Who will Goldman Sachs (GS) allow to stay in business?

by SJ Leeds

On Monday morning, I was speaking with a good friend and really smart guy (a medical doctor) and he said to me, “I don’t know enough about the markets, but I feel like there is a small group of people who control the system for their own benefit and they use the government to get whatever they want.” I chuckled because everyone in the financial community is talking about a Rolling Stone article, “The Great American Bubble Machine,” (written by Matt Taibbi) that makes that same argument. The article is written about Goldman Sachs. I’ll paraphrase here, but Taibbi would probably prefer to see Goldman Sachs renamed to Goldman Sucks - it’s an incredibly harsh article.

I want to give you a quick summary of Taibbi’s allegations and then give you some of my thoughts on the article. But before we discuss the allegations and my brief thoughts, we have to start with a key background assertion that Taibbi makes: Goldman Sachs (GS) runs the world. Aside from the power of being the most revered investment bank, GS alumni are in powerful government positions throughout the financial system. Some of those include:

Former Treasury Secretary Rubin
Former Treasury Secretary Paulson
Former Merrill Lynch CEO - John Thain
Former Wachovia CEO - Robert Steel
Former Bush Chief of Staff - Joshua Bolten
Current Treasury Chief of Staff - Mark Patterson (was a lobbyist for GS)
Former AIG CEO - Ed Liddy

Other Positions Include: heads of Canadian and Italian national banks, World Bank, NYSE, CFTC and last two heads of NY Federal Reserve Bank.
We can argue about whether this happens simply because GS recruits the smartest people or if this is a fraternity that helps their brethren obtain these positions to further the firm’s future profits. Regardless, it’s hard to deny the fact that GS rules the world.

Taibbi’s Allegations

Taibbi alleges that GS “engineered every major market manipulation since the Great Depression.” He argues that they do this by selling crappy securities and changing laws by making contributions to politicians (contributions which are a tiny fraction of the money that GS makes). His description of Goldman’s involvement in our country’s past problems includes:

1. The Great Depression - GS created leveraged investment trusts (sort of like mutual funds) that ultimately failed. He said that the amount of losses from these trusts (in today’s dollars) was $475 billion. He said that they would start one trust (with investor money) and use it to buy another trust that they started. GS would make money through their original sale of the trust, as well as by holding on to some of the units and selling them later at a higher price.

2. Tech Bubble - everyone knows that crappy companies were hyped and taken public. Taibbi alleged that GS’s innovation was to abandon the industry standards of quality control. It used to be that a company had to be profitable in order to go public. GS brought many companies public that weren’t profitable. In 1997, 1/3 of the 24 companies that they took public were not profitable. In the first four months of 2000, they took 18 companies public and only four had profits. He also argued that GS was guilty (and paid fines) for laddering (GS will give you some of the IPO if you agree to buy shares in the aftermarket) and spinning (giving IPO shares to top executives at companies so that they will select Goldman when they have banking business). He said that GS’s rampant use of these mechanisms resulted in GS sponsored IPOs outperforming the industry average. (One quick comment…all businesses try to reward their best customers and spinning is simply an example of this. The real problem with spinning is that the corporate executive misappropriates money that really belongs to his company. I blame the corporate executives much more than I blame the bankers - and as you know, I tend to blame bankers for everything.)

3. The Housing Bubble - GS participated by securitizing crappy mortgages. Just like we saw a decline in the standards for stocks (during the tech bubble), we saw a decline in mortgage quality (homebuyers no longer had to put 10% down) and this wouldn’t have happened if firms like GS didn’t provide a market for these securities. GS actively participated in the market for credit default swaps after being told by the NY State Insurance Department that these swaps would not be regulated as insurance (the office was run by a former GS employee - Neil Levin). While selling CDOs, GS was also taking short positions in this market. Later, when Paulson bailed out AIG (due to credit default swaps), $13 billion of the bailout money went directly from AIG to GS.

4. Oil and Other Commodities Crisis - he argues that GS convinced pension funds and other institutional investors to speculate on commodities. Earlier, GS had convinced the CFTC to allow financial firms to be considered as a “hedger” and to escape position limits that are put on speculators. This CFTC ruling led to a massive investment in commodities and these are “long only” investors - so it puts upward buying pressure on prices. At the same time, a GS analyst was predicting $200 oil. As all commodity prices rose, poor countries couldn’t afford food and riots ensued. He argues that in the six months prior to oil peaking, short term supply was increasing and demand was decreasing (and this should have resulted in lower prices).

5. The Bailout Bonanza - Taibbi alleges that the next pool of money to attack was the government bailout. First, Paulson let Lehman fail, eliminating a competitor for Paulson’s old firm. Then, he bailed out AIG and $13 billion of that money went to GS. Next, he put together the $700 billion TARP plan and put a former GS banker in charge of it. GS converted to a bank-holding company and accessed cheap government money. As a bank holding company, Goldman’s main regulator switched to the NY Fed whose chairman (Stephen Friedman) was the former GS co-chairman. Now, the President of the NY Fed (William Dudley) is a former GS employee. Finally, Taibbi alleges that the government required banks to meet certain terms (such as issuing debt with a maturity greater than five years) prior to being allowed to repay TARP funds, and GS did that in advance of the announcement (signaling that they either knew the rules or influenced the rule making).

6. Cap and Trade (the next bubble) - the new cap and trade rules cap carbon emissions and allow firms to trade the “pollution rights” that they won’t use. GS is apparenty lobbying for this system as they will profit from this market (GS is usually anti-regulation).

Some of My Thoughts on This Article

1. Regardless of whether this article is true or false (and it’s probably somewhere in between), this will tarnish GS’ reputation for a long time. (It’s sort of like asking someone when they stopped beating their wife - it doesn’t matter if they never did it; we’ll always assume they did.) For many years, GS has been seen as the premier investment banking firm, truly the smartest guys in the room, and a firm that was more “polished” than other firms. Now, many will think of them as market manipulators.

2. I think that this article is sloppily written, full of innuendos and loose comments. Taibbi throws so much out there that it all sounds bad. There are things that are mentioned that don’t have any incriminating value, but they still sound bad. As an example, in the midst of telling us about all of the unprofitable companies that GS brought public during the tech bubble, he tells us that they brought 47 companies public in 1999. It sounds like an allegation, yet we don’t know how many were profitable.

3. I’m not a fan of the major investment banks (it’s still “banks” and not “bank”, isn’t it?) and I think that this article would have been much better if written as an indictment of all banks, not just GS. (Of course, the anti-bank articles have already been written and they don’t sell.) The idea that GS caused the Great Depression or the tech bubble or the mortgage crisis is a tough one for me. The banks certainly had a significant role in the crisis, but so did many others (the mortgage originators, home buyers, ratings agencies, investors, etc.).

4. Maybe the reason that people are willing to blame GS more than other banks is that they seemed to profit (both financially and competitively) from the housing crisis. In addition, the government power held by their alumni base does make it easy to believe that they have an unfair advantage.

5. While I have some problems with this article, there are plenty of troubling allegations contained in it. For example, it’s hard to think about a firm selling securities to investors and effectively shorting the same market. (I’m a big fan of shorting, but I don’t like to see the sell side firms short what is effectively the same product that they are selling to clients. You wouldn’t like it if your realtor sold you a house and then you found out that he was shorting the neighborhood.) It’s also troubling to think of GS promoting regulation and that the cap and trade program is going to enrich the bankers.

6. I think that we all have trouble thinking about bankers that are still receiving large bonuses after playing a major role in our current crisis when so many people are suffering.

7. Rolling Stone missed a huge opportunity to make a lot of money from this article. You can only read a shortened version of it on their website. People had to read it on other websites. The publishers were probably thinking that everyone would buy the magazine. But they made a HUGE mistake. This financial topic tends to appeal to men and no self-respecting man is going to buy this issue when they put the Jonas Brothers on the cover. My guess is that Goldman was responsible for this…

In sum, true or false, this article does change my opinion of GS. For several years, I have talked about Goldman “ruling the world,” but this article highlighted many more GS alumni in powerful positions (than I knew about). Goldman probably is too powerful and is probably willing to do the very same things that other banks do (or have done). I did think of Goldman as the smartest guys in the room and maybe that was naïve. Maybe they are simply the most well-connected. Regardless, I think that this has tarnished their “elite” image. Finally, I would tell my friend (the doctor) that it’s hard to disagree with his premise.

http://leedsonfinance.com/?p=611

Related Posts:

• THE GREAT AMERICAN BUBBLE MACHINE
• Goldman Sachs and JP Morgan have and always will be cheats.
• Modern Investing: Google up Goldman Sachs’ Moves
• It is a definite “must read” for everyone playing the markets.
• In Goldman We Trust. A Government & Banking System Of, For, & By Goldman Slacks.

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