For one, Goldman is overvalued considering the economic profit that it
generates. See
Continuing the Goldman Sachs Valuation Debate (for those who have
closely followed my Goldman opinion, you can skip down to the Bloomberg
article towards the bottom of the page):

RM: GS return on equity
has declined substantially due to deleverage and is only marginally
higher than its current cost of capital. With ROE down to c12% from c20%
during pre-crisis levels, there is no way a stock with high beta as GS
could justify adequate returns to cover the inherent risk. For GS to trade back at 200 it has
to increase its leverage back to pre-crisis levels to assume ROE of 20%.
And for that GS has to either increase its leverage back to 25x. With
curbs on banks leverage this seems highly unlikely. Without any increase
in leverage and ROE, the stock would only marginally cover returns to
shareholders given that ROE is c12%. Even based on consensus estimates
the stock should trade at about where it is trading right now, leaving
no upside potential. Using BoomBustBlog estimates, the valuation drops
considerably since we take into consideration a decrease in trading
revenue or an increase in the cost of funding in combination with a
limitation of leverage due to the impending global regulation coming
down the pike. Using your method, our valuation would drop from where it
is to an even lower point.

Second, it still has a bunch of trash on its balance sheet, see
Reggie
Middleton
vs Goldman Sachs, Round 2:

So, what is GS if you strip it of its government protected, name
branded hedge fund status. Well, my subscribers already know. Let' take a
peak into one of their subscription documents ( Goldman Sachs Stress Test
Professional 2009-04-20
10:06:45 4.04
Mb - 131 pages). I
believe many with short term memory actually forgot what got this bank
into trouble in the first place, and exactly how it created the
perception that it got out of trouble. The (Off) Balance Sheet!!!

Contrary to popular belief, it does not appear that Goldman is a
superior risk manager as compared to the rest of the Street. They may
the same mistakes and had to accept the same bailouts. They are
apparently well connected though, because they have one of the riskiest
balance sheet compositions around yet managed to get themselves insured
and protected by the FDIC like a real bank. This bank's portfolio looked
quite scary at the height of the bubble.

You know what most people don't realize is that it looks quite scary
now as well.

If one were to strip out the revenues from prop trading, it would leave
bards some balance sheet issue. Again, I query, should virtual hedge
funds that pay out half of revenue as compensation trade at such high
premiums to the rest of the market? I don't think so, and I have put my
money behind the idea that the market will not think so in the near
future either.

Now that we
have established at least a basic understanding of what is underneath
the GS hood, let's see how the engine runs in order to generate said
profits. In Reggie
Middleton
vs Goldman Sachs, Round 1, I noted that
Goldman often peddled horrible advice and products to clients that
repeatedely lost tons of money, yet Goldman is still considered the best
and the brightest on the Street. Let's take a look:

The mainstream media jumps when Goldman's sales and marketing staff analysts make a recommendation or
prediction, despite the fact that no one really bothers to look back to
see how profitable the GS sales and
marketing staff analysts
have been for their clients vs the risk-adjusted profitability for
their bonus pool shareholders. One example that I
have used in my previous posts was Lehman Brothers, who I became
increasingly bearish on in early 2008 (if you're a regular reader,
please bear with this rehash):

• See
  "Is
  Lehman really a lemming in disguise?" (Thursday, 21 February 2008)
• Lehman
  rumors may be more founded than some may have us believe Tuesday, 01 April 2008 (be sure to read through the
  comments, its like deja vu, all over again!)
• Lehman
  stock, rumors and anti-rumors that support the rumors Friday, 28
  March 2008 and Funny CLO business at Lehman Friday, 04 April 2008.

The esteemed Goldman Sachs did not agree with my thesis on Lehman.
Reference the following graph, and click it if you need to enlarge.
Notice the tone, and ultimately the outright indication of a fall in the
posts from February through April 2008 above, and cross reference with
the rather rosy and optimistic guidance from the esteemed Goldman
(Sachs) boys during the same time period, then... Oh yeah, Lehman
filed for bankruptcy!!!

Does anybody think that Lehman was a "one off" occurrence? Or for that
matter does anyone believe that only Goldman is guilty of a lack of
actual performance for their clients vs. their bonus pool???

...

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 formed
"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!]

‘Too Uncanny’

“It’s almost too uncanny,” Calacci says. “If these banks had insight
into the underlying loans because they had relationships with banks,
originators or servicers, that’s at the least unethical.”[At the
very least. I think it's called ILLEGAL!]

The identification of securities in the document, known as Schedule A,
and data compiled by Bloomberg show that Goldman Sachs
underwrote $17.2 billion of the $62.1 billion in CDOs that AIG insured
-- more than any other investment bank. Merrill Lynch &
Co., now part of Bank of America Corp., created $13.2 billion of the
CDOs, and Deutsche Bank AG underwrote $9.5 billion.

These tallies suggest a possible reason why the New York Fed kept so
much under wraps, Professor James
Cox of Duke University
School of Law says: “They may have been trying to shield Goldman
-- for Goldman’s sake or out of macro concerns that another investment
bank would be at risk.”

Poor Performers

Goldman Sachs spokesman Michael
DuVally declined to
comment. [Of course...]

Schedule A also makes possible a more complete examination of why AIG
collapsed. Joseph
Cassano, the former president of the AIG Financial Products unit
that sold the swaps, said on a December 2007 conference call that his
firm pulled back from selling swaps on U.S. subprime residential CDOs in
late 2005. The list shows that the $21.2 billion in CDOs minted
after 2005, mostly based on prime and commercial mortgages, performed as
badly as or worse than the earlier subprime vintages. [I
seriously doubt so. Don't you guys know we are in the middlet of a steep
"V" shaped economic recovery and a roaring bull(shit) market? The CRE
and residential real estate markets have just about bottomed out and the
worst is over!]

.... As details of the coverup emerge, so does anger at the perceived
conflicts.Philip
Angelides, chairman of the Financial Crisis Inquiry Commission,
at a hearing held by his panel on Jan. 13, questioned how banks
could underwrite poisonous securities and then bet against them. “It
sounds to me a little bit like selling a car with faulty brakes and then
buying an insurance policy on the buyer of those cars,” he said.

[Actually, if I may correct you my good man, it's more like
selling a car with faulty breaks, then buying a car accident swap on the
driver (through your own car accident swap dealer which has practically
cornered the car accident swap market, may I add) and getting repeat
business from the sucker who bought the car with bad breaks in order to
sell him multiple upgarded models of said faulty break car, complete
with free car accident swap counterparty membership! You make money off
of him until he dies, and then you simply cash in your swap. The swaps
may not be as profitable as they once were because the damn bad brake
and car accident swap regulators are starting to bitch and moan about
you making so much money from damn near killing poeple while having
access to federal funds. God's work, forbid. They are actually asking us
to foot the bill for damn near killing the clients without access to
the Fed window and 0.25% rates on our FDIC insured bonds!!!]

‘Part of the Coverup’

Janet
Tavakoli, founder of Tavakoli Structured Finance Inc., a
Chicago-based consulting firm, says the New York Fed’s secrecy has
helped hide who’s responsible for the worst of the disaster. “The
suppression of the details in the list of counterparties was part of the
coverup,” she says.

E-mails between Fed and AIG officials that Issa released in January
show that the efforts to keep Schedule A under wraps came from the New
York Fed. Revelation of the messages contributed to the heated
atmosphere at the House hearing.

“What date did you know there was a coverup?” Republican CongressmanBrian
Bilbray of California
demanded of Geithner. Lawmakers used the word coverup more than a dozen
times as they peppered Geithner with questions.

...

The government has committed more than $182 billion to AIG and owns
almost 80 percent of the company.

Document Withheld

In late November 2008, the insurer was planning to include Schedule A
in a regulatory filing -- until a lawyer for the Fed said it wasn’t
necessary, according to the e-mails. The document was an attachment to
the agreement between AIG and Maiden Lane III, the fund that the Fed
established in November 2008 to hold the CDOs after the swap contracts
were settled.

AIG paid its counter parties -- the banks -- the full value of the
contracts, after accounting for any collateral that had been posted, and
took the devalued CDOs in exchange. As requested by the New York Fed,
AIG kept the bank names out of the Dec. 24 filing and edited out a sentence that
said they got full payment.

The New York Fed’s January 2010 statement said the sentence was deleted
because AIG technically paid slightly less than 100 cents on the
dollar.

Paid in Full

Before the New York Fed ordered AIG to pay the banks in full, the
company was trying to negotiate to pay off the credit- default swaps at a
discount or “haircut.”

By March 2009, responding to a request from Christopher
Dodd, chairman of the Senate Committee on Banking, Housing and
Urban Affairs, AIG released the names of the counterparty banks. In a
filing later that month, AIG included Schedule A, showing bank names
while withholding all identification of the underlying CDOs and the
amounts of collateral each bank had collected. The document had more
than 800 redactions.

In May 2009, AIG again filed Schedule A, this time with about 400
redactions. It revealed that Paris-based Societe Generale got the
biggest payout from AIG, or $16.5 billion, followed by Goldman Sachs,
which got $14 billion, and then Deutsche Bank and Merrill Lynch. It
still kept secret the CDOs’ identification and information that would
show performance...

“This is something that belongs in the public domain because it was
done with public money,” Issa says. “The public has the right to know
what was done with their money and who benefited from it.” Now, thanks
to Issa, the list is out, and specific information about AIG’s
unraveling can be learned from it. At the Jan. 27 hearing, the New
York Fed was still arguing that the contents of Schedule A shouldn’t be
fully disclosed. Thomas
Baxter, the New York Fed’s general counsel, testified that
divulging the names of the CDOs could erode their value: “We will be
hurt because traders in the market will know what we’re holding.”

[Let's get this straight, your selling your housem but it had a fire
and 60% of it is burned down. According to Baxter, you don't want
anyone to tell your broker or other housing investors that your house
has burnt down or even the address because it could (and let me quote
this for the most accurate effect) "could erode
their value: “We will be hurt
because traders in the market will know what we’re holding."
Now (and excuse my French here), if that ain't some shit to be
admittting in public, in a Congressional hearing to boot, I don't know
what it. You guys have balls the size of bowling balls, ya' hear me!]

Tavakoli calls that wrong. With many CDOs, providing more information
to the market will give the manager a greater chance of fetching a
realistic price, she says. [Who wants a realistic price when you can try
to fetch a Goldman RIPOFF price??? Really, let''s be real here!]

Jack
Gutt, a spokesman for the New York Fed, declined to comment, as did
AIG’s Mark
Herr. What comment could they possibly have after a statement like
one above???

Bad to Worse

Tavakoli also says that the poor performance of the underlying
securities (which are actually specific slices or tranches of CDOs)
shows they were toxic in the first place and were probably replenished
with bundles of mortgages that were particularly troubled. Managers who
oversee CDOs after they are created have discretion in choosing the
mortgage bonds used to replenish them.

“The original CDO deals were bad enough,” Tavakoli says. “For some that
allow reinvesting or substitution, any reasonable professional would
ask why these assets were being traded into the portfolio. The Schedule A
shows that we should be investigating these deals.”

Among the CDOs
on Schedule A with notional values of more than $1 billion, the worst
performer was a tranche identified as Davis Square Funding Ltd.’s DVSQ
2006-6A CP. It was held by Societe Generale, underwritten by
Goldman Sachs and managed by TCW Group Inc., a Los Angeles-based
unit of SocGen, according to Bloomberg data. It lost 77.7 percent of
its value -- though it isn’t in default and continues to pay. [Hey,
doesn't this remind you fo the GSAMP Slide, that funky new dance,
introduced above???!!!]

[As you can see, part of the probable reason for bailing out SocGen
was that Goldman sold them the equivalent of a financial terrorism
event, and the French government probably said, "Make this right, or
we'll go public!]

[Well, for all of those guys who oppose mark to market rules, this
CDO hasn't lost any of its value since it continues to pay and is
probably considered a longer term asset. Mayhap they will take their
capital and buy it at par???]

SocGen spokesman James
Galvin and TCW
spokeswoman Erin
Freeman declined to comment. [Of Course]

One really wonders why anyone would even bother to buy trash like this
from Goldman or any other bank. Oh well, why not? They are the best and
the brightest, Right???

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!

• Reggie Middleton on Goldman Sachs' fourth quarter, 2008 results
• Goldman and Morgan losses in the news, about 11 months late
• Blog vs. Broker, whom do you trust!
• Monkey business on Goldman Superheroes
• Reggie Middleton asks, "Do you guys know who you're messin' with?"
• Reggie Middleton on Risk, Reward and Reputations on the Street: the Goldman Sachs Forensic Analysis
• Reggie Middleton on Goldman Sachs Q3 2008

§ As Reality hits, the Masters of the Universe are starting to look like regular bank employees

Reggie Middleton's Goldman Sach's Stress Test: Breaking Ranks with the Crowd Once Again!

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