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Nathan Lewis

Nathan Lewis

Posted: August 1, 2009 11:28 AM

The GS-Files 3: Heads We Win, Tails You Lose


You may have heard that Goldman Sachs is "a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money," as Matt Taibbi put it recently.

This is true, but just calling names doesn't accomplish much. We continue here with our preliminary investigations of how financial Vampire Squids operate.

Last week, we were looking at how the likes of Goldman Sachs (I say "the likes of" because there are others) manages to stuff the U.S. taxpayer, and taxpayers of other countries too, with its losses.

To that we can add the now-infamous $13 billion freebie that Goldman got via the $189 billion AIG "bailout." Of course, AIG itself was not bailed out. It is in government receivership, which is more-or-less the same as Chapter 11 bankruptcy. Usually, when you have an agreement with a company that can't pay you, you don't get paid. This is very basic capitalism-type stuff. Also, you probably heard that Goldman got paid "100 cents" on its CDS insurance contracts with AIG. This is more -- maybe several multiples more -- than they should have been paid, even if AIG was able to pay. Most of AIG's CDS-writing was actually on AAA-rated "super senior" structures, where a 100% loss is basically impossible, and even a 30% loss would be extreme. (This is again the sort of thing that nobody would have learned about if not for the bloggers. Stealing is getting more difficult for the Goldman types.)

Remember that Goldman has about $50 billion in capital, which it levers into $500 billion of assets. So, a $13 billion hit alone would have meant a very serious blow, possibly enough to put the company in crisis.

A typical modus operandi is not to "bail out" the bankers directly, but to bail out the ones that owe the bankers money. AIG is one case of this, but it applies also to Joe Homeowner. Let's say you owe a banker $250,000, but you can't pay. The government then swoops in and "saves you." They loan you $250,000, maybe with some sort of modified easy terms. The banker gets 100% of his money back. No losses for Mr. Banker. And you? Your situation hasn't changed. You weren't actually "bailed out" at all. You still have a $250,000 debt, which you still can't pay. However, instead of not paying the banker, now you don't pay the government.

Many of the recent "mortgage modification"-type programs around these days are variants on this theme. They are packaged to sound like they are helping the small homeowner, but they are really a way to make bankers whole. Usually, the homeowner would be better off just to walk away from the property.

Barry Ritholz of The Big Picture described one such program in detail last year. In this program, the bank holding a busted mortgage would take a 10% loss, and foist the rest on the taxpayer. This was much better than taking a 50%+ loss common for a foreclosure at the time.

The Big Picture on an early banker scam

This particular bill was not passed, but it is a good example of the typical strategy of bankers looking to stuff the taxpayer with their losses. We can be sure that the bankers will try over and over to pass something of this sort. Not only for homeowners either, but also for busted commercial real estate operators and corporations.

As of June 2009, Fannie Mae and Freddie Mac have restarted 125% loan-to-value refinance mortgages. This is rather unusual coming from companies that always specialized in LTV no higher than 80%, without independent mortgage insurance which is now largely unobtainable. Remember, every time there is a refi into a now-government-guaranteed GSE loan, that means the previous lender gets paid back 100%. Which is pretty nice considering the borrower is underwater and needs a refi. You, dear taxpayer, get to eat the loss that the banker would have taken. And the homeowner? They still owe just as much money as before, although the lending terms might be marginally better. Some bailout. Many would probably be better off just walking away from the property.

The taxpayer has already given Fannie and Freddie $85 billion to cover their various losses, to which has been added an additional $200 billion commitment by the U.S. Treasury. Not the last, I'd wager.

Calculated Risk: GSEs Unlikely to Repay Bailout

Many commercial real estate owners are suffering similar problems. The Federal Reserve, as of May 2009, now allows new and legacy CMBS to be used as collateral in the TALF program. Translation: if you have a commercial real estate loan, you can dump it on the Fed's trashpile and get nice, clean cash in return. Or, if your borrower is in trouble, you can make a new loan and dump it on the Fed. The Fed claims this is not the purpose of the program, and that it takes only highest-quality loans. But, maybe you've noticed how hard the Fed is fighting pressure for an independent audit -- which might reveal how trashy the Fed's trashpile is.

S&P hinted at the answer when it downgraded certain CMBS tranches from AAA all the way down to BBB- on July 14 -- then, on July 22, upgraded the same debt all the way back up to AAA. I wonder why they did that.

ZeroHedge: S&P Flip-Flops on CMBS Rating

Theoretically, the banks will have to take their trash back from the Fed at some point, but it might be at a time when they can comfortably offset it with current profits, or when they've been able to get the politicians to set up a program whereby the government will take the ultimate loss. Possibly the Fed might even make things better with more of their printed money.

Then, there is the plain old beat-them-on-the-head-and-take-their-money-when-nobody's-looking strategy. In September 2008, Rob Kirby noticed something very strange happening with the bankruptcy of Lehman Brothers. In a transaction that was noted only in Lehman Brothers' bankruptcy court legal documents, the Federal Reserve advanced JP Morgan $138 billion "to settle securities transactions" with Lehman Brothers. Kirby believes that, in the bankruptcy, JP Morgan dumped an enormous pile of trash on Lehman's books, and got a $138 billion "reload" direct from the Fed.

Rob Kirby: JP Morgan's Reload.

In Kirby's words:

It is highly likely [or a certainty on my planet] that J.P. Morgan was insolvent and was "bailed out" last Monday, September 15, to the tune of 138 billion dollars. This would explain why the Fed and Treasury dictated that Lehman fail -- to disguise or otherwise obfuscate the recapitalization of or illicit transfer of 138 billion to a much sicker, teetering entity, J.P. Morgan Chase.

The Lehman bankruptcy is curious because the bondholders got only 8.625 cents on the dollar -- a very low figure compared to initial estimates of about 60 to 80 cents. That would make sense if Lehman was used as a dumping ground for other bankers' failures. It would also suggest why Lehman was allowed to go bust in the first place -- Goldman and JP Morgan needed a dumpster to dump their losses, and receive fresh, clean cash from the Fed in return.

Reuters: Lehman Debt Expected To Get 60-80 Cents On Dollar

Marketwatch: Lehman Bond Auction Prices At 8.625 Cents

The losers, of course, would be the Lehman bondholders -- pension funds, mutual funds, individuals, honest bankers, and others not in the inner circle of Vampire Squids.

JP Morgan is the world's largest CDS dealer, so it is possible that some of this $138 billion ended up in Goldman's pocket, as JP Morgan paid off its CDS liabilities to Goldman.

The only reason we even know about this transaction is that someone managed to find it. Have there been others that we don't know about? Probably. These things are like cockroaches. If you see one, there are probably ten, twenty, or a hundred. Obviously it was very effective, which probably means it will be done, or has been done, over and over again.

Disclosure: the author has a short position in Goldman Sachs (GS)