Goldman Sachs

Investment Manager's Letter May 2010

At 1.7 times book and with a PE of 7 is Goldman Sachs a fat pitch? Or do 2009’s earnings have anything to say about the Goldman Sachs’s future. Maybe, maybe not.

Michael Lewis in his book "The Big Short" says Wall Street is over. So who is correct? Will Goldman Sachs return to the glory of its recent past or has its business model been blown? I, as investment manager, have to admit to a good deal of fascination on this issue. On Monday I, investment manager, was thinking of buying the stock because it appeared cheap. Now, the more I read, the more I wonder. Maybe Lewis is right. If commercial banks are forced to give up their trading book, their derivative trading, and their private equity business, how does this effect the company’s earnings future? Can our beloved legislators actually pass regulations that would terminate Goldman Sachs’s master-of-the-universe license? We know that these congressman would be reluctant to forgo campaign money that has been provided by Wall Street, but this is an election year and the voters are looking for fresh meat, so big things can happen.

There is just a lot of stuff that has been going on at Goldman Sachs and its Wall Street cronies that our economy really does not need. Can we expect this problem to be solved by government intervention? We doubt it, but this does not mean that they are not going to try. I (Richard Losch, investment manager) think it is a fairly easy guess that Congress will take some measures likely to materially damage Goldman Sachs’s bottom line. However, the real damage is more likely to come from the marketplace. Because of all the attention in the press — the amount of detail put into print about these particular CDOs and John Paulson’s role — Goldman Sachs’s customers can now see that they have been the patsy at the poker table. Goldman Sachs may have a legal defense, but the whole thing smells bad. It’s like Charlie says, “To call this stuff sewage is to give sewage a bad name”.

Think about CDOs. Do synthetic collateralized debt obligations really offer anything to society that would justify the damage they have inflicted? They do not create capital or allocate capital in any way that is useful to anyone. They only exist to generate commissions, and the reward goes to the trader while shareholders get stuck with any losses.

Lewis thinks that Goldman Sachs should be broken up and that it’s high risk businesses sold to hedge funds. Lewis thinks that compensation plans for traders need to reflect the risks the traders are taking. He says that high-risk trades belong in a partnership because then the people taking the risk have all of their own skin in the game. Losch Investment Management Company do not know if this is realistic but have to admit it sounds like a good idea. It would be similar to Buffett’s idea that CEOs of busted banks should end up broke. But Lewis’s solution would be more effective because this way all of the big players — not just the CEOs — would end up broke.

Surely one the most irritating aspects of the financial collapse, is the amount of loot accumulated by people who made foolish mistakes. Lewis points to one Morgan Stanley trader who was buying subprime CDO’s up until almost the moment of collapse and who all by himself cost Morgan Stanley and it’s share holders $9 billion who when asked to resign still managed to walk away with tens of millions of dollars in compensation for 2007. Most of the people that ran the big financial institutions that have disappeared are left with fortunes in the hundreds of millions.

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