Some of the top secret AIG bailout info is out. Guess who's at the heart of it, making money by creating straight trash, selling it to its clients then buying insurance to benefit from its inevitable crash? I have been warning about Goldman's ability to sell trash to its clients for some time now.
This is not a short post, for it is packed with a lot of supporting information, analysis and data. If you are looking for quippy paragraph, soundbyte or quick headline to get an overview of,,, well whatever, click here, or better yet, click here. For everyone else who may be looking for deeper investigative analysis and the unbridled TRUTH for a change, please continue on.
First a little background info. Goldman is supremely overvalued in my opinion. It is even more so considering much of its profit is generated solely from the raping of its clients. I say this holding absolutely no ill will towards Goldman. This is strictly factual. Let's walk through the evidence, of profit potential, valuation, and the stuff behind some of the value drivers in their business model, like brokerage and investment banking...
For one, Goldman is overvalued considering the economic profit that it generates. See Continuing the Goldman Sachs Valuation Debate (for those who have closely followed my Goldman opinion, you can skip down to the Bloomberg article towards the bottom of the page):
RM: GS return on equity has declined substantially due to deleverage and is only marginally higher than its current cost of capital. With ROE down to c12% from c20% during pre-crisis levels, there is no way a stock with high beta as GS could justify adequate returns to cover the inherent risk. For GS to trade back at 200 it has to increase its leverage back to pre-crisis levels to assume ROE of 20%. And for that GS has to either increase its leverage back to 25x. With curbs on banks leverage this seems highly unlikely. Without any increase in leverage and ROE, the stock would only marginally cover returns to shareholders given that ROE is c12%. Even based on consensus estimates the stock should trade at about where it is trading right now, leaving no upside potential. Using BoomBustBlog estimates, the valuation drops considerably since we take into consideration a decrease in trading revenue or an increase in the cost of funding in combination with a limitation of leverage due to the impending global regulation coming down the pike. Using your method, our valuation would drop from where it is to an even lower point.
Second, it still has a bunch of trash on its balance sheet, see Reggie Middleton vs Goldman Sachs, Round 2:
So, what is GS if you strip it of its government protected, name branded hedge fund status. Well, my subscribers already know. Let' take a peak into one of their subscription documents (Goldman Sachs Stress Test Professional 2009-04-20 10:06:45 4.04 Mb - 131 pages). I believe many with short term memory actually forgot what got this bank into trouble in the first place, and exactly how it created the perception that it got out of trouble. The (Off) Balance Sheet!!!
Contrary to popular belief, it does not appear that Goldman is a superior risk manager as compared to the rest of the Street. They may the same mistakes and had to accept the same bailouts. They are apparently well connected though, because they have one of the riskiest balance sheet compositions around yet managed to get themselves insured and protected by the FDIC like a real bank. This bank's portfolio looked quite scary at the height of the bubble.
You know what most people don't realize is that it looks quite scary now as well.
If one were to strip out the revenues from prop trading, it would leave bards some balance sheet issue. Again, I query, should virtual hedge funds that pay out half of revenue as compensation trade at such high premiums to the rest of the market? I don't think so, and I have put my money behind the idea that the market will not think so in the near future either.
Now that we have established at least a basic understanding of what is underneath the GS hood, let's see how the engine runs in order to generate said profits. In Reggie Middleton vs Goldman Sachs, Round 1, I noted that Goldman often peddled horrible advice and products to clients that repeatedely lost tons of money, yet Goldman is still considered the best and the brightest on the Street. Let's take a look:
The mainstream media jumps when Goldman's
sales and marketing staffanalysts make a recommendation or prediction, despite the fact that no one really bothers to look back to see how profitable the GS sales and marketing staffanalysts have been for their clients vs the risk-adjusted profitability for their bonus poolshareholders. One example that I have used in my previous posts was Lehman Brothers, who I became increasingly bearish on in early 2008 (if you're a regular reader, please bear with this rehash):
- See "Is Lehman really a lemming in disguise?" (Thursday, 21 February 2008)
- Lehman rumors may be more founded than some may have us believe Tuesday, 01 April 2008 (be sure to read through the comments, its like deja vu, all over again!)
- Lehman stock, rumors and anti-rumors that support the rumors Friday, 28 March 2008 and Funny CLO business at Lehman Friday, 04 April 2008.
The esteemed Goldman Sachs did not agree with my thesis on Lehman. Reference the following graph, and click it if you need to enlarge. Notice the tone, and ultimately the outright indication of a fall in the posts from February through April 2008 above, and cross reference with the rather rosy and optimistic guidance from the esteemed Goldman (Sachs) boys during the same time period, then... Oh yeah, Lehman filed for bankruptcy!!!
Does anybody think that Lehman was a "one off" occurrence? Or for that matter does anyone believe that only Goldman is guilty of a lack of actual performance for their clients vs. their bonus pool???
Reference "Blog vs. Broker, whom do you trust!" and you will be able to track the performance of all of the big banks and broker recommendations for much of the year 2008 for the companies that I covered on my blog. Since the concept of sell is rather remote to any big broker whose trading desk is not net short a particular position, it would be safe to assume that if the market turns the broker's recommendations will also turn in a similarly abysmal year as well. Just to be clear, this is not about ability, or who is the smartest. It is about marketing and conflicts of interest. Brokers do not charge for their research. Thus it should be obvious to anyone with even the slightest modicum of business savvy that the sunk costs that is freely disseminated research is most likely a loss leader (with the losses being born by the consumers of said research) otherwise known as the marketing arm for underwriting, sales and trading.
The blind following of Wall Street marketing research, and the abject worshipping of Goldman
marketing, inventory dumping, salesresearch allows them to rake billions of dollars off of their clients backs, yet clients still come back for more pain. A fascinating, Pavlov's dog's/Stockholm Syndrome style phenomena. Have you, as a Goldman client, performed as well as their employees receiving $19 billion in bonuses? Don't get me wrong. I'm not hating Goldman, but now they are actually rapingraking billions of dollars off of the tax payers backs as well. I do not do business with them, hence I do not want get my back raked - but it appears that as a US taxpayer I have no choice. A company that nearly collapsed a year ago, receives mysteriously generous government assistance (AIG full payout during its near collapse as an insolvent company) with the help of highly ranked government officials (many of which are ex-Goldman employees) and then pays out record bonuses on top of so many tens of billions of dollars of taxpayer aid with taxpayers facing high unemployment and sparse credit is not necessarily a company that should be looked upon as a scion of Wall Street. There is no operational excellence here. The only reason such an aura exists is because main street and Wall Street clients have an amazingly short memory, as I will demonstrate in the paragraphs below. This goes for the big Wall Street banks in general, and Goldman in particular.
As stated above, Goldman is now underwriting CMBS under a broad
fund our $19 billion bonus pool"buy" recommendation in the CRE REIT space. Let's take a look at another big bonus development exercise, marketing push they made into MBS a few years ago...
In April of 2006, a Goldman Sachs formed "Goldman Sachs Alternative Mortgage Products", an entity that pushed residential mortgage backed securities to its
victimsclients through GSAMP Trust 2006-S3 in a similar fashion to the sales and marketing of the CRE CMBS that is being pushed to its victimsclients as described in the links above. The residential real estate market faced very dire fundamental and macro headwinds back then, just as the commercial real estate market does now. I don't think that is the end of the similarities, either.
Less then a year and a half after this particular issue was floated, a sixth of the borrowers defaulted on the loans behind this product, according to CNN/Fortune, where the graphic to the right was sourced from. Here's an excerpt from the article of October 2007 (less than a year after the issue was sold to Goldman clients, clients who probably didn't know that Goldman was short RMBS even as Goldman peddled this bonus bulging trash to them):
By February 2007, Moody's and S&P began downgrading the issue. Both agencies dropped the top-rated tranches all the way to BBB from their original AAA, depressing the securities' market price substantially.
In March, less than a year after the issue was sold, GSAMP began defaulting on its obligations. By the end of September, 18% of the loans had defaulted, according to Deutsche Bank.
As a result, the X tranche, both B tranches, and the four bottom M tranches have been wiped out, and M-3 is being chewed up like a frame house with termites. At this point, there's no way to know whether any of the A tranches will ultimately be impaired...
,,, Goldman said it made money in the third quarter by shorting an index of mortgage-backed securities. That prompted Fortune to ask the firm to explain to us how it had managed to come out ahead while so many of its mortgage-backed customers were getting stomped.
The party line answer to the bolded phrase above is "risk management". Goldman is prone to say, "We were just hedging out client positions". Well, I wonder, were they net short or net long RMBS. You want to know what my guess is??? Looking back to there CMBS offerings of late, clients and bonus pool enhancement customers should inquire, "Is Goldman net short the
trash, bonus pool enhancementCMBS products that they are peddling to me???"
Now, fast forwarding to the present day, we look into "GSAMP Trust 2006-S3" and we find (courtesy of a follow-up CNN/Fortune article):
...the formulas used by Moody's and S&P allowed Goldman to market the top three slices of the security -- cleverly called A-1, A-2 and A- 3 -- as AAA rated. That meant they were supposedly as safe as U.S. Treasury securities.
But of course they weren't. More than a third of the loans were on homes in California, then a superhot market, now a frigid one. Defaults and rating downgrades began almost immediately. In July 2008, the last piece of the issue originally rated below AAA defaulted -- it stopped making interest payments. Now every month's report by the issue's trustee, Deutsche Bank, shows that the old AAAs -- now rated D by S&P and Ca by Moody's -- continue to rot out.
As of Oct. 26, date of the most recent available trustee's report, only $79.6 million of mortgages were left, supporting $159.9 million of bonds. In other words, each dollar of bonds had a claim on less than 50¢ of mortgages.
All the tranches of this issue, GSAMP-2006 S3, that were originally rated below AAA have defaulted. Two of the three original AAA -rated tranches (French for "slices") are facing losses of about 90%, and even the "super senior," safer-than-mere-AAA slice is facing losses of 25%.
As of Oct. 26, date of the most recent available trustee's report, only $79.6 million of mortgages were left, supporting $159.9 million of bonds. In other words, each dollar of bonds had a claim on less than 50¢ of mortgages.
... ABSNet valued the remaining mortgages in our issue at a tad above 20% their face value. Now, watch this math. If the mortgages are worth 20% of their face value and each dollar of mortgages supports more than $2 of bonds, it means that the remaining bonds are worth maybe 10% of face value.
...If all the originally AAA -rated bonds were the same, they'd all be facing losses of 90% or so in value. However, they weren't the same. The A-1 "super senior" tranche was entitled to get all the principal payments from all the borrowers until it was paid off in full. Then A-2 and A-3 would share the repayments, then repayments would move down to the lower-rated issues.
But under the security's rules, once the M-1 tranche -- the highest-rated piece of the issue other than the A tranches -- defaulted in July 2008, all the A's began sharing in the repayments. The result is that only about 28% of the original A-1 "super seniors" are outstanding, compared with more than 98% of A-2 and A-3. If you apply a 90% haircut, the losses work out to about 25% for the "super seniors," and about 90% for A-2 and A-3.
So, after reminiscing about the GSAMP Slide, we get to a news story in Bloomberg released just this morning...
Secret AIG Document Shows Goldman Sachs Minted Most Toxic CDOs
Feb. 23 (Bloomberg)
Representative Darrell Issa, the ranking Republican on the House Committee on Oversight and Government Reform, placed into the hearing record a five-page document itemizing the mortgage securities on which banks such as Goldman Sachs Group Inc. and Societe Generale SA had bought $62.1 billion in credit-default swaps from AIG...
The public can now see for the first time how poorly the securities performed, with losses exceeding 75 percent of their notional value in some cases. Compounding this, the document and Bloomberg data demonstrate that the banks that bought the swaps from AIG are mostly the same firms that underwrote the CDOs in the first place.
The banks should have to explain how they managed to buy protection from AIG primarily on securities that fell so sharply in value, says Daniel Calacci, a former swaps trader and marketer who's now a structured-finance consultant in Warren, New Jersey. In some cases, banks also owned mortgage lenders, and they should be challenged to explain whether they gained any insider knowledge about the quality of the loans bundled into the CDOs, he says. [Let's not play games here. The banks knew what trash was hidden where!]
"It's almost too uncanny," Calacci says. "If these banks had insight into the underlying loans because they had relationships with banks, originators or servicers, that's at the least unethical."[At the very least. I think it's called ILLEGAL!]
The identification of securities in the document, known as Schedule A, and data compiled by Bloomberg show that Goldman Sachs underwrote $17.2 billion of the $62.1 billion in CDOs that AIG insured -- more than any other investment bank. Merrill Lynch & Co., now part of Bank of America Corp., created $13.2 billion of the CDOs, and Deutsche Bank AG underwrote $9.5 billion.
These tallies suggest a possible reason why the New York Fed kept so much under wraps, Professor James Cox of Duke University School of Law says: "They may have been trying to shield Goldman -- for Goldman's sake or out of macro concerns that another investment bank would be at risk."
Goldman Sachs spokesman Michael DuVally declined to comment. [Of course...]
Schedule A also makes possible a more complete examination of why AIG collapsed. Joseph Cassano, the former president of the AIG Financial Products unit that sold the swaps, said on a December 2007 conference call that his firm pulled back from selling swaps on U.S. subprime residential CDOs in late 2005. The list shows that the $21.2 billion in CDOs minted after 2005, mostly based on prime and commercial mortgages, performed as badly as or worse than the earlier subprime vintages. [I seriously doubt so. Don't you guys know we are in the middlet of a steep "V" shaped economic recovery and a roaring bull(shit) market? The CRE and residential real estate markets have just about bottomed out and the worst is over!]
.... As details of the coverup emerge, so does anger at the perceived conflicts. Philip Angelides, chairman of the Financial Crisis Inquiry Commission, at a hearing held by his panel on Jan. 13, questioned how banks could underwrite poisonous securities and then bet against them. "It sounds to me a little bit like selling a car with faulty brakes and then buying an insurance policy on the buyer of those cars," he said.
[Actually, if I may correct you my good man, it's more like selling a car with faulty breaks, then buying a car accident swap on the driver (through your own car accident swap dealer which has practically cornered the car accident swap market, may I add) and getting repeat business from the sucker who bought the car with bad breaks in order to sell him multiple upgarded models of said faulty break car, complete with free car accident swap counterparty membership! You make money off of him until he dies, and then you simply cash in your swap. The swaps may not be as profitable as they once were because the damn bad brake and car accident swap regulators are starting to bitch and moan about you making so much money from damn near killing poeple while having access to federal funds. God's work, forbid. They are actually asking us to foot the bill for damn near killing the clients without access to the Fed window and 0.25% rates on our FDIC insured bonds!!!]
'Part of the Coverup'
Janet Tavakoli, founder of Tavakoli Structured Finance Inc., a Chicago-based consulting firm, says the New York Fed's secrecy has helped hide who's responsible for the worst of the disaster. "The suppression of the details in the list of counterparties was part of the coverup," she says.
E-mails between Fed and AIG officials that Issa released in January show that the efforts to keep Schedule A under wraps came from the New York Fed. Revelation of the messages contributed to the heated atmosphere at the House hearing.
"What date did you know there was a coverup?" Republican Congressman Brian Bilbray of California demanded of Geithner. Lawmakers used the word coverup more than a dozen times as they peppered Geithner with questions.
The government has committed more than $182 billion to AIG and owns almost 80 percent of the company.
In late November 2008, the insurer was planning to include Schedule A in a regulatory filing -- until a lawyer for the Fed said it wasn't necessary, according to the e-mails. The document was an attachment to the agreement between AIG and Maiden Lane III, the fund that the Fed established in November 2008 to hold the CDOs after the swap contracts were settled.
AIG paid its counter parties -- the banks -- the full value of the contracts, after accounting for any collateral that had been posted, and took the devalued CDOs in exchange. As requested by the New York Fed, AIG kept the bank names out of the Dec. 24 filing and edited out a sentence that said they got full payment.
The New York Fed's January 2010 statement said the sentence was deleted because AIG technically paid slightly less than 100 cents on the dollar.
Paid in Full
Before the New York Fed ordered AIG to pay the banks in full, the company was trying to negotiate to pay off the credit- default swaps at a discount or "haircut."
By March 2009, responding to a request from Christopher Dodd, chairman of the Senate Committee on Banking, Housing and Urban Affairs, AIG released the names of the counterparty banks. In a filing later that month, AIG included Schedule A, showing bank names while withholding all identification of the underlying CDOs and the amounts of collateral each bank had collected. The document had more than 800 redactions.
In May 2009, AIG again filed Schedule A, this time with about 400 redactions. It revealed that Paris-based Societe Generale got the biggest payout from AIG, or $16.5 billion, followed by Goldman Sachs, which got $14 billion, and then Deutsche Bank and Merrill Lynch. It still kept secret the CDOs' identification and information that would show performance...
"This is something that belongs in the public domain because it was done with public money," Issa says. "The public has the right to know what was done with their money and who benefited from it." Now, thanks to Issa, the list is out, and specific information about AIG's unraveling can be learned from it. At the Jan. 27 hearing, the New York Fed was still arguing that the contents of Schedule A shouldn't be fully disclosed. Thomas Baxter, the New York Fed's general counsel, testified that divulging the names of the CDOs could erode their value: "We will be hurt because traders in the market will know what we're holding."
[Let's get this straight, your selling your housem but it had a fire and 60% of it is burned down. According to Baxter, you don't want anyone to tell your broker or other housing investors that your house has burnt down or even the address because it could (and let me quote this for the most accurate effect) "could erode their value: "We will be hurt because traders in the market will know what we're holding." Now (and excuse my French here), if that ain't some shit to be admittting in public, in a Congressional hearing to boot, I don't know what it. You guys have balls the size of bowling balls, ya' hear me!]
Tavakoli calls that wrong. With many CDOs, providing more information to the market will give the manager a greater chance of fetching a realistic price, she says. [Who wants a realistic price when you can try to fetch a Goldman RIPOFF price??? Really, let's be real here!]
Bad to Worse
Tavakoli also says that the poor performance of the underlying securities (which are actually specific slices or tranches of CDOs) shows they were toxic in the first place and were probably replenished with bundles of mortgages that were particularly troubled. Managers who oversee CDOs after they are created have discretion in choosing the mortgage bonds used to replenish them.
"The original CDO deals were bad enough," Tavakoli says. "For some that allow reinvesting or substitution, any reasonable professional would ask why these assets were being traded into the portfolio. The Schedule A shows that we should be investigating these deals."
Among the CDOs on Schedule A with notional values of more than $1 billion, the worst performer was a tranche identified as Davis Square Funding Ltd.'s DVSQ 2006-6A CP. It was held by Societe Generale, underwritten by Goldman Sachs and managed by TCW Group Inc., a Los Angeles-based unit of SocGen, according to Bloomberg data. It lost 77.7 percent of its value -- though it isn't in default and continues to pay. [Hey, doesn't this remind you fo the GSAMP Slide, that funky new dance, introduced above???!!!]
[As you can see, part of the probable reason for bailing out SocGen was that Goldman sold them the equivalent of a financial terrorism event, and the French government probably said, "Make this right, or we'll go public!]
[Well, for all of those guys who oppose mark to market rules, this CDO hasn't lost any of its value since it continues to pay and is probably considered a longer term asset. Mayhap they will take their capital and buy it at par???]
One really wonders why anyone would even bother to buy trash like this from Goldman or any other bank. Oh well, why not? They are the best and the brightest, Right???
More of Reggie on Goldman Sachs
- Reggie Middleton on Goldman Sachs' fourth quarter, 2008 results
- Goldman and Morgan losses in the news, about 11 months late
- Blog vs. Broker, whom do you trust!
- Monkey business on Goldman Superheroes
- Reggie Middleton asks, "Do you guys know who you're messin' with?"
- Reggie Middleton on Risk, Reward and Reputations on the Street: the Goldman Sachs Forensic Analysis
- Reggie Middleton on Goldman Sachs Q3 2008
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