Did Goldman Sachs get too greedy this time? If so, the gravy train could be coming to an end…

Fenster: They treat me like a criminal. I’ll end up a criminal.
Hockney: You are a criminal.
Fenster: Why you gotta go and do that? I’m trying to make a point.
– The Usual Suspects (1994)

Ah, Goldman Sachs, how we despise thee. Let us count the ways.

First there is the matter of jaw-dropping compensation. As The New York Times reported last week:

Goldman posted the richest quarterly profit in its 140-year history and, to the envy of its rivals, announced that it had earmarked $11.4 billion so far this year to compensate its workers.

At that rate, Goldman employees could, on average, earn roughly $770,000 each this year – or nearly what they did at the height of the boom.

Senior Goldman executives and bankers would be paid considerably more…

The unofficial party line from Goldman is, “Don’t hate us because we’re smart.” (Or in the street vernacular, “Don’t hate the player, hate the game.”)

To get rich in a capitalist system you need three things – hard work, smarts and luck. America, rightly, bears little or no ill will when fortunes are made through the combination of these three. Take the Google guys, for example… or Warren Buffett… or any other number of big winners in our (quasi) free market system.

Heck, America even goes one better than that. In the United States, you can make ridiculous sums of money that no one even remotely thinks you deserve, and most folks won’t begrudge your good fortune.

If a ne’er do well CEO convinces his shareholders to pay him a bonus worth tens of millions for doing diddly-squat, that might be a shame… but it’s the shareholders’ money, free to be wasted as they wish.

Or if an athlete signs on to a professional sports team for tens of millions and then, say, gets into a nightclub shooting, wilts under pressure, or otherwise turns out to be a total flop, well… c’est la vie. A contract is a contract.

Point being, private financial exchanges are akin to what happens in the privacy of a home. The result may be weird or goofy or stupid or obscene, but as long as consenting adults are involved, the public doesn’t really care.

Where Goldman (and others) crossed the line is in the source of their gains…

Taxpayer Largesse

First, an interesting tidbit. Goldman’s take of $770,000 per employee is stunning enough. But as it turns out, Goldman may have actually used a subtle accounting trick to make that number smaller, so as to tone down some of the spotlight glare.

Various Wall Street sources have reported to Dealbook that “in a footnote to its financial results… Goldman said that for the first time it was including consultants and temporary staff in its overall employee figures. This had the result of increasing its official staffing levels by 2,000 jobs or so in both the first and second quarters.”

By spreading the haul over a bigger head count, you see, the gaudy top line number – average profit per employee – is reduced.

So by throwing in consultants and temps and, who knows, maybe even janitors and deli delivery boys, Goldman can practice its own peculiar brand of modesty in at least keeping the profit per head below a million bucks.

Again, the reason for gall is not because Goldman’s traders are “smart.” It is because this pound of flesh was extracted directly from taxpayer’s hides.

On one level the chain of events is simple:

• Goldman Sachs takes huge, multibillion-dollar taxpayer cash infusion from the government.
• Goldman uses these funds to make an absolute killing.
• Goldman says “Gee thanks!” and pays back the money with minimal (i.e. zero) penalty attached.

But actually it’s a lot murkier and uglier than that.

Thanks a Billion, Hank

To really get a bead on how stinky this whole situation is, consider why 2009 has proven so profitable for Goldman Sachs. Two reasons stand out. First, half its competition has been crippled or killed off. Second, AIG (a major Goldman Sachs counterparty) was specifically kept afloat.

If you’ll recall, the previous Treasury Secretary was Hank Paulson, a.k.a. “Hammerin’ Hank,” the ex-CEO of Goldman Sachs. (Paulson was recently back in the news defending his tough-guy leanings in the whole Bank of America/Merrill Lynch fiasco.)

Taipan Daily is not one to promote irresponsible conspiracy theories. But nor do we shy away from putting two and two together. So with that in mind, let’s look back at the dark days of September 2008.

During Paulson’s time at Treasury, there was no question who was top dog (in terms of the relationship between the Treasury and the Federal Reserve). Hammerin’ Hank was everywhere. Bernanke was a shrinking violet in comparison.

Now the uncomfortable questions…

On that fateful weekend in question when Lehman Brothers collapsed, who stood to benefit (in the long run) from the disappearance of a major Wall Street competitor? Goldman Sachs.

Coincidence? Maybe. But then note what happened just a few days later. Within 72 hours of Lehman Brothers’ collapse, Paulson announced that AIG would be saved… at an outrageous opening bid of $85 billion. (The taxpayer tab would eventually run much, much higher – and it’s still running.)

Again, using the old Latin phrase “cui bono” (Who benefits?) as our guide, one has to ask… who was one of the major beneficiaries, if not THE major beneficiary, in seeing AIG survive?

Goldman Sachs.

This is true because AIG played the role of busted bookie, having made tens of billions worth of dumb bets with other investment houses on the street. Normally when a gambling house folds, the gamblers waiting to be made whole are SOL – a technical acronym which means “out of luck.”

But when the gamblers are high rollers it’s a different story. In part, Paulson and Bernanke saved AIG, flooding it with tens of billions in taxpayer cash, so that those very same funds could be kicked right back out to other players on the street. In its death throes AIG served as a “beard”… a convenient one-stop money laundering shop, used by the Treasury and the Fed to avoid the political inconvenience of writing big checks out in the open.

As a result of AIG’s last-minute bailout, and the discreet transfer operation outlined above, Goldman walked away with a cool $13 billion or so… profits on AIG-backed contracts that would not have paid off had Hammerin’ Hank – the ex Goldman CEO – not saved the day.

Rotten Egg Insurance

There is yet another amusing question that must be asked. It would be a small miracle if Congress figures out the importance of this question, but who knows – they may eventually get around to it.

That question has to do with the morality, or even the legality, of buying rotten egg insurance on the very eggs one is selling.

Put it this way… suppose I set myself up in the fly-by-night homebuilding business. You decide to trust me, and soon move your family into a beautiful new 3,000 square foot home built by my construction firm.

In time you discover the home is a disaster. The drywall is rotted and mildewed… the electrical wiring is a fire hazard… the foundation is cracked… the generic insulation is asbestos-prone… a residential nightmare through and through.

Naturally you would want restitution on this disaster of a house. You might get some money back, but nowhere near enough. On top of that, the emotional anguish (and headache and hassle) could never be repaid.

So how would you feel if you later found out that, even as I sold you the house, I had acted with foresight by loading up on a certain type of disaster insurance… insurance that paid off specifically in the event of a construction-related loss? And what if, let’s further say, you found out that I made an absolute killing on the trade – making more from my side bet than I paid in restitution on our deal?

This is a fair summation of what Goldman Sachs did in relation to the whole toxic asset subprime debacle. It sold rotten eggs – or rotten houses if you like – and protected itself by taking out disaster insurance on the very garbage it was selling.

This is murky legal ground, of course. One can hardly blame an investment bank for looking out for itself. And making bearish bets in the market should hardly be illegal.

At the same time, this dramatic separation between “sell side” and “buy side” is very interesting. What to make of it when an organization that is shoveling toxic-related assets out the door as fast as it can – stuffing its clients like geese until their livers explode – is simultaneously making aggressive downside bets on the very same dreck?

It’s no big deal though… they were just being “smart”…

An Age-Old Pattern

There is yet more… plenty more. We could get into the front-running accusations tied to the stolen Goldman code, or the practices of certain players that look tantamount to stealing $15 billion-$25 billion a year directly from investors’ pockets, or the direct manipulation of certain markets… but that would be overkill. By now the point has hopefully been driven home.

The truth of the matter is that nearly all major banks – not just Goldman Sachs – have exploited their privileged position within the system for decades. Goldman is simply the biggest, most brazen example at this point in the cycle – and one of the few “smart” enough not to have blown itself up.

The crux of the problem is “regulatory capture,” in which the players in an industry amass so much power and influence that they successfully “capture” the watchdogs who are supposedly watching them.

Financial history has seen these episodes play out over and over again. One over-the-top example was the 1980s failure of Continental Illinois Bank and Trust Company – at one time the seventh largest bank in the United States.

When “Conti” finally failed, it was only after an extended comedy of errors, in which the bone-headed bankers running the show repeatedly told the Federal Reserve to shove off and mind its own business. Conti’s ship of fools was piloted by buffoonishly confident captains until the very day it ran aground.

And the Fed, far from being the all powerful regulator and stern disciplinarian it was supposed to be when it came to reining in the big money center banks, was instead cowed and stymied by Conti’s political clout and systemic importance. (Just as it is thoroughly cowed by the likes of Goldman Sachs and JPMorgan today…)

A Bonus Too Far

The reason this kind of thing matters is because now, finally, the big banks may have taken their greedy taxpayer rip-off game “a bonus too far.”

And again, it isn’t just Goldman Sachs. It isn’t even just the United States. In a recent piece titled “The devil’s punchbowl,” The Economist reports:

A new hiring frenzy in the City [London's financial district], with bonuses guaranteed for “only” the first year; investment-banking results for the second quarter likely to top those of the first; an innovative securitisation [sic] by Barclays to get bank loans off its balance sheet. The term “business as usual” normally delights tradesmen and their customers. Applied to the banks that plunged Britain into economic crisis, it strikes fear to the heart.

Surprisingly, there has been a steady drumbeat of public outrage over Goldman Sachs’ latest round of eye-popping profits (rather than the usual obliviousness). It is no longer quite “business as usual” for the most connected player on Wall Street.

The American taxpayer is slowly waking up to the true source of such profits, and the free market travesty such ill-gotten gains represent. If anything, these fat cats are more socialist than capitalist in their smoky back-room domination of a secretive, incestuous, oligarch-infested state.

But with that said, your humble editor doubts it will be outrage alone that derails the big bank gravy train. Politicians love a bit of theater in front of the cameras to please the folks back home, but most of the time it winds down to nothing.

No, what would really wreck the gravy train would be another global banking crisis… a sort of “financial supernova 2.0″ with as much destructive power as the first one (if not more).

And we could see it too… more on that to come.

Source: A Bonus Too Far (Bankers on Borrowed Time)