Friday, 07 October 2011 08:35

I've Told You Before, And I'll Tell You Again - Goldman Sachs Investment Advice Sucks!!! Featured

I recieved this in the mail from a connected media editor regarding Goldman's very recent investment advisories...

Buy calls for a likely relief rally on earnings (Oct 20th)

We see the potential for a rebound in MS shares on earnings, but the event is not without risk. We believe concerns regarding its European swap and loan exposures appear overdone, as the firm signaled its net exposures to France and the periphery are modest if not immaterial. Uncertainty generated by press reports, as well as difficult markets have driven shares below levels reached when the market was at its March 2009 lows.

Balance sheet strengthened; sell short-dated CDS as fear falls

We believe the recent widening in MS CDS spreads does not reflect actual credit fundamentals. MS appears to have enough capital and liquidity

($182 bn in global liquidity pool + its bank status) to withstand significant market duress. Its 14.6% Tier 1 common ratio is at the high end of the industry. We expect the market focus to remain on European sovereign exposures and liquidity levels, and expect management to discuss this, highlighting the strength of its cash position, hedging and collateral, and progress in reaching its strategic goals, somewhat calming fears.

I responded with the rant below...

A)     Goldman’s investment advice sucks, big time – see Is It Now Common Knowledge That Goldman's Investment Advice Sucks?

B)      The term “net” exposures is misleading and in many cases, make believe. The offsetting hedges used to “alledgedly” hedge the gross exposure were written off of counterparties in the same businesses, trading the same products in the same markets as Morgan. When the feces hits the cooling machine blades, everyone’s liquidity will move in the same direction – downward. There is no true diversity, hence there is no true hedge – only academic hedges written, and traded, in paper form.

a.     I have addressed this ad nauseum on the blog, but the answer to that questions has been put best by Tyler Durden, at ZeroHedge put it best: ...Wrong. The problem with bilateral netting is that it is based on one massively flawed assumption, namely that in an orderly collapse all derivative contracts will be honored by the issuing bank (in this case the company that has sold the protection, and which the buyer of protection hopes will offset the protection it in turn has sold). The best example of how the flaw behind bilateral netting almost destroyed the system is AIG: the insurance company was hours away from making trillions of derivative contracts worthless if it were to implode, leaving all those who had bought protection from the firm worthless, a contingency only Goldman hedged by buying protection on AIG. And while the argument can further be extended that in bankruptcy a perfectly netted bankrupt entity would make someone else who on claims they have written, this is not true, as the bankrupt estate will pursue 100 cent recovery on its claims even under Chapter 11, while claims the estate had written end up as General Unsecured Claims which as Lehman has demonstrated will collect 20 cents on the dollar if they are lucky. The point of this detour being that if any of these four banks fails, the repercussions would be disastrous. And no, Frank Dodd's bank "resolution" provision would do absolutely nothing to prevent an epic systemic collapse.

C)    There is evidence that corroborates bullet point “B” in Goldman’s own missive, and I quote “Balance sheet strengthened; sell short-dated CDS as fear falls.” Are we to believe that Goldman is only giving this advice to those clients large enough, liquid enough, solvent enough and adequately diversified from the financial services, asset management and investment industry (this can be read as absolutely no hedge funds, HNW, pension funds and family offices – Yeah, right!) so as to ensure the ability to pay out these CDS in a fat tailed event? Or is Goldman peddling this advice that is not paid for to incentivize clients act in a fashion that Goldman is paid for, ex. Market maker/broker/principal/agent in the CDS market? As Goldman pushes CDS sales onto any willy nilly who’s willing to wright them, Goldman compounds the risks already inherent in a much less than perfect system. Isn’t that why AIG had to be bailed out to the tune of over a fifth a TRILLION US dollars?

D)    As for the last comment “MS appears to have enough capital and liquidity ($182 bn in global liquidity pool + its bank status) to withstand significant market duress. Its 14.6% Tier 1 common ratio is at the high end of the industry. We expect the market focus to remain on European sovereign exposures and liquidity levels, and expect management to discuss this, highlighting the strength of its cash position, hedging and collateral, and progress in reaching its strategic goals, somewhat calming fears.” I direct you to my latest post on what Superheroes may look like in real life –  Hunting the Squid, Part 5: Sometimes You…

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