Putting the Gold in Goldman

As the stock market rallied, former Treasury Secretary Hank Paulson was busy explaining to the House Committee on Oversight and Government Reform how he coerced Bank of America CEO, Ken Lewis, to complete the purchase of Merrill Lynch last December.

Paulson explained how he “saved” Merrill Lynch. Left unsaid was how he destroyed the American system of free enterprise in the process. Paulson's testimony was alarming on at least three counts. First, he blatantly admitted to a form of coercion that closely resembles illegal intrusion into a private enterprise. Second, he offered his testimony as if it portrayed an honorable reaction to the credit crisis, rather than a dishonorable dereliction of his duties as Treasury Secretary. Third, no one seemed to care what crimes Hank Paulson may or may not have committed…as long as the stock market continued to rally.

In his own words, the law-bending former Treasury Secretary explained:“[S]ome have suggested that there was something inappropriate about my conversation of December 21st with [Bank of America CEO, Ken] Lewis in which I mentioned the possibility that the Federal Reserve could remove management and the board of Bank of America if the bank invoked the MAC clause [i.e., the material adverse condition clause to pull out of the Merrill takeover]. I believe my remarks to Mr. Lewis were appropriate. I explained to him that the government was supportive of Bank of America, but that it felt very strongly that if Bank of America exercised the MAC clause, such an action would show a colossal lack of judgment and would jeopardize Bank of America, Merrill Lynch, and the financial system. I further explained to him that, under such circumstances, the Federal Reserve could exercise its authority to remove management and the board of Bank of America. By referring to the Federal Reserve’s supervisory powers, I intended to deliver a str ong message reinforcing the view that had been consistently expressed by the Federal Reserve, as Bank of America’s regulator, and shared by the Treasury, that it would be unthinkable for Bank of America to take this destructive action for which there was no reasonable legal basis and which would show a lack of judgment.”

So there you have it. Lewis could have chosen either to abide by Hank Paulson's wishes or he could have chosen to "show a colossal lack of judgment” by pursuing a "destructive action for which there was no reasonable legal basis.” In other words, Paulson gave Lewis an offer he couldn't refuse: “Do what I say or be dismissed from Bank of America in disgrace.” Reading between the lines, it is not hard to imagine that Paulson’s threat also contained the implied threat of federal indictments and subpoenas, if Lewis failed to "play ball." Gee, sounds perfectly legal to us.

Meanwhile, back at the former Treasury Secretary's old stomping grounds, business continues as usual…or rather, as UN-usual. Despite the enormous volatility besetting all major financial markets during the last two years, Goldman Sachs has steadily increased its risk exposure, as measured by value-at-risk (VAR) – a widely utilized risk metric. VAR, as presented in Goldman’s quarterly reports, displays the firm’s probable maximum loss per trading day. During the recent quarter, Goldman’s daily VAR established a new record high for the firm of $245 million. One might have imagined that last fall's stock market collapse, coupled with the near-implosion of the financial system, would have reduced Goldman's appetite for risk just a smidge. But the VAR data tell the exact opposite story.Goldman upped its risk exposure, even while borrowing billions of dollars from the government. And by the way, Goldman's VAR did not merely increase in absolute terms, it also increased relative to the size of the company’s shareholder equity. In other words, no matter how you slice or dice the numbers, this swashbuckling financial firm has been ramping up its risk exposure.

This disturbing fact leads your California editor to ponder a couple of troubling thoughts:
Thought #1: Goldman's VAR data make all of us American taxpayers into complete stooges – utter patsies. Here we were, wringing our hands, listening to Wall Street's CEO’s tell us how urgently we needed to rescue the financial system, and watching Washington's elected (and unelected) officials dole out hundreds of billions of dollars to Wall Street firms.
But there THEY were, taking the bailout monies and taking the subsidized loans, in order to take advantage of the collective national desire to save our financial system. There THEY were INCREASING the balance sheet risks that landed us in this desperate situation in the first place!

Thought #2 (possibly related to Thought #1) Goldman’s new risks may not be as risky as they would appear. Here's why: Bear Stearns and Lehman Brothers are gone, while Bank of America/Merrill Lynch, Citigroup, AIG and many other financial firms remained hobbled by their crippled balance sheets. Thus, several of Goldman’s former competitors are in no condition to compete. Without competition, therefore, Goldman's stated risk exposure may not be as risky as it would appear.Is there a connection between Goldman's soaring VAR and its disappearing competitors? Maybe.

Looking back over the last 12 months, we are all left to wonder why the former Treasury Secretary enabled some financial firms to survive, forced others into the arms of unwilling saviors and allowed others to fall into bankruptcy. No immediately apparent logic seemed to guide these disparate responses. To be a struggling financial firm in 2008 was to be a wife of Henry VIII - divorced, beheaded, died, divorced, beheaded, survived.And since no immediately apparent logic seemed to guide these capricious responses, perhaps some clandestine - or nefarious - logic guided these responses.

AIG survived, for example, and it promptly paid millions of dollars to Goldman Sachs to settle counterparty transactions. Lehman Brothers, on the other hand, died. Lehman’s elimination from the marketplace as a competitor bestowed an immediate and direct benefit to Goldman Sachs. Hmmmm…. interesting. (And let’s not forget that the decision to let Lehman fail and to bailout AIG both emerged from the same closed-door meeting between Hank Paulson and various finance company CEO’s, including Goldman CEO, Lloyd Blankfein. We're not pointing fingers, just raising a very skeptical eyebrow).All of this is ancient history, of course. And a delightful history is. Goldman Sachs is now America's most prosperous financial firm and the stock market is about 2,000 points above the low it hit in early March. So maybe it's time for critical skeptics and skeptical critics - like your California editor - to keep his mouth shut and enjoy the fruits of government intervention.
Maybe. But we critical skeptics can't seem to shake off our nagging suspicion that these fruits are rotten to the core, and that the first delectable morsels of our apparent economic "recovery" merely conceal the diseased morsels in the center. Goldman Sachs is thriving. Main Street is still breaking down. To pretend otherwise is to embrace the sorts of delusions that usually produce large capital losses(Rude Awakening's Editor Eric Fry).