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

By: Reggie Middleton | Thu, Sep 25, 2008
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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).

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
Maximum Exposure to Loss in Nonconsolidated VIEs
Derivatives Loans
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$373 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...

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

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: Broker VaR Worksheet (634.49 kB 2008-07-05 09:25:24)5.

Goldman Sachs' exposure

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%

Paulson to the rescue!

1. Reggie Middleton on Risk, Reward and Reputations on the Street: the Goldman Sachs Forensic Analysis6
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)
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 20087
(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 Street2
(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...



Reggie Middleton

Author: Reggie Middleton

Reggie Middleton

Reggie Middleton

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