Warren Buffett & Goldman Sachs: The Scandal We Might Never Know

Rich Nixon – Would You Buy a Used Derivative From This Man?

By Donald Caploe PhD, Chief Political Economist, EconomyWatch.org, 11 February 2010

Advisory: The following is based purely on circumstantial evidence as well as analogical reasoning and NOT any within information.

By David Caploe PhD, Main Political Economist, EconomyWatch.com, 11 Feb 2010

Advisory: The following is based purely on circumstantial evidence and analogical reasoning and NOT any inside information.

During the actual Watergate hearings of the mid-1970s – examining dirty tricks that, in today’s perspective, seem almost laughably collegiate, but were taken very seriously at the time, which only exhibits how degraded American political culture has since become – a dramatic moment was supplied by Republican Senator Howard Baker of Tennessee, as he asked two very simple connected questions: what did President Nixon know – and when did he realize it ???

Today the biggest political economic scandal on the horizon remains the near-meltdown of the global financial system that almost took place in Black September 2008, during which the venerable Lehman Brothers did in fact go under, nearly bringing with it several of it’s competitive collaborators, and ushering in not only a continuing global recession, but a crisis of credibility in major financial institutions almost everywhere – except, of course, Canada, that despite its physical closeness to the US, has somehow remained immune from the contagion still running rampant just below its southern border. [Ed: EconomyWatch.com do of course cover this subject in Canada – The Best Advanced Economy in the World.]

That the Canada situation – so close, and yet therefore far – is practically NEVER discussed highlights a sad truth about public discussion regarding the causes and ramifications of those still-frightening events: even now we know almost as little about what happening behind the scenes as we did in the time.

To be sure, there have been a raft of self-justifying accounts of these occasions, most recently by then-Treasury Secretary, as well as former head of Goldman Sachs, Holly Paulson, who discussed his On the Brink: Inside the Race To Stop the Collapse of the Global Financial System on February 9 with the most successful proponent of “value investing”, the Oracle of Omaha themself, St. Warren of Buffett, in an interview streamed live on CNBC.com.

Now We generally like Buffett, basically because he takes a long-term approach to investing, and never hesitates to criticize Wall Road practices he considers questionable, deceptive, or dishonest, even if they are the SOP of the day.

But as I watched his disappointingly unrevealing chat with Paulson, skipping here and there over various “highlights” of the run-up to, and dark days of, that Black September, I suddenly got a very bad feeling.

Because despite the great deal we still don’t know about what was going on then, one factor we DO know, all-too-clearly, is that Goldman Sachs, at least so far, has come out of the still-unfolding crisis within visibly better shape than any other Western financial institution.

And as indicated by two disturbing, yet brilliantly reported, articles through Gretchen Morgenson and Louise Story from the New York Times – both of which, we have argued, were seemingly “concealed in plain sight”, one on Christmas Eve, the other on the Friday night / ‘life was imple’ of Super Bowl weekend break – it also seems Goldman Sachs took a major role in “heightening the contradictions” that led to the outbreak of this worldwide disaster.

There are several explosive information in the Christmas Eve tale about how Goldman – and, to be sure, additional investment banks and hedge funds – sold their clients derivative packages, allegedly solidly backed by home loans – the infamous mortgage-backed securities, or MBSs – while, at the same time, making OTHER wagers against the very same items they were promoting their clients.

Now, to be sure, Buffett has railed towards derivatives, famously calling them “weapons of economic mass destruction”.

But the crucial reason for this context is WHEN do Goldman start playing this dual game of betting against the very same debt packages they were selling their clients as if they had no doubts about their solidity ???

Worried about a housing bubble, top Goldman executives made the decision in December 2006 to change the firm’s overall stance on the mortgage market, from positive to negative, though it did not disclose that publicly.

Indeed, the article points out that several key players within Goldman had started taking this stance even before the firm’s general policy on the housing market shifted into bear-ish precincts.

So a good 18 months at least prior to Black September 2008, Goldman being an institution had moved against what it perceived from that point forward as a bubble in the housing market they were fairly certain was going to collapse – even as they continued to sell derivatives based on that market to their clients.

What about the Super Bowl weekend story ???

Well, it was about exactly how Goldman basically pushed AIG to the wall in a quiet but intense dispute over valuations of these very same “derivatized” mortgage-based securities against which Goldman had been institutionally betting, for at least a year, by taking out insurance on them along with AIG.

The dramatic climax of this conflict, with which the Times’ story begins, took place in a conference call at the end of January 2008 – a year after Goldman had privately turned bearish on the housing market, as well as nine months before the explosion of Black September – a major function of which, you may recall, had been the hysteria engendered by the possible collapse of the largest insurer within the world, that very same AIG.

The obvious inference, obviously, is that Goldman’s desire to make good on its bets From the housing market led it to place pressure on AIG they understood the insurance company could not withstand.

Not surprisingly, Goldman potentates vehemently took umbrage at the very concept:

[David] Viniar [Goldman’s Chief Financial Officer] said that Goldman had done nothing wrong and that the actual firm was merely trying to enforce its insurance policy with A.I.G. “I don’capital t think there is any shame whatsoever,” he concluded.

Lucas truck Praag, a Goldman spokesman, reiterated which position. “We requested the collateral we were entitled to under the terms of our agreements,” he said in a written statement, “and also the idea that A.I.G. collapsed because of our represents is ridiculous.”

But read on and you might feel these distinguished men were being a bit disingenuous, to say the least:

Perhaps probably the most intriguing aspect of the relationship in between Goldman and A.I.G. had been that without the insurer to supply credit insurance, the investment bank could not have generated some of its enormous profits betting against the mortgage market.

And whenever that market went south, The.I.G. became it’s biggest casualty — and Goldman became one of the biggest beneficiaries.

So why is the time here so important ???

Because when Street Warren of Buffet finally did are available in on his white equine to rescue Wall Street from its own voracious greed, and the rest of the world from its callousness as well as stupidity, he had his choice of places where he might put his money as a means of showing faith in the system that seemed to be failing at the seams.

He obviously hadn’t become involved during the whole Bear Stearns debacle earlier in 2008. And he could have chosen in order to rescue Lehman Brothers, the venerable expense house established in 1855 – however he didn’t. Or he could even have taken his billions and help stabilize the world’s biggest insurance company, AIG – but he didn’t do that either.

Instead, on the 23^rd of September, 2008, Goldman announced a private deal to market Berkshire Hathaway $5 billion of perpetual favored stock – basically a loan having a guaranteed 10% annual dividend of $500 million dollars – Along with a “bonus” of the right to buy $5 billion of GS common at $115 / share at any time during the next five years.

Now, given Buffett’utes penchant for long-term investments, one could bet he wasn’t too concerned when, at one point in the first year of the “bonus” period, GS was, like so many American houses were and would turn out to be, “underwater”, at around $47 / share.

Only these 43,478,260 warrants weren’t places Buffett was planning to live in, but, rather cash in at some point later within the 5-year period. So when the price a year later was at $186, Buffett – had he sold the entire lot – would have made a good profit of some $3 billion.

In this context, we are duty-bound to raise the question of due diligence.

Certainly Buffett is not a guy to throw his money away. And, almost equally certainly, the Oracle of Omaha had enough connections in and around Wall Street to know both

a)   

that GS had turned bear-ish on the housing market by the end of 2006 AND

b)  

that they’d taken out downside positions backing that up with AIG – positions which, if he had known about them, he or she certainly knew would place AIG in the toilet to the advantage of GS if the housing market collapsed, as he almost certainly knew it would.

The concerns therefore that Howard Baker requested of President Nixon re Watergate suddenly resound loudly in the wake associated with Black September 2008:

What do Warren Buffett know about the negative position of Goldman Sachs towards the housing market – and when – such that he had great confidence giving a $5 billion loan to GS at a time when the whole financial world seemed heading towards Doomsday ???

Maybe someday we’ll know if there’s yet another Goldman Sachs scandal to be uncovered – this time around involving the last man anybody would ever suspect: Warren Buffett.

Or perhaps we won’t.

David Caploe PhD

EconomyWatch.com