Reggie Middleton vs Goldman Sachs, Round 1

By: Reggie Middleton | Wed, Dec 9, 2009
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This is the opinion piece that I promised on Goldman Sachs research and product sales. I want it to be clear that I have absolutely nothing against Goldman Sachs, and if I worked there I would want $19 billion of bonuses too, despite the fact that I just got bailed out by the taxpayer to the tune of over $50 billion and still have middle class taxpayer funded government subsidies intact. The fact of the matter is that I don't work for Goldman Sachs, and the reverence that they receive is illogical and borderline sickening, not to mention having nothing to do with the reality of the situation.

Note: I am typing this post at 3:30 in the morning, so there may be some typos and guffaws in the text, which I will try to catch and demarcate with a strikethough.

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):

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???

In January of 2008, who among the Wall Street bank brand name crowd had a failure warning or even a sell call on Bear Stearns? Lord knows one was definitely called for, see Is this the Breaking of the Bear?. We can go on theme-wise with:

  1. regional banks (As I see it, 32 commercial banks and thrifts may see the feces hit the fan blades).
  2. commercial real estate (The Commercial Real Estate Crash Cometh, and I know who is leading the way!),
  3. the monoline insurers (A Super Scary Halloween Tale of 104 Basis Points Pt I & II, by Reggie Middleton -11/13/2007), Ambac is Effectively Insolvent & Will See More than $8 Billion of Losses with Just a $2.26 Billion in Equity 11/29/2007), etc. I can go on for quite a while, but hopefully you see a trend here.

As a matter of fact, many of these failed and failing companies actually managed to sell securities and raise capital at some of the worst time for any potential investor. Who do you think provided the optimistic research to lay the groundwork for said sales? More to the point, who do you think actually facilitated the sales? And the ass kicker question, "How did the buyer of said securities fare?" Looking back at two egregious examples:

In keeping with the theme of Wall Street's ability to peddle nearly anything to the Name Brand enamoring masses, I have decided to offer an addendum to the recent REIT analysis for my subscribers that provides a scenario for an additional (this would be the second in 12 months) equity offering in an attempt to close the equity gap between what the maximum practicaly LTV on assets and the extant amount of debt to be refinanced. The original update only had scenarios for distressed sale of assets, distressed debt refinancing and voluntary allowance of foreclosure of assets. Although I would consider it unlikely that an equity offereing could be pulled off, I have seen stranger things happen.

MAC Report_Consolidated_051209 equity offering addendum 2009-12-08 03:33:30 308.60 Kb

Well, the Wall Street Marketing Machine AKA "sell side research" is at it again. Just as I turn bearish on CRE for the second time (see Re: Commerical Real Estate and REITs - It's About That Time, again...), check out the "pump and dump job" from Merrill: Here's a Big Company Bailout by the Taxpayer That Even the Taxpayer's Missed!. I received emails about DDR's predicament (Diversified Development Realty Email of Interest), which makes sense, because Goldman Sachs is pushing CMBS secured by this company's malls (Reggie Middleton Personally Contragulates Goldman, but Questions How Much More Can Be Pulled Off), which of course had a AAA tranche (see more on this Goldman phenomena below). What a coincidence! If you think that is a coincidence, just as pressure starts to turn up on in the CRE space with a bad macro outlook and an even worse fundamental outlook, Goldman upgrades the entire sector and issues a buy on Taubman (see my take. The Taubman Properties Research is Now Available). Anyone want to bet that Goldman won't help these REITs trade bad debt for more bad debt or bad equities??? Do you think they will have the gall, nerve, ability to push AAA financing for Macerich (A Granular Look Into a $6 Billion REIT: Is This the Next GGP?)?

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 victims clients 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.

Next, I will look into the true performance of the residential, non-conforming mortgage market using information sourced directly form our government.

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Reggie Middleton

Author: Reggie Middleton

Reggie Middleton

Reggie Middleton

Who am I?

Well, I fancy myself the personification of the free thinking maverick, the ultimate non-conformist as it applies to investment and analysis. I am definitively outside the box - not your typical or stereotypical Wall Street investor. I work out of my home, not a Manhattan office. I build my own technology and perform my own research - in lieu of buying it or following the crowd. I create and follow my own macro strategies and am by definition, a contrarian to the nth degree.

Since I use my research as a tool for my own investing to actually put food on my table, I can stand behind it as doing what it is supposed too - educate, illustrate and elucidate. I do not sell advice, I am not a reporter hence do not sell stories, and I do not sell research. I am an entrepreneur who exists just outside of mainstream corporate America and Wall Street. This allows me freedom to do things that many can not. For instance, I pride myself on developing some of the highest quality research available, regardless of price. No conflicts of interest, no corporate politics, no special favors. Just the hard truth as I have found it - and believe me, my team and I do find it! I welcome any and all to peruse my blog, use my custom hacked collaborative social tools, read the articles, download the files, and make a critical comparison of the opinion referencing the situation at hand and the time stamp on the blog post to the reality both at the time of the post and the present. Hopefully, you will be as impressed with the Boom Bust as I am and our constituency.

I pay for significant information and data, and am well aware of the value of quality research. I find most currently available research lacking, in both quality and quantity. The reason why I had to create my own research staff was due to my dissatisfaction with what was currently available - to both individuals and institutions.

So here I am, creating my own research for my own investment activity. What really sets my actions apart is that I offer much of what I produce to the public without charge - free to distribute and redistribute, as long as it is left unaltered and full attribution is given to the author and owner. Why would I do such a thing when others easily charge 5 and 6 digits annually for what some may consider a lesser product? It is akin to open source analysis! My ideas and implementations are actually improved and fine tuned when bounced off of the collective intellect of the many, in lieu of that of the few - no matter how smart those few may believe themselves to be.

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