March, Thursday 15, 2012

DOW + 58 = 13252
SPX + 8 = 1402
NAS  + 15 = 3056
10 YR YLD + .01 = 2.28%
OIL +.35 = 105.46
GOLD + 13.50 = 1658.30
SILV + >39 = 32.64
PLAT + 11.00 = 1688.00

          Yesterday we talked about the op-ed article in the New York Times written by Greg Smith, an executive from Goldman Sachs who was quitting the firm. He blasted Goldman in the article, saying the firm had changed, and not for the better. Smith chided his employer of nearly 12 years for its "toxic" environment and practice of "ripping clients off" while calling them "muppets."

          One of the stupidest responses came from the editorial board at bloomberg.com. No specific names here, just the “editorial board”.  They replied with an article titled: “Yes, Mr. Smith, Goldman Sachs is all about Making Money”. They say: “If you want to dedicate your life to serving humanity, do not go to work for Goldman Sachs. That’s not its function, and it never will be. Go to work for Goldman Sachs if you wish to work hard and get paid more than you deserve even so.”

          And here I thought Goldman Sachs was doing God's work. That's what Lloyd Blankfein said; I guess  he was lying? Yep. The Bloomberg editorial board just described a mercenary's job description. Nobody seriously expects Goldman investment bankers to serve humanity, but it doesn't mean they should work to destroy it. Bloomberg and Goldman both work in the financial industry. In fact, Goldman is one of Bloomberg's biggest clients. The editorial board of Bloomberg proved they believe in the idea of taking care of their client.

          The article goes on to say: “Goldman and other investment banks do perform an important role in our economy,” but they don't tell us what that important role is. As best I can tell they gamble with other people's money and when they win they keep a big chunk but when they lose, they force the taxpayer to cover their bets. Goldman Sachs doesn't build cars or houses; they don't grow food or trees; they don't design computer chips or code; they don't perform surgery; they don't paint pictures or buildings, and they don't seem to do anything that has any productive purpose. And shouldn't the important role, whatever it might be, include client suitability and a fiduciary responsibility to clients and to avoid lying to the government and the public?

          The article goes on to say that the culture at Goldman hasn't really changed, that they never were a charity and that its kind of dumb to have some distorted idea where: “one imagines Goldman bankers spending their days delivering fresh flowers to elderly shut-ins and providing shelters for abandoned cats.”

          True, the investment bankers have always been a bunch of sleazy, self-serving, SOB's. A little history on Goldman Sachs; let's set the way back machine to the 1920's, the Roaring Twenties.

          Investment banking's game is gambling, built on leverage. And the perfect vehicle for investment banking was the Investment Trust. An Investment Trust could raise cash by selling its own paper. For example, the Investment Trust G could raise $150 million worth of cash, by issuing $150 million of its own paper: $50 million of its own bonds, $50 million of its own preferred stock, and $50 million of its own common stock. After the sale of its own instruments, Investment Trust G uses the $150 million in cash to buy the common stock of other companies, such as AT&T, Ford, GM, and US Steel. These stocks became Investment Trust G's assets.

          In the 1920’s, the fractional reserve banking system had inflated the money supply and much of the inflated money went to the stock market. Assume all common stocks rise, on average, by 50% in value. Then, the assets that Investment Trust G owns, which were worth $150 million, would now be worth $225 million. If the value of Investment Trust G's assets are worth $225 million, then the value of the paper that Investment Trust has issued---its bonds, preferred stock, and common stock--should reflect this increase, by also being worth $225 million; bonds worth $75 million, preferred stock worth $75 million, and common stock worth $75 million. But the bonds and preferreds only paid interest and dividends, and the only paper issued by Investment Trust that could rise in value is the common stock. Since the total value of Investment Trust G was now worth $225 million, then the value of common stock issued by Investment Trust G increased in value from $50 million before, to $125 million now.

          The value of the assets--the common stock of other companies--that Investment Trust G owned, increased in value by 50%; but the value of Investment Trust G's own common stock increased in value by 150% (from $50 million to $125 million), that is, at a rate three times greater than the common stock of other companies that Investment Trust G owns. That’s leverage. In this example, the ratio of leverage is 3:1, between the increase in the value of common stock, and its production of a threefold increase in the value of Investment Trust common stock.

          Why stop there? You could theoretically set up another Investment Trust, let’s call it Investment Trust S, which would buy up and hold the common stock of Investment Trust G. Investment Trust S would issue bonds, preferred stock, and common stock; and Investment Trust S would buy the common stock of Investment Trust G. If the leverage of Investment Trust G to the common stocks it held was 3, and the leverage of Investment Trust S to Investment Trust G was 3, then the leverage of Investment Trust S to the common stock in the portfolio of Investment Trust G was 9:1.

          This example is based upon the very real formula of the Goldman Sachs Trading Company, and its subsidiaries Shenandoah Inc. and BlueRidge Inc. Of course, the Goldman Sachs Trading Company did not produce anything, they did not manufacture any product, and they did not provide any particular service beyond moving paper around. And Goldman Sachs was not unique; many banks were speculating in the market, pushing depositors to become investors in their schemes. Everyday investors borrowed money, on margin, to invest in the stock market, which became artificially inflated. Leverage resulted in the Roaring Twenties, a bubble economy.

          Eventually the Ponzi Scheme collapsed. There were certainly other causes of the Great Depression, but the new turbocharged leverage was definitely a big contributor. They took a combination of debt and equity and leveraged it; taking money from depositors to gamble in stocks and increasing the bet through leverage. The gamble failed in 1929.

          Did Goldman Sachs do this for their clients? Well it certainly didn't help their clients who invested in Goldman preferred stock or Goldman bonds, but it worked like a charm for Goldman. There is a long and notorious history of investment bankers behaving badly. It's not limited to Goldman.

          The recent story of the theft of more than $1.6 billion from client accounts at MF Global should serve as a wake up call. Who's ox is getting gored?

Did you hear about the plot to rig global interest rates? The muni bond rigging scheme to rip off  needy schools and cities? The ingenious plan to suck multiple fees out of the unemployment checks of jobless workers? And let's not forget the robosigning scandal. All five of the Big 5 Banks, and quite a few others thought it was a good idea to created bogus documents, present them in a court of law, and commit the biggest, most massive case of perjury and forgery in history.

          I understand that someone shouldn't go to work at Goldman in order to serve humanity, but that doesn't mean they should go there to lie and cheat and steal. 

          What else is going on in the world?The S&P 500 closed above 1,400 for the first time since the 2008 financial crisis. Virtually every metric offered to gauge investor behavior is showing money draining out of the market and insiders skeptical about the future.

          From mutual fund flows to insider selling to analyst downgrades and upgrades there is plenty of pessimism.Stock-based mutual funds have lost $1.2 billion since the start of February even though those same funds have returned 9.8 percent in 2012. Moreover, bond mutual funds have pulled in at least $6 billion for six weeks running, totaling $29.6 billion in the past four weeks, which was 11.8 times as much the $2.5 billion into all equity funds.

          Finally, and perhaps most damning, corporate insiders are dumping their holdings in droves, selling $6.8 billion in February, the most in 11 months and 13 times the level of insider buying, which is way above the norm of 8.6 times.

          And yet...the market keeps on rising.

          A Trend in Place....

          The number of Americans claiming new jobless benefits fell back to a four-year low last week, dropping 14,000 to a seasonally adjusted 351,000.

          The New York Federal Reserve said its Empire State general business conditions index rose to its highest level since June 2010 - 20.21 in March, up from 19.53 in February.

          Reuters reports that Britain and the US have reached an agreement to cooperate on releasing oil from strategic reserves. Details of the timing, volume and duration of a new emergency drawdown have yet to be settled but a detailed agreement is expected by the summer. White House spokesman Jay Carney said Obama and Cameron discussed rising oil prices, but he declined to comment on whether the leaders discussed a release of reserves. He said no deal had been reached on a release or timetable for such a move.

          Meredith Whitney the founder of the Meredith Whitney Advisory Group said it's no big surprise that most U.S. banks made it through the recent stress tests, and the banks are still oversold and should be trading around book value. It was her Citigroup call five years ago that first brought Whitney to national prominence, when she said the bank was plagued with toxic subprime mortgage assets.

          More recently, though, she is noted for predicting a wave of municipal bond defaults that has yet to materialize. She continues to back the call, however. "There's been so much backroom political maneuvering to keep these cities from going bust...There's been every effort on the part of states to prevent really this tidal wave of defaults which is going to happen sooner or later," Whitney said. "If people want to tell me 'you're wrong because this hasn't played out,' stay tuned."