Posts Tagged: Goldman Sachs

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10
Mar 10

Are We a Socialist Country?

Europeans and Russians are socialists.  Americans are staunch capitalists.  Maybe all it took was a financial crisis to reveal the slide toward socialism in America.  During the Cold War, faced with a military threat from the Soviet Union, Americans would rather have died than become socialists:  better dead than red.  Unwittingly, we now invite socialism into our lives.  Ironically Wall Street firms and large industrial corporations, the purported bastions of capitalism, have paved the way to socialism.  A left-leaning Administration has been only too happy to oblige.

The Slippery Slope

The road to hell is paved with good intentions.  I do not think any of the pillars of our economy intended that the country become socialistic.   Each entity was merely maximizing its own position, seeking to enhance shareholder value.   When financial crisis hit, our formerly capitalistic businesses could not rush to Washington fast enough to seek support, bailouts and guarantees from the government.   The government was only too happy to oblige with the passage of TARP and then an alphabet soup of government support and guarantee programs.  In one short crisis period from summer 2008 to spring 2009, the government ignored 200 years of American economic and constitutional history to save a group of greedy and profligate bankers and industrial corporations.   The end result: we privatized profit and socialized losses.

A Factual Progression

Here are the events that have taken us on the path to socialism:

  • The Federal Reserve’s active role in the forced sale of Bear Stearns to JP Morgan
  • The Government seizure of Fannie Mae and Freddie Mac
  • TARP:  Government purchase of troubled assets from private financial institutions
  • Goldman Sachs and Morgan Stanley become banks by expedited process  to obtain government guarantees
  • Government seizure of AIG and complete payback to private institutions for credit derivative losses
  • Federal Reserve intervention in broker mergers, with guarantees against losses (Washington Mutual with JP Morgan, Wachovia with Wells Fargo)
  • Federal Reserve intervention with $1.3 trillion in loans to companies outside the financial sector (GE).
  • Government removal of management at GM and Chrysler
  • Restrictions on executive pay for banks receiving bailout funds
  • Government restrictions on foreclosures unless there has been a Home Affordable Modification Program review.
  • Administration desperation to pass comprehensive health insurance program.   See Timeline:Global  Economy in Crisis

How Did We Get Here?

We invited the devil in the door.  Banks claimed that they could not withstand loan and derivative losses.  Unemployed Americans wanted extensions in unemployment benefits and stimulus programs.  Nobody wanted to see the stock market crash and their portfolios and retirement plans decimated.  Big business wanted the profit opportunity in universal health care coverage.  Insurance companies did not want to hurt their policy holders.  Auto workers wanted to maintain their rich union contracts.  The litany goes on.

Once we were a brave, independent and self-reliant nation.  Now when adversity strikes our first inclination is to blame others and call Washington for a bailout or a handout.  I do believe in the concept of welfare.  Welfare was meant for the truly dire circumstance, the impoverished citizen. Welfare was not meant for auto workers to maintain above market wages and job guarantees, banks to get paid in full for risky derivative bets, GE or GM, homeowners who falsified their income disclosures to remain in McMansions or every insurance policy to be paid in full.

Capitalism is about freedom, risk and failure.  Without failure there can be no progress.  The slide toward socialism is an escape from freedom and ultimately an end to progress.

My European immigrant grandfather lived through the Depression, World War Two, and into the 1980’s.  He once told me he was most proud that he never went on relief (welfare).  We should return to the ways of our forbearers, regain our mettle and become too proud to ask for a handout or bailout.   Our freedom and that of our children depend on it.

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2
Mar 10

Goldman and the Winner Take All Society

Finally, Goldman Sachs has gone too far.  In A Reputation as Good as Goldman?  Part I, we discussed Goldman’s selling of mortgage backed securities, and its role in the current Greek budget crisis.  These activities clearly contributed to its self-inflicted reputational damage.

Perhaps the hubris went further.   Does Goldman believe that its status as a favored Federal Reserve “too big to fail” firm will insulate it from government investigation? Last week Ben Bernanke put a dent in Goldman’s Teflon shield:

Ben S. Bernanke, the Federal Reserve chairman, told Congress Thursday that the Fed was ‘looking into a number of questions relating to Goldman Sachs and other companies and their derivatives arrangements with Greece.’

Mr. Bernanke said the Securities and Exchange Commission was also concerned about how derivatives — financial instruments that are largely unregulated and do not trade on public exchanges — have contributed to Greece’s problems. ‘Obviously, using these instruments in a way that intentionally destabilizes a company or a country is counterproductive,’ he said. See In Greece’s Crisis, Fed Studies Wall St.’s Activities.

In Is Goldman Finally About to Be Leashed and Collared? Yves Smith observes and analyzes Goldman’s corporate culture.  As a former employee, she reports on colleagues’ piggish and overly aggressive behavior. But in an otherwise excellent post, I believe she overlooks the role of current compensation systems.

Pay Practices and Reputation

In previously discussing the banking crisis, we pointed out a fundamental principal: you get what you incent.

Banks were interested in generating upfront fees. Incentives were predicated on “making the deal.”  The best way to make a deal was to ignore the creditworthiness of the borrower.  The banker who made the bad loan suffered no personal financial penalty.  There was no “skin in the game.” Why not write as many loans to poor credits as possible? See Hard Truths from the Banking Crisis.

The Goldman culture incents a “winner take all” mentality.  Since it is a public corporation rather than a partnership everyone is an employee.    A highly mobile employee rather than an owner is far less concerned about the firm’s long term reputation.  That employee wants to maximize current compensation; worrying about future consequences is for suckers.  Drawing on this paradigm, we are not shocked by headlines excoriating the firm for trading against its clients’ interests, shorting the municipal bonds it helped underwrite, skirting EU rules, or tanking the housing market.

Goldman operates in a larger Wall Street and indeed general culture that encourages greed at the expense of overall civic good:

  • Successful hedge funds report individual earnings in the hundreds of million dollars per employee.
  • Loyalty is dead.  Employees change firms. Highly paid athletes change teams without a second thought.
  • The media treats great wealth as reason for great celebrity.
  • Compensation validates individual worth.
  • Government backstops losses and allows gains to remain private.
  • The zeitgeist promotes: “I better grab as much as I can now before the economy implodes.”

Does It Have To Be This Way?

Any alert Board of Directors should be asking some difficult questions.  Why aren’t we concerned about the long-term firm reputation?  What do we want the corporate culture to be? Just because we can legally do a transaction should we be doing it?  How do we blend partnership-based personal accountability with a public corporation structure?   How do we get employees to care about the long-term view?  How do we meet the competitive threat of hedge funds and private equity without damaging corporate reputation? How does our compensation system comport with these concerns?

Yves Smith noted that it was as dangerous for anyone to get in the way of a Goldman employee and a profit making opportunity as it was to get between a predatory animal and its kill.  Goldman has managed to get itself between a very worried Obama Administration and a very angry public.  How ironic if the Goldman predatory lion becomes the Administration sacrificial lamb.

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19
Feb 10

A Reputation as Good as Goldman Part II

In A Reputation as Good as Goldman Part I, we examined Goldman’s role in exacerbating the housing market collapse, AIG’s demise, and the Greek government debt crisis.  These major stories were the subject of separate front page articles in the New York Times. Mentors had always warned me no to be too clever by half, a lesson Goldman perhaps missed.   Are the Goldman stories symptomatic of behavior for the last ten years on Wall Street?  Was this always the way Wall Street firms and Goldman behaved?

Sydney Weinberg

In 1930, Sydney Weinberg became the head of Goldman Sachs. He ran the firm for the next 39 years.  By 2010 standards, he was an unlikely person for the job. He had left school at 15 (1907) and started at the struggling brokerage firm as a janitor’s assistant.  He then served in the Navy during World War I, returned to the firm and ultimately became co-head of the securities trading group. He is credited with saving Goldman Sachs from bankruptcy during the Depression. See Annals of Business: The Uses of Adversity by Malcolm Gladwell

In 1956, Weinberg managed his greatest corporate coup. Goldman Sachs was selected to handle for the Ford Motor Company the enormously difficult, largest ever until that time, initial public offering.  The effort took two years. The most fascinating part of the transaction was Weinberg’s fee:

When Henry Ford had asked Weinberg at the outset what his fee would be, Weinberg had declined to get specific; he offered to work for a dollar a year until everything was over and then let the family decide what his efforts were really worth.  Far more than the actual fee, Weinberg always said he appreciated an affectionate, handwritten letter he received from Ford which says, along with other flattering things, “Without you, it could not have been accomplished.” Weinberg had the letter framed and hung in his office, where he would proudly direct visitors’ attention to it, saying: “That’s the big payoff as far as I am concerned…” The fee finally paid was estimated at the time to be as high as a million dollars. The actual fee was nowhere near that amount: For two years’ work and a dazzling success, the indispensable man was paid only $250,000. Deeply disappointed, Sidney Weinberg never mentioned the amount.  See The Partnership: The Making of Goldman Sachs by Charles D. Ellis.

Weinberg understood the value of a continuing relationship with Ford Motor Company and was soon appointed to their board.  Moreover, for nearly a half century, Goldman became the chief investment bank for Ford which vaulted the firm into the top tier of Wall Street firms.  To Sydney Weinberg reputation was everything.

Tradition and the Making of a Culture

John Weinberg followed his father Sidney as head of the firm.  The younger Weinberg preserved his father’s ethic and corporate culture.

Once upon a time, Goldman Sachs shunned publicity.  During the period from 1930 to 1969, Sydney Weinberg ran Goldman Sachs where he developed a staunch corporate cultural aversion to publicity.  During the 1970s, a tandem of John Weinberg and John Whitehead assumed the reigns of leadership at Goldman Sachs.  Whitehead left the company in 1984 to enter public life.  John Weinberg carried on in the same vein as his father Sydney – shunning publicity – to the point where he hired a man to keep his name and his firm’s out of the press.  He kept him off the full-time payroll (though he sat full-time at a desk in head office) so that if, improbably, a comment did slip out, it could be honestly dismissed as not coming from a Goldman Sachs employee.  John Weinberg served as sole senior partner and chairman until 1990.  His mantra was to put the client’s interests first and he wouldn’t allow Goldman to be involved in (sic) hostile takeovers. See All Roads Lead to Goldman Sachs.

As a young law student, Ben Stein interviewed with John Weinberg.  He was impressed with Weinberg as a “smart guy,” but also surmised that he inherited the position from his father, Sydney Weinberg:

But what I did not know about John Weinberg was that even though he was rich and well connected, as a young man he joined the Marines to fight the Japanese in the Pacific, then fought again in Korea. That was America’s ruling class then. The scions of the rich went off to fight. See Looking for the Will Beyond the Battlefield

Clearly, John Weinberg believed that honor and service to one’s country mattered.  But in the current Goldman and Wall Street culture, going off to serve one’s country is for the common folk: why do that and miss out on so many deals and great bonuses?

What Changed?

The end of the Weinbergs’ era can be traced to several factors.  First, Goldman Sachs, Morgan Stanley and other large investment firms were partnerships.  This means the partners were investing their personal fortunes.  Moreover, retained capital was extremely important to the future success of the business.  Thus, there was a limit on executive compensation based on capital and personal preservation.  Second, as firms went public, it was easier to convince a less involved board of directors (rather than partners) to pay large bonuses to executives. Third, those same executives became increasingly greedy, and probed and trampled ethical boundaries. Short-term thinking reigned on Wall Street.  Fourth, compliant government officials endorsed and enabled these behaviors instead of regulating them.

Finally, we need to look at the important intersection of law and ethics.  Just because something is legal does not mean one should do it.  A legal thing is not always an ethical thing.  Would the Weinbergs’ have permitted Goldman to take positions against their own clients?   Would they have forced AIG into insolvency? Would they have designed scams to fool the EU? I doubt it.

It will be a long time before Goldman restores its reputation.  And President Obama is not catalyzing any restoration of ethics or reputation by calling the current Goldman CEO a savvy businessman.   By its actions, I doubt if Goldman Sachs cares.

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18
Feb 10

A Reputation as Good as Goldman? Part I

Part I of II in a series. Part II here.

“It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently.”

Warren Buffett

Arguably the greatest living investor, Warren Buffet, clearly valued a person’s or an organization’s reputation.   In 2008 Buffet was the “white knight” investor for a struggling Goldman Sachs, investing $5b in the firm.  A mentor of mine had wise complementary counsel to Buffet’s:  when providing legal advice, be sure that you would be comfortable if that advice were to appear in a New York Times, Washington Post or Wall Street Journal front page article.

We live in  an age of greed, and indeed supreme irony.   Perhaps Mr. Buffet never shared his wise advice with the senior management of Goldman Sachs.  Worse, maybe he did and they ignored him.  In any event, how has Goldman’s reputation fared?  Let’s examine three separate front page New York Times articles.

Banks Bundled Bad Debt, Bet Against It And Won (NY Times, December 24, 2009)

Goldman Sachs sold mortgage-backed debt securities to pension funds and insurance companies. To hedge their position and to profit from a decline in the housing market, Goldman created a synthetic derivative security called Abacus. This second security was a direct bet against the position of their institutional clients. The mortgage-backed debt securities sold to the institutional clients performed poorly, with losses in the billions. Some of the original securities were of such poor quality that losses occurred within months of issue. Goldman created these synthetic securities well in excess of any hedging needs, permitting it to profit handsomely at the expense of its institutional clients.  The obvious ethical problem was succinctly stated:

“The simultaneous selling of securities to customers and shorting them because they believed they were going to default is the most cynical use of credit information that I have ever seen,” said Sylvain R. Raynes, an expert in structured finance at R & R Consulting in New York. “When you buy protection against an event that you have a hand in causing, you are buying fire insurance on someone else’s house and then committing arson.”

The SEC and other governmental agencies are investigating Goldman and other firms to determine whether or not they violated “fair dealing” rules.

Testy Conflict with Goldman Helped Push A.I.G. to Edge (NY Times, February 7, 2010)

AIG insured some of Goldman’s complex mortgage securities.  When the housing crisis deepened, AIG paid Goldman $2b to cover potential losses. AIG later asserted that Goldman had inflated the potential losses and sought monies back. Goldman countered that it was due even more money.  The SEC is now looking into whether or not Goldman’s demands for loss coverage depressed the mortgage market and hastened AIG’s demise.

In another supreme irony, after the government took over AIG, Goldman received an additional $12.9b from taxpayers, one hundred percent of expected losses.

Wall St. Helped to Mask Debt Fueling Europe’s Crisis (NY Times, February 14, 2010)

Goldman’s questionable financial maneuvers were not confined to the United States.

As worries over Greece rattle world markets, records and interviews show that with Wall Street’s help, the nation engaged in a decade-long effort to skirt European debt limits. One deal created by Goldman Sachs helped obscure billions in debt from the budget overseers in Brussels.

Even as the crisis was nearing the flashpoint, banks were searching for ways to help Greece forestall the day of reckoning. In early November — three months before Athens became the epicenter of global financial anxiety — a team from Goldman Sachs arrived in the ancient city with a very modern proposition for a government struggling to pay its bills, according to two people who were briefed on the meeting.

The bankers, led by Goldman’s president, Gary D. Cohn, held out a financing instrument that would have pushed debt from Greece’s health care system far into the future, much as when strapped homeowners take out second mortgages to pay off their credit cards.

European authorities are looking into the role of Goldman and others in skirting EU rules.

Is There Another Way?

Has the American public been lulled into believing that this is an acceptable way of doing business, or do we require the people involved to be publicly excoriated, tried, convicted and jailed before we acknowledge their tactics were shabby?  Is Goldman Sachs an institution now synonymous with crafty machinations and greedy outcomes? Are its tactics symptomatic of a Wall Street “disease?”  Is there an alternative way of doing things?  Does reputation matter?  Part II will examine these issues and possibilities.

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28
Dec 09

Trust Once Lost

My college history professor had an astute observation: “trust once lost cannot be easily regained.”  Naked Capitalism has two excellent posts today: “Is Blaming AAA Investors Wall Street Serving PR?” and “Has Obama Been a Success despite Suspicions of Crony Capitalism?” A common theme that both articles fail to fully articulate is– trust.  Trust is a commodity everyone now sells short.

Wall Street’s Treatment of Investors

In “Is Blaming AAA Investors Serving Wall Street PR?” Thomas Adams argues that Goldman Sachs and other clever bankers are pinning the blame on institutional investors who bought AAA-rated, collateralized debt obligations. Many of these securities turned out to be worthless. The investment banking community argues “caveat emptor,” but Adams convincingly rebuts:

The argument that the CDO market blew up because it was so complex and speculative is fundamentally flawed. Believe it or not, the bonds that caused the damage to AIG, the bond insurers, and banks were not highly speculative, high risk bonds. They were AAA securities and were supposed to be virtually free of credit risk. In many cases, they were “super senior” bonds – meaning they had another layer of protection above the AAA level to make them even safer than regular AAA bonds.

AAA securities were meant to be easily understood by any investor.  These products should not have required sophisticated analyses as Goldman and others now argue.

Adams cuts to the heart of the investment banker’s sin:

The problem with the CDO market, and a good chunk of the financial crisis, is that the participants took complex, highly volatile, highly risky and highly leveraged assets and passed a magic wand over them to turn them into AAA. Unfortunately, this process did nothing to remove the volatility, risk, complexity or leverage (in fact, the CDO made all of these worse). From the very start, the market for AAA CDO bonds backed by ABS collateral was a fraud….

Most telling is that the same investment banks selling these investments as AAA securities were simultaneously shorting the same securities to profit from their eventual default. See Banks that Bundled Bad Debt Also Bet Against It.

This is the new age of investment banking.  Would Sidney Weinberg the legendary head of Goldman Sachs bet against his own clients? I suspect not. Mr. Weinberg understood the basic value of trust.

What Price Success?

The Obama administration is extremely proud of stabilizing the economy.  In “Has Obama Been a Success Despite Suspicions of Crony Capitalism?” Edward Harrison addresses the large gap between the President’s words and deeds. Harrison bypasses Obama labels — liberal, a closet republican, technocrat — and instead examines the evidence:

The evidence, therefore, tends to demonstrate that we have witnessed an orchestrated campaign by the Bush and Obama Administrations to recapitalize too big to fail institutions by hook or by crook, bypassing Congressional approval if necessary. And when it comes to healthcare, both Congress and the White House have bent over backwards to keep the lobbyists onside. As I see it, our government has favored special interests in the past year of Obama’s tenure to our detriment.

Thus, banks or pseudo-banks are guaranteed survival (e.g. American Express, GE, Goldman Sachs and others) while Main Street (small businesses and community banks) is pushed to the back of the economic assistance line.

And consider other erosions of public trust by the Obama Administration:  an alphabet soup of federal guarantee programs, sham bank stress tests, suspended accounting rules, and favoritism toward health insurance companies and big pharmaceuticals in the current health care debate.

The Age of Cynicism

We live in an age of flawed short term thinking.  How do we make our numbers for the next quarter? How do we get through this financial crisis? How do we get a health care bill passed so we can claim victory? How do we win the 2010 elections?  Each “success” comes at a very high price.  America is a carefully woven social contract with trust as its bedrock.  But increasingly, cracks now appear in this bedrock of trust just when it is most needed.  Will public trust be completely gone when the inevitable next crisis occurs?

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23
Oct 09

Relying on the Kindness of Strangers

Whoever you are, I have always depended on the kindness of strangers.

Blanche DuBois  – A Streetcar Named Desire by Tennessee Williams

The United States has one of the world’s largest and most well-equipped militaries. A truism about military might: it requires a lot of money and a sound budget.  But we are unable to finance our trade deficits from domestic sources and have imperiled our international standing.  We now rely on the kindness of foreign financing and have created a self-defeating “Achilles Heel” in our US foreign and military power.

Projecting Power Throughout the World

Through its system of international bases, large annual military budgets and sophisticated weapons systems, the US projects global American power. These expenditures dwarf expenditures of other countries:

The 2009 U.S. military budget is almost as much as the rest of the world’s defense spending combined and is over nine times larger than the military budget of China (compared at the nominal US dollar/Renminbi rate, not the PPP rate). The United States and its close allies are responsible for about two-thirds of the world’s military spending (of which, in turn, the U.S. is responsible for the majority).

The Iraqi army learned that direct confrontation with American armed forces is a losing strategy.  Unfortunately, we are undermining this American military supremacy by owing massive amounts of money to foreign creditors.

Owing your Banker

There is a wise old shibboleth: “If you owe a bank thousands, you have a problem; owe a bank millions, the bank has a problem.”   Over the next ten years, new estimates project cumulative budget deficits of 9 trillion dollars. Health care proposals will swell even that projection.  Who is going to finance this deficit?  With traditional funding sources, pension funds and private investment under pressure, the answer has to be foreign investment.  Despite promises to the contrary, the US dollar has been in a controlled decline.  Our fiscal and monetary policy is punishing our foreign creditors by reducing the value of their dollar holdings.

The Intersection of Economics and Politics

Can we keep up our level of spending and direct military intervention in light of the ever-cheapening dollar?  More importantly, how will our foreign creditors react to American intervention?  If we embrace the realistic probability that countries like China and Russia do not wish us well, deficits have handed these antagonistic creditors a counterweight and serious threat to our military power.

Let’s assume you are the foreign minister of mainland China.  Taiwan has always been a thorn in the side of the Beijing government.  Assume also that you wish to minimize loss of Chinese lives and destruction of military hardware.  Why not reach an understanding with the US that your government will not dump its hoard of cheapening US treasury securities and for goodwill purposes China will buy even more.  The quid pro quo: no United States opposition to the peaceful reuniting of Taiwan and the mainland.  Such a diplomatic initiative in a Congressional or Presidential election year would present a quandary to both political parties.  Electoral political expediency would enable China to reunite.  In this scenario, the nukes remain in their silos, our expensive military hardware remains unused, and T-bills become more powerful than hydrogen bombs.

Bad Habits Always Catch Up With You

Bad economic habits weaken the global position of the United States. But where is the fiscal and monetary discipline in Washington?  While we focus on bailing out bankers and making JP Morgan and Goldman Sachs richer, our enemies are thinking about how to take advantage of our economic disarray.  Is it smart to continue to rely on the kindness of strangers?

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