Goldman: "Hate the Game Baby Not the Playah."

In the last few days, details of Goldman Sach's potential $1 billion CIT bonanza have been coming out.  Before we get into that I want to reminisce about a lesson I learned way back in the mid- 1990's.  Back then I worked at a very large, powerhouse financial shop.  I was just a little pisher (small fry, dweeb, pimple on a elephant's butt, etc..) at the time.  A more senior front-office player once told me the philosophy of the bank as it was once related to him by a very senior member of the firm.

"If you roll a guy and he's dumb enough to get up....knock him down and roll him again."

I think about this philosophy as I sit and read about Goldman Sachs and the "ailing" CIT.  The Financial Times has a nice summary; Goldman To Be Paid $1 Billion if CIT Fails

Goldman Sachs stands to receive a payment of $1bn – while US taxpayers would lose $2.3bn – if embattled commercial lender CIT files for Chapter 11 bankruptcy protection, people familiar with the matter said.

The payment stems from the structure of a $3bn rescue finance package that Goldman extended to CIT on June 6 2008, about five months before the Treasury bought $2.3bn in CIT preferred shares to prop it up at the height of the crisis. The potential loss for taxpayers would be the biggest to crystalise so far from the government’s capital injection plan for banks.

The agreement with Goldman states that if CIT defaults or goes bankrupt, it “would be required to pay a make-whole amount” that totals $1bn, the people familiar with the matter said

While Goldman is entitled to demand the full amount, it is likely to agree to postpone payment on a part of that sum, these people added. A CIT filing last week said that it was in negotiations with Goldman “ concerning an amendment to this facility”.

Goldman said: “This would not be a windfall payment. The make-whole payment is simply the present value of the spread to be earned over the life of the facility."

Hah!   Just the "present value of the spread over the life of the facility."  That is awesome!  Naturally, five months later, when Hank Paulson and Treasury allocate $2.3 billion of TARP funds to CIT, Treasury doesn't insist on putting themselves in front of Goldman's interest.  Considering Treasury had just bailed Goldman out (little stuff like rescuing AIG and giving Goldie a federal bank charter...even though they don't actually do anything that resembles a commercial bank), they may have had just a bit of leverage....if they wanted it of course.  But I guess they didn't.

Wait though because it even gets better.  Goldman also has a undisclosed amount of Credit Default Swaps (CDS) on CIT!  Why the hell not right?  After all, no matter who the counterparties on the CDS are, Uncle Hank or Uncle Timmy isn't going to let them go down so it's all good.  Therefore, if CIT declares bankruptcy, Goldman gets their money back plus a nice profit.  It's not often that you can lend money to a super high-risk counterparty and then end up rooting for them to declare bankruptcy!

Is this wrong?  Well, not if you go back to the adage I learned over a decade ago, 

"If you roll a guy and he's dumb enough to get up....knock him down and roll him again."

Goldman was/is just playing the game based on the rules as listed above.  They saw a way to make a high spread loan to a Fredo entity like CIT, wedge their way to the top of the capital structure in the event of default, collateralize the bejeezus on their position, lock in the spread and then create a win/win/win by buying CDS protection on CIT.  As Michael Corleone said, "It's nothing personal.  It's strictly business."

The question is, is this the business or the game we want our financial institutions to be playing?

Comments

[reddweb]

Checkout Felix Salmon's counterpoint goldman-empathetic article on this.

If you asked Obama about this last year, he would have said "They are acting with-in the existing financial laws, we cannot go after them". Which is exactly what he said when asked about massive financial fraud and tax-payer bailout last year.

I give Ben credit for one thing : Making everybody believe that USA has enough money to backstop everything. Perception of "No more Big failures". Alas, this bullshit only prolongs the zombie situation.

[eric]

We can always hope Red. Have to keep the light shining.

[reddweb]

This was accepted practice last year. I am glad everybody is talking about it now, even before GS got the payout. Maybe something will be done. you can hope right?

[williambanzai7]

Instead of commenting on this very well written diatribe against a wonderful Wall Street institution, I am going to provide the following link: http://www.youtube.com/watch?v=6F1omvf4NCc