Posts tagged ‘Goldman Sachs’
Lewis Sells Flash Boys Snake Oil
I know what you’re saying, “Please, not another article on Michael Lewis’s Flash Boys book and high frequency trading (HFT),” but I can’t resist putting in my two cents after the well-known author emphatically proclaimed the stock market as “rigged.” Lewis is not alone with his outrageous claims… Clark Stanley (“The Rattlesnake King”) made equally outlandish claims in the early 1900s when he sold lucrative Snake Oil Liniment to heal the ailments of the masses. Ultimately Stanley’s assets were seized by the government and the healing assertions of his snake oil were proven fraudulent. Like Stanley, Lewis’s over-the-top comments about HFT traders are now being scrutinized under a microscope by more thoughtful critics than Steve Kroft from 60 Minutes (see television profile). For a more detailed counterpoint, see the Reuters interview with Manoj Narang (Tradeworx) and Haim Bodek (Decimus Capital Markets).
While Lewis may not be selling snake oil, the cash register is still ringing with book sales until the real truth is disseminated. In the meantime, Lewis continues to laugh to the bank as he makes misleading and deceptive claims, just like his snake oil selling predecessors.
The Inside Perspective
Regardless of what side of the fence you fall on, the debate created by Lewis’s book has created deafening controversy. Joining the jihad against HFT is industry veteran Charles Schwab, who distributed a press release calling HFT a “growing cancer” and stating the following:
“High-frequency trading has run amok and is corrupting our capital market system by creating an unleveled playing field for individual investors and driving the wrong incentives for our commodity and equities exchanges.”
What Charles Schwab doesn’t admit is that their firm is receiving about $100 million in annual revenues to direct Schwab client orders to the same HFT traders at exchanges in so called “payment-for-order-flow” contracts. Another term to describe this practice would be “kick-backs”.
While Michael Lewis screams bloody murder over investors getting fraudulently skimmed, some other industry legends, including the godfather of index funds, Vanguard founder Jack Bogle, argue that Lewis’s views are too extreme. Bogle reasons, “Main Street is the great beneficiary…We are better off with high-frequency trading than we are without it.”
Like Jack Bogle, other investors who should be pointing the finger at HFT traders are instead patting them on the back. Cliff Asness, managing and founding principal of AQR Capital Management, an institutional investment firm managing about $100 billion in assets, had this to say about HFT in his Wall Street Journal Op-Ed:
“How do we feel about high-frequency trading? We think it helps us. It seems to have reduced our costs and may enable us to manage more investment dollars… on the whole high-frequency traders have lowered costs.”
Is HFT Good for Main Street?
Many investors today have already forgotten, or were too young to remember, that stocks used to be priced in fractions before technology narrowed spreads to decimal points in the 1990s. Who has benefited from all this technology? You guessed it…everyone.
Lewis makes the case that the case that all investors are negatively impacted by HFT, including Main Street (individual) investors. Asness maintains costs have been significantly lowered for individual investors:
“For the first time in history, Main Street might have it rigged against Wall Street.”
In Flash Boys, Lewis claims HFT traders unscrupulously scalp pennies per share from retail investor pockets by using privileged information to jump in front of ordinary investors (“front-run”). The reality, even if you believe Lewis’s contentions are true, is that technology has turned any perceived detrimental penny-sized skimming scheme into beneficial bucks for ordinary investors. For example, trades that used to cost $40, $50, $100, or more per transaction at the large wirehouse brokerage firms can today be purchased at discount brokerage firms for $7 or less. What’s more, the spread (i.e., the profits available for middlemen) used to be measured in increments of 1/8, 1/4, and 1/2 , when today the spreads are measured in pennies or fractions of pennies. Without any rational explanation, Lewis also dismisses the fact that HFT traders add valuable liquidity to the market. His argument of adding “volume and not liquidity” would make sense if HFT traders only transacted solely with other HFT traders, but that is obviously not the case.
Regardless, as you can see from the chart below, the trend in spreads over the last decade or so has been on a steady, downward, investor-friendly slope.
Source: Business Insider
How Did We Get Here? And What’s Wrong with HFT?
Similarly to our country’s 73,954 page I.R.S. tax code, the complexity of our financial market trading structure rivals that of our government’s money collection system. The painting of all HFT traders as villains by Lewis is no truer than painting all taxpayers as crooks. Just as there are plenty of crooked and deceitful individuals that push the boundaries of our income tax system, so too are there traders that try to take advantage of an inefficient, Byzantine exchange system. The mere presence of some tax dodgers doesn’t mean that all taxpayers should go to jail, nor should all HFT traders be crucified by the SEC (Securities and Exchange Commission) police.
The heightened convoluted nature to our country’s exchange-based financial system can be traced back to the establishment of Regulation NMS, which was passed by the SEC in 2005 and implemented in 2007. The aim of this regulatory structure was designed to level the playing field through fairer trade execution and the creation of equal access to transparent price quotations. However, rather than leveling the playing field, the government destroyed the playing field and fragmented it into many convoluted pieces (i.e., exchanges) – see Wall Street Journal article and chart below.
Source: Wall Street Journal
The new Reg NMS competition came in the form of exchanges like BATS and Direct Edge (now merging), but the new multi-faceted structures introduced fresh loopholes for HFT traders to exploit – for both themselves and investors. More specifically, HFT traders used expensive, lightning-fast fiber optic cables; privileged access to data centers physically located adjacent to trading exchanges; and then they integrated algorithmic software code to efficiently route orders for best execution.
Are many of these HFT traders and software programs attempting to anticipate market direction? Certainly. As the WSJ excerpt below explains, these traders are shrewdly putting their capitalist genes to the profit-making test:
Computerized firms called high-frequency traders try to pick up clues about what the big players are doing through techniques such as repeatedly placing and instantly canceling thousands of stock orders to detect demand. If such a firm’s algorithm detects that a mutual fund is loading up on a certain stock, the firm’s computers may decide the stock is worth more and can rush to buy it first. That process can make the purchase costlier for the mutual fund.
Like any highly profitable business, success eventually attracts competition, and that is exactly what has happened with high frequency trading. To appreciate this fact, all one need to do is look at Goldman Sachs’s actions, which is to leave the NYSE (New York Stock Exchange), shutter its HFT dark pool trading platform (Sigma X), and join IEX, the dark pool created by Brad Katsuyama, the hero placed on a pedestal by Lewis in Flash Boys. Goldman is putting on their “we’re doing what’s best for investors” face on, but more experienced veterans understand that Goldman and all the other HFT traders are mostly just greedy S.O.B.s looking out for their best interests. The calculus is straightforward: As costs of implementing HFT have plummeted, the profit potential has dried up, and the remaining competitors have been left to fend for their Darwinian survival. The TABB Group, a financial markets’ research and consulting firm, estimates that US equity HFT revenues have declined from approximately $7.2 billion in 2009 to about $1.3 billion in 2014. As costs for co-locating HFT hardware next to an exchange have plummeted from millions of dollars to as low as $1,000 per month, the HFT market has opened their doors to anyone with a checkbook, programmer, and a pulse. That wasn’t the case a handful of years ago.
The Fixes
Admittedly, not everything is hearts and flowers in HFT land. The Flash Crash of 2010 highlighted how fragmented, convoluted, and opaque our market system has become since Reg NMS was implemented. And although “circuit breaker” remedies have helped prevent a replicated occurrence, there is still room for improvement.
What are some of the solutions? Here are a few ideas:
- Reform complicated Reg NMS rules – competition is good, complexity is not.
- Overhaul disclosure around “payment-for-order-flow” contracts (rebates), so potential conflicts of interest can be exposed.
- Stop inefficient wasteful “quote stuffing” practices by HFT traders.
- Speed up and improve the quality of the SIP (Security Information Processor), so the gaps between SIP and the direct feed data from exchanges are minimized.
- Improve tracking and transparency, which can weed out shady players and lower probabilities of another Flash Crash-like event.
These shortcomings of HFT trading do not mean the market is “rigged”, but like our overwhelmingly complex tax system, there is plenty of room for improvement. Another pet peeve of mine is Lewis’s infatuation with stocks. If he really thinks the stock market is rigged, then he should write his next book on the less efficient markets of bonds, futures, and other over-the-counter derivatives. This is much more fertile ground for corruption.
As a former manager of a $20 billion fund, I understand the complications firsthand faced by large institutional investors. In an ever-changing game of cat and mouse, investors of all sizes will continue looking to execute trades at the best prices (lowest possible purchase and highest possible sales price), while middlemen traders will persist with their ambition to exploit the spread (generate profits between the bid and ask prices). Improvements in technology will always afford a temporary advantage for a few, but in the long-run the benefits for all investors have been undeniable. The same undeniable benefits can’t be said for reading Michael Lewis’s Flash Boys. Like Clark Stanley and other snake oil salesmen before him, it will only take time for the real truth to come out about Lewis’s “rigged” stock market claims.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold long positions in certain exchange traded funds (ETFs), but at the time of publishing SCM had no direct position in GS, SCHW, ICE, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Bond-Choking Central Banks Expand Investment Menu
Central banks around the globe are choking on low-yielding bonds, and as result are now expanding their investment menu beyond Treasuries into equities. Expansionary monetary policies purchasing short-term, low-rate bonds means that central banks have been gobbling up securities on their balance sheets that are earning next to nothing. To counteract the bond-induced indigestion of the central banks, many of them are considering increasing their equity purchasing strategies. How can you blame them? With the 10-year U.S. Treasury notes yielding 1.66%; 10-year German bonds eking out 1.21%; and 10-year Japanese Government Bonds (JGBs) paying a paltry 0.59%, it’s no wonder central banks are looking for better alternatives.
More specifically, the Bank of Japan (BOJ) is planning to pump $1.4 trillion into its economy over the next two years to encourage some inflation through open-ended asset purchases. Earlier this month, the BOJ said it has a goal of more than doubling equity related exchange traded funds (ETFs) by the end of 2014. According to Business Insider, the BOJ is currently holding $14.1 billion in equity ETFs with an objective to reach $35.3 billion in 2014.
I can only imagine how stock market bears feel about this developing trend when they have already blamed central banks’ quantitative easing initiatives as the artificial support mechanism for stock prices (see also The Central Bank Dog Ate my Homework).
While expanded equity purchases could break the backs of bond bulls and stock naysayers, some smart people agree that this strategy makes sense. Take Jim O’Neill, the chairman of Goldman Sachs Asset Management, who is retiring next week. Here’s what he has to say about expanded central bank stock purchases:
“Frankly, it makes a huge amount of sense in a world of floating exchange rates and such incredible opportunity, why should central banks keep so much money in very short term, liquid things when they’re not going to ever need it? To help their future returns for their citizens, why would they not invest in equity?”
How big is this shift towards equities? The Royal Bank of Scotland conducted a survey of 60 central banks that have about $6.7 trillion in reserves. There were 13% of the central banks already invested in equities, and almost 25% of them said they are or will be invested in equities within the next five years.
While I may agree that stocks generally are a more attractive asset class than bubblicious bonds right now, I may draw the line once the Fed starts buying houses, gasoline, and groceries for all Americans. Until then, dividend yields remain higher than Treasury yields, and the earnings yields (earnings/price) on stocks will remain more attractive than bond yields. Once stocks gain more in price and/or bonds sell off significantly, it will be a more appropriate time to reassess the investment opportunity set. A further stock rise or bond selloff are both possible scenarios, but until then, central banks will continue to look to place its money where it is treated best.
The central bank menu has been largely limited to low-yielding, overpriced government bonds, but the appetite for new menu items has heightened. Stocks may be an enticing new option for central banks, but let’s hope they delay buying houses, gasoline, and groceries.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Ping Pong Vet Blasts Goldman
Source: Photobucket
In a recent New York Times op-ed, Greg Smith, former Goldman Sachs Group Inc. (GS) employee and ping pong medalist at the Jewish Olympics, came out with an earth-shattering revelation… he discovered and revealed that Goldman Sachs was not looking out for the best interests of its clients. I was floored to discover that a Wall Street bank valued at $60 billion would value profits more than clients’ needs.
Hmmm, I wonder what new eye-opening breakthrough he will unveil next? Perhaps Smith will get a job at Las Vegas Sands Corp. (LVS) for 12 years and then enlighten the public that casinos are in the business of making money at the expense of their customers. I can’t wait to learn about that breaking news.
But really, with all sarcasm aside, any objective observer understands that Goldman Sachs and any other Wall Street firm are simply middlemen operating at the center of capitalism – matching buyers and sellers (lenders and borrowers) and providing advice on both sides of a transaction. As a supposed trusted intermediary, these financial institutions often hold privileged information that can be used to the firms’ (not clients) benefit.
Most industry veterans like me understand how rife with conflicts the industry operates under, but very few insiders publicly speak out about these “dirty little secrets.” Readers of Investing Caffeine know I am not bashful about speaking my mind. In fact, I have tackled this subject in numerous articles, including Wall Street Meets Greed Street written a few months ago. Here’s an excerpt**:
“Wall Street and large financial institutions, however, are driven by one single mode…and that is greed. This is nothing new and has been going on for generations. Over the last few decades, cheap money, loose regulation, and a relatively healthy economy have given Wall Street and financial institutions free rein to take advantage of the system.”
As with any investment, clients and investors should understand the risks and inherent conflicts of interest associated with a financial relationship before engaging into business. While certain disclosures are sorely lacking, it behooves investors and clients to ask tough questions of bankers and advisors – questions apparently Mr. Smith did not ask his employer over his 12 year professional career at Goldman Sachs.
Reputational Risk Playing Larger Role
Even though Goldman called some clients “muppets,” Smith states there was no illegal activity going on. Regardless of whether the banks have gotten caught conducting explicit law-breaking behavior, the public and politicians love scapegoats, and what better target than the “fat-cat” bankers. With a financial crisis behind us, along with a multi-decade banking bull market of declining interest rates, the culture, profitability-model, and regulations in the financial industry are all in the midst of massive changes. As client awareness and frustration continue to rise, reputational risk will slowly become a larger concern for Wall Street banks.
Could the Goldman glow as the leading Wall Street investment bank finally be getting tarnished? Well, besides their earnings collapsing by about 2/3rds in 2011, the selection of Morgan Stanley (MS) and JPMorgan Chase (JPM) ahead of Goldman Sachs as the lead underwriters in the Facebook (FB) initial public offering (IPO) could be a sign that reputational risk is playing a larger role in investment banking market share shifts.
The public and corporate America may be slow in recognizing the shady behavior practiced on Wall Street, but eventually, the excesses become noticed. Congress eventually implements new regulations (Dodd-Frank) and customers vote with their dollars by moving to banks and institutions they trust more.
I commend Mr. Smith for speaking out about the corrupt conflicts of interest and lack of fiduciary duty at Goldman Sachs, but let’s call a spade a spade and not mischaracterize a situation as suddenly shifting when the practices have been going on forever. Either he is naïve or dishonest (I hope the former rather than the latter), but regardless, finding a new job on Wall Street may be challenging for him. Fortunately for Mr. Smith, he has something to fall back on…the professional ping-pong circuit.
***Other Relevant Articles and Video:
- Goldman Gambling Prosperity at Client Expense
- Goldman Cheat? Really?
- Stephen Colbert: Breaking the Sacred Trust
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in FB, GS, MS, JPM, LVS, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Bove on Goldman-Facebook Deal: Hug the Public!
In a recent research report titled, Has Goldman Learned Anything?, esteemed Rochdale Research analyst Richard Bove chimed in about the recent controversy surrounding the failed U.S. private offering of Facebook shares by Goldman Sachs (GS) to the bank’s wealthiest clients. In the note, Bove states the following:
“The company is embroiled in a ‘headline’ controversy surrounding its handling of a Facebook offering which implies that Goldman does not understand the public’s interest at all.”
Bove goes onto add:
“I fear that this company may not yet understand that those actions that do not appear to be in the public’s interest can, in fact, harm the company.”
I’m having a real difficult time understanding how Goldman privately raising funds for a private company has anything to do with the public? Am I wrong, or don’t millions of private companies raise capital every year without getting approval from Mr. Joe and Mrs. Josephine Public? What exactly does Bove want Goldman CEO Lloyd Blankfein to say to Facebook chief Mark Zuckerberg?
“Oh hello Mr. Zuckerberg, this is Lloyd Blankfein calling from Goldman Sachs, and if I understand it correctly, you are interested in raising $1.5 billion for your company. I know you are arguably the greatest internet brand on this planet, but unfortunately I do not think we can help you because I believe the broader public may not be happy with their lack of ability to participate in the offering. If you don’t have Morgan Stanley’s or JP Morgan’s phone number, just let me know because perhaps they can assist you. Have a great day!”
Come on…Goldman Sachs is not a charitable organization with a mission to make the world a better place – they are one of thousands of publicly traded companies attempting to grow profits. Sure, could Goldman have more discreetly pursued this offering without attracting the massive media barrage? Absolutely. But let’s be fair, the buzz around Facebook is deafening and the paparazzi are following Mark Zuckerberg around as closely as Raj Rajaratnam chases insider trading tips. New York Times columnist and reporter Andrew Ross Sorkin (see Too Big to Fail book review) summed it up best when he said, “You take the words Facebook and Goldman Sachs and put them in the same sentence, it becomes a media sensation unto itself. So I think this was bound to happen one way or the other.”
So while I have no reason to cheerlead for Goldman Sachs, and I’m sure there are plenty of other reasons for the investment bank to be crucified, attempting to raise money for a private company is not a felony in my book. I commend Richard Bove’s altruistic intentions in protecting the public from Goldman Sachs’s evil capital raising activities, and I may even contribute to a group hug with the mass investing public. If he catches me on the right day, I may even give CEO Lloyd Blankfein a hug.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in GS, MS, JPM, Facebook, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Do as I Say, Not as I Do
“Be smart…but don’t pay attention to me.”
Watching Goldman Sachs (GS) executives sweat it out under the hot lamps of Senator questioning makes for gripping television (see Goldman article), but as we all know the ethical standing of a significant number of politicians calls into question whether the pot should be calling the kettle black. Ever since I was a kid, I was told by seemingly responsible adults to “do as I say and not what I do.” I suppose the Goldman execs should follow the advice of Congress, but not their actions.
Based on a recent Wall Street Journal article that studied the investment activity of Congressional members (and spouses) during the financial crisis, the analysis discovered 13 of them were betting against the market. Just as Goldman and hedge fund manager John Paulson partnered to bet against the housing market via shorting synthetic CDOs (Collateralized Debt Obligations), Congressmen and their spouses were wagering against the market through the use of debt loaded (leveraged) exchange traded funds, which integrate derivatives.
Were any of the Congressional investment activities illegal? Likely not, but some question the ethical appearance of such behavior. The former head of the House Ethics Committee and past Representative Joel Hefley of Colorado believes such conduct “doesn’t look real great when the economy is tanking and people are blaming the government.” Facing similar challenges, the SEC’s (Security and Exchange Commission’s) squishy fraud charge complaint against Goldman Sachs is expected to encounter significant difficulty in proving the investment bank’s guilt.
Source: The Wall Street Journal (Yellow Dots = Shorting Exposure Trades)
Other politicians were critical of Wall Street too, despite apparent hypocritical behavior. For example, Representative Shelley Berkley of Nevada chided Wall Street for its reckless activities. “No casino on the planet behaves as irresponsibly and recklessly as Wall Street does. Wall Street ought to be ashamed, and take a lesson from the casino industry.” Nearly at the same time, Shelley’s husband Lawrence Lehrner placed 57 bearish trades.
I find it very amusing the same politicians shredding apart the Wall Street firms are in many cases the same politicians stretching the bounds of ethical behavior. Various politicians do a great job pontificating about the latest shortcomings of the financial industry, but fail to take some accountability for missing one of the greatest real estate booms of all-time. Where were the regulators and politicians when the debt bubble was bursting? Unfortunately, “reactive” is a much larger part of a politician’s lexicon than “proactive.” Responding to populist fervor is easier than leaning against consensus views, even if going against consensus makes more strategic sense.
For those having difficulty in deciphering the advice given by esteemed Congressmen, just remember to “do what they say, and not what they do.”
Read Full Wall Street Journal Article
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
*DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct positions in GS, or any security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
SEC Awake at the Switch…Sort Of
The SEC is accusing Goldman Sachs (GS) of screwing its own clients through lack of disclosure (see also Goldman Cheat? article), but the SEC apparently enjoys passively watching a little action itself. Throughout the financial crisis, as investors watched the collapse of major financial institutions like Bear Stearns (JPM), Lehman Brothers, and AIG, the SEC was accused of falling asleep at the switch. As it turns out, the SEC was not asleep, but rather they were quite awake switching on the porn.
Efficiency may not be the core strength of all governmental agencies (several of my horrific trips to the department of motor vehicles (DMV) can attest to that fact), but little did I know that my tax dollars were supporting six-figure salaries (some over $200,000), so SEC employees could watch skin flick classics like Pulp Friction, Spankenstein, or Buttman and Throbbin’.
I guess from a certain standpoint, one might appreciate SEC employee ingenuity and determination. For example the Associated Press reported the following:
“An accountant was blocked more than 16,000 times in a month from visiting websites classified as “Sex” or “Pornography.” Yet he still managed to amass a collection of “very graphic” material on his hard drive by using Google images to bypass the SEC’s internal filter, according to an earlier report from the inspector general.”
“A senior attorney at the SEC’s Washington headquarters spent up to eight hours a day looking at and downloading pornography. When he ran out of hard drive space, he burned the files to CDs or DVDs, which he kept in boxes around his office.”
Perhaps the SEC is just like Goldman Sachs? They both just happened to get caught, even though many others have participated in the sinful behavior. How widespread is pornography viewing in the workplace? A study conducted by Websense in 2006 reported that 16% of men with internet access admitted to watching porn during office hours.
Watching nudey movies is less damaging than allegedly misrepresenting and hiding information from investors, but Dick Fuld, Bernie Madoff, and Allen Stanford are certainly thankful to the distracted SEC staffers for the extra time the crooked Wall Streeters were given to run their schemes. Wall Street has become a lightning rod, and given the fact that 2010 is an election year, there is extreme pressure on politicians to limit the power, size, and activities of the major banks. Maybe the new regulatory reform legislation being crafted in Congress will even include a ban on workplace pornography viewing. With additional free time, the SEC may successfully find more law-breakers. Who knows, possibly Goldman could even help the government recover some lost tax revenue by auctioning off excess dirty movies left over at the SEC?
Read the Rest of the AP Article
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
*DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds and in a security derived from an AIG subsidiary, but at the time of publishing SCM had no direct positions in GS, Bear Stearns (JPM), and Lehman Brothers, or any security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Goldman Cheat? Really?
Really? Am I supposed to be surprised that the SEC (Securities and Exchange Commission) has dug up a CDO (Collateralized Debt Obligation) deal with $1 billion in associated Goldman Sachs (GS) losses? The headline number may sound large, but the billion dollars is not much if you consider banks are expected to lose about $3 trillion dollars (according to an International Monetary Fund report) from toxic assets and bad loans related to the financial crisis. Specifically, Goldman is being charged for defrauding investors for not disclosing the fact that John Paulson (see Gutsiest Trade), a now-famous hedge fund manager who made billions by betting against the subprime mortgage market, personally selected underlying securities to be included in a synthetic CDO (a pool of mortgage derivatives rather than a pool of mortgage securities).
Hurray for the SEC, but surely we can come up with more than this after multiple years? More surprising to me is that it took the SEC this long to come up with any dirt in the middle of a massive financial pigpen. What’s more, the estimated $1 billion in investor losses associated with the Goldman deal represents about 0.036% of the global industry loss estimates. These losses are a drop in the bucket. If there is blood on Goldman’s hand, my guess is there’s enough blood on the hands of Wall Street bankers to paint the White House red (two coats). The Financial Times highlighted a study showing Goldman was a relative small-fry among the other banks doing these type of CDO deals. For 2005-2008, Goldman did a little more than 5% of the total $100+ billion in similar deals, earning them an unimpressive ninth place finish among its peers. As a matter of fact, Paulson also hocked CDO garbage selections to other banks like Deutsche Bank, Bear Stearns, and Credit Suisse. The disclosure made in those deals will no doubt play a role in determining Goldman’s ultimate culpability.
Context, with regard to the fees earned by Goldman, is important too. Goldman earned less than 8/100th of 1% of their $20 billion in pretax profits from the Abacus deal. Not to mention, unless other charges pile up, Goldman’s roughly $850 billion in assets, $170 billion in cash and liquid securities, and $71 billion in equity should buttress them in any future litigation. These particular SEC charges feel more like the government trying to convict Goldman on a technicality – like the government did with Al Capone on tax evasion charges. At the end of the day, the evidence will be presented and the courts will determine if fraud indeed occurred. If so, there will be consequences.
Demonize Goldman?
How bad can Goldman really be, especially considering their deep philanthropic roots (the firm donated $500 million for small business assistance), and CEO Lloyd Blankfein was kind enough to let us know he is doing “God’s work,” by providing Goldman’s rich menu of banking services to its clients.
Certainly, if Goldman broke securities laws, then there should be hell to pay and heads should roll. But if Goldman was really trying to defraud investors in this particular structured deal (called Abacus 2007-ACI), then why would they invest alongside the investors (Goldman claims to have lost $90 milllion in this particular deal)? I suppose the case could be made that Goldman only invested for superficial reasons because the fees garnered from structuring the deals perhaps outweighed any potential losses incurred by investing the firm’s own capital in these deals. Seems like a stretch if you contemplate the $90 million in losses overwhelmed the $15 million in fees earned by Goldman to structure the deal.
Maybe this will be the beginning of the debauchery flood gates opening in the banking industry, but let’s not fully jump on the Goldman Scarlet Letter bandwagon just quite yet. Politics may be playing a role too. The Volcker rule was conveniently introduced right after Senator Scott Brown’s Senate victory in Massachusetts, and political coincidence has reared its head again in light of the financial regulatory reform fury swelling up in Washington.
Waiting for More teeth
There is a difference between intelligent opportunism and blatant cheating. There is also a difference between immorally playing a game within the rules versus immorally breaking laws. Those participants breaking the law should be adequately punished, but before jumping to conclusions, let’s make sure we first gather all the facts. While the relatively minute Abacus deal may be very surprising to some, given the trillions in global losses caused by toxic assets, I am not. Surely the SEC can dig up something with more teeth, but until then I will be more surprised by Jesse Jame’s cheating on Sandra Bullock (with Michelle “Bombshell” McGee) than by Goldman Sachs’s alleged cheating in CDO disclosure.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
*DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct positions in GS, DB, Bear Stearns (JPM), and CSGN.VX/CS.N or any security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Meredith Whitney’s Cloudy Crystal Ball
Meredith Whitney, prominent banking analyst at her self-named advisory group, should have worn a bib to protect her from the adoring drool supplied by Maria Bartiromo in a recent CNBC interview. Ms. Whitney has quickly become a banking rock star during this “Great Recession” period. She was right at a critical juncture, and as a result she was thrust into the limelight. Much like Abby Joseph Cohen, the perma-bull Goldman Sachs strategist who gained notoriety in the late 1990s, Whitney (the perma-banking bear) will continue having difficulty living up to the lofty expectations demanded of her.
Despite the accolades, Whitney’s crystal ball has gotten cloudy in 2009. I suppose accuracy is not very important, judging by her bottom-half 2007 ranking (year of her major Citigroup call) in recommendation performance and 48%-ile ranking in the first half of 2008. Analysts, much like reporters, can avoid looking dumb by reporting the news du jour and by following the herd. Whitney has followed this formula with her continuous bearishness on the financial sector, excluding a brief but late upgrade of Goldman Sachs in July. Not only was her analysis tardy (Goldman’s stock tripled from the 2009 bottom), but her call has also underperformed the S&P 500 index since the upgrade.
Incoherent Inconsistencies
Like a bobbing and weaving wrestler (her husband John Layfield is a retired staged professional wrestler from the WWE), Whitney tries to concoct a completely mind-boggling narrative to explain her forecasts this year in the CNBC interview with Maria Bartiromo:
11/18/09 (XLF Price $14.60): “For the year, I have been at least ‘cover your shorts, go long.’ I haven’t been this bearish in a year.” (See Maria Bartiromo Interview)
Hmm, really? Are you kidding me? Wait a second…is this the same “go long” Meredith Whitney that expressed the following?
3/17/09: (XLF: 8.55 then, 14.60 now +71% ex-dividends): “These big banks are sitting on loans that were underwritten with bad math, and the stocks are going to go down…these stocks are uninvestable.”
(Fast forward to minute 8:20 for quote above)
2/4/09 (XLF: 8.97 then, 14.60 now +63% ex-dividends): “Investors should not even consider owning banks on an equity basis” (Click here and fast forward to minute 8:10 for quote).
The schizophrenic accounting of her postures are all the more confusing given her stance that the sector was “fairly valued” in October, according to the CNBC Bartiromo interview.
Don’t get me wrong, she made an incredible bearish call on Citigroup in the fall of 2007 and was expecting blood in the streets until a massive rebound in 2009 surprised her. Investors need to be wary of prognosticators that get thrust into the limelight (see Peter Schiff article) for a single prediction. The law of large numbers virtually guarantees a new breed of extreme forecasters will be rotated into the spotlight any time there is a major shift in the market direction. I choose to follow the footsteps of Warren Buffett and stay away from the game of market timing and market forecasts. I believe James Grant from the Interest Rate Observer states it best:
“The very best investors don’t even try to forecast the future. Rather, they seize such opportunities as the present affords them.”
Meredith Whitney may be a bright banking analyst and perhaps she’ll ultimately be proven right regarding the downward banking stock price trajectories, but like all bold forecasters she must live by the crystal ball, and die by the crystal ball.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and its clients own certain exchange traded funds (including VFH), but currently have no direct positions in C, GS, or XLF. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Goldman Sachs in Talks to Acquire Treasury Department
Andy Borowitz from the Borowitz Report published an article a few months ago satirizing the ever increasing conspiracy theories being spread regarding Goldman Sachs’ (GS) role in the global financial crisis. Spearheading the scapegoating Goldman Sachs brigade is Matt Taibbi of Rolling Stone who wrote Inside The Great American Bubble Machine. Megan McArdle at The Atlantic has a detailed critique of Taibbi’s loose facts and outlandish generalizations.
On a lighter note, here’s what Mr. Borowitz has to say about the Goldman Sachs/Treasury Department merger, with tongue firmly in cheek:
According to Goldman spokesperson Jonathan Hestron, the merger between Goldman and the Treasury Department is “a good fit” because “they’re in the business of printing money and so are we.” The Goldman spokesman said that the merger would create efficiencies for both entities: “We already have so many employees and so much money flowing back and forth, this would just streamline things.” Mr. Hestron said the only challenge facing Goldman in completing the merger “is trying to figure out which parts of the Treasury Dept. we don’t already own.” Goldman recently celebrated record earnings by roasting a suckling pig over a bonfire of hundred-dollar bills.
If Matt Taibbi is having difficulty coming up with some fresh new material, perhaps he could target some of these hotly debated areas of contention:
- The 40 year anniversary of NASA faking the moon landing.
- The CIA assassination of John F. Kennedy and the 4th shot from the “grassy knoll.”
- Crashed UFO aircraft remains stored at Area 51, Air Force base in Nevada.
- Elvis still alive.
- Paul McCartney actually dead.
- 9/11 terrorist attacks government cover-up.
- The creation of HIV/AIDS by the CIA.
If Bill Clinton can’t suppress sexual relations with Monica Lewinsky and Dick Cheney can’t hide the fact he shot someone in the face with a shotgun, I guess the Goldman crew is just better at pulling the wool over the eyes of 6.5 billion people…less one smart cookie, Matt Taibbi.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management and client accounts do not have direct positions in GS at the time the article was published. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
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