Goldman’s Orphan Month

Goldman Sachs just put out pretty good results and did a big capital raising.

Here is a table for Goldman Sach’s revenue for the three months ended Feb 2008, Nov 2008 and March 2009 respectively.  The table comes from the 8K dated 13 April 09 – essentially the 8K in which they announced results to raise money.

(click for detail)

Now the observant amongst you will notice that these three month periods are not contiguous.  Indeed the three months to November 2008 and the three months to March 2009 conveniently forget the month of December 2008.

That is right.  Goldman Sachs changed its balance date – and there is a one month period not reported in the usual quarterlies.  An “orphan month”.

Now December 2008 was a pretty bad month.  Probably the worst on record.

Here – also from the same 8K is Goldman Sach’s revenue during the orphan month.

It is hardly linear.  Total revenue for the three months ended March 2009 was 9425 million.  For the one month it was 183 million.  Of course this revenue was offset by some very large charges rammed into the orphan month.  If you click on the attached table you will find that Fixed Income Commodities and Currency (FICC) revenue refers to Note 19.  Note 19 says blandly that it “includes the writedowns of approximately $1 billion related to non-investment-grade credit origination activities and approximately $625 million (excluding hedges) related to commercial mortgage loans and securities”

Ah – that explains it.

There is also another billion in losses labelled as "other corporate and real estate gains and losses".  That line doesn't even occur in the March accounts.

The costs are also non-linear – but not as non-linear as the revenue.  

The net loss applicable to common shareholders for the orphan month was just over a billion dollars.  The four month period was just profitable.

Am I surprised that Goldies had an “orphan month” and stuffed the bad news in it?  No.  If you were – then obviously you are new to investment banking.

But I am surprised at the credulity of the press.  Most stories about the quarterly result simply omitted the December month.  This story though at the WSJ Deal Blog was considerably better – noting that December was really ugly but not understanding why.

They even note that December is seemingly omitted from the official records – but doubt it is deliberate.

The Deal Blog is more observant than most.  

But perhaps they too are new to investment banking.  Note 19 explains about half of it.  The mysterious "other corporate and real estate gains and losses" explains most the rest.

Post script:  The excellent Floyd Norris (New York Times) also picked this up.   There are some journalists way better than average.  

Further postscript:  Krugman has also commented.

Farewell Greg Newton

I only spoke to Greg Newton (of the Naked Shorts blog) twice and my email box has about a dozen emails. 

He died suddenly recently.

I want to second Nihon Cassandra's fitting obit.  

http://nihoncassandra.blogspot.com/2009/04/farewell-greg-newton.html

---------

Post script:  I have rejected several anonymous comments along the lines that he was (a) crooked, (b) revolting, (c) better dead.

I have always seen him - even in the title of his blog - as poking fun at people who deserved fun poked at them.  He was a little more vicious at the people who were bent.

The people who are picking arguments with him I am happy to publish in the comments - so long as the posts are not anonymous and the arguments are detailed.

My view- the nasty(but not rationally argued) comments about a dead guy tend to show he was onto something good.

J

Bed and Breakfast capital at Bramdean Alternatives

I keep an eye on Bramdean Alternatives – the listed fund of hedge funds and private equity funds run by Nicola Horlick’s Bramdean Asset Management.

What really interests me is the capital calls on private equity – these being numbers large enough to potentially bankrupt Bramdean Alternatives.

So far the capital calls have been manageable – but detailed disclosure about how large they are and when they are due is not available.  Without that disclosure I am inclined to think the worst.

Anyway the February "factsheet" contains the following gem (emphasis added):

Four capital calls were received from underlying Funds in February, though one of these was purely for regulatory capital purposes and was refunded the same day. Revaluations were received from two managers of the Company's Private Equity and Specialty Funds and these have been incorporated into the February NAV calculations. Both revaluations were downwards revaluations, reflecting falls in the values of market comparables and adverse currency movements. As stated in previous communications, downward valuations are to be expected given the exceptional market environment and it is likely that the Company will receive further fair market valuation write-downs, including valuations as at 31 December 2008, from some of its managers. As at February, six of the 18 private equity and specialty managers have reported their December 2008 year-end valuations; these have been reflected in the NAV of BAL. One other manager's portfolio is revalued every month.

The first sentence just leaves me gobsmacked.  Bramdean sent a whole lot of money – a capital call – to a private equity fund (or other fund) – and they sent it back the same day – after presumably including it in their accounts.

This was done for "regulatory purposes" – but – for the life of me – I cannot think what the regulatory purpose might be – and why this might be legitimate.  

If it was to fool a regulator or a creditor into believing that the fund had adequate capital on balance date it looks and smells like it was designed to mislead or at least to circumvent some kind of regulatory test.

But it could be another reason – it is just that I can’t think of any real reason why a fund of funds would send its money to some underlying fund for just a few hours without a design on fooling someone.  I sent an email to Bramdean hoping that they might give me a legitimate reason but alas there was no reply.

And I am not picking on Nicola Horlick here.  If Bramdean sends the capital and it comes back on the same day the fund presumably sent this request to several funds-of-funds – and they all complied.  And they all didn’t think it unusual that their money might be needed for a few hours.

So to repeat the question.   Can anyone think of a legitimate purposes for this?

Please.

John

ps.  If you want to spot me a few million dollars for a few hours - then - I am interested.   I just can't think of any legitimate reason why you would want to do that either.

pps.  Someone with no intention to repay may be more interested still.  

That Legacy Word

Toxic assets are no more.  The Geithner Plan is officially a “legacy asset plan”.

Legacy assets sounds so much better than toxic assets.

By contrast Chevron (latest security analysts conference call) has as its first stated goal (in upstream business) to "grow profitably in core areas and build new legacy positions".

Bankers and oilmen leave a different legacy.

The seemingly criminal Sheila Bair*

I am not opposed to the Geithner Plan – but the execution is bordering on criminal.  This article in the FT runs as follows:

Bailed-out banks eye toxic asset buys

By Francesco Guerrera in New York and Krishna Guha in Washington 

Published: April 2 2009 23:20 | Last updated: April 2 2009 23:57

US banks that have received government aid, including Citigroup, Goldman Sachs, Morgan Stanley and JPMorgan Chase, are considering buying toxic assets to be sold by rivals under the Treasury’s $1,000bn (£680bn) plan to revive the financial system.

The plans proved controversial, with critics charging that the government’s public-private partnership - which provide generous loans to investors - are intended to help banks sell, rather than acquire, troubled securities and loans. 

Spencer Bachus, the top Republican on the House financial services committee, vowed after being told of the plans by the FT to introduce legislation to stop financial institutions ”gaming the system to reap taxpayer-subsidised windfalls”.

It is so blatantly obvious that the people that should not participate as buyers in the Geithner funds are the conflicted.  This was first pointed out by Steve Waldman – but I thought his dark thoughts were too dark.  However Clusterstock argues that Sheila Bair is seemingly oblivious to the corruption possibilities.

She isn't seemingly oblivious.  She is totally captured by JPM and Citi.

After all WaMu was gifted to JP Morgan in a reckless and irresponsible manner and she attempted to gift Wachovia to Citigroup.  It should not surprise me that Sheila Bair continues to act as if she is on the take.  That represents no change in behaviour.

Recommendation:  Indict Sheila Bair if she won't resign.  Indict her now.

*Note - I have always believed that Sheila Bair is either incompetent or corrupt.  She seems to be corrupt - but incomeptence in her case is probably a sound defence.  She should resign before she is (perhaps mistakenly) indicted for corruption.  

A little bit of careful thinking – and why Krugman’s despair is misplaced

I am not an economics academic. I gave that game away for the lure of lucre and funds management. But this job throws up more than a few ideas for publishable economics papers – whereas when I was a student I was desperately short good ideas.

Here is one – a pure throwaway – for anyone that wants it. (It’s a nice paper for a masters thesis.)*

It has also explained neatly the problem of not getting banks to bring assets to the Geithner Funds – and in a way which I suggest is surprising.

It started as I tried to pick apart Rortybomb’s analysis of the Geithner Plan. Rortybomb does – in more formal form what Krugman does – analyse the non-recourse financing of the plan as a subsidy. He suggests that the non-recourse nature of the funding is a put option to the Treasury/FDIC of the assets – and that the correct way to model it is using (standard) option pricing models. Rortybomb’s posts are here and here. Krugman is a little more simplistic – but the idea is the same. Krugman produces a two-outcome model (rather than the range implicit in the option pricing model) and demonstrates there is a subsidy. Krugman’s post is here.

Anyway if you use a standard option pricing model and assume some volatility of outcome it is not hard to quantify the subsidy implicit in the plan. I have borrowed Mike’s (ie Rortybomb’s) diagrams. I hope he doesn’t mind.

The subsidy is dependent – as Rortybomb would acknowlege – on the leverage of the fund, the diversification of the fund and the variability of outcomes (particularly stress outcomes). All of this is standard option theory.

Now this is all fairly convincing until you work out that the party selling the assets (presumably a large and stressed bank) is also subsidized. The policy of the US Government (stated many times) is that there should be “No More Lehmans”. You may argue with this policy (reasonable people myself not included) think that this is the wrong policy. But you can’t argue that it isn’t the policy. The demonstration is that any bank that gets into any kind of liquidity trouble gets a “Sunday Night Liquidity Fix”. The availability of that Sunday Night Fix is a subsidy for the bank – just as surely as the non-recourse funding is a subsidy for the Geithner Fund.

So the issue is whether the Geithner Funds reduce the tail risk for the government – not whether the funds are themselves subsidized. After all the assets being sold are from non-recourse finance banks (losses beyond capital borne by the taxpayer) to non-recourse financed funds (losses beyond capital borne by the government). It depends on the relative solvency of the banks and the Geithner funds.

Thinking carefully there should be four broad outcomes:

• Both the bank and the Geithner fund is solvent

• Both the bank and the Geithner fund is insolvent

• The Geithner fund is insolvent but the bank is solvent

• The Geithner fund is solvent and the bank is insolvent

When both the bank and the Geithner Fund is solvent ex-poste there was no cost to the government. Sure there was an ex-ante subsidy but it didn’t cost anything. This case should not worry us.

The second case – when both the banks and the Geithner funds are insolvent the government will lose money – but it will lose less money than it would without the Geithner Plan. After all there was some private money in the fund – and that reduced the end loss borne by the government. In other words subsidy be damned - the plan reduced government losses.

The third case is problematic. If the Geithner Fund is insolvent and the bank is solvent then the Geithner plan cost the taxpayer real money.

The fourth case where the fund is solvent and the bank is insolvent is also problematic – but in a different way. The fourth case is where the banks sold good assets to the fund (presumably for liquidity) and kept the bad book for itself (because it could not sell it). Now in this case the subsidy to the Geithner Funds is not a problem – rather it is the desperation of the banks to sell assets, any assets and only being able to sell good assets. The more subsidy you give the Geithner Funds and the more competition between Geithner Funds you have (bidding up the price of the asset) the lesser the end problem for the banks. Either way however we shouldn’t be that stressed about the subsidy to the Geithner Fund.

Indeed the only place that we should be really stressed about subsidy to the Geithner Funds is the third case – where the fund is insolvent but the banks are solvent.

Oops. The people that are really stressed about the subsidy to the Geithner Fund (Krugman, Felix Salmon, Yves Smith of Naked Capitalism, Mike of Rortybomb) are also worried about or even convinced that the banks are insolvent. Indeed several of these people just advocate nationalisation now.

This is illogical. It is the second time I have accused Krugman of gross illogic – but it is simply illogical to believe that

(a). The banks are largely insolvent,

(b). The right or actual government policy is guarantee big banks (ie no more Lehmans) and

(c). The subsidy to the Geithner Funds is a real problem.

If both (a) and (b) applied the Geithner Fund MUST save the government money - so the subsidy is irrelevant.  

This illogic extends to several of the bloggers I admire most. That is why I think there is a good academic paper in there. Krugman actually expresses “despair” over the subsidy. His despair is misplaced.

I guess the extension is to model it with many Geithner Funds, some of which are solvent, and some of which are insolvent. The situation might wind up more nuanced. Indeed my rough modelling (Monte Carlo rather than rigorous maths) suggests that it is more nuanced – but only slightly. The nuance disappears if the diversity of the Geithner Funds matches the diversity of the banks.

Success of the Geithner Plan

One concern with the Geithner plan is that the banks won’t actually come to the party and sell assets. It’s a concern taken up by Charlie Rose when he interviewed Timothy Geithner and dismissed in the Bronte Capital submission on administration of the plan.

Now – thinking about it I am not quite so sure. There are simple explanations as to why banks won’t bring assets to the plan – see for instance this post from Accrued Interest. But the most obvious reason is that the relatively good assets logically belong with the party with the biggest subsidy. And that might be the banks. The fact that banks won’t bring assets to the Geithner funds is in fact a measure that the relative subsidy of the Geithner funds is too low.

John Hempton

*At one stage I tried to contact Brad DeLong possibly about being involved in a PhD program at Berkley (ideally with him). We managed never to connect. And I have since given up that goal.

Rortybomb argues my point (though he didn't mean to)

Rortybomb is a blog where I find myself entirely agreeing with the mathematics and totally disagreeing with the conclusion.  I have added it to the blog roll – and intend on taking a few shots at it.  I consider Rortybomb as providing an illustration of all the things you can do to abuse mathematics in economics.  

Mike (the blogger) posts empirical research suggesting the obvious – that big banks selling loans that can’t be securitised tend to have fatter margins.  When they sell loans that can be securitised they tend to have thinner margins.

He then concludes that we should have smaller banks and more access to securitisation.  Felix Salmon agrees with him and wants smaller banks and more securitisation.

No objection to the empirical fact that oligopolistic banks without securitisation competition are profitable.  I see it in many places.  And I see it today.  Securitisation is being removed and bank margins are going up.  Pre-provision, pre-trading loss profit of banks is rising.

My objection to Rortybomb is to the conclusion.  Fat margins for banks are a good thing.  They lead to the absence of financial crises.  Thin margins lead banks to take more risk – and when they fail they have huge collateral damage.  

Having a few fat rich banks is a small price to pay if you don’t trigger great depressions.  

In the olden days banks used to give out toasters to anyone who would open an account.  Why?  Because new customers were frightfully profitable.  Why didn't the banks compete with lower prices?  Because they were not allowed to.  Bank regulators actually regulated the value of the gifts (then known as "premiums") that banks could give their customers.  They wanted to ensure that the toasters did not cost too much.  Essentially they wanted to guarantee bank profitability.  Krugman wants to go back to the toaster days.  I just want to go back to days when banks were consistently very profitable over a cycle.

Big banks with no securitisation will be sufficiently profitable.

Rortybomb makes precisely my argument for big banks.  That they rip us off.  And that is a good thing.

Submission to the FDIC on the Legacy Loan Program

The FDIC has called requested submissions as to how the Legacy Loan Program should be run.

You can find the request here.

Given that we are publicly minded people with some expertise you can find our submission here.  

It should later be posted to the FDIC website.  At least it will if the FDIC keeps its promises.

The concerns I detail are the same as outlined on this blog - particularly conflict of interest, the appropriate degree of leverage and the continuance of Sheila Bair in her current position.

Read only if you are into boring government documnents.

I do however have lots of opinionated readers.  Give them good submissions.  It can't hurt.

John

Covering the Ricks short

Several months ago I put a short on Rick’s Cabaret – a listed strip club owner with a private jet.  The code of ethics covered use of the private jet.

I wondered what executives of a listed jiggly joint could do with a private jet that breaches their (rather narrowly written) code of ethics.  (The original post is here.)  

Anyway Ricks still looks like it will fail due to unrefinanceable debt – but the stock has been hammered and I covered recently.  

Not worth mentioning because the position was so small as to be for comedy value only.  [Also might make a visit tax deductible!  Stock research of course…  Just kidding – I never went.]

The old saying about Wall Street is that when the tide goes out you see who is swimming naked.  Nobody much swims in New York any more.  But boy do they dance.

Now the News Corp "Paper of Record" (The New York Post) reports former Wall Street analysts are jiggling at Ricks.  (See Axed Gals take Pole Positions.)  

Slogan for the 21st Century: When the tide goes out you get to see who is dancing naked.  

Come to think of it - not a great slogan.  Can you imagine what Sandy Weill or Dick Fuld look like?  

John

Also - before Wall Street gets high-and-mighty about this - the former Wall Street Analyst notes that the strip joint is run better than her former Wall Street firm (Morgan Stanley) and that the level of sexual harrassment is lower.  

Wall Street has much to be ashamed of - and not all of it is financial.  

Two days later this was added:

PPS.  It appears the New York Post story was false.  I was inclined to believe it because I am naturally short RICKS and the story was positive for Ricks.  

General rule as a stock picker: take seriously stories that are against your position - and not seriously stories that are in favour of your position.

General rule as a blogger or journo.  Believe nothing.

My bad.

PPPS:  I still think that Ricks can't refinance its debt.  But at this market cap I am not interested in staying short.  Ricks will go to zero though.

Sheila Bair is either a criminal or a grotesquely incompetent stark raving idiot

It is no secret that I do not like Sheila Bair.  My original reason for dislike was posted here.

But now she is open to deliberately allowing massive fraud against US Taxpayers.

There is a serious conflict of interest problem with the Geithner Plan.  These problems were first outlined by Steve Waldman in his “dark thoughts” post.  I noted that the application terms for the Geithner funds seem guaranteed to maximise conflict of interest.

In short – if you have a small interest in a fund (kindly levered to be large by the US taxpayer) and a big interest in a bank you have a massive incentive to overpay for the assets purchased from the bank sticking the losses to taxpayers and thus increasing the value of your bank holdings.

The defence of course is to have strict separation between the banks selling the assets and the Geithner Funds buying the assets.  Arms length separation is thus a basic and minimal requirement of the Geithner Plan.

However Sheila Bair is now open to letting banks selling assets participate in the Geithner funds.  This was reported in the WSJ – hat tip to Clusterstock.

I guess Sheila Bair can’t see a conflict of interest – only a “convergence of interest”.

However designing the plan to maximise theft is designing the plan to fail.  This is American politics – and rampant deliberate tampering with government procurement (ie criminality) is a possibility – but in Sheila Bair’s case I see only incompetence.

I am naturally attracted the Geithner plan.  I have stated that many times – but now I am plain sickened.  Sheila Bair should be removed from office if the Obama administration is to have any chance of succeeding.  This statement potentially maximising conflict of interest – and the possibility that criminal fraud is the driver – should be enough to impeach her.  Her defence – and in her case it is a solid defence – is incompetence.  And that determines the right outcome.  She should resign.