Goldman Sachs Pulls Off 2nd Biggest "scam" in Financial History

Of course, it was done completelly legally although the ethics are another question.

Record Bonuses on tap for Goldman Staff
by CalculatedRisk on 6/21/2009 09:56:00 AM

From The Observer: Goldman to make record bonus payout (ht Jonathan)

Goldman Sachs staff can look forward to the biggest bonus payouts in the firm's 140-year history after a spectacular first half of the year ...

Staff in London were briefed last week on the banking and securities company's prospects and told they could look forward to bumper bonuses if, as predicted, it completed its most profitable year ever....In April, Goldman said it would set aside half of its £1.2bn first-quarter profit to reward staff, much of it in bonuses. It is believed to have paid 973 bankers $1m or more last year, while this year's payouts are on track to be the highest for most of the bank's 28,000 staff, including about 5,400 in London.



NC: I have no problem with people making an honest buck - or even millions of them. And I have no personal problem with Goldman Sachs, in fact, I have several friends that work there and I obviously hope they get a good bonus. But this scam they are on the verge of pulling off is truly infuriating.

I have done some research on Goldman's "record profits" based on their 2008 annual report and some articles that were printed in October - December of last year and this is how I believe it went down (take that with a grain of salt).

[Please note that this is my analysis and, obviously, could be incorrect (especially some of the details). I welcome any comments, feedbacks and corrections whether posted by name or anonymously.]

• The "AIG bailout" was always about funneling tax payer money to the banks. Basically, the Treasury (namely Hank Paulson and now Geithner) and the Fed found away to subsidize their buddies on Wall Street without needing congressional approval. The sent the money via derivative contracts between AIG and the Wall Street banks under the guise of a Fed bailout of AIG.
• You see, and this is from the GS annual report, Goldman was already protected from an AIG default. They had purchased derivative contracts called CDS (credit default swaps) which are investments that go up in value when a reference company - in this case AIG - has a decline in creditworthiness. These contracts are generally bi-lateral agreements between two entities but their value is determined by a very liquid CDS market.
• Ironicallly, the reason that Goldman was hedging (or mitigating) its risk of AIG default is that it had $20 billion of CDS trades with AIG. In other words, Goldman had billions of dollars worth of CDS contracts with AIG that were protecting Goldman from defaults of mortgage bonds. It protected itself from an AIG default by buying CDS protection on AIG with completely independent 3rd parties.
• In October, when it appeared that AIG was about to go bankrupt, the CDS contracts on AIG would haved increased in value several times over again. So let's say on $20 billion worth of contract value that was purchased as $500 million, the value was now $15 billion.
• Goldman closed its CDS trades with the 3rd parties at a huge gain - somewhere around $10 billion (this is deduced from the mosaic theory between the 2008 annual report and several media reports that I read last year). Some people say that Goldman was told by Paulson (the former CEO of Goldman who still owns hundreds of million dollars worth of GS shares) that AIG would be rescued, so they closed the trades knowing that AIG would not default. But there is no evidence of this, so that can be ignored.
• Either way, Goldman already protected itself from the AIG default risk and was greatly compensated for doing so.
• Now, the Fed and the Treasury come in and pay out the counterparties of AIG on CDS trades. Goldman was a the top of that food chain and received somewhere between $12 billion and $20 billion in settlements from the U.S. taxpayers.

So you can now see how Goldman was able to "double-dip" and was paid out twice for the same contracts. And that is a huge part of how you are now seeing "record profits" for fiscal year 2009 as the government money via AIG is recorded as straight profits. Certainly, there are other factors allowing Goldman to report record earnings (such as a change in the FAS 157 accounting rules where companies can value assets at whatever price suits their bonus :) - but the AIG settlement is the largest factor.

To me, this is just completely outrageous. And the arrogance of announcing record bonuses is a poor PR move to say the least.