THE CASE AGAINST GOLDMAN SACHS
By Matt Pitzer
April 21, 2010
"Woe be to the man who bets against Goldman." -- W.D. Allen, February 23, 2010
This report is different from the analysis we have done thus far in Investment
Fund Management. Instead of an in-depth financial analysis, I have analyzed Goldman
Sachs' current non-financial situation and reached a recommendation.
Earlier in the semester, Bradley Kast prepared an outstanding analysis of the
firm's financials and justifiably concluded that we should retain our holding of 150
shares. In his report, Bradley suggested that Goldman's stock could reach $200 by the end
of 2010 because of its strong performance. On April 15, the day before the SEC said it
was pursuing a fraud case against Goldman, the stock closed at $184.27.
Also, on April 20, 2010, Goldman reported first-quarter profits of $5.59 a share,
or $3.3 billion, the company’s second-most profitable quarter ever. Goldman
unquestionably remains a source of immense profits. This analysis, however, is not
focused on the financial acumen of the company.
I believe we should sell our position in Goldman Sachs because the company has
engaged in a series of unethical and immoral practices leading up to and in the aftermath
of the financial crisis. Goldman has been at the center of many of the untoward practices
which have come to light as the crisis has unfolded. While these acts perhaps are not
illegal, Goldman has a demonstrated track record of pushing the envelope of acceptable
financial practices. As the vehicle of an institution that teaches and nurtures future
business leaders, the Mizzou Investment Fund has an obligation to invest in highly ethical
and moral companies, regardless of the financial consequences. Therefore, the fund
should divest itself from Goldman Sachs.
Founded in 1869, Goldman Sachs has a long history of its senior executives
landing coveted, powerful government positions, so much so that it has earned the
nickname, “Government Sachs.” It also has risen to the top of the heap of Wall Street
banks. Its jobs are some of the most coveted in the industry and its influence is felt in
seemingly every major deal. It has emerged from the financial crisis with a dominant
position in the industry.
Goldman Sachs also has a long history of testing the boundaries. Dating to 1928,
its Goldman Sachs Trading Corp., a closed-end mutual fund that had aspects of a Ponzi
scheme, collapsed during the 1929 market crash, lost huge amounts of money for its
investors and tarnished the company's reputation (Fox, 2005). Since then, its trading
acumen has made the company enormous sums of money, making it a very profitable
investment. Goldman's stock has approximately doubled over the past 10 years; the S&P
500 is down about 17% in the same time.
Recently, the string of Goldman executives moving into important government
positions has been significant. On one hand, this is the recognition of the company's great
success. Who better to run important government institutions than people who minted
such huge profits? On the other hand, when issues of public policy and taxpayer interest
are introduced, the question becomes more complicated. Where does effective policy end
and aggressive protection of self-interests begin?
Stephen Friedman was Goldman's chief operating officer, co-chairman and sole
chairman between 1987 and 1994. In January 2008, he joined the board of the New York
Fed and became chairman. During the time that the New York Fed helped coordinate the
federal government's aggressive response to the financial crisis and negotiated the AIG
bailout, Friedman sat on the boards of both Goldman and the New York Fed. At the
height of the crisis, in December 2008, Friedman bought about $3 million of Goldman
stock. It has since roughly doubled in value (Kelly and Hilsenrath, 2009).
Friedman's co-chair at Goldman was Robert Rubin, who later was Treasury
Secretary in the Clinton Administration from January 1995-July 1999. By one account,
Rubin was the "most Wall Street-friendly Treasury Secretary ever." (Salmon, 2009).
Rubin then was Chairman of Citigroup from November 2007 to January 2009.
Citigroup's stock price dropped by nearly 82% during that time.
The most noteworthy former Goldman chair and chief executive officer is Henry
Paulson, who left Goldman in June 2006 when he was named Treasury Secretary, a
position he served until the end of George W. Bush's administration in January 2009.
Paulson's accomplishments included passage of the now infamous $700 billion financial
bailout plan, the death without public assistance of Lehman Brothers, one of Goldman's
key rivals, and the bailout of AIG, of which Goldman was the largest beneficiary
Mario Draghi, the current head of the Italian central bank, is a former Goldman
managing director in Europe. That post came after a stint as director of the Italian
Treasury, and Draghi has been mentioned as a potential successor to European Central
Bank president Jean-Claude Trichet when Trichet steps down in 2011. To run the $700
billion bailout fund, Paulson picked Neel Kashkari, another Goldman alum. Also, Marc
Patterson, a registered Goldman lobbyist as recently as 2008, is chief of staff to Treasury
Secretary Timothy Geithner (Rood and Schwartz, 2009).
Goldman's most recent public relations crisis began on Friday, April 16, 2010
when the SEC announced it would charge Goldman in a civil fraud case. According to
the SEC's claim, Goldman sold a package of mortgage-backed securities that it knew
would go bad, while simultaneously positioning itself to profit handsomely when those
securities did, in fact, go bad.
The final repercussions of the case will not be known for a long time, perhaps
years. If the case causes partners and investors to lose faith in Goldman, then the firm
could suffer material financial damage. To understand the potential scope of the case,
consider that British prime minister Gordon Brown - in the middle of an election
campaign - said he is shocked by the firm's "moral bankruptcy" (Goldman Sachs, 2010).
But this is not the first time Goldman has been in the ethical spotlight because of
its actions in recent years. Goldman was a central player in the events that led to the
collapse of AIG and subsequent $180 billion backing by the government. One reason
AIG collapsed was because it was unable to meet collateral payments on credit default
swaps it sold. AIG tried to negotiate lower payments with Goldman after it was obvious
AIG could not meet all of its obligations (Sorkin, 2009). What if Goldman refused to
lower its demands knowing it had friends in important government positions who would
back-stop those positions if necessary?
Indeed, after the AIG bailout, Goldman had nearly $6 billion in securities that it
already had marked down. It sold them to a government backed entity for full par value
(Sorkin, 2009). Had AIG failed, those securities could have been worthless.
Nor would the events related to the current SEC case be the first time Goldman
has been accused of betting against its own clients. In January, a Goldman executive
admitted that company provided investment advice that it already had traded on, or had
sometimes traded against, a practice that a Dartmouth finance professor called "laden
with conflicts of interest" (Sorkin, 2010). In that email, Goldman made it clear that it
prized its own trading profits ahead of advice it provided clients.
In one sense, we should not be surprised that Goldman was doing all of this
trading seemingly against its own advice. In a little-noticed article published on
Christmas Eve, The New York Times described in detail how Goldman - as well as other
companies - packaged these financial instruments and then bet against them (Morgenson
and Story, 2009). That piece specifically introduced the idea that banks knowingly
selected securities it believed were likely to default and then profited when those
securities did indeed default.
Goldman also got itself in the middle of the looming Greek debt crisis. Goldman
arranged about $1 billion in off-balance-sheet debt for Greece through a series of
currency swaps (Torres, 2010). Those swaps, while completely legal, helped hide
Greece's true amount of debt, leading future creditors to accept deals they might not
otherwise have if they knew Greece's true situation. The rub comes from reports that
Goldman also bought credit default swaps on Greece's debt, positioning itself to profit
handsomely should Greece in fact default. Goldman would have been in a unique
position to understand the true likelihood of a Greek default.
Another particularly questionable ethical situation was exposed just before the
SEC case when a member of Goldman's board, Rajat Gupta, was linked to the
widespread insider trading case against Galleon Group founder Raj Rajaratnam (Pulliam,
2010). According to this claim, the government is looking into what Gupta told Galleon
about Goldman's stock between June 2008 and October 2008, the height of the financial
crisis and a period that saw massive volatility in the share prices of many financial firms.
Finally, it is important to note that Goldman Sachs was aware for months that the
SEC was investigating a case against it. Goldman refused to disclose a Wells Notice had
been filed against it sometime in the past six months. The government uses the notices to
indicate the likelihood that it will file an enforcement action against a company.
Companies have no obligation to disclose such notices, but many publicly traded
companies do and such disclosure is viewed as a sign of forthright communication to the
market (Goldstein and Eder, 2010).
The preceding evidence suggests Goldman Sachs has a long-term, institutional
trend toward pushing the boundaries of what is proper and acceptable, even in the cut-
throat investment banking business. Goldman appears to have been the most aggressive
firm in this regard. I believe it to be in the best interests of the Mizzou Investment Fund
to no longer invest in Goldman until it raises its ethical standards to a level at which the
University of Missouri would be proud to be associated.
I am under no pretense that Goldman is the only firm who engages in borderline
questionable behavior, and the ongoing SEC investigation might yet embroil other top
financial companies. The string of evidence related to Goldman, however, is too great to
ignore. And when the players involved reach into the corporate boardroom and may even,
in fact, include some of the company's most senior executives, it is clear to me that
Goldman has become an ethically corrupt firm.
The reasons for this likely are many and complicated, but they do not matter in
the end. Despite its recent history as one of the top performing financial institutions --
indeed, one of the top firms in any industry -- I no longer believe our fund's best interests
are served by owning it.
I am not comfortable with a company that believes it is not obligated to disclose
to its shareholders that it could be subject to an SEC investigation. Even though Goldman
did not have a legal obligation to reveal it had been served a Wells Notice (or subpoenas
prior to that), it had an ethical obligation to do so. The immediate market reaction to the
SEC news proves that this was a material event that was not disclosed. I believe that
companies should exercise an abundance of caution in ethical and moral territory. It is
clear that the current Goldman regime has no intention of doing so.
I also believe that Goldman is emboldened by the placement of its former
executives in powerful public positions. How would the company have acted had its
former CEO not been in charge of the federal bailout program? The question is
impossible to answer, but a logical inference is that Goldman was not as worried about
being pushed into bankruptcy as, for example, Lehman Brothers might have been. That
allowed Goldman to be more aggressive and take additional risk, ultimately resulting in
greater taxpayer expense, than a more responsible firm would have.
These mammoth federal bailout decisions are being made by people who have a
reason to expect substantial future financial gain from doing things in Goldman's best
interests -- and who have many friends who likewise stand to profit considerably.
Last week, Howard Jacobson told us that he would not invest in companies that
he believed to have questionable ethics or morals because sooner or later, that firm would
trip on itself and sustain financial damage. That might have happened already last week
with Goldman. (It lost more than $12 billion in market cap value on the day of the SEC
announcement.) But the biggest damages might yet be ahead, either in legal cases or in
loss of customer and investor confidence. Therefore, it also could be in the fund's
financial interests to sell the holding.
Based on past results, that is a hard sell. And the SEC announcement could have
been the low point for Goldman. Perhaps the company stays on the straight and narrow
from here on, reacquires the trust of all customers and investors and continues to mint
gigantic profits. Consider, however, the five-year chart of Goldman's performance vs. J.P.
It is awfully easy for me to be self-righteous with somebody else's money. If
Goldman's stock goes on to double over the next six months, I will not be out any money.
But in addition to bottom-line success, we need to consider our standing as an institution
of higher education. Is the modest gain of Goldman over J.P. Morgan of the past five
years worth the potential ethical headache of owning Goldman?
Further, as an educational institution, we should impose on ourselves a duty to
invest in companies that practice high ethical standards, or at least do not have
questionable ones, to set an example as the types of business leaders we aspire to. As we
have said many times in this course, there are a lot of stocks out there. Why mess around
with one that dances up to the line of what is acceptable?
I did not perform a rigorous analysis of any competing firms if we wish to move
our money out of Goldman. Perhaps that can be a goal for one of the remaining reports if
we wish to maintain exposure to the big banks. I believe that J.P. Morgan, Morgan
Stanley and Wells Fargo would provide similar exposure, although each of those firms
has its own particular differences. (Disclosure: I own a position in J.P. Morgan stock.)
The preponderance of evidence indicates Goldman Sachs is no longer acting in
the best interests of its shareholders. While the financial impact of that might not be felt
for a long time, if ever, the fund should mitigate any such risk and sell its position in
Fox, J. (2005, May 16). Goldman: We Run Wall Street. Fortune. Retrieved from:
Kelly, K. and Hilsenrath, J. (2009, May 4). New York Fed Chairman's Ties to Goldman
Raise Questions. The Wall Street Journal. Retrieved from:
Goldman Sachs Fraud Charges Could Herald the Beginning of Years of Legal Action.
(2010, April 19). The Daily Mail (U.K.). Retrieved from:
Goldstein, M. and Eder, S. (2010, April 16). Goldman Knew for Months Charges Were
Possible. Reuters. Retrieved from:
Mandel, M. (2009, March 3). German and French Banks Got $36 Billion From AIG
Bailout. BusinessWeek. Retrieved from:
Morgenson, G. and Story, L. (2009, December 24). Banks That Bundled Bad Debt Also
Bet Against It. The New York Times. Retrieved from:
Pulliam, S. (2010, April 15). Goldman Director to Step Down. The Wall Street Journal.
Retrieved from: http://www.businessweek.com/news/2010-02-26/bernanke-says-fed-
Rood, J. and Schwartz, E. (2009, January 27). Another Lobbyist Heads into Obama
Administration. ABCNews.com. Retrieved from:
Salmon, F. (2009, November 4). A Brief History of Goldman Sachs heads. Reuters.
Retrieved from: http://blogs.reuters.com/felix-salmon/2009/11/04/a-brief-history-of-
Sorkin, Andrew Ross. (2010, January 12). Goldman E-Mail Message Lays Bare Conflicts
in Trading. The New York Times. Retrieved from:
Sorkin, Andrew Ross. (2009, March 20). Goldman Maintains It Had No A.I.G. Exposure.
The New York Times. Retrived from:
Torres, C. (2010, February 26). Bernanke Says Fed Reviewing Goldman Sachs-Greece
Contracts. BusinessWeek. Retrieved from: http://www.businessweek.com/news/2010-02-