government. It turned out that Goldman's conversion to a garden-variety bank-holding company offered an amazing advantage: Goldman now had access to incredibly cheap money. Exploiting its new status, Goldman became the first financial institution to sell $5 billion in government-backed bonds through the Federal Deposit Insurance Corporation, which allowed Goldman to start doing deals when the markets were at a near standstill.
Those FDIC notes they got were lifesaving because they couldn't issue any debt. If it had gone on another week or two, Goldman would have failed, they would have gone the way of Lehman, and you'd be talking about Lloyd the way you talk about [Lehman CEO] Dick Fuld."
Even Goldman alumni were struck by the company's shameless posture in ramping up the leverage again so soon after the government bailouts. "It's a statement of arrogance," says one former executive.
Goldman claims that there is a Chinese Wall between the advisory business and the trading business. "There are rules and laws regarding information sharing, and we scrupulously follow them," says a company spokesman.
But two former clients told me they had observed firsthand how Goldman traded against their interests to improve its own bottom line-one who didn't like it, the other accepting it with a shrug and saying, admiringly, that Goldman's ability to convince the world that it is a "client-oriented" business was its most masterful PR coup.
Goldman's profiting from this ethical gray area was exemplified by the real-estate market and the subprime-mortgage collapse: Goldman Sachs sold subprime-mortgage investments to its clients for years, but then in 2006 began trading against subprime on its own balance sheet without informing its clients, a hedge that ultimately let it profit when the real-estate market cratered. For some, this was a prescient call; for others, a glaring conflict of interest and inherently dishonest, since the firm let its clients take the fall.
Earlier this month, Goldman had an ex-employee arrested for allegedly stealing computer codes that could be used, as the prosecutor noted, "to manipulate markets in unfair ways." Some hedge-fund traders and financial bloggers have speculated that Goldman itself could have been using the codes for the same purpose.
Now attention is turning to Goldman's dominance of trading on the New York Stock Exchange-as the exchange's biggest high-speed program trader as well as a provider of liquidity to other traders-and whether that ubiquity has afforded the firm undue advantage. If Goldman's database knows nearly every trade that is about to be made, sophisticated computer codes could, theoretically, instantly execute fail-safe trades on Goldman's behalf milliseconds beforehand. This, some are insisting, is where the company is manipulating the markets and making hundreds of millions of dollars a day.
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