Goldman Sachs reacts to its critics, which include Gordon Brown...
The waste hit the air-conditioning last Friday at about 3.30pm, when world stock markets started to fall. This followed an announcement from US financial watchdog the Securities and Exchange Commission (SEC) that it had charged elite investment bank Goldman Sachs and one of its vice-presidents with civil fraud.
Goldman takes a bath
Of course, this lawsuit caused Goldman's shares to fall off a cliff; on Friday, they closed down 13% at $160.50. However, this potential liability now seems to be priced in, as the shares look to fall only slightly on Monday.
Nevertheless, this news shocked world markets and caused the S&P 500 Financials Index to slide 4% on Friday, with every constituent of this index closing down.
Apparently, the SEC has been probing the world's most admired (and hated) investment bank for 20 months, but Goldman categorically denied any wrongdoing in September 2009. Clearly wound up, the regulator chose to issue legal charges, rather than negotiate a settlement.
On Friday, Goldman issued an aggressive rebuttal of the SEC's claims, arguing that it lost $75 million on the ABACUS 2007-AC1 collateralised debt obligation (CDO) deal. Hence, there was no incentive or intent for the bank to issue a 'designed to fail' CDO.
As you'd expect, news of potential conflicts of interest at Goldman brought the bank-bashers out en masse. For example, Gordon Brown accused the investment bank of 'moral bankruptcy' in its dealings with its clients. Also, Brown urged the Financial Services Authority to launch a similar enquiry into banking excesses during the credit bubble.
One of the three investors in the collapsed CDO was German bank IKB Deutsche Industriebank (IKB), which was bailed out by the German government after becoming an early victim of the credit crunch. Hence, the German government is considering legal action to recover the $150 million IKB lost.
Likewise, the UK government may take action to recover the $850 million Royal Bank of Scotland (LSE: RBS) lost by investing in the failed CDO.
Buffett: Oh no, not again!
One person who must be fuming is investment guru Warren Buffett. The billionaire's firm, Berkshire Hathaway, put more than $5 billion into Goldman Sachs in September 2008, in the aftermath of the collapse of Lehman Brothers.
The 'Oracle of Omaha' owns $5 billion of perpetual preferred shares in Goldman which pay a coupon of 10%. In addition, he has 43.5 million warrants to buy further shares at $115 a share. On paper, Buffett looks to have lost a cool billion dollars on Friday. However, his preferred shares and warrants are less volatile than Goldman's common stock, so his likely loss is sure to be much lower (one estimate is $120 million).
Nevertheless, the world's greatest investor is unlikely to be too happy, because he's been embarrassed before, both personally and financially, by Wall Street scandals.
In September 1987, Buffett's firm Berkshire Hathaway bought $700 million of Salomon convertible preferred stock paying a coupon of 9%. This 12% stake instantly made Berkshire the largest investor in Salomon, with Buffett seen as a 'white knight' repelling predators surrounding the bank.
Alas, in August 1991, the US Treasury banned Salomon from bidding in auctions for US government bonds after the bond dealer rigged previous auctions. This ban would have meant the end for the bond dealer, but Buffett's actions -- he took the helm of the bank from August 1991 to June 1992 -- saved the firm.
Hence, to protect his investment in, and restore the reputation of, Salomon Brothers, Buffett became chairman of the investment bank. Salomon settled the bond-rigging case by paying a fine of $290 million.
In time, the 'Wisdom of Salomon' prevailed and the firm was sold to Travelers Group for $9.3 billion in November 1997. Overall, Berkshire walked away with a profit of roughly $1 billion from its roller-coaster ride on Salomon.
What next for Goldman?
Although Buffett has yet to show his public support for Goldman, he has lots of options. One worry on Wall Street is that this scandal could spell the end of Goldman's besieged Chairman and CEO, Lloyd Blankfein. Then again, were Buffett to step into Blankfein's shoes, Goldman shares would rocket.
Of course, it's very early days, the case is far from clear-cut, and the SEC could well lose. After all, with $5 billion to spend on pay and bonuses in the first quarter of 2010, Goldman can afford the very best legal representation.
What's more, Goldman is sure to argue that it dealt almost exclusively with professional investment firms when it structured and sold CDOs and other securitised derivatives. Frankly, these firms should know about 'buyer beware' when dealing with investment banks -- and particularly when buying from Goldman!
Goldman's first-quarter results, due out on Tuesday, should make interesting reading. In the meantime, Buffett famously said, "Be fearful when others are greedy and greedy when others are fearful". On this basis, Goldman Sachs shares may be worth buying for a short-term bounce-back...
The first of many?
One thing is certain: the charges laid against Goldman are only the opening shot in the SEC's war to punish investment banks that misled or defrauded clients during the securitisation frenzy of 2005 to 2007.
Indeed, according to Monday's Financial Times, the SEC is looking into CDO deals from just about every major Wall Street player, including Bank of America, Barclays (LSE: BARC), Citigroup, Credit Suisse, Deutsche Bank, Merrill Lynch, Morgan Stanley and UBS.
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