Poor Goldman Sachs. Don't you feel sorry for these guys, having to fork over $500 million even though they probably didn't do anything wrong? Well, you probably don't. But then, you've probably never been the subject of an SEC witch hunt before either... In any case, you'll recall our skepticism that the SEC case against Goldman Sachs would ever amount to much:
[I]t seems clear to me suing Goldman about this issue – a case involving a synthetic CDO that the regulator will probably lose – is simply raising a red herring. Left unexamined is the much larger issue: the extraordinary amount of fraud in mortgage underwriting between 2004 and 2007. – April 21, 2010, Digest
Wall Street seems relieved by the settlement. But we stand by our forecast that the Goldman lawsuit was just a warm-up. You see, this case simply involved synthetic CDOs – investment vehicles that can only exist if there's an investor who wants to short mortgages. The real fireworks will come in the investigations over CDOs containing bona fide mortgages. These vehicles were completely riddled with fraud and insider dealing. Then, almost half of them were sold to Fannie and Freddie, now owned by Uncle Sam.
When you defraud the sovereign, watch out. We think the fines are going to get a lot bigger... and we'd be surprised if Morgan Stanley survives. Interestingly, we also think the amount of fraud in the mortgage security industry means it's unlikely the insurance on these bonds will remain in force. And that means the $30 billion or so of implied losses mortgage insurer MBIA faces may never be paid out. That's a big number for a stock with a current market value of only $1.35 billion and assets of $25 billion.
The SEC settled its case for what seems like a huge sum of money, more than $500 million. However, that amount equals only 14 trading days of profits for Goldman. We pose the question to you, dear subscribers... If Goldman had actually been doing anything like what the SEC alleged (tricking its own clients into buying the same vehicles it was able to sell short successfully), would this settlement represent any real justice? If the most powerful bank in the world was actually defrauding its A-level clients – pension firms, the world's wealthiest people (including Warren Buffett), insurance companies, and hedge funds – would it still be in business today? All of these people are smart enough to know if they're being snookered. Or even if they aren't (which is highly unlikely), would a $500 million fine represent an equitable penalty for what was alleged to be a multibillion-dollar fraud?
It seemed clear to us from the beginning, the lawsuit was simply a charade. And it wouldn't surprise us in the least to learn that Goldman orchestrated the entire case, simply to create the illusion that it's not completely in control of Wall Street. A $500 million fine that seems to prove you don't have the entire system rigged is probably a smart investment for Goldman to make.
You think that's too cynical? Not by half. Goldman Sachs earns an incredible amount of money every day doing what's called proprietary trading. Currently, the firm makes around $100 million, per day, in gross profit. It makes these trades using huge amounts of leverage. Exactly how much leverage is hard to know because the banks are very good at "dressing up" their numbers at the end of the quarter. But knowledgeable banking analysts estimate the leverage is typically around 20-30 times. With that much leverage, even a small loss can cause catastrophic damage to a bank's balance sheet. Losses as small as 5% of assets could wipe the bank out.
So... think about this with me for a minute. How does Goldman Sachs (or any other big "prop-trading" desk) make so much money, despite having such narrow acceptable loss parameters? Can you imagine investing in your own account using 20 times leverage? A single bad week would wipe out your entire life's savings. How do these guys survive taking such enormous risks? And how do they make so much money, almost all of the time?
The answers aren't that hard to figure out. Having been in finance for 15 years now, I know most of what these guys are doing. I understand why it takes so much capital. They don't do the kind of trading most individuals do. They're doing pairs trades (buying one stock, while selling another), which limits risk. They're selling options, rather than buying them. They're trading very low-risk bonds, near maturity. And they have extremely accurate options-pricing models that give them a wide margin of safety on their trades. Rather than trying to make 10% or 20% on each trade, these strategies are designed to earn small (1%) gains in a way that's essentially risk-free – day after day. While that might not sound like much... it adds up.
How do I know how Goldman does it? Well, there's one sure way to find out. Hire a trader from Goldman's own prop desk. That's what I did when I hired Dr. David Eifrig. He was one of the most successful proprietary traders in the world during the late 1980s and early 1990s. He worked on several of the top trading desks, starting at Goldman Sachs' derivatives desk in New York. Then, he went to Goldman Sachs London. Then to Chase. And then to Yamaichi – Japan's version of Goldman Sachs. They called these guys "masters of the universe" because their knowledge of the markets and high-level trading techniques gave them the ability to essentially print money. Eifrig has taught me many of their techniques. They're not hard to learn... but they require you to understand the difference between real risk and apparent risk. And that takes a bit of expertise.
Now... you might rightfully wonder... how did I come to hire one of Goldman's former top traders? Why would someone with these skills ever go to work for anyone else? You'd have to know Doc (as I call him) to understand. You see, he actually got tired of making millions of dollars by "ripping people's faces off" – which is what they call it when you make a good trade. He didn't want to spend his life focused on making money – and taking it from other investors who were less sophisticated. He walked away from the life – from the fancy dinners, the Rangers hockey tickets, the private planes, etc. He left finance completely and became a medical doctor – an eye doctor to be specific. Medicine was the family business, and Doc wanted to do something he felt was better for society than just making money.
I met Doc about 10 years ago through mutual friends at the beginning of his medical career. He was a mentor to me in many ways – especially in understanding how to make a lot of money safely with my own trading. As Doc explained these strategies to me, I realized how perfect they were for people who are retired. A retired person needs income to live on. A short-term trading system that can produce small gains, quickly and safely, would be perfect for our audience, which is filled with retired investors. The more Doc and I talked over the years, the more excited he became about sharing his secrets with more people – especially folks like him who are retired. (Doc has now retired twice: once from Wall Street and more recently from practicing medicine.)
Are you retired? Or are you simply tired of having to put so much capital at risk to earn a decent amount of investment income? Wouldn't you like to have a trading record that's more like Goldman Sachs' and less like the poor saps who get their faces ripped off by Wall Street's prop-trading desk every day? Who better to teach you the right way to trade than a former Goldman trader?
So... even if you never imagined yourself as a trader before, I hope you'll take the time today to sign up for Doc's new trading advisory - Retirement Trader. Doc's super-safe and consistent trading style is perfect for retireers. Click here to learn more.
The Senate passed the Frank-Dodd bill today, and OBAMA! is expected to sign it into law next week, but there's still plenty of time for Wall Street and its lobbyists to soften the blow. The bill calls for the immediate creation of the 10-member Financial Stability Oversight Council. Then, the administration will have one year to create the Bureau of Consumer Financial Protection, which will regulate mortgages, credit cards, debit cards, etc. Most everything else, including the derivatives regulation, will pan out over the next three years. There was one glaring omission in the 2,300-page bill... It doesn't address the two drivers for this entire crisis (and one of the largest government boondoggles in history), Fannie Mae and Freddie Mac. Our guess is this increased regulation will lead to more of the same... The government will try to regulate Wall Street, and Wall Street will find ways around it – as it's been doing since the beginning. One thing this bill will certainly do... create more high-paying government jobs.
New highs: Keyera Facilities Income Trust (KEY-UN.TO), Anheuser-Busch InBev (BUD), Enterprises Products (EPD), AmeriGas Partners (APU).
Melting middle class, Goldman Sachs, and more in today's mailbag. Send us something to enjoy over the weekend: feedback@stansberryresearch.com.
"YEAH, count me in on the 'Melting Middle Class.' I am more like the a man on a deserted island. I don't feel comfortable in the USA, anymore. The middle class started melting around the '70's, when middle class values started eroding. Hence, Uncle Sam is this nation's largest customer of baby formula. Middle class used to take care of their own in times of an unexpected, new mouth to feed. Then, they got jealous of the disadvantaged receiving something, that 'they' were not. They bought into the 'free-for-all.' I'm more akin to the displaced American Indian. Been lied to, cheated and robbed by our Federal System. The next thing to erode for the MIDDLE CLASS is their pocketbooks. Middle classes are growing in regions like India and China. American politicians and the Financial Elite think that 'middle class' – are TWO DIRTY WORDS! Don't leave the lights on for me." – Paid-up subscriber Nelson Montz
"So Goldman Sachs has 'accepted' a settlement in its fraud case equal to just about three days profit – with no admission of wrongdoing whatsoever. Is it my imagination, or is this the second big GS announcement made just before options expiration day? By the close of business Thursday, the GS July $145 calls had jumped from a low of $0.05 to a high of $3.59, settling at $2.50 – and ended the day with a gain of almost 826%. I admit it: I love a good conspiracy theory. But I genuinely wonder: who got even richer (again) yesterday??? Maybe a better question for the SEC..." – Paid-up subscriber Peter Cavaliere
"My experience with crossing the border would indicate Casey's man (that you referenced) does not have the real scoop. In fact I dare him to try crossing a border with a tube of Krug's and see how it works out! I tried crossing into Canada with merely a receipt for some silver bars... bad idea. They didn't believe me when I said I didn't have them with me and nearly tore my car apart trying to find them. They most definitely require you to report them. Funny thing was, on the way back into the U.S. they barely gave me a look." – Anonymous
Porter comment: I admit I'm a bit mystified about why anyone would want to carry lots of bullion across borders. You can wire any amount of money you want out of the country right now, bank to bank, for a small fee. Or you can use various debit or credit systems to buy gold bullion in many different countries around the world. Sell your gold here. Buy it back in Switzerland, or wherever. I'd never carry much gold on my person. It's an invitation to get robbed – whether by a mugger or a government, doesn't really matter.
Regards,
Porter Stansberry and Sean Goldsmith
Baltimore, Maryland
July 16, 2010