Monday, April 26, 2010

In Goldman Sachs They Trusted - 1929 and 2008 Deja Vu

“In Goldman we trust” - Kenneth Galbraith warned us 55 years ago

In 1955 Kenneth Galbraith published what is considered the definitive book on the great depression called with all the wit and imagination of an economist – “The Great Depression”  What it may have lacked in marketing edge it made up for in content and insight. It has been held to the test of time and emerged today as an essential work on the economic meltdown of the 1930s.

However, a recent reread showed how it can also be seen as a prescient warning. You might want to be sitting down for this one. Chapter 3 of his historic book is titled “In Goldman Sachs We Trust” In it; Galbraith explains how the firm went from being one of the newest kids on the block to the leading promoter of closed end stock funds prior to the great crash.

Essentially these closed end funds were exactly the same as the ones operated today by Goldman and reputable firms throughout the world. A fixed number of shares in the closed end fund are sold to raise capital. This money is used to invest in other stocks. The manager of the fund is presumed to be able to outperform the market and from this performance the fund will earn a profit in excess of the market.

These funds were essentially the first derivatives, since they drew their value not from their own effort but by the underlying value of the stocks they bought. But, the difference is that in 1928 Goldman basically turned the idea of closed end funds into a pyramid ponzi scheme. They issued Goldman Sachs Trading Company in December 1928. One million shares were issued at $100 a share to capitalize the firm at $100, 000, 00. Then 90% of the stock was sold to the public. Within 2 months Goldman bought back 560,724 shares of its own stock, this created huge market demand and the stock prices soared. By the end of the month after sending prices to $222 a share Goldman sold of most of its shares at over 120% profit. Then in 1929, Shenandoah Corporation was created. Its major purpose – to purchase shares of Goldman Sachs Trading Company. Within months they had created the Blue Ridge Corporation. Its major purpose – you guess it – to purchase shares of Shenandoah.

This scam went on until the US economic meltdown in October of 1929. At its peak, this pyramid scheme drove shares of Goldman Sachs Trading Company to over $280 a share. By 1932 when Goldman was being hauled into Congress for a series of investigations the shares were worth a buck and some change. On the stock of the Trading Company alone Goldman Sachs had lost over $565 million dollars. Adjusted for inflation that would be over 7 billion dollars today.

The losses for Shenandoah and Blue Ridge were similar in style and scope. However, this is not the limit to the Goldman touch on the great depression. In their first two years of operation Goldman Sachs issued similar deals with leveraging of up to 99 to 1. These created, merged, bought or managed dozens of the closed end funds. The total cost to the people is billions and billions of dollars beyond calculation.

Goldman was hauled into Congress and all over Washington. They were excoriated and fined. But to no avail. For Goldman showed even way back then how adept it was at creating a profit opportunity – seizing the bulk of the profit – but then astutely letting go before the phony economics caught up with the deal.

Goldman Sachs always leaves someone else holding the bag. In 1929 they did it to millions but most spectacularly to William Crapo Durant. Durant was the founder of General Motors and later became a big player in the stock market. Goldman sold a huge amount of its shares to Durant. By 1936, Durant died bankrupt and living on charity. Goldman Sachs however, had stashed away enough of its money to pay all the fines it was levied and to hire the best admen available to rehabilitate its image.

In 2008 they did it to AIG, Lehman Brothers and the American taxpayer. Now it only awaits for them to suffer whatever pitiful fury their lapdogs in congress are willing to parade out for public consumption. That dealt with, Goldman will do what it has done before. Pay its fines and go on to the next scheme.

At the height of the current meltdown, Michael Robinson, the ex public affairs and policy chief for the SEC said of Goldman: "This is entirely new territory for them," "They are not accustomed to it.” Unfortunately no, it isn’t new to them and yes, they are accustomed to it. The problem is we never learn even from our most vivid histories. “Those who refuse to learn from history are doomed to repeat it” – historian George Santayana.


“The Great Depression” by Kenneth Galbraith 1955

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