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Thinking About The Government

Look out, Kid.  It's something you did.  God knows when, but you're doin' it again.
 - Bob Dylan, "Subterranean Homesick Blues"

Our colleague Todd Enders shared with us a recent Politico poll, accessible at

Todd spells out the survey's highlights as follows:

1) Obama is trusted by half-again as many Americans as any other public figure or entity.

2) American belief that the government is headed in the right direction has jumped from 34% to 54% in 3 months.

3) 61% of Americans believe regulation should be increased.

All we can say is - we told you so.   Killer double-whammy one-two punch.  The public overwhelmingly favors President Obama.  And the public overwhelmingly favors increased regulation in the financial markets.

The President is not out of the woods - indeed, we fear he may be dragged back into the woods.  But for the moment he is riding high, and those in favor of increased market regulation have been handed the Talking Stick.

For all the breathtaking irresponsibility and wanton partisanship of Pelosi & Co, the Republicans themselves are doing everything in their power to maintain President Obama's Teflon coating.  Let's face it, even at their worst, Pelosi, Frank, Dodd and Schumer - call them The Four Horsepersons of the Fiscal Apocalypse - are no match for the new face of the Republican Party: Rush Limbaugh.  Did we mention that political debate in this country has sunk to a sorry state? 

Oh, and what's the deal with accusing the President of "taking on too much"?  Those who believe President Obama should be limiting his scope have only to look at then-candidate McCain's gambit, putting the campaign on hold and heading back to Washington to deal with the fiscal emergency.  It did not do McCain credit as a candidate, and it would do Obama far less credit as President.  No, we urge President Obama - for whom we voted largely on the strength of his ability to handle complexity, as demonstrated in the management of his campaign - to keep moving forward on all fronts.  The job of a Chief Executive is to be in charge of everything at once.  

President Obama has so far pulled off the Regeanesque act of making the Geithner-Paulson-Goldman link not stick to him.  And all is well and good, as long as he still has that new-President smell.  We wonder what sequence of events will cause a significant portion of the public, in their new-found thirst for regulatory oversight and avoidance of conflict, to turn against him.

Clearly, we are in for some serious muscling-about on the regulatory front.  We told you so.

Item: The Wall Street Journal ran a story in its weekend Money and Investing section (11-12 April, "Investors Face Tough Duel When Fighting Brokers") describing the tribulations of retail customers trying to sue brokers over portfolio losses.  The article makes a couple of worthwhile points.  Private investors who deal with brokers are generally clueless about FINRA's arbitration process.  This often works against them, particularly by setting unrealistic expectations and overestimating their leverage to force a lucrative settlement.  Even when they win, investors often suffer through months - if not years - trying to collect their awards, only to see one-third of their proceeds taken off the top by their lawyers.  It is all around a nasty business.

Drawing on our years of experience, we believe that there are observable patterns in investor lawsuits.  The WSJ article says "With the market still off more than 40% from its peak in 2007, investors are examining how their portfolios ended up so filthy - and blaming brokers.  Through March 31, investors filed 1,264 arbitration cases with the Financial Industry Regulatory Authority, or Finra, up 114% from the year-earlier period."

As with many other social phenomena, the call to arms - here in the form of angry investors filing arbitrations and lawsuits - comes after the fact.  The financial services industry runs purely on emotion.  But whereas in dealing with the death of a loved one, there is a finality, investors continue to be tormented by the notion that their losses may reverse, if only they hold onto their positions. Dr. Kubler-Ross would have a field day applying the Five Stages of Grief to the psychology of the investor.  There is a psychological lag between Destruction and Revenge.  The recognition that lost money will not be recouped is also spurred by tax season, but we believe that a large blip in customer arbitration filings likely signals that we have passed the peak in market destruction.

Item: Other phenomena include President Obama's latest attempts to talk up the markets (Financial Times, 15 April, "Obama Hints at Hopes for Recovery"), perhaps an attempt to capitalize on his own great call on the market. 

Item: We hear from recruiters specializing in the compliance sector that things are turning up.  Folks we have not heard from in months are resurfacing.  Indeed, folks we have never heard from at all.  Something is in the air.  Alongside media reports and hopeful Presidential prognoses, there is the reality that Wall Street and the banks are going to be put under very real pressure, and that new programs launch best in hopeful times.  There will be far less traction if the nation feels we are staring down into the abyss, than if we feel we are at last clambering out.

But Obama & Co will have to work to find the handle in all this.  It will be no easy matter to balance the financial connections between the banks and the Democrats, with a popular - if not yet "populist" - push to force draconian regulation. 

Bush brought us Paulson.  But Obama gave us Geithner who, as President of the New York Fed, both supported and learned from Paulson.  It is something of a vanishing act for Obama and the Democrats to distance themselves from the excesses and lack of judgment of the Bush administration, when the Democrats voted for Paulson's TARP, and when Obama replaces Bush appointees with their own acolytes.

Obama is playing for very high stakes with Secretary Geithner.  One might take the position that walking Lloyd Blankfein into a room full of government officials, and letting him walk out with Goldman's AIG exposure paid off at one hundred cents on the dollar, is nothing more than the end of the process started under the Bush Administration, but that is a complicated argument and likely to be a tough sale.  As reported last September and October by the NY Times' Gretchen Morgenson, Blankfein was part of the group that met with Secretary Paulson in early September.  One of the results of that meeting was the decision to deliver the coup de grace to Goldman's ailing competitor, Lehman Brothers.  Another result was the decision to move heaven and earth to rescue AIG - which owed Goldman $12.6 billion.

Are we free of conflicts of interest yet?

Now Goldman is pandering to the public's lust for blood, with CEO Blankfein writing a resounding OpEd piece in the Financial Times (6 February, "Do Not Destroy the Essential Catalyst of Risk") in which he made all the right noises.  "Much of the past year has been deeply humbling for our industry. People are understandably angry and our industry has to account for its role in what has transpired... Financial institutions have an obligation to the broader financial system. We depend on a healthy, well-functioning system but we failed to raise enough questions about whether some of the trends and practices that had become commonplace really served the public's long-term interests."  The man sounds positively socially responsible.

Add to this his YouTube appearance, in which he did all but don sackcloth in his promise of future good citizenship.  What appears to be stacking up is the Obama Administration and Goldman Sachs on one side, and everybody else on the other.  We hope President Obama can walk this tightrope with his reputation intact.  John Gapper, commenting in the Financial Times (16 April, "Don't Set Goldman Free, Mr. Geithner") observes that, on the heels of Blankfein's criticism over Wall Street pay practices, "Goldman is still putting aside 50 percent of revenues - $4.7bn in the first quarter - for the bonus pool."

We have not examined Goldman's recent earnings release - of which more below - but we wonder whether this is characterized as a contingent liability, on the chance that the Government actually caps Goldman executives' compensation in 2009.  We would not take the other side of a bet against Goldman, regardless of who sits in the White House.

The wave of investor arbitrations is the signal: the public has come to terms with these losses and does not believe the markets will rebound.  The fact that this sentiment may, itself, prove to be a market bottom is not lost on us, but we do not make market calls.  We leave that to the President, and to our own CEO.  What we do foresee is a pending clash.

Driven to desperation by their losses, the public are starting to read newspapers, to analyze the business practices of the companies and sectors that have harmed them, and to demand full accountability and the undoing of conflicts of interest.  There will be a change in thinking.

We believe Goldman will get to pay back its TARP loans.  It is still a private enterprise, and it is financially sound.  (Indeed, as an advertisement for America, we wonder how many banks will actually come off looking all right when Secretary Geithner announces the results of the Stress Tests.  Would you buy a used financial sector from this man?)  Secretary Geithner has stated for the record that he does not want the government running financial institutions.  More to the point, among the very biggest beneficiaries of Wall Street financial contributions are Senator Schumer -  who, through his positions on the Senate Finance and Banking committees, is one of the nation's most important influences on Wall Street - and President Obama himself.

The upshot is likely to be a strengthened Goldman Sachs, and a damaged approval rating for the President.  Goldman, already romping on the carcasses of its one-time competitors, will remain untouchable.  Thus, in order to be seen to be doing their job, the regulators will have to beat up on other firms.  Which may explain the recent uptick in compliance hiring.

You don't need a weatherman to know which way the wind blows. 

Theories of Relativity

O brave new world, that hath such creatures in it!
 - Shakespeare, "The Tempest"

As we all remember from high school physics, Time is relative.  This has now been brought home forcefully by Goldman Sachs, which has recast Time in service of its own new place in the cosmos and in so doing appears to have rewritten reality.

NY Times chief business correspondent Floyd Norris, writing in his blog last week, took Goldman to task over their differentiating between the $10 billion advanced to them under TARP - which they are chomping at the bit to unload - and "the $19.5 billion it borrowed in the credit markets with a guarantee from the federal government... A spokesman tells me it has no plans to pay that back early," writes Norris.

Note that, unlike the TARP cash, federal backstopping came with no conditions.

In discussing Goldman's earnings, Norris digs into Goldman's reporting their first quarter on a January-March calendar basis - a change from their traditional November fiscal year end.  The Goldman spokesman told Norris "that the change in fiscal year was required when it converted to a bank holding company. The bank regulators did not, however, force Goldman to avoid any mention of the December orphan month in the text of its earnings release, instead relegating it to a table deep in the announcement."

Writing in the WSJ blog Deal Journal (14 April), Heidi Moore gets up close and personal with Goldman's latest earnings report.

According to Moore, one had to be alert and "checking the news last night after the market closed, when Goldman made a surprise announcement of its first-quarter earnings and cancelled its previously scheduled 11 a.m. analyst call..."

Instead, Goldman's CFO David Viniar hosted the quarterly earnings call at 7 AM the following morning, prompting the following exchange with star banking analyst Meredith Whitney:

Meredith Whitney: Good morning. Too early this morning.
David Viniar: Sorry, Meredith.
Meredith Whitney: I'm back on caffeine.

The medical condition known as caffeinism probably strikes more Wall Streeters than goes recorded.  We urge Meredith to look into whether her insurance carrier has a provision for the condition.  Of course, now that she is running her own shop, she will likely not qualify for workmen's comp.

Quoting further from Ms. Moore's piece - and grateful that she was both alert to the news and awake for the dialogue - we see the following examples of Goldman's own Theory of Relativity.

Optimism ahoy: CFO David Viniar noted, "Our economists are, I would say, more optimistic or less pessimistic than they've been about the outlook for the economies going into the second half of the year, so that gives us some cause for optimism, but we're still in a difficult economic environment and that's what makes us cautious."

We note that "more optimistic" and "less pessimistic" occupy the same location on the continuum, the only difference being one's angle of approach.

Quoting from Moore's blog again:
"Later, Viniar commented on the deal pipeline for Goldman:
So I think over the last several weeks, you've already started to see a pretty big pick up in capital markets activities... if the equity markets hold, given the need many companies have for equity, I think you'll see a pretty big pick up in capital markets activity."

This translates as: If things get better, they ought to get better.

Finally, one would think that an entity of the size, scope, and influence of Goldman Sachs (clearly Too Big To Fail) would, as part of the TARP terms, be required to report two sets of earnings figures - one, according to its old fiscal year, and one corresponding to its new accounting.  One would also expect them to state clearly any and all changes to their accounting practices, as a result of their converting to a bank holding company.  Instead, writes Moore, "It's like December never happened: In its 10-K in January, Goldman Sachs told investors that it would move its fiscal year-end from November to December, which erased the entire month between Nov. 29 and Dec. 26 from the firm's financial record. CFO David Viniar did, however, lay out the carnage that took place in December, when Goldman would have booked a $1.3 billion pre-tax loss."

CFO Viniar did give an explanation of December's numbers ("December net revenues were $183 million. Net earnings were negative $780 million..."), but we are not aware of anyone having gotten a clear statement from Goldman as to what year end (November) and first quarter (February) would have looked like under their old structure, and where the palpable differences lie.

Goldman's surge in profitability should come as no surprise, and the latest positive results from Goldman's compadres such as Citi, were telegraphed in a case of what our CEO Keith McCullough calls publicly available inside information.  The financial press ran a series of front page articles predicting big earnings lifts as a result of trading for customers.  See, for example, the Financial Times (5 April, "Trading for Clients Lifts Bank Revenues") telling us "A number of US banks said last month they had enjoyed a good start to the year in comments that have helped lift sentiment towards the sector."

Trading spreads, which had narrowed to the barest limits of profitability during the boom years, have now loosened dramatically.  "Now, according to a report from Morgan Stanley-Oliver Wyman, bid-offer spreads and margins in some markets are up 50-300 per cent from last year."

This means that the Goldmans, Citis and Morgans of the world have been raking it in by matching their customer orders in-house and pocketing the spreads.  This was the business model created and exploited so successfully by Bernie Madoff - when he actually had a business.  He had to pay folks for their order flow.  Goldman does not.

Sharp pencil types out there take note: Morgan Stanley also converted from a November year to a calendar year, in keeping with its new reporting responsibilities as a bank holding company.  Stay tuned as they prepare to report earnings this week. 

Quoting from the FT story, "Simplicity is in," says Fred Brettschneider, head of global markets for the Americas at Deutsche Bank. "It's a most favourable trading environment for liquid products."

Indeed, paying yourself out of your customers' own money is, as Bernie might have said, simplicity itself.

The Lehmanator

Finally, the ultimate in toxic assets.

Lehman Brothers is holding some 500,000 pounds of yellowcake, enough unprocessed uranium-oxide concentrate to make a nuclear bomb. 

According to Bloomberg (14 April, "Lehman Sits on Bomb of Uranium Cake as Prices Slump") uranium prices have declined steadily since last year, partly over concerns that Lehman might be forced to sell its holdings.

But Lehman says they are holding and will sell "when the market improves."  How long can they hold out?  There is always the possibility that Goldman may bid for it - say, if Geithner balks at letting them off the hook for the TARP terms.  Otherwise, uranium has a half-life of almost 4.5 billion years.  Presumably the markets will be in better shape before then.

Moshe Silver
Chief Compliance Officer