THE DEVIL IN THE DETAILS IS GOLDMAN SACHS, PART II

Like I said in Part I, all analogies will collapse if pushed far enough. That still goes, so give me a break.

Say you are Goldman, and I am Sachs (or vice-versa). We own a bank. We have a rep for being able to solve anyone's financial problems. It is also well known that we are extremely risk averse, so our fees are high, and our profits must be assured.

Mr. Zorba comes to us having a real bad problem. He wants to join a very exclusive club whose members are all snobs of European descent. The people in the club don't think you're rich unless you hold Euros. The club has high admission standards, and requires potential members to prove that they have short-term debts of no more than 3% of their annual incomes, and long-term debt of no more than 60%. Zorba explains that he can't meet either standard, and he needs to put some cash on the books, because he wants to join the club real bad.

Zorba says he's heard that we helped his acquaintance, Salvatore, get into the club in the past. We can neither confirm or deny this, but we say that if Zorba gives us the ugly truth about his finances, we'll see what we can do.
Zorba's financial statement shows that he holds a lot of real estate, and recently bought a parking garage in Little Tokyo. To buy the business, he borrowed Yen. To buy real estate, he borrowed Dollars. Interest costs are eating him up.
We explain to Zorba that his interest expenses on his debt could be reduced if it were expressed in Euros, but while this would be good, he couldn't really put any cash on the books by a break-even transaction in the present spot currency market.

And so...

We suggest that we could pick out an historical exchange rate that would be quite favorable for him, and we could acquire his debt at that rate, paying him in Euros. But he couldn't tell anyone. This would give him the equivalent of $1 billion right away, and maybe $9 billion more in the long term. Of course, he'd have to pay us back with a balloon payment in 15 or 20 years. This sounds good to Zorba.
Then we go see an insurance agent named Otto. He charges us $200 million for a policy insuring us against Zorba's default on the $1 billion. Of course, Zorba has to pay for our credit risk. That would only be fair.

With Zorba's balance sheet now looking pretty good, he applies for admission into the club. He gets in, and is very happy.

Now all we have to do is sell Zorba's debt to somebody else, and, you know, "buyer beware". This won't be too tough, because, after all, he just got into a very exclusive club, and everyone in the world knows that to get in, your financial statement has to be in great shape. Besides, the "currency swap/loan" was off the books. He'll have to deal with all the deferred interest payments the best way he can, if he can. Not our problem. We got him in the club, and we're off the hook. Plus we made money.

This is basically how Goldman Sachs helped Greece get into the European Union by falsifying its balance sheet and concealing its true debt levels. Then they underwrote Greek debt and sold it, knowing it was shaky.

THE DEVIL IN THE DETAILS IS GOLDMAN SACHS, PART I

All analogies break down when pushed far enough. I know this. But bear with me.

Say my name is Goldman, and you are Sachs (or vice-versa). We recently bought a house for $165,000 cash. The fair market value is $200,000. Our friend, Lehman, wants to buy it, but he's making $400/month payments to his brother for a car loan that he got on a handshake deal, and he can't make a 20% down payment. We tell him we'll take 5% down, and we'll finance the balance with interest payments he can afford. We require a financial statement from him which leaves out the part about the car loan. We close the deal.
Then we take all the mortgage papers and Lehman's financial statement to another friend, Mr. AIGner, who is an insurance agent/bookie who thinks he knows something about real estate finance. We tell AIGner (with tongue in cheek) that although we know we have made a very solid loan, we'd like for him to sell us a kind of insurance policy against Lehman's possible default. AIGner examines the documents,and goes for it. We agree to pay premiums of $100/month for a $200,000 "policy'.
Then we put the word out that we have a golden mortgage loan for sale. Lots of people who trust us want to buy it. The more we talk it up, the greater the demand to buy it increases. We decide to sell the loan at auction. The bidding is frenzied, and our other friend, Stearns, pays us $210,000 for the note. We transfer it to him. We no longer on the hook as a lender.

But we still own the "insurance policy".

So when Lehman defaults two months later, we have $419,800 in bank (which we also own), and everyone else is screwed and tattooed.

This is how credit default swaps work. This is how Goldman Sachs hyped crummy mortgage paper (that they knew was crummy), sold it to people who should have known better, and put AIG on the hook for all of it.

TAXING THE BANKS

The federal government is beginning to think that they are not going to recover about $120 billion in TARP money that was used to bail-out American car companies and AIG. What's the surprise? GM never had any hope of repayment. So now, what to do? To get about $100 billion, President Obama is considering taxing what he believes are the windfall profits of the biggest banks in the U.S.
These are the same banks that themselves got a TARP bail-out, and have repaid the money with interest. Wasn't that the deal?
Now that the banks are in "bonus season", everyone is watching to see how huge the banks' bonus pay-outs will be. No doubt, they will be large. And a lot of people will be angry about this, President Obama among them. His rationale for taxing the banks will be based on their bonus payments, and his belief that the banks' accepting TARP money in the first place creates a social obligation on their part to pay the debts of other companies that cannot pay their own.
So what will be the consequence for large banks which will be taxed? Well, for one thing, they will have less money to lend. (I know they are not lending anyway. That's not the point. We've been over this before.) Secondly, President Obama's apparent hostility toward profit-makers will be demonstrated once again. This will create the suspicion among the business community that they will also be subject to new taxation in the future. This will contribute to the "uncertainty" that most people believe is causing businesses to avoid new hiring. And that defeats any jobs program you can name.

ALLY BANK

Just so you know: GMAC was the financial serves arm of General Motors. For a long time, GMAC's main business was providing loans to GM dealers and customers. Then they got into the insurance business, and mortgage operations. A few years ago, GM sold it off in order to raise some cash. When the financial crisis rolled around, GMAC re-organized as a bank holding company so they could apply for a bail-out via TARP funds. They are set to get their next infusion soon. The government is the majority shareholder.
Earlier in 2009, GMAC's banking unit became known as Ally Bank. So if you've seen their commercials on TV, and you had never heard of them, that's who they are.

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