Wednesday, 28 April 2010

Goldman Sachs and capitalism's ‘New Normal’

Goldman Sachs (GS) prepares to take on the US government, in the form of the US Senate and the Securities and Exchange Commission (SEC), in the coming months. The GS Chief Executive Officer Blankein versus Senator Levin exchange is a small battle in a larger war.

In the internet age we have a tendency to redefine traditions. Thirty is the new twenty, small is the new big and billions are the new millions.
High finance has been no exception. It has been redefined.
Traditional banking business is a relic of the past. Bankers do not lend money anymore. Bankers invest money aka play with OPM (other peoples' money). Yes, at some level the 'investments' are actually loans, but the degrees of separation between the lender and the borrower are umpteen.
Certainly, few bankers know the people to whom they lend money. Personal assessments of character and ability to repay are replaced by point systems. Few bankers visit business premises to check plant and machinery of borrowers.
When an AIG trader, if there are any left, buys a synthetic security he buys a piece of paper with a value associated with another piece of paper. The second piece of paper is linked to a loan securitized such that it becomes another piece of tradable paper. Perhaps the third piece of paper is the 'real' loan which some individual is servicing as a mortgage on their home.
It's easy to see why active market participants may not even care about the underlying exposure (loan) of the synthetic security. They leave the qualitative judgement on the final loan on which the entire structure is built to the rating agencies.
The rating agencies, like the hedge funds which proliferate through the financial ecosystem, rely upon quantitative, disciplined back testing to determine loan default rates. Of course, historical relationships, quantitative or otherwise, tend to break down over time.
China was a communist, centrally planned economy until the 1990s. India, with its pseudo-socialist economy, was a Soviet ally during the Cold War. Kabul, Afghanistan was the end point of the Hippie Trail which started in Volkswagen vans all across Europe. Brazil was a basket case economy suffering from chronic hyper-inflation and budget deficits.
Similarly in finance, relationships that remained stable for the last decade change dramatically at short notice. Whether the changes were triggered by Greenspan's easy credit era or home sellers running out of buyers to 'flip' their houses to, it really does not matter.
Ultimately, the system broke down. It will take years to fix and the world economy's new structure is still uncertain. The Chinese Renminbi may be the international reserve currency several decades hence, or perhaps the world will revert to the gold standard. No one can say for certain.

The 'New Normal' for capitalism is trading in paper certificates. The certificates may represent pork bellies, oil or paper which relies on paper which relies on paper which relies on paper which is valued based on the upward movement of US Dollar interest rates when it is sunny in London but when it is raining in London the value of one hundred bushels of wheat are to be used!
Ultimately, it's all paper and as long as one buys low and sells high (not necessarily in that order) then it's all worthwhile. Taking out money from the market is the new mantra for international bankers.
Play with the numbers enough and it's not a zero sum game. In other words, the money can be 'created' and original goods and services are no longer necessary.
So when watching the Goldman Sachs versus the World drama, let's remember that it's a world which the financial sector did not create without active participation from the broader society. When times were good everyone cheered.
Today, Iran's nuclear threat is no longer the greatest threat to Western civilization. The honour belongs to Goldman Sachs CEO Blankfein and his loyal (though greedy) troops scattered around the world's various financial capitals.  
Just in case someone wishes to profit from the entire mess, there are some gainers. During the last two weeks, as Goldman Sachs stock price dropped seventeen percent, Morgan Stanley's stock price gained three percent. In the old fashioned investment world, a relative outperformance of twenty percent is worthy of a handsome bonus.

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