The Goldman Sachs Conspiracy

This MarketWatch story is stretching to find something that I don’t think is there.  But it makes for a good read, and it does provide evidence to show that Goldman Sachs is way too influential in our government.  Here’s a taste….

He (“Hank the Hammer” Paulson) got $38 million his last year as CEO in 2006 before becoming Treasury Secretary.

Then during the market meltdown six months ago the $700 million personal fortune he built at Goldman was threatened by Goldman’s huge $20 billion derivatives exposure at AIG: Suddenly his responsibilities at Treasury merged with a strong self-interest in protecting his personal fortune. AIG was “saved.”

There’s a lot more here – some of which I talked about in a previous post – but read it for yourself.

gk

Capitalism without balls

This is a hilarious article – with a serious message – from Bill Bonner of The Daily Reckoning.  I received it in their daily email, but I cannot find it on the Daily Reckoning site right now.  I’ll post a link to the article if I find it later.

Mr. Bonner –  I’m going to post a copy of the the article here.  Please let me know if you’d prefer if I excerpted it – which I’d do now if I could find a link to the full article.  🙂

Enjoy the article – it’s Bill Bonner at his sarcastic best!

gk

Yes We Can’t!
By Bill Bonner
Paris, France

Free market capitalism is the “god that failed,” writes Martin Wolf. Thus does Financial Times lead off a feeble chorus of lament in its “Future of Capitalism” series. What do we do now? is the question. Can capitalism be tamed? Can it be harnessed? “Yes we can!” says America’s president.

Richard Layard from the London School of Economics, offered a way forward:

“We should stop the worship of money and create a more human society,” he writes. “Happiness has not risen since the 1950s in the US or Britain,” he points out, despite big increases in wealth. “Modern happiness research can help find answers,” he believes.

“Old fashioned socialist planning is the only coherent alternative to a collapsing capitalist economy,” an alert FT reader added.

Given the depth of these insights, we decided not to dive into this discussion headfirst. Instead, we will simply mock the swimmers from the bank. Brazil’s president, Lula da Silva, for example, could only come up with a campaign slogan: “The future of human beings is what really matters.” But who can blame them? They want a capitalism that makes people happy…fairer, gentler, greener… they want to reform it…to housebreak it…to cut its balls off so they can safely put it on a leash and introduce it to their daughters.

But they miss the point of it altogether: we can’t reform capitalism; it reforms us. Capitalism punishes mistakes and rewards virtue (or good luck) – not necessarily quickly or gently…but roughly and imperfectly, like a hanging judge in a frontier town. On paper, of course, we can do better. Imagine a world where public employees are saints and geniuses who do such a swell job of allocating capital we want for nothing. But then, when we get a chance to see them in action, we find that they are bigger rascals than the capitalists themselves.

This week, under pressure from its new proprietor – the U.S. government – AIG released a list showing who had gotten more than $100 billion of its bailout money. At the top of the list of recipients was a familiar name – Goldman Sachs. In a truly astonishing co-incidence, Goldman is the firm that had been run by the very person who headed up the AIG rescue – former Treasury Secretary Hank Paulson. And what serendipity! Lloyd Bankfein – Goldman’s top man now – was actually in the room with the feds when the AIG rescue plan was put together.

“…we can’t reform capitalism; it reforms us. Capitalism punishes mistakes and rewards virtue (or good luck) – not necessarily quickly or gently…but roughly and imperfectly…”

In the room; in the deal. But the big scalawags ducked out of the press almost immediately. Instead, the headlines focused on the small fry. AIG paid bonuses of $450 million – some charged it was $1 billion – to its executives. These guys shouldn’t get bonuses, came the popular outcry; they should get a firing squad.

You’ll recall the story. The insurance giant AIG lost money on a series of gambles. For example, it gambled that it could insure the mortgage payments of people who couldn’t afford to buy a house. During the bubble years, people bought houses at outrageous prices. They could borrow 80% of the purchase price from government-backed debt mongers Fannie Mae and Freddie Mac. Buyers were supposed to put up the other 20% themselves, giving lenders a margin of safety in case the transactions didn’t work out as planned. But, if an insurance company would guarantee the other 20%, Fannie could cover 100% of this “enhanced” mortgage loan. AIG found that insuring this part of the loan was profitable – as long as nobody asked questions. But then the market price for the collateral dropped – by as much as 50% in some areas. Suddenly, people were walking away from their houses. Defaults on these “enhanced” loans ran at 5 times the rates on normal Fannie-backed mortgages.

An ordinary person would look at these facts and pronounce the same judgment as the capitalist market: AIG and Fannie both deserve to go broke. But give him enough higher education in the economics department, or a job in government, and the fool rushes in –with someone else’s money.

In the theory of bailouts, an ailing firm is given a helping hand when it needs it. This gives it time to get back on its feet, and prevents it from dragging down its employees, lenders, investors and counterparties. But what actually happens is much simpler. Money is goes from the pocket of the person who earned it…to the pocket of someone who didn’t…from the innocent bystander to the fellow who caused the accident. Capitalism takes money away from erring capitalists; the capitalism improvers give it back to them.

And who decides who gets the loot? Ah…as soon as you hold them up to the light, the angels’ wings fall off. By and large, these are the same cherubim and seraphim – such as Hank Paulson – who were supposed to be leading…regulating…and controlling capitalism when it ran into a ditch. Not a single one raised a warning. Instead, they whooped for the free market and passed the whiskey bottle to the driver! And now, thanks to their bailouts, AIG continues writing insurance against mortgage loans. Seventy-three AIG executives continue getting $1 million bonuses. A long line of reckless counterparties goes unpunished. And Hank Paulson offers advice to Financial Times readers on how to make capitalism work better.

But that is always the problem with improving capitalism…even in the slapstick American way. The reformers promise a ‘new deal,’ but they’ve always got an ace up their sleeve somewhere.

Enjoy your weekend,

Bill Bonner
The Daily Reckoning

Bush is an idiot – another example

If you needed another example of how badly Bush sucked as leader of the US, here’s one from Today’s Daily Reckoning:

When the going was good, a small addition to the financial sector’s capital would be multiplied many times. The limit for Wall Street’s investment firms was 12 to 1…until it was increased to 33 to 1 in 2004. Thereafter, if you put $100 into an investment bank…counterparties would soon have about $3,300 worth of credits.

Easy come…easy go! When the financial system rolled over last year, the banks lost money. Suddenly, $100 less in bank capital forced the banks to reduce outstanding credit by as much as $3,300. Cash disappears and everyone is forced to cut back.

Here’s a link to a NY Times article from October 2nd, 2008 that describes how the Bush Administration made this debt crisis much worse.  The story reads in part:

But decisions made at a brief meeting on April 28, 2004, explain why the problems could spin out of control. The agency’s failure to follow through on those decisions also explains why Washington regulators did not see what was coming.

On that bright spring afternoon, the five members of the Securities and Exchange Commission met in a basement hearing room to consider an urgent plea by the big investment banks.

They wanted an exemption for their brokerage units from an old regulation that limited the amount of debt they could take on. The exemption would unshackle billions of dollars held in reserve as a cushion against losses on their investments. Those funds could then flow up to the parent company, enabling it to invest in the fast-growing but opaque world of mortgage-backed securities; credit derivatives, a form of insurance for bond holders; and other exotic instruments.

One of these days I’ve got to take the time to document all of the lame-brained, half-assed decisions that led me to conclude that Bush is an idiot – and that he’ll go down as the worst President in our history.  And it’s pretty tough to be worse than my former number one – Jimmy Carter.

gk

GE earnings miss isn't a shocker

Wow, lots of stories today about the “shocking” earnings miss (and lowered forecast) by GE.  MarketWatch said “GE’s warning pokes hole in recent sentiment that credit crunch has passed” and “The rebound had been fueled by renewed sentiment on Wall Street that the worst of the credit crisis — including the threat of spiraling financial bankruptcies — was past.”

A story on CNN said “My guess is that earnings forecasts for 2008 are still pretty high relative to the economic reality,” Davidson said.

I have one word for Mr. Davidson – Duh!

As I posted just yesterday, I don’t think we’re anywhere close to a bottom yet, and the earnings estimates for 2008 and 2009 are way too high.  Eventually, stock prices adjust to reflect earnings, and sometimes the adjustment process is long and painful – as we all learned in 2000 through 2003.

All the stories about Goldman Sachs’ and Lehman CEO’s saying that they can see the light at the end of the tunnel – while simultaneously upping their own writedowns – are crap.  If the CEO’s are so good at predicting the future, why couldn’t they tell us what losses their own companies were going to have?

Speaking of Goldman, I think the glitter is coming off.  This past week they announced that the amount of “Level 3 assets” increased from $69 billion to $96 billion during the first quarter.  If you haven’t been keeping score, “level 3” assets are those for which there’s basically no market, no one wants them, so Goldman is stuck with them. 

Kinda like having a house that’s “worth” $1 million, but no one will buy it, so you’re stuck with the mortgage payments – but you can say you have a $1 million house.  At least until you have to sell it because you can’t make the payments any longer – then it suddenly becomes a $500k house – and you just lost $500k.

It also means that the value of those assets is a 100% guess.  In effect, Goldman is saying “we think we might have $96 billion in assets, but we really don’t know what they’d be worth if we tried to sell them.  They might be worth $96 billion (but we’re almost certain that that’s not right) but they might be worth 3 cents on the dollar.  We don’t have a clue, so we pulled that $96 billion number out of our butt.”

Level 3 assets are, by definition, “hard to value”.  In fact, they are impossible to value, because no one will buy them.  So companies use a “mark to model” method to come up with a number.  And since “mark to model” varies depending on the model used, we’re back where we started – no one has any idea what these assets are worth.

You may be asking why it’s a bad thing that the value of the assets rose so much in one quarter, and that’s a good question.  Wouldn’t it be a good thing if my $1 million house went up to $1.5 million in one quarter?   The answer to why it’s bad is that it’s a made up number.  I know that this is probably getting old but you need to understand it – NO ONE WILL BUY IT AT ANY PRICE RIGHT NOW!

Your next question is probably something like “why would they make up a higher number for these assets if that’s viewed as a negative?  Another good question, but the answer is easy.  You see, if you claim that your assets are worth more, you can use them as collateral so you can borrow more money.

Kinda neat isn’t it?  Goldman increased its’ ability to borrow by $27 billion in just one quarter.  But who would take these level 3 assets as collateral you ask?  You’re on your “A” game tonight dear reader – another good question.

The answer is that there’s only one place to go to borrow against these assets that no one will buy – the Fed.  You and me (via the government) are loaning Goldman billions of dollars by allowing them to give (I’m going to make up some numbers here – let’s call them “level 3” numbers) the Fed $10 billion in level 3 assets.  In exchange, the Fed give Goldman $10 billion in Treasuries.

So you and I are now on the hook for $10 billion of basically worthless assets, while Goldman now has $10 billion of nice safe Treasuries.  Nice trick ain’t it?  That’s the Federal Reserve’s new Term Securities Lending Facility (TSLF) in a nutshell.

That’s one of the ways that the Fed is propping up the banks and brokerage houses right now – short of an indirect buyout like they did with Bear Stearns anyway.  But sooner or later, the losses from these made up level 3 assets need to be accounted for. 

The only question remaining is who will pay for the losses – the banks who made the risky loans, the investment houses that took the risky loans and leveraged them, or the taxpayer.  My best level 3 guess is that we’ll see a combination of the above, but taxpayers will eat a significant chunk of the losses.

As a result, the Fed will have to print more money to pay the bills, so the dollar will continue to fall, and the stock market will drop in inflation adjusted terms – and quite probably in real terms as well.  Within the next 12 months, Dow 9,000 is much more likely than Dow 15,000 in my opinion.

gk