08/27/2009 05:12 am ET Updated May 25, 2011

Why Goldman Still Owes Us

Goldman has given some cash back, but it's chump change for a company that's benefited from close ties to the Fed for more than 15 years, Marshall Auerback argues at NewDeal2.0

Give Lloyd Blankfein some credit. After weeks of being raked over the coals, Goldman Sachs became the first major bank to repay the warrants held by the US Treasury. Best of all, they did so at the price demanded by the Treasury (in contrast to JP Morgan and its supposedly politically astute boss, Jamie Dimon), accompanied by a seemingly heart-felt thank-you. In the words of Lucas van Praag, a Goldman Sachs spokesman, "We're grateful to the government for the extraordinary steps taken to stabilize the financial system, and have always maintained it was appropriate that taxpayers should receive a significant return on their investment."

You're welcome, Lucas. Applause for getting something right, although it took a while to get there: your employer's first offer for the repayment of the warrants was a paltry $400m. This might seem like a lot until one considers that the warrants were highly profitable, given the recent sharp run-up in Goldman's stock price. The warrants carry the right (but not the obligation) to buy 12.2 million Goldman Sachs shares at $122.90 each. Goldman's closing price of $165.45 (as of July 23rd) put the warrants "in the money" by a bit over $400 million. But after a bang-up quarterly earnings result, it looks like Goldman decided that an additional $700m was a price well worth paying to eliminate the now widespread perception that they are public enemy number one.

Even so, let's not for a moment kid ourselves and suggest (as the Financial Times did the other day) that the group has now "shake[n] off the last vestige of its participation in the government bail-out programme after just nine months."

This is likely to be the prevailing spin going forward, but the reality is that virtually all of the banks, including Goldman, remain wards of the state in one form or another. As Yves Smith pointed out, Goldman most assuredly has not paid back the FDIC borrowings, nor reimbursed the AIG collateral postings, and that's before we get to the hard-to-calculate but very real benefit of super-low funding costs and low credit spreads engineered by the Fed. It would be interesting to see the impact on Goldman's share price if the government were to announce tomorrow that it would be withdrawing all FDIC guarantees for Goldman's debt.

Recall that in the dark days of the autumn of 2008, Goldman Sachs's credit default swaps were trading at 600. This gives some indication about what the markets were thinking about the bank's future (or lack of it). The credit default swaps are now marginally over 100.

What happened? Well, for one thing, the US taxpayer, via the FDIC, offered to guarantee Goldman's paper, in effect saving billions in interest charges over 3 years with no payback to the US taxpayer for such munificence. The bank's earnings have also been unduly flattered by an AIG related payout, a highly dubious transaction which came about in spite of claims by the bank that they were 'hedged' against any possible credit loss from their credit default swaps with AIG and yet appear to have collected twice over, courtesy of the taxpayer.

And, incidentally, the bank also indicated said they were going to increase their leverage again.

What about banking minimum rules; why is GS allowed to exceed the normal 10-12 to 1 leverage? Wasn't the whole quid pro quo for allowing them access to the Fed's various new lending programs and FDIC guarantees an understanding that GS would play by the same rules as every other commercial bank? No such luck: Goldman continues to play by its own rules, exploiting an environment in which most of its major competition has been eliminated. Recall that this came courtesy of some capricious decisions by former US Treasury Secretary (and ex Goldman CEO) Hank Paulson, then NY Fed President Timothy Geithner, and Ben Bernanke, all of whom refused to bail out Bear Stearns or Lehman, yet offered a lifeboat to Goldman. (This episode in particular is symptomatic of the incestuous ties between Goldman Sachs, the Federal Reserve Bank of New York, and the Treasury department over the past sixteen years.)

Contrast this with the behavior of Morgan Stanley, whose "conservative practices" (in the words of the Wall Street Journal) are implicitly criticized by the Journal because they appear to recognize that they have some responsibility to the taxpayer not to act like reckless gunslingers going forward in a manner which again puts the entire financial system at risk. Well, the message has clearly been received: Morgan Stanley now plans to rev up its risk-taking, which it has been averse to doing since the company came close to perishing or being forced into a government-assisted takeover last fall, according to CEO John Mack.

Of course, this sense of entitlement is nothing new for "Government Sachs." If you have a copy of this book on the shelf, pull out Roger Lowenstein's superb account of the LTCM crisis, When Genius Failed. The final chapter on the negotiations themselves is very revealing ("At the Fed"). Here we are having a systemic crisis, yet Goldman gets its attorney, in a crucial negotiating role, to cut the deal to favor Goldman. It is simply breathtaking. They know exactly how to find leverage (no pun intended) and exploit it, and are frighteningly adept in negotiating strategy (as to what issues to run through what channels).

These are all important things to bear in mind, the next time you hear spin from the mainstream press suggesting that Goldman Sachs has become a model financial citizen. Plus ca change.

Roosevelt Institute Braintruster Marshall Auerback is a contributor to NewDeal2.0 and a market analyst and commentator.