Goldman's Revolving Door: Who is Protecting Whom?

So let me get this straight, Henry Paulson, who, according to Market Watch, has a net worth of at least $500 million, wants a blank check, signed by all of us, the US taxpayers, for one trillion dollars (can't you hear Dr. Evil, pinky-positioned in his mouth, saying that?).

Again...Paulson, the "CEO" of the United States Treasury, the man that George W Bush appointed as "executive" in charge of our country's stock (also known as "the dollar"), wants a blank check for somewhere between $700 billion and $1 trillion dollars to fix his "company", I mean, our country.

I think we need to know a little bit more about this guy.....

Prior to being appointed by George W. Bush to serve as "executive envoy" and "CEO" of the United States Treasury, Henry "Hank" Paulson was the CEO of Goldman Sachs, one of our country's most prominent investment banks. I happened to meet Paulson when he was taking Goldman Sachs public in 1999 when he brought the Goldman Sachs' "roadshow" (an investment term for "product expo") to Texas in an effort to encourage investors to buy shares in his company.

According to Market Watch, by 2006, just prior to accepting the Treasury position, Paulson, as Goldman Sachs' CEO, owned 3.23 million shares in Goldman Sachs (NYSE: GS) worth an estimated $500 million. In addition to the 3.2 million shares, Paulson also owned restricted stock which represented an additional 494,054 shares of common stock, worth about $75 million back (based on Goldman Sachs' closing price of $152.50 on the day that Paulson's announced his acceptance of the Treasury position).

At the time, Paulson also owned options to purchase an additional 680,474 shares of common stock, all of which are exercisable (meaning he could cash out at any time, exercising his right to even more money!) which earned him a total ownership in Goldman Sachs of approximately 1.02% of the outstanding shares of common stock.

Goldman obviously thought highly of their CEO to compensate him this way, so what did Paulson do for Goldman to have earned him well in excess of half a billion dollars? (I hear Dr. Evil again, don't you?).

Well, funny you should ask, especially given the current financial crisis relating to the mortgage industry...

In the spring of 2006, while Paulson was still the CEO of Goldman, Goldman decided to roll out a new product. A new line of Mortgage Backed Securities.

Sounds complicated. It's not. Goldman went on a shopping spree buying up mortgages -- yours, mine and your neighbors, and bought 8,274 of them. But instead of buying up the original mortgages like the ones that you and I took out to purchase our houses (you know, the ones where you put 20 percent down....), Paulson and Goldman decided to buy the riskier ones - 8,274 of them - the ones called "second mortgages": a second loan given to homeowners to pay for the purchase of their homes.

And boy, were these second loans risky! Not only did they require that you put nothing down (actually, technically speaking, according to the Washington Post, you were required to put down 0.71 percent of the value of your home in an upfront payment (that's right, you could borrow 99.29 percent of the value of a home!), but "some 58 percent of the loans were no-documentation or low-documentation. You can see why borrowers lined up for the loans, even though they carried high interest rates. If you took out one of these second mortgages and a typical 80 percent first mortgage, you got to buy a house with essentially none of your own money at risk. If house prices rose, you'd have a profit. If house prices fell and you couldn't make your mortgage payments, you'd get to walk away with nothing (or almost nothing) out of pocket. It was go-go finance, very 21st century."

And Goldman loved it.

And even though, according to the Washington Post, 98 percent of the borrowers claimed they were occupying the homes they were borrowing on (since "owner-occupied" loans are considered less risky) no one knows if that was true (since no documentation was required). And since no documentation was required, no one knows whether borrowers' incomes or assets bore any serious relationship to what they told the mortgage lenders."

So under Paulson's tenure as CEO, Goldman went on a shopping spree for these second mortgages, buying up 8,274 of them. In order to transform this "junk", er, I mean these loans into a Goldman product that they could sell to investors, Goldman bundled them up into a "secure" package. Goldman called this newly assembled package the "GSAMP Trust 2006-S3", and rolled it out as a new Goldman product, arguably, putting lipstick on a pig in order to sell it. According to the Washington Post "Goldman knew a lot about this market: GSAMP, this new Goldman product, was just one of 83 new mortgage-backed products that Goldman sold that year" under Henry Paulson's execution.

According to Bloomberg, "Goldman, the most profitable investment bank, was one of 14 primary dealers of U.S. Treasuries who contributed to a three -- year binge as $1 trillion of subprime mortgages were packaged and sold to investors." Goldman bundled these mortgages into products like the GSAMP and then divided them into tranches (-- which, as noted by the Washington Post, is French for "slices," in case you're interested) in order to sell its new product to investors. And it worked. As a matter of fact, Goldman put lipstick on 83 pigs that year, sliced them up, sold them and cashed out. Paulson and Goldman netted Goldman $44.5 billion in the sale of these products.

And as the Washington Post so aptly pointed out, just as "Tyson can slice a chicken into breasts, legs, thighs, giblets -- and Lord knows what else -- and get more for the pieces than it gets for a whole chicken," so Goldman did the same with their 83 little "piglets", making "customers happy because they get only the pieces they want."

Until all hell broke loose in the pig corral. Apparently, Paulson and Goldman didn't do quite enough "due diligence" (the investment banking term for "doing your homework"). What they failed to account for was that if a "homeowner" "borrowed 99 percent-plus of the purchase price (as the 8,274 GSAMP borrowers did) and couldn't make your payments, couldn't refinance, and couldn't sell at a profit, it was over. Lights out." And since these 8,274 borrowers hadn't been required to put more than 0.71 percent down or to show any income or any proof that they actually occupied the homes for which the loan was made, Goldman had no financial recourse, since there simply weren't any assets backing up these loans (no house to repossess, zip, nada, zilch).

Since no money had been set aside to repay the first mortgage, much less the second mortgage, there was nothing to foreclose on! So Goldman, as the "second-mortgage holder through their GSAMP product line, couldn't foreclose on deadbeats unless the first-mortgage holder also foreclosed." So Goldman was left holding...well, nothing!

Indeed, as further reported by the Washington Post, monthly reports issued by Deutsche Bank, the issue's trustee, indicate that GSAMP has recovered almost nothing on its foreclosed loans.

But Paulson, having earned the nickname "Hurricane Hank" because he was always so quick to act, once again moved with speed, "and even though many of Goldman's mortgage-backed customers were getting stomped (you know, the customers who had bought the slices of the GSAMP product), Goldman still made money on mortgages that year, shorting an index of mortgage-backed securities. "Although we recognized significant losses on our non-prime mortgage loans and securities, those losses were more than offset by gains on short mortgage positions," Goldman said in a recent SEC filing."


I guess Paulson was lucky he could still short financial securities, since he hadn't yet become Treasury Secretary and banned the short sale of 799 financial stocks, including the short sale of Goldman Sachs (NYSE: GS). I guess he was also lucky that the "conflict of interest" rules mandated that he sell his $500 million in Goldman Sachs shares back in 2006 before accepting Bush's offer to be "executive envoy" enabled him to cash out.

And I guess it was also lucky for Paulson, that according to the Economist, he didn't have to pay the $200 million in taxes owed on that $500 million, due to a provision put in place by the US government. Phew! I mean, who would want to cash out on $500 million if you had to pay $200 million in taxes like the rest of us?! That would have only left Paulson $300 million...!

Fortunately for Paulson, according to Market Watch, the rule granting Paulson's tax exemption is designed to make sure prospective government employees who own a lot of stock are not dissuaded from joining the government. Good thing, too, according to the New York Times, Paulson follows former Goldman employees right out Goldman's revolving door on to head the New York Stock Exchange, the World Bank, the U.S. Treasury Department, the White House staff, and firms such as Citigroup and Merrill Lynch.

So it should come as no surprise that shares of Goldman Sachs are up almost 20 percent on the news of Paulson's bailout (NYSE: GS).

And where does that leave Paulson?

Standing right in the middle of the corale, surrounded by his fellow bankers (squealing like piglets), waiting for you, me and every taxpayer you know to sign that blank check for him...

Author's Note: Extreme gratitude to Allan Sloan of the Washington Post for his October 16, 2007 article, "An Unsavory Slice of Subprime".