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Goldman sachs – a bubble making machine


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Abaucs, Internet Boom, The Great Depression

Abaucs, Internet Boom, The Great Depression

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  • 1. Goldman Sachs – A Bubble Making MachineDate :- 25th November 2012 1
  • 2. RoadmapGoldman Sachs HistoryBubble 1 – Great DepressionBubble 2 – Internet AgeBubble 3 – Abacus – Housing Boom 2
  • 3. Goldman Sachs - History  World’s most powerful Investment bank  Founded in 1869, and headquartered in the Lower Manhattan area of New York City  Founded by German immigrant named Marcus Goldman, with his son-in-law Samuel Sachs.  Its everywhere across Globe  Firm Provides M&A advice, Underwriting services, Asset Management and Prime Brokerage to its Clients1869 2012 3
  • 4. The Great Depression  Started in late 1920’s  Goldman 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”1869 2012 1928 - 1929 4
  • 5. Goldman Sachs 1928-29 GoldmanThey bought it all with its Sachs own money Issued 1 Million Shares @ $ 100 per share July 1929 Goldman Sachs Trading Co. 1928 7.2 Million Shares – 6.2 Shenandoah Blue Ridge Million Shares owned by Corp. Shenandoah mostly owned by GSTC. Public Sold common & Preferred Share to Public The sold 90% to Public at $ 104. 5
  • 6. The Great Depression – 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.1869 2012 1928 - 1929 6
  • 7. Internet Age – Technology Boom  After 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”1869 2012 1999 – 2001 7
  • 8. 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.1869 2012 1999 – 2001 8
  • 9. 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, and  As leading Underwriter of internet stocks, goldman provided profits far more volatile than those of its competitors,.1869 2012 1999 – 2001 9
  • 10. Internet Age – Contd.. Laddering SpinningManipulating the share prices of the new offerings Process of bribery Artificially jack up the new companys price which Offering the executives of newly public companyis of course was to banks benefit - 6% fee of $500 shares at extra-low prices, in exchange of future million IPO is a very serious money underwriting business.Goldman was repeatedly sued by shareholders for Banks engaged in spinning would then undervalue engaging in laddering in IPOs. 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 Spinning of hot IPO shares was not a harmlessGoldman as worst Perpetrator, as goldman totally corporate perk, instead it was an integral part of fueled the bubble. 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 10
  • 11. 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.1869 2012 1999 – 2001 11
  • 12. Abacus – The Housing Boom  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 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? 1. 31 year old, Executive Director in Goldman Sachs 2. Part of the Correlation Trading Desk 3. Responsible for structuring & marketing of ABACUS1869 2012 12 2007
  • 13. Abacus – 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 1869 2012 13 2007
  • 14. Abacus - Residential Mortgage Backed Securities1. Group of residential mortgages that banks package together2. A type of security whose cash flows come from residential mortgages3. Holders of an RMBS receive interest and principal payments from the residential debt Bank: Bank: Packages securities into RMBS Packages securities into RMBS Loan Loan Homeowner Homeowner Homeowner Homeowner Homeowner Mortgage payment1869 2012 2007 14
  • 15. Abacus – Collateralized Debt Obligations Features of CDO– 1. A kind of bond / assets (RMBS) 2. One bank borrows money from RMBS: another bank by selling it’s asset portfolio Packages securities into tranches rated 3. Exchange of interest payment & by risk the principle amount due on maturity 1 1 3 4 4. Value derived from underlying portfolio 2 Seller Bank 5. CDO rely upon the cash flowBuyer Bank 5 generated from RMBS to pay the interest payments 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 15
  • 16.  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 CDOs1869 2012 2007 16
  • 17. Abacus – Credit Default Swaps• 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 Reference CDO,• Performance is evaluated based on the underlying assets based on portfolio of RMBS SCDO: Debt security packaged in a Special Purpose Vehicle In credit event, the Initial 1 3 protection buyer investment receives All sellers Money Protection Seller Shorting the CDS in 2 Protection Buyer Long CDS in order to order to Premiums short SCDO Long SCDO * Goldman Sachs Paulson & Co. * ACA / ABN Amro * IKB * ACA 17
  • 18. Abacus - Structure CDS protection CDS protection Buyer Seller 100% ACA/ ABN Amro Super Senior notesPaulson 50% Goldman Sachs 45% IKB Class - A notes ACA 21% Lower-rated Notes 9% Equity Tranche 18 18 0%
  • 19. Abacus – 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.1869 2012 2007 19
  • 20. Abacus - 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.1869 2012 2007 20
  • 21. We welcome Questions?Thank You 21