Monday, April 26, 2010

Goldman Sachs & God

In financial markets, Goldman Sachs is like a god. Goldman Sachs was about the only big investment bank that did well during the subprime financial crisis, JP Morgan did OK as well. But both went about doing alright in very different ways. Now people are complaining that Goldman Sachs cooperated (conspired?) with a hedge fund hustler in John Paulson (maverick or genius depending on whom you are talking to) to assemble and sell "synthetic collateralized debt obligations" that everyone involved, except maybe the purchasers knew would probably fail. The hedge fund hotshot made $1 billion.

I think Goldman Sachs did what a great investment bank should have done anyway. If you are smarter than the rest, you do the smart thing. Its a for profit entity, Goldman Sachs made most of its money by trading anyway, not by marrying trades.

Goldman Sachs is a convenient pinyata for those wanting to point out and punish those who behaved unethically and profited from the crisis. What GS did was not illegal but probably unethical. The basis for saying that is that most of the buyers of synthetic CDOs did not know the full extent of what they were buying - or did they? You don't go around buying billions of that stuff and then claim that you don't know what you were buying!!?? So what if GS knew that it was probably a bad trade for those who bought the CDOs. If you bought IOI Corp via GS, and then 6 months later IOI fell by 50%, is GS culpable?

GS, John Paulson, Steve Eisman, Mike Burry and the others in the brilliant new Michael Lewis book, The Big Short, basically got the right read on the subprime markets. Its never ethical to make money when you are short the markets, you can try to justify it but its not ethical. Its a profitable bet, its a calculated bet, its a knowledge bet, you are betting that the majority of the markets are wrong. In any crisis, its the majority who will suffer.

If you read The Big Short, you will fully understand how little GS and John Paulson knew of what they were doing. Those who were really the geniuses were people like Mike Burry and Steve Eisman, who were vilified and laughed at for a couple of years when they tried to short the subprime markets.

Dimon steered JP Morgan away from the subprime market early enough with an edict to his employees not to touch the stuff, but JP Morgan did not make bets against the subprime market. But then again, JP Morgan is not a big player in proprietary trading.

What was stupid was the GS CEO Blankfein saying that they are doing God's work. Just run GS as what we all know it is, a devil's playground where money is God. You do not need to make excuses on how you made money as no one expects you to be saintly or even ethical (really). Those who now trumps the word "ethical" as an absolute requirement for the character of the firm are deluding themselves. Ethics are just classes you take for GS to appease the lawmakers. It will never be allowed to conflict with money making motives. In fact, if you read The Big Short, you will know that GS was just like Bears Stearns, Citigroup and Merrill Lynch, holding the stuff on their books. It wasn't till late into 2006 that someone wised up at GS and said this was pretty stupid stuff if more than 7% of the loans defaulted - they actually went to 30% default rate in the end. Thats a risk they measured and a risk they acknowledged, the rest of the investment banks and AIG never put into their model that property prices could stop rising or that defaults could ever be higher than 3%.

If fact, if the subprime crisis imploded 6 months earlier, GS would have lost billions just like the rest. I guess, that is what people want, to have GS suffer alongside with all of them. Do any of those who shorted subprime (John Paulson, Mike Burry, Steve Eisman, GS, etc.) really have an edge - no, they just figured it was a better bet to go the other way. No one will know for sure that their bets will turn out exactly the way they wanted. We all buy and sell stocks with the information we have and the big picture beliefs that we hold. Some will be better at it but it does not mean they will be right. Just because they better correctly in a big way, is that a crime? Just be better consumers, be better investors - the only thing was that were some people DUPED, like in a Ponzi scheme? GS is not big enough to do that, and if you read the still excellent book The Big Short, you will know that GS was probably a bit lucky.

Can you really put in ethics into the mantra of an investment bank? Seriously folks, ... its a nice to have, but its never going to happen in reality. Should it be something we should work towards to, yes, by all means ... are we going to get there, I seriously doubt it, not when the people are paid by how much they bring into the bank and not by whether they had been ethical. Can we penalise them, probably, but will it be big and hurting enough to bring about a change in behaviour? I doubt that, not when people are making hundreds of thousands a year in bonuses or more.

Sydney Morning Herald, April 26, 2010

AS THE mortgage crisis in the United States gained momentum and many banks were suffering losses, Goldman Sachs executives traded email messages saying they would make ''some serious money'' betting against the housing markets.

The messages, released on Saturday by the US Senate Permanent Subcommittee on Investigations, appear to contradict statements by Goldman that left the impression the firm lost money on mortgage-related investments.

In the messages, Lloyd Blankfein, the bank's chief executive, acknowledged in November 2007 that it had lost money initially. But it later recovered by making negative bets, known as short positions, to profit as housing prices plummeted. ''Of course we didn't dodge the mortgage mess,'' he wrote. ''We lost money, then made more than we lost because of shorts.''

In another message, dated July 25, 2007, David Viniar, Goldman's chief financial officer, reacted to figures that said the company had made a $US51 million profit from bets that housing securities would drop in value. ''Tells you what might be happening to people who don't have the big short,'' he wrote to Gary Cohn, now Goldman's president.

On Saturday Goldman denied it had made a significant profit on mortgage-related products in 2007 and 2008. It said the committee had ''cherry-picked'' email messages from the nearly 20 million pages of documents it provided.

This sets up a showdown between the committee and Goldman, which has aggressively defended itself since the Securities and Exchange Commission filed a security fraud complaint against it nine days ago. Tomorrow seven current and former Goldman employees, including Mr Blankfein, are expected to testify at a congressional hearing.

Carl Levin, head of the committee, said the email messages contrasted with Goldman's public statements about its trading results.

''The 2009 Goldman Sachs annual report stated that the firm 'did not generate enormous net revenues by betting against residential related products','' Senator Levin said. ''These emails show that, in fact, Goldman made a lot of money by betting against the mortgage market.''

On October 11, 2007, a Goldman executive, Donald Mullen, predicted a windfall because credit-rating companies had downgraded mortgage-related investments, which caused losses for investors.

''Sounds like we will make some serious money,'' Mr Mullen wrote, and received the response, ''Yes we are well positioned.''

Documents released by the committee appear to indicate that in July 2007 Goldman's accounting showed losses of $US322 million on positive mortgage positions, but its negative bet - what Mr Viniar called ''the big short'' - brought in $US373 million.

Messages from as early as 2006 show Goldman executives discussing ways to get rid of the firm's positive mortgage positions by selling them to clients. In one, Mr Viniar wrote: ''Let's be aggressive distributing things.''

On December 14, 2006, he called Goldman's mortgage traders and risk managers to a meeting and concluded they would reduce overall exposure to the subprime mortgage market. This was largely done by making bets against the market to cancel out bets it had placed that the market would rebound. A day after the meeting Mr Viniar wrote to Tom Montan, co-head of the securities division, saying, ''There will be very good opportunities as the market goes into what is likely to be even greater distress and we want to be in position to take advantage of them.''

This typified exchanges on whether to continue to neutralise Goldman's exposure to subprime mortgages or expand investment in them well into 2007. By November 30, 2007, Goldman had largely cancelled out its exposure to subprime mortgages by increasing its bets that the market would continue to slide, according to the document.

Goldman also released statements for its mortgage trading unit which showed traders in what was known as the structured products group made a profit of $US3.69 billion as of October 26, 2007, more than covering losses in other parts of its mortgage unit.

Several traders from that group will testify tomorrow and their profitable short positions are likely to be of interest to the committee.


Anonymous said...

Dear Dali

Do you have investment idea on Nihsin. These stock is trading at lowest level of 21sen since listed in bursa!?

Nihsin currently trading cum dividend of 0.67sen, together with two interim dividend of 0.75sen and 0.5sen, total dividend payout are 1.92sen, dividend yield of more than 9%!

horrrny_duuude said...

William Black, senior regulator for the Federal Home Loan Board who cracked down on banking during the Savings & Loan crisis of the '80s, was on to talk about Goldman et al:

walla said...

juicy said...

hi dali,
good write up ... the rating agencies still sing like before ... no one seems to be interested in questioning their abilities to rate any finicial instruments

clk said...

Trading in whatever form with "insider information" would be deemed illegal. The fact that they "had" some inside info and traded and made money from this info, in my layman opinion would certainly be deemed insider dealing.

Without having detailed information, I would have classified the actions as such. Unless one can say that derivatives trade and/ or OTC products are not caught under any rules or regulations.

Salvatore_Dali said...


gs did not have inside information... go and read the book The Big Short, its a brilliant almost documentary evidence of how and what happened, its about the 5 people who got the whole thing right and how they tried to short the markets... gs risk dept wised up to the other side of the trade and reversed their position, thats all... all info they got was in puting in the assumption that property prices in the US may actually fall by 7% or more or that default rates may hit 7% or more... if any of the big banks did that, none would be holding the papers

Salvatore_Dali said...


gs did not have inside information... go and read the book The Big Short, its a brilliant almost documentary evidence of how and what happened, its about the 5 people who got the whole thing right and how they tried to short the markets... gs risk dept wised up to the other side of the trade and reversed their position, thats all... all info they got was in putting in the assumption that property prices in the US may actually fall by 7% or more or that default rates may hit 7% or more... if any of the big banks did that, none would be holding the papers

showpanmohsin said...

Its very interesting and very informative and i really like your approach.

yauwenchin said...

we know that gs is not the only one doing it. gs is only use as a good sample to gain political milage, period. gs and other fi, just set up the casino, not knowing they had such a good response. i suppose the only measurement we can make out of this issue is, who gain and who losses, but at the taxpayers expense, that is one sided.

clk said...

Sorry, I've not read Lewis book yet, but as you said, the entire premise rest on the fact that they took an opposite position when they smell something happening.

It would be interesting to wait and see the outcome of the trial as to whether their intuition or something else triggered this change of position.

BenQio said...

In short, the synthetic CDO buyer is betting on the loaners continue to pay off the mortgage while the CDO buyer which is Poulsen&Co is betting on the loaners to default their payment. Or like what the SEC claims, Poulsen&Co is 'shorting' for profits.

Earth2Tim said...

I am in the process of reading the Big Short now. Any thoughts on what the next Big Financial debacle will be?



Why Capital Gains Tax Should Not Be Implemented

I have to reiterate why a Capital Gains Tax is a very bad idea for Malaysia. Unique traits of Malaysia: a) Very open economy b) Ringg...