Thursday, 29 April 2010 06:27

Wall Street Compensation Is Much More Complex Than It Needs To Be. Let's Take Goldman For Example...

The Wall Street Compensation issue is being made much more complex than it needs to be. Let's take Goldman for example. - Bloomberg: Self-Evaluations Seen as New Source of Concern After Goldman Sachs Hearing

April 28 (Bloomberg) -- Wall Street employers, long concerned that their staff’s e-mails may be used against them, now have another thing to worry about: the self-evaluations employees fill out.

At a 10-hour congressional hearing yesterday, senators pointed to Goldman Sachs Group Inc. employees’ self-evaluations, which included boasts about making “extraordinary profits” by betting against the subprime market, as proof the company misled investors into a mortgage-linked investment. [If they made "extraordinary profits", then the transactions shouldn't be considered an economic hedge]

The fact that self-evaluations were used against Goldman employees could keep companies from being open in their own review process, hampering feedback that makes evaluations productive, said Gary Hayes, co-founder of management consulting firm Hayes Brunswick & Partners in New York. [Or they could just be more open with their clients, and wouldn't have to worry about being secretive in their self reviews - duhh!]

“That’s fairly chilling,” Hayes said. “It would make many senior executives very cautious, if not guarded in what they say in evaluations. You’ll hinder the kind of dialogue that’s necessary.” Such evaluations are “a standard part of corporate America,” he said. [Again, why doesn't this guy say "It would make many senior executives very cautious, if not guarded in how they treat their clients"!!!!????? It's as if it is expected that GS will screw their clients, and the hurdle is how to conduct a review without getting busted for it!]

Senators used e-mails and self-evaluations produced by Goldman, which is being sued by the U.S. Securities and Exchange Commission, to attack the firm. Goldman denies the charges.

In his 2007 self-evaluation, Michael Swenson, a managing director in the structured-products group, said he earned the firm “extraordinary profits” after he recognized the subprime mortgage market was going to crumble and “aggressively capitalized” on betting against it.

‘Enormous Opportunity’

“It should not be a surprise to anyone that the 2007 year is the one I am most proud of to date,” Swenson wrote. “I can take credit for recognizing the enormous opportunity for the ABS synthetics business 2 years ago. It was clear that the market fundamentals in subprime and the highly levered nature of CDOs was going to have a very unhappy ending.” [And consequently, the GS bankers and analysts created CDO product inventory and the GS sales force was instructed to dump this inventory onto the patsy as GS shorted it into oblivion. Hey, I was heavily short during that period too. It was obvious, but I didn't have to mislead a patsy to make a profit! Those who are defending GS in this regard are being far from objective!]

In his own self-review that year, Joshua Birnbaum, a former managing director in the same group, wrote, “I concluded that we should not only get flat, but get VERY short_Much of the plan began working by February as the market dropped 25 points and our very profitable year was under way.” [The easiest and most profitable way to do that is to get our patsies clients long our product!]

Self-evaluations became popular after World War II, as corporations expanded, Hayes said. The more thorough “360” reviews -- where employees are evaluated by themselves, their bosses, their peers and their subordinates -- became more popular at Wall Street firms about 10 years ago, he said.

// // // // // //

I was wondering when, and if the GSAMP slide would gain some traction. I wrote about this numerous times (see below). As for a solution, I have also come up with a very simple solution that will end this entire charade in about a fiscal quarter - tie the GS compensation directly to risk adjusted return, with deferral and clawbacks. That is RISK ADJUSTED returns, not revenues!

The Solution to the Goldman (and by Extension, the Securities Industry) Compensation Dilemma

Add to this the requisite Client's best interests/bank as a fiduciary standard (which will make the banks think twice before fornicating the patsy) and we have a recipe for a near instantly reformed financial system. More must read opinion on Goldman Sachs...

I huffed and puffed about how overvalued GS is, particularly considering the amount of risk that it faced, I got a lot of blow back. The same blow back I got in early 2008 when I shorted GS from $180 to $75 (see Reggie Middleton on Risk, Reward and Reputations on the Street: the Goldman Sachs Forensic Analysis). Well, I guess we can all see the risk that I was referring to, right??? It was obvious that Goldman played the client as the patsym R.eggie Middleton vs Goldman Sachs, Pt. Deux: Buy into a Collapsing Market to Fund Bonuses, PLEASE!!!. Read through these excerpts of past posts on patsyism and overvaluation on a risk adjusted (not accounting revenue) basis...

When the Patina Fades… The Rise and Fall of Goldman Sachs??? Tuesday, 16 March 2010

I have warned my readers about following myths and legends versus reality and facts several times in the past, particularly as it applies to Goldman Sachs and what I have coined “Name Brand Investing”. Very recent developments from Senator Kaufman of Delaware will be putting the spit-shined patina of Wall Street’s most powerful bank to the test. Here is a link to the speech that the esteemed Senator from Delaware (yes, the most corporate friendly state in this country). A few excerpts to liven up your morning…

Reggie Middleton vs Goldman Sachs, Round 1Tuesday, 08 December 2009 and Reggie Middleton vs Goldman Sachs, Round 2 Sunday, 31 January 2010

On December 8th of last year, I penned “Reggie Middleton vs Goldman Sachs, Round 1″ wherein I challenged all to take a critical look at exactly how much money was lost by Goldman Sachs’ clients. Well, here comes round 2, which is directed at Goldman (over)valuation.

For Those Who Chose Not To Heed My Warning About Buying Products From Name Brand Wall Street Banks, Wednesday, 24 February 2010 -Those CDO buyers shoudl really heed this article. Not only did the GSAMP investors lose over 80%, but the real estate investors lost 98% (see Wall Street Real Estate Funds Lose Between 61% to 98% for Their Investors as They Rake in Fees!).

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…

But wait! There’s more, and it get’s quite interesting…

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, sales research 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 raping raking 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 forced “Goldman Sachs Alternative Mortgage Products”, an entity that pushed residential mortgage backed securities to its victims clients 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 enhancement CMBS 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

From Bloomberg:

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!]

More of Reggie on Goldman Sachs

Reggie Middleton vs Goldman Sachs, Round 2

Reggie Middleton Personally Contragulates Goldman, but Questions How Much More Can Be Pulled Off

Get Your Federally Insured Hedge Fund Here, Twice the Price Sale Going on Now!

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    Last modified on Thursday, 29 April 2010 06:27
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