Wednesday, 24 September 2008 10:15

Reggie Middleton asks, "Do you guys know who you're messin' with?"1

This is a follow up to the post that I made early this morning, "Shock and Awe, 2.0!" (I consider it a must read)1.
I was one of those hedgie-type guys who were shorting the Goldman
stock. Why was I doing it? Was it because I was unpatriotic? Was I a
shark out for blood? Out to destroy the very financial fabric of
America? I'll tell you why I did it (and quite profitably, may I add,
see the notes and links at the bottom of this article). I did it becaue
Goldman takes a lot of excessive risk in relation to their profits (see
Risk vs. Reward vs. Reputations on the Street)2,
in an environment that is fraught with peril, while carrying a lot of
immovable trash on their balance sheet, as they sport the highest price
and valuation on all of Wall Street, despite hiring the same people as
their competitors (what's left of 'em) who went to the same schools to
learn the same trading methods to move the same products. If you click
the link above, they are so correlated to their fallen brethren that
their stock even moves in the same patterns. In a nutshell, I saw
disequilibrium in the market, and I saw an opportunity to capitalize on
the markets fixing this problem. Alas, I digress...

Henry Paulson just asked for a revolving
$700 billion credit line to fix the mess that he literally, and I do
mean literally, created. Take a look at this graph or inflation
adjusted real estate prices (courtesy of Professor Shiller's irrational
exuberance data), and take note that Paulson ran the biggest investment
bank during the years between 1998 and 2006 (the exact years of the
real estate boom).

image001.png

Let's take a close look at the stuff that Paulson's company hid off
balance sheet while he was CEP (these are recent numbers, but the
categories are the same).

Unconsolidated VIE's ($ mn)

31-May-08

VIE Assets

Maximum Exposure to Loss in Nonconsolidated VIEs

Purchased and retained interests

Commitments and Guarantees

Derivatives

Loans and investments

Total

Mortgage CDOs

18,569

516

0

8,144

0

8,660

Corporate CDOs and CLOs

10,891

402

0

1,398

0

1,800

Real estate, credit-related and other investing

28,216

0

8

0

3,977

3,985

Municipal bond securitizations

254

0

254

0

0

254

Other mortgage-backed

0

0

0

0

0

Other asset-backed

4,200

0

0

1,793

0

1,793

Power-related

438

2

37

0

16

55

Principal-protected notes

5,948

0

0

5,683

0

5,683

Total

68,516

920

299

17,018

3,993

22,230

Three guesses as to the type of
assets he and Bernanke will want to pay "above firesale prices" for if
they get the $700 billion they desire. Color rhymes with
Fed???

Why is it that I'm the only one who
finds it rather silly that the man who created much of the problem will
ask me and my family to pay taxes to dig his old firm and the "crew"
out of the whole. Care to hazard what he made during thehot bubble era
generating these assets that we now are being asked to bailout? From
Forbes via Wikipedia:

His compensation package, according to reports, was US$337 million in 2005, and US$16.4 million projected for 2006.[9]4 (and this is just for two years out of the 8). His net worth has been estimated at over US$700 million.[9]4
Do you think this bailout play will incude his giving some of that
money back? And you wonder whey exec comp limitations are being bandied
about as part of the package????

Let's take a look at the risk that his alma mata is taking to make those monies...

image014.gif

We
have looked at company’s recent quarterly filings and 10K to have a
closer view of Goldman Sachs’ (GS) exposure. Following are some of our
observations:

Value at Risk (VAR) and Risk Adjusted Return on Risk Adjusted Capital (RARORAC)

Goldman has the highest VAR among its peer group of $184 mn, followed by Lehman at distant $123 mn (we all know how well LEH is currently faring). Notably, GS also the highest range (difference of highest and lowest daily VAR during a quarter) of daily trading VAR of $92 million, reflecting significant (read risky) volatility
in its trading portfolio. This is higher than $61 mn and $67 mn (for
1Q2008) for Lehman and JPM, respectively. This is also being reflected
in the lowest risk adjusted return on risk adjusted capital (RARORAC -
a much more grounded measure of risk adjusted return) of 14.8% for GS
among its peer group. Just so this doesn't escape anybody, GS has the
lowest risk adjusted return on the Street. Simply analyzing earnings (or looking at CNBC) would lead one to believe that Goldman has the highest return on investment, but unfortunately, the world is a bit more complex than an earnings statement or a cable news channel.

Average Daily Trading VAR (in million dollars)

Q208

Q108

Q407

Q307

Goldman Sachs

184

157

138

139

Morgan Stanley

99

97

89

87

Merrill Lynch

NA

65

65

76

Lehman Brothers

123

130

124

96

JPM

NA

122

107

112

Range of Daily Trading VAR (Difference between highs and lows) (in million dollars)

Q208

Q108

Q407

Q307

Goldman Sachs

NA

92

77

68

Morgan Stanley

NA

34

46

36

Merrill Lynch

NA

39

51

32

Lehman Brothers

37

61

107

66

JPM

NA

67

138

64

image002.gif

  • Risk Adjusted return on risk adjusted capital (RARORAC)

Q208

Q108

Q407

Q307

Goldman Sachs

12.9%

14.8%

16.1%

15.3%

Morgan Stanley

19.7%

19.1%

21.5%

23.3%

Merrill Lynch

NA

31.6%

32.5%

30.5%

Lehman Brothers

14.0%

12.3%

12.0%

15.3%

JPM

NA

54.1%

60.2%

56.8%

Goldman also has the highest adjusted leverage ratio (adjusted
asset divided by adjusted equity) of 18.6x (for 1Q2008) among its peer
group, reflecting lower equity cushion against any valuation write-down
or loss. This highest leverage portends much greater volatility in
economic earnigns. In other words, when the win chooses not to blow in
their direction, the sh1t will hit the fan that much harder than the
rest of the Street

Adjusted leverage ratio

Q208

Q108

Q407

Q307

Goldman Sachs

NA

18.6x

17.5x

18.0x

Morgan Stanley

14.1x

16.0x

17.6x

18.8x

Merrill Lynch

NA

18.2x

20.3x

17.9x

Lehman Brothers

12.0x

15.4x

16.1x

16.1x

JPM

NA

13.1x

12.7x

12.3x

Click here for a worksheet that illustrates the VaR exposure for all ofthe big US brokers in detail: icon Broker VaR Worksheet (634.49 kB 2008-07-05 09:25:24)5.

Goldman Sachs’ exposure

  • GS’
    level 3 assets as percentage of its equity at 258% is close to highest
    figure of 274% among its peer group. Its level 3 assets proportion to
    total asset has increased consistently from 5.7% in 2Q2007 to 8.1% in
    1Q2008.
  • image006.gif
  • It
    is also worth noting that approximately 25% of its OTC derivative
    credit exposure (comprised in level 3 assets) is rated BBB and lower.

OTC Derivative Credit Exposure ($ mn)

Feb-08

% of total

Nov-07

% of total

AAA/Aaa

$15,387

15.6%

$14,596

20.7%

AA/Aa2

$33,820

34.2%

$24,419

34.7%

A/A2

$25,291

25.6%

$16,189

23.0%

BBB/Baa2

$9,724

9.8%

$6,558

9.3%

BB/Ba2 or lower

$13,354

13.5%

$7,478

10.6%

Unrated

$1,236

1.3%

$1,169

1.7%

Total

$98,812

100.0%

$70,409

100.0%

  • In March 2008, Standard & Poor’s affirmed Group Inc.’s credit ratings but revised its outlook from “stable” to “negative.

Paulson to the rescue!

Here is my detailed opinion on Goldman Sachs. Be sure to review my precursor to this report: Goldman Sachs Snapshot: Risk vs. Reward vs. Reputations on the Street. Anybody who is interested in how I
Thursday, 24 July 2008


2. Reggie Middleton on Goldman Sachs Q3 2008 7
(Reggie Middleton's Boom Bust Blog/MyBlog)
...rish view on Bear Stearns in a bear market and Is this the Breaking of the Bear's Back?), I am bearish on Goldman as well (Goldman Sachs Snapshot: Risk vs. Reward vs. Reputations on the Street and Re...
Wednesday, 17 September 2008


3. Goldman Sachs Snapshot: Risk vs. Reward vs. Reputations on the Street 2
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)
...t shared by most of the analyst community and those that follow them. This brings me to the issue of Goldman Sachs. I have been bearish on commercial, mortgage and investment banks for over a y...
Saturday, 05 July 2008
Last modified on Wednesday, 24 September 2008 10:15

4 comments

  • Comment Link sec Friday, 26 September 2008 02:02 posted by sec

    How much is a worthless piece of paper worth? Nothing, unless you can sell it to the American taxpayer. Don't be fooled. It isn't called a "bailout" for no reason. It truly is a bailout. What is being proposed is that the American taxpayer buy the "derivative securities

    Report
  • Comment Link Reggie Middleton Thursday, 25 September 2008 16:54 posted by Reggie Middleton

    I'll post a list soon. I have developed a short list already.

    Report
  • Comment Link shaun noll Thursday, 25 September 2008 14:54 posted by shaun noll

    are there any pure play chinese banks that could be shorted? THOSE guys are in serios trouble, all sorts of corruption and house of cards over there and a whole mess of perverse incentives built into their financial system.....

    Report
  • Comment Link shaun noll Thursday, 25 September 2008 14:54 posted by shaun noll

    did you see this reggie?

    After several days of rumors and speculation, long lines of depositors are now lining up at the bank desperate to take their money out – and have been so since late last night. Deposit withdrawals actually began on Tuesday, but only really picked up steam last night. Bloomberg says this is Hong Kong’s first bank run since the Asian Crisis of 1997, but the South China Morning Post lists the last bank run as BCCI in 1991.

    Report
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