Goldman Sachs – A Bubble Goldman Sachs – A Bubble Making Making MachineMachine

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Date :- 25th November 2012

RoadmapRoadmapGoldman Sachs HistoryBubble 1 – Great DepressionBubble 2 – Internet AgeBubble 3 – Abacus – Housing

Boom

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Goldman Sachs - HistoryGoldman Sachs - HistoryWorld’s most powerful Investment bankFounded in 1869, and headquartered in

the Lower Manhattan area of New York CityFounded by German immigrant named

Marcus Goldman, with his son-in-law Samuel Sachs.

Its everywhere across GlobeFirm Provides M&A advice, Underwriting

services, Asset Management and Prime Brokerage to its Clients

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1869

2012

The Great DepressionThe Great DepressionStarted in late 1920’sGoldman Sachs were pioneer in using the

Commercial paper, made money lending out of short term IOUs to small time vendors in downtown Manhattan

Main Financial tool used to attract investors was “Investment Trust”

Made an Endless Investment Pyramid.; Goldman hiding behind Goldman.

First Effort was “Goldman Sachs Trading Corporation”

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1869

20121928 - 1929

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GoldmGoldman an

SachsSachs

Goldman

Sachs Trading

Co. 1928

Shenandoah

Blue Ridge Corp.

Public

Issued 1 Million Shares @ $ 100 per

share

They bought it all with its own money

July 1929

7.2 Million Shares – 6.2 Million Shares owned by Shenandoah mostly owned by GSTC.

The sold 90% to Public at $ 104.Sold common &

Preferred Share to Public

Goldman Sachs 1928-29

The Great Depression – The Great Depression – Contd..Contd.. Simple technique was a daisy chain of borrowed

money.

E.g.: You have a $1, and you borrow $9 against it.. Then you take that $10 fund to borrow $90, then again take your $100, so long as public is still lending, Borrow and invest $900.

If last fund in the line starts to lose value, you no longer have money to pay back and every one gets into losses.

Bank suffered a totaled losses of $475 Billions.

Economist John Galbraith held up the Blue Ridge and Shenandoah trusts as classic examples of madness of leverage based investment.

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1869

20121928 - 1929

Internet Age – Technology Internet Age – Technology BoomBoomAfter the depression, strict underwriting

guidelines were followed that Wall Street adhered to taking a company Public.

After 1995, technology outperformed all other sectors, and .com service companies started performing better.

After around 65 years, Goldman Sachs created a reputation for attracting the smartest talent on the street.

It trained its executives to firms Mantra = “LONG TERM GREEDY”

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20121999 –

2001

Internet Age – Contd..Internet Age – Contd..Robert Rubin, Goldman’s Co-chairman

became the treasury Secretary of America.He was prototypical Goldman banker. Just as it did with “Investment Trust” in the

1920’s, Goldman started slow in this era and finished crazy in the Internet Years.

Major problem was Nobody told Investors that the rules had changed. “Everyone on the inside knew”.

Goldman has denied that it changed its underwriting standards during the Internet Years.

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20121999 –

2001

Internet Age – Contd..Internet Age – Contd..Goldman helped Yahoo, a little known

company with weak financials to go public in 1996.

Technology boom had begun.Goldman quickly became the IPO king of the

Internet Era. In 1999, Goldman at the height of boom,

took 47 companies public including etoys.com, and webvan.com

As leading Underwriter of internet stocks, goldman provided profits far more volatile than those of its competitors,.

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20121999 –

2001

Internet Age – Contd..Internet Age – Contd..

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Laddering Spinning

Manipulating the share prices of the new offerings

Process of bribery

Artificially jack up the new company's price which is of course was to bank's

benefit - 6% fee of $500 million IPO is a very serious money

Offering the executives of newly public company shares at extra-low prices, in

exchange of future underwriting business.

Goldman was repeatedly sued by shareholders for engaging in laddering in

IPO's.

Banks engaged in spinning would then undervalue the IPO, ensuring that hot

openings price shares it had handed out to insiders would be more likely to rise

quickly, supplying bigger first day rewards for chosen few.

Maier, a leading hedge fund manager termed Goldman as worst Perpetrator, as

goldman totally fueled the bubble.

Spinning of hot IPO shares was not a harmless corporate perk, instead it was an integral part of fraudulent scheme to win new investment banking business.

This led to the market crash, As they built these stocks upon an illegal

foundation, manipulated up.

 

Goldman paid $40 million for its laddering violations

 

Internet Age – Contd.. Internet Age – Contd.. Some $5 Trillion of wealth was wiped out on NASDAQ

alone. Major problem wasn’t money that was lost by

shareholders, it was money gained by investment bankers who received hefty bonuses.

Goldman paid $28.5 billions in compensation and benefits from 1999 to 2002.

Market was no longer a rationally managed place to grow real and profitable businesses. It was ocean of someone else’s money

Goldman paid $7 billion a year into salaries and $110 million fines.

After Internet Tech bubble, Goldman was ready with its new profit driven strategy, just for another bubble to inflate.

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20121999 –

2001

Abacus – The Housing Abacus – The Housing BoomBoom A legal entity registered in the “Cayman Islands” in 2005 Series of SCDO structured & marketed by Goldman Sachs Managed by the “Correlation Trading Desk” of Goldman Sachs

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What is “ABACUS 2007 – AC1”?What is “ABACUS 2007 – AC1”?

SCDO structured & marketed by Goldman Sachs in 2007

Consisted reference portfolio of 90 RMBS amounting to $2B (mostly sub-prime mortgages)

Who is Fabrice Tourre?Who is Fabrice Tourre?

1. 31 year old, Executive Director in Goldman Sachs

2. Part of the Correlation Trading Desk

3. Responsible for structuring & marketing of ABACUS

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Abacus – Players InvolvedAbacus – Players Involved• Goldman Sachs & Co:

A global investment banking & securities firm founded in 1869 Known for advisory service & proprietary trading

• Paulson & Co: Well known Hedge fund founded in 1994 by John A. Paulson Known for advisory service & proprietary trading

• ACA Management: Well known manager of Collateralized Debt Obligations Experience in analyzing Credit Risk in RMBS

• ACA Capital: Parent company of ACA Management Experience in under writing protection

• IKB Deutsche Industriebank AG: Bank based in Dusseldorf, Germany Specializes in lending to small & medium sized companies

• ABN Amro: Major European bank

• Security & Exchange Commission (SEC): Agency that acts as the primary enforcer of federal securities laws

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Abacus - Abacus - Residential Mortgage Residential Mortgage Backed SecuritiesBacked Securities

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1. Group of residential mortgages that banks package together

2. A type of security whose cash flows come from residential mortgages

3. Holders of an RMBS receive interest and principal payments from the residential debt

Bank:Packages securities into

RMBS

Bank:Packages securities into

RMBS

Homeowner

Homeowner

Homeowner

Homeowner

Homeowner

LoanLoan

Mortgage payment

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Abacus – Collateralized Debt Abacus – Collateralized Debt ObligationsObligations

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1. Holder Bank divides RMBS into tranches & sells to another party

2. Buyer pays initial principal to seller, accordingly to tranches

3. Buyer receives interest from cash flows

4. Seller receives principal from cash flows

5. Seller pays back principal to Buyer on maturity

Buyer Bank

Seller Bank

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RMBS:Packages

securities into tranches rated

by risk1

3 4

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Features of CDO–

1. A kind of bond / assets (RMBS)

2. One bank borrows money from another bank by selling it’s asset portfolio

3. Exchange of interest payment & the principle amount due on maturity

4. Value derived from underlying portfolio

5. CDO rely upon the cash flow generated from RMBS to pay the interest payments

Works exactly similar to normal CDO

Except that buyer doesn’t have to own any underlying assets

Mirror image / Replica of normal CDO

Operates through financial contract called “Credit Default Swaps”

Risk of loss on SCDO is divided into tranches just like normal CDOs

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Abacus – Credit Default Abacus – Credit Default SwapsSwaps

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• OTC traded “Derivative contract” (Kind of insurance policy)

• There are 2 sides, protection buyer & protection seller

• Each have a different perspectives on the reference CDO’s future performance

• Buyer of protection pays monthly premiums

• Performance is evaluated based on the underlying assets

SCDO:Debt security packaged in a

Special Purpose Vehicle

Reference CDO, based on

portfolio of RMBS

Protection Seller

Shorting the CDS in order to Long SCDO

Protection Buyer

Long CDS in order to short SCDO

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2

3Initial investment

Premiums

In credit event, the protection buyer

receives All sellers Money

Paulson & Co.* Goldman Sachs* ACA / ABN Amro

* IKB* ACA

Abacus - StructureAbacus - Structure

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Super Senior notes

Class - A notes

Equity Tranche

0%

9%

21%

45%

50%

100%

Paulson

CDS protection Buyer

CDS protection Seller

ACA/ABN Amro

Goldman Sachs

IKBACA

Lower-rated Notes

Abacus – Ethical IssuesAbacus – Ethical Issues Serving two clients on the opposite sides of the

same deal Goldman withheld the information from IKB about Paulson’s

significant involvement in selecting the securities in the ABACUS CDO.

GS provided wrong information to ACA that Paulson had long equity in CDO & represented that ACA was the sole “Portfolio Selection Agent” to investors.

Truth Telling & Transparency Goldman withholds a material fact in its marketing brochure

& does not inform its client verbally of the same fact.

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Abacus - ConclusionAbacus - Conclusion CDO failed due to Subprime market meltdown. Johan Paulson earn approx $ 1billion due to short sale. IKB lost approx $ 150 million. ACA Capital lost approx $ 900million GS lost approx 100million which was partially offset by $15million

fees which he received from Paulson. GS also charged by SEC worth $550 million for marketing

materials for the ABACUS transaction with incomplete information.

ABN AMRO has filed a case in SEC against Goldman Sachs

Bottom line, based on the information in this case study of the Goldman Sachs ABACUS case, Goldman Sachs acted unethically because:

1. The institution failed in its fiduciary duty to act in the best interest of its client.  It failed in this duty because it chose to be in a position where it was subject to conflicts of interest.

2. The institution was not honest.  It failed to disclose material information to its client, IBK and to its service provider, ACA.

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Thank YouThank You

We welcome Questions?

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