Not Your Average Pundit A Few of Eric Fry's Insights from the Year Gone By
Joel Bowman From the shores of Mar del Plata, Argentina...
Yesterday, The Daily Reckoning's editorial director, Eric Fry, took a break from his eggnog to offer some kind words about Fellow Reckoner, Chris Mayer.
In today's edition, your managing editor puts down his bomba y maté, to offer some kind words about Mr. Fry.
It's not only that Eric is far too modest to sing his own praises that we honor his contributions to these pages, either. And, lest the reader think we're engaging in some kind of ritualistic, year-end back-patting festival around the office, we present below two columns, authored by the accused, as evidence of exactly the kind of writing with which he is charged.
Where most of the mainstream pundits go out of their way to miss the point entirely, Eric drives it home with an industry-rare mixture of wit and honesty. Indeed, few financial commentators rally with such editorial rigor against the state-sponsored corporatism so prevalent in today's system. Given that 2010 was such a bull market for exactly this kind of cronyism, we are all the more pleased to present a couple of Eric's best insights from the year gone by.
We'll leave it to the intellectual safekeeping of the reader to connect the dots between these two most revealing observations...and to then feel suitably disgusted by it all. Enjoy!
The Daily Reckoning Presents Goldman's Perfect Quarter Eric Fry [Reckoning on May 12, from Laguna Beach, California]
While the European Central Bank (ECB) was busy manipulating markets and making headlines Monday, Goldman Sachs was quietly revealing a different story of market manipulation...or something that walks and quacks very much like a market manipulation duck.
In an SEC filing, Goldman disclosed its first-ever "perfect" quarter. The firm's proprietary trading desk navigated the first quarter without producing a single day of losses, the first time it had accomplished such a feat.
How is this possible? Please permit us to offer a simple explanation: It's not.
Imagine a poker player who competes against skilled competitors for 63 sessions of 6 1/2 hours each, then walks away with a profit after all 63 sessions. Would that be possible? Not unless the poker player is holding a stack of aces up his sleeve. But Goldman accomplished this improbable feat. Its trading desk turned a profit on each and every day of the first quarter - that's 63 trading sessions of 6 1/2 hours each, not counting whatever additional shenanigans Goldman was conducting in foreign markets.
There is something wrong with this picture...very, very wrong. And yet, Goldman trumpets this success as an example of something that is very, very right. "This is the first time we have reported zero trading loss days in a quarter," crowed Samuel Robinson, a Goldman Sachs spokesman. "We believe it shows the strength of our customer franchise and risk management."
An alternative interpretation would attribute Goldman's uncanny trading success to the strength of its "political franchise," subsidized risk- taking and various forms of de facto front-running. If, as James Howard Kunstler asserts, the US stock market has become "a robot combat arena where algorithms battle for supremacy of the feedback loops," Goldman Sachs must control the "Supreme Combat Robot." But we wonder whether this robot is abiding by all applicable securities laws, or vaporizing them with his special "Mega-fraud laser beam."
"The firm did not record a loss of even $0.01 on even one day in the last quarter," Durden says. "The statistic probability of this event is itself statistically undefined. Goldman is now the market - or, in keeping with modern market reality, Goldman is the 'house,' it controls the casino, and always wins. Congratulations America: you now have far, far better odds in Las Vegas that you have making money with your E- Trade account."
In fairness to Goldman, JP Morgan also produced a perfect quarter of proprietary trading. Morgan Stanley, the relative loser in the crowd, managed to produce a trading profit on only 93% of its trading days.
"The rape and pillage of the middle class was not isolated to Goldman," Durden continues. "JP Morgan also had a flawless quarter. And if the odds of Goldman making 63 out of 63 are virtually impossible in any universe in which risk goes hand in hand with return (but in those in which monopolies are encouraged and bailed out), the coincidence of the two main firms that control the world having a perfect track record is impossible. And since things in reality tend to be zero sum, when everyone makes money, someone may be tempted to ask the question, just who is losing money? And the answer, dear taxpayers, and [Goldman/JPMorgan] clients, is you."
Perfection is either a religious virtue or a devilish fraud, dear reader; it is never a financial market reality. So there's something a little troubling about the perfection achieved by Goldman's (and Morgan's) trader-bots. In fact, there might be something a lot troubling about their trader-bots, as well as their investment-bank- atrons.
Perhaps the truth will come to light in the fullness of time...or in the details of a future SEC complaint.
Goldman acknowledged in Monday's SEC filing that it still faces a large and diverse number of criminal and quasi-criminal investigations. In addition to a bevy of investigations by the SEC, Goldman is facing detailed probes by the Justice Department, the Financial Industry Regulatory Authority and the UK's Financial Services Authority related to CDO offerings and related matters.
"We anticipate that additional putative shareholder derivative actions and other litigation may be filed, and regulatory and other investigations and actions [will be] commenced against us with respect to offering of CDOs," Goldman's filing somberly disclosed, "[These probes] could result in collateral consequences to us that may materially adversely affect the manner in which we conduct our businesses."
Hmmm...we'd guess that the list of "collateral consequences" would include reducing Goldman's trading success from 100% to something much lower. And since trading revenues accounted for 80% of Goldman's revenue in the first quarter, we'd guess that much lower net profit will be another "collateral consequence."
Outing Ben Bernanke by Eric Fry [Reckoning on Dec. 15, from Laguna Beach, California]
Deception in the financial markets is not always costly, but it is rarely remunerative. Investors cannot afford to ignore this tendency.
Recent disclosures from the Federal Reserve reveal that honesty was one of the earliest casualties of the 2008 financial crisis. These disclosures contain a number of juicy tidbits, like the fact that Goldman Sachs received tens of billions of dollars in direct and indirect succor from the Fed.
Thanks to these spectacularly large taxpayer-funded bailouts, Goldman was able to continue "doing God's Work" - as CEO Lloyd Blankfein infamously remarked - like the work of producing billion-dollar trading profits without ever suffering a single day of losses.
Thanks to the Fed's massive, undisclosed assistance, Goldman Sachs managed to project an image of financial well-being, even while accessing tens of billions of dollars of direct assistance from the Federal Reserve.
By repaying its TARP loan, for example, Goldman wriggled out from under the nettlesome compensation limits imposed by TARP, while also conveying an image of financial strength. But this "strength" was illusory. Goldman repaid the TARP loans with funds it procured days earlier from the Federal Reserve. Then, over the ensuing months, Goldman recapitalized its balance sheet by selling tens of billions of dollars of mortgage-backed securities to the Fed.
And the public never knew anything about these activities until two weeks ago, when the Fed was forced to reveal them.
In a free-market economy, certain precepts seem fundamental...and essential:
1) Taxpayers have a right to know who's spending their money.
2) Dollar-holders have a right to know who's debasing their money.
3) Investors have a right to know who's cheating them out of their money...by hiding the truth.
All three camps have a very large and legitimate bone to pick with the Fed's secret bailouts of 2008 and 2009. But let's consider only the case of the deceived investor...
Secret bailouts do not merely benefit recipients; they also deceive investors into mistaking fantasy for fact. Such deceptions often punish honest investors, like the honest investors who sold short the shares of insolvent financial institutions early in 2009.
Some of these investors had done enough homework to understand that no private-market remedy could ride to the rescue of certain financial firms. Therefore, these investors sold short the shares of certain ailing institutions and waited for nature to take its course. But the course that nature would take would be shockingly unnatural. We now know why. The Federal Reserve altered the course of nature, and did so without telling anyone.
Many of the investors who sold short ailing financial firms in 2009 were alert to the possibility that bailouts by the Federal Reserve could change the calculus. In other words, the Fed could make the bearish case less bearish...at least temporarily. Therefore, many of these investors studied the Federal Reserve's disclosures, as well as corporate press releases, in order to quantify the Fed's influence.
Based on all available public disclosures, the story remained fairly grim into the spring of 2009. Accordingly, the short interest - i.e., number of shares sold short - on Goldman Sachs common stock hit a record 16.3 million shares on May 15, 2009 - about 3.3% of the public float. But over the ensuing six months, Goldman's stock soared more than 30% - producing roughly $500 million in losses for those investors who had sold short its stock. Not surprisingly, the total short interest during that timeframe plummeted to less than 6 million shares, as short-sellers closed out their losing positions.
Was it just bad luck? Or was something more nefarious at work here?
Let the reader decide. But before deciding, let the reader carefully examine the chart below, while also carefully considering a selection of public announcements from Goldman Sachs during this timeframe.
Based upon contemporaneous public disclosures, Goldman Sachs was "forced" by the Federal Reserve to accept a $10 billion loan from the TARP facility in October 2008. But Goldman's top officers repeatedly - and very publically - bristled under the compensation limits the TARP loan imposed.
Therefore, as early as February 5, 2009, Goldman's chief financial officer, David Viniar, remarked, "Operating our business without the government capital would be an easier thing to do. We'd be under less scrutiny..." And on February 11, 2009, CEO Blankfein magnanimously remarked, "We look forward to paying back the government's investment so that money can be used elsewhere to support our economy."
But at that exact moment, we now know, Goldman was operating its business with at least $25 billion of undisclosed "government capital."
In April, 2009, The Wall Street Journal observed, "Goldman Sachs group Inc., frustrated at federally mandated pay caps, has been plotting for months to get out from under the government's thumb... Goldman's managers have a big incentive to escape the state's clutches. Last year, 953 Goldman employees - nearly one in 30 - were paid in excess of $1 million apiece... But tight federal restrictions connected to the financial-sector bailout have severely crimp the Wall Street firm's ability to offer such lavish pay this year."
On May 7, 2009, a Goldman press release states: "We are pleased that the Federal Reserve's Supervisory Capital Assessment Program has been completed... With respect to Goldman Sachs, the tests determined that the firm does not require further capital... We will soon repay the government's investment from the TARP's Capital Purchase Program."
On June 17, 2009, Goldman finally got its wish, thanks to some timely, undisclosed assistance from the Federal Reserve. Goldman repaid its $10 billion TARP loan. But just six days before this announcement, Goldman sold $11 billion of MBS to the Fed. In other words, Goldman "repaid" the Treasury by secretly selling illiquid assets to the Fed.
One month later, Goldman's CEO Lloyd Blankfein beamed, "We are grateful for the government efforts and are pleased that [the monies we repaid] can be used by the government to revitalize the economy, a priority in which we all have a common stake."
As it turns out, the government continued to "revitalize" that small sliver of the economy known as Goldman Sachs. During the three months following Goldman's re-payment of its $10 billion TARP loan, the Fed purchased $27 billion of MBS from Goldman. In all, the Fed would purchase more than $100 billion of MBS from Goldman during the 12 months that followed Goldman's TARP re-payment.
Did private investors not have the right to know that the Federal Reserve was secretly recapitalizing Goldman's balance sheet during this period? Did they not deserve to know that the Fed's MBS buying was producing Goldman's "perfect" trading record during this timeframe?
Yes, would seem to be the obvious answer.
"There's a saying in poker: If you don't know who the patsy is at the table, it's you," observes Henry Blodget, the once and again stock market analyst, "Next time you feel like bellying up to the Wall Street poker table, therefore, ask yourself again who the sucker is."
Regards, Eric Fry for The Daily Reckoning