Vivek Kaul
The investment bank Goldman Sachs is at it again. In a report dated March 14, 2014, the bank said that it expects the Nifty index to touch 7600 points during 2014. As I write this (on March 19, 2014, around noon) the Nifty is at around 6526 points.
This means that the Nifty needs to rally by around 16.5% from its current level to touch 7600 points. And if the Sensex rallies by similar levels it will cross 25,000 points during the course of the year.
Goldman Sachs offered a spate of reasons justifying the target of 7600 points for the Nifty (You can read them here). The only trouble here is that similar predictions made by Goldman Sachs in the past have gone majorly wrong.
Blogger and analyst Deepak Shenoy writes about these predictions in a post on his blog www.capitalmind.in. In November 2012, Goldman Sachs predicted that India will grow by 6.5% during 2013. The actual growth came in at less than 5%.
In March 2012, the investment bank predicted that by March 2013, Nifty would touch 6100 points. As on March 28, 2013, the Nifty was way lower at 5682.55 points. In August 2011, the investment bank predicted that by September 2012, the Nifty would touch 6600 points. As on September 28, 2012, the Nifty was at 5730.3 points. It only got anywhere near 6600 points very recently.
So that is how the past predictions of Goldman Sachs have gone. Hence, why take this new prediction seriously?
In fact, truth be told, Goldman Sachs is not the only financial firm making such predictions. They come by the dozen. Here are a few such predictions that were made at the beginning of this year. CLSA has predicted that the Sensex will touch 23,500 points by December 2014. Deutsche Bank Markets Research did better than CLSA and predicted that Sensex will touch 24,000 points by the end of this year. And Goldman Sachs in an earlier report dated November 5, 2013, had predicted that the Nifty would touch 6900 points by the end of 2014. This target has now been upped to 7600 points.
The economist John Kenneth Galbraith termed the entire business of prediction as a fraud. As he writes inThe Economics of Innocent Fraud “The fraud begins with a controlling fact, inescapably evident but universally ignored. It is that the future of economic performance of the economy, the passage from good times to recession or depression and back, cannot be foretold. There are more ample predictions but no firm knowledge.”
And why is that? “There is the variable effect of exports, imports, capital movements and corporate, public and government reaction thereto. Thus the all-too-evident-fact: The combined result of the unknown cannot be known,” writes Galbraith.
Given this, why are such predictions made? For one, making such predictions is a fairly lucrative career option. Also, investors (like most other people) want to know in which direction are the markets headed. In the recent past, there have been a spate of reports which essentially have been telling us that markets will continue to go up, because Narendra Modi will be the next prime minister of India.
The stock market investors are largely supporters of Modi, and any report that links Modi and the stock market going up is music to their ears. Sometime back an Indian stock brokerage predicted that Narendra Modi is likely to win the next elections and even made projections on how many seats the Bhartiya Janata Party is likely to win. This after some of its analysts had travelled six hundred kilometres through fifteen districts.
In a country where the most detailed polls go wrong, how can anyone in their right mind make a prediction on the number of seats a party is likely to win, after travelling through just 15 districts? The report was immediately lapped up by the pink papers and their readers, given that Narendra Modi winning the elections is music to their ears. As Galbraith puts it “The men and women so engaged believe and are believed by others to have knowledge of the unknown; research is thought to create such knowledge. Because what is predicted is what others wish to hear and what they wish to profit or have some return from, hope or need covers reality.”
Also, financial firms need a story to sell stocks to their clients. As the old saying goes, every bull market has a theory behind it. Andy Kessler, who used to be analyst with Morgan Stanley, recalls his experience in Wall Street Meat. As he writes “The market opens for trading five days a week… Companies report earnings once every quarter. But stocks trade about 250 days a year. Something has to make them move up or down the other 246 days [250 days – the four days on which companies declare quarterly results]. Analysts fill that role. They recommend stocks, change recommendations, change earnings estimates, pound the table—whatever it takes for a sales force to go out with a story so someone will trade with the firm and generate commissions.”
Predicting which way the stock market is headed is also a part of this game. Also, revising targets is an important part of this game. As Kessler writes “For some reason, Morgan Stanley was into price targets. I hated them. To me, they were pure marketing fluff. I would recommend Intel at, say $25. The first question I would get is what is my price target. My answer would be $40 for no particularly good reason. It was high enough to interest investors, but I was guaranteed to be wrong. If it hit $38, it was a great call, but I was wrong. If it went to $60, it was an even better call, but I was still wrong. What usually happened was that if the stock hit $35, I was asked to adjust my price target to $50, so that sales force would have a call to go out with.”
Let’s understand this in the context of Goldman Sachs’ Nifty target of 7600. In November 2013, the firm predicted that Nifty would touch 6900 by the end of 2014. Three months into the year the Nifty has already crossed 6500 points and hence, a target of 6900 points doesn’t sound ‘sexy’ enough. The solution, of course, is a new target which is at a much higher 7600 points.
What this also does is that it gives the financial firm a lot of coverage in the media. Every pink paper in the country, along with almost all business news websites have carried the news about Goldman Sachs’ new Nifty target. So, in a way it’s free advertising for Goldman Sachs.
Interestingly, when the stock market hit an all time high in January 2008, a stock brokerage which was looking to go public, released a report saying that the Sensex will touch 25,000 points before the end of the year. The report was covered comprehensively through the day across all business news channels. The next day the pink papers also splashed the news big time. So, the stock brokerage got the publicity that it needed. Of course, the Sensex still hasn’t touched 25,000 points, more than six years later.
This is not to say that the Sensex will not cross 25,000 by the end of the year or the Nifty will not touch 7600 points, as predicted by Goldman Sachs. For you all we know that might turn out to be the case. And the analysts at Goldman will then be termed as visionary. But when it comes to markets, it is always worth remembering what John Maynard Keynes, the great man that he was, once said: “Markets can remain irrational longer than you can remain solvent.”
The article originally appeared on www.FirstBiz.com on March 19, 2014
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Goldman Sachs
Fasten your seatbelts: Not only United Bank, a major part of banking is in trouble
Vivek Kaul
In an editorial today (i.e. February 26, 2014), on the troubled United Bank of India, The Financial Express asks “Wasn’t anybody watching?”. “It is amazing that things could have been allowed to come to such a pass without action being taken to stop it,” the pink-paper points out.
In fact, The Financial Express should have been asking this question about the Indian banking sector as a whole, and not just the United Bank in particular. As of September 30, 2013, the stressed asset ratio of the Indian banking system as a whole stood at 10.2% of its total assets.
This is the highest since the financial year 2003-2004 (i.e. the period between April 1, 2003 and March 31, 2004) point out Tushar Poddar and Vishal Vaibhaw of Goldman Sachs in a recent report titled India: No ‘banking’ on growth.
Interestingly, the public sector banks are in a worse situation that their private sector counterparts. As the latest RBI Financial Stability Report points out “Among the bank-groups, the public sector banks continue to have distinctly higher stressed advances at 12.3 per cent of total advances, of which restructured standard advances were around 7.4 per cent.”
The stressed asset ratio is the sum of gross non performing assets plus restructured loans divided by the total assets held by the Indian banking system. What this means in simple English is that for every Rs 100 given by Indian banks as a loan(a loan is an asset for a bank) nearly Rs 10.2 is in shaky territory. The borrower has either stopped to repay this loan or the loan has been restructured, where the borrower has been allowed easier terms to repay the loan (which also entails some loss for the bank) by increasing the tenure of the loan or lowering the interest rate.
The restructuring of a loan happens through the Corporate Debt Restructuring(CDR) cell. The Goldman Sachs analysts point out in their report that 85% of restructured loans were restructured during the last two years (i.e. financial year 2011-2012 and 2012-2013).
What makes the situation even more precarious is the fact that the stressed loans could keep increasing. Goldman Sachs projects that among the banks its research team covers stressed loans could go up by as much as 25% in 2013-2014 (i.e. the period between April 1, 2013 and March 31, 2014). Also, some of the troubled loans have still not been restructured or classified as bad loans by banks. Hence, the situation is worse than what the numbers tell us.
As Akash Prakash of Amansa Capital wrote in a recent column in the Business Standard “Most investors believe that many of the problem assets are yet to be recognised by the system. These banks continue to increase their exposure to the problem areas of power and infrastructure.”
Five sectors, namely, Infrastructure, Iron & Steel, Textiles, Aviation and Mining, have the highest level of stressed advances. “At system level, these five sectors together contribute around 24 percent of total advances of SCBs [scheduled commercial banks], and account for around 51 per cent of their total stressed advances…The share of above mentioned five sectors in the loans portfolio of Public Sector Banks,” the RBI Financial Stability Report points out. Hence, the public sector banks are in greater trouble than their private counterparts.
Of the five sectors the infrastructure sector has contributed around 30% of the total stressed assets even though its share of total loans is only about 15%.
The banks have also not been provisioning enough money against stressed loans. “Moreover, provisions for stressed assets are still low, and the lowest in the region. For public-sector banks under its coverage, our Financials Research team assesses the provision coverage ratio for stressed loans at only 24%,” write Poddar and Vaibhav.
What this means is that the banks are not setting aside enough money to deal with prospect of a greater amount of their stressed loans being defaulted on by borrowers and turning into bad loans. And to that extent, banks have been over-declaring profits. That wouldn’t have been the case if they had not been under-provisioning.
Despite the under-provisioning the capital adequacy ratio of banks has fallen dramatically in the recent past. “The Capital to Risk Weighted Assets Ratio (CRAR) at system level declined to 12.7 per cent as at end September 2013 from 13.8 per cent in as at end March 2013…At bank-group level, PSBs recorded the lowest CRAR at 11.2 per cent,” the RBI Financial Stability Report points out. In fact, since September 30, the capital adequacy ratio of the entire banking system would have fallen even more, given that bad loans have gone up. The capital adequacy ratio of a bank is the total capital of the bank divided by its risk weighted assets.
In the days to come, the banks, particularly public sector banks (given their falling capital adequacy ratio), will have to raise more capital to have a greater buffer against the mounting bad loans. The RBI estimated in late 2012 that banks need to raise around $26-28 billion (or around Rs 1,61,200 crore – Rs 1,73, 600 crore, if one dollar equals Rs 62) by 2018.
This is a huge amount. “The capital raising requirement could increase to US$43bn [Rs 2,66,600 crore] under a stress scenario where gross NPLs[non performing loans] and restructured assets rise to 15% of loans, the previous historical high,” estimates Goldman Sachs.
So where is this money going to come from? For the financial year 2014-2015 (i.e. the period between April 1, 2014 and March 31, 2015). the finance minister P Chidambaram has set aside only Rs 11,200 crore for capital infusion into public sector banks. This is simply not enough.
So should government pump in more money into the banks? It simply doesn’t have the capacity to do so. As Akash Prakash writes “There is no way the government can fund this; there is simply no fiscal capacity. Nor do investors want to stand in front of this freight train, since the capital needs for most banks are greater than their current market capitalisation.”
Let’s take the case of the United Bank of India. The current market capitalisation of the bank is around Rs 1442 crore(assuming a share price of Rs 26). The government has decided to pump in Rs 800 crore into the bank. Given that, the market capitalisation of the bank is around Rs 1442 crore, which private investor would have been ready to pump in Rs 800 crore? Also, when the State Bank of India tried to sell shares worth Rs 9,600 crore to institutional investors recently, it failed to raise the targeted amount and had to be rescued with the Life Insurance Corporation pitching in and picking up its shares.
If the biggest public sector bank in the country, which accounts for nearly 20% of Indian banking, is unable to sell its shares completely, what is the chance for other public sector banks being able to do so?
Given these reasons, Indian banking is in for a tough time ahead. Fasten your seatbelts.
The article originally appeared on www.FirstBiz.com on February 26, 2014.
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Why the Modi bull market is likely to continue
Vivek Kaul
If foreign investors into the Indian stock market are to be believed, India is currently in the midst of a Modi rally. Goldman Sachs had explained this phenomenon best in a note titled Modi-fying our view, published on November 5, 2013. “The BJP led National Democratic Alliance (NDA) could prevail in the next parliamentary elections that are due by May 2014. Equity investors tend to view the BJP as business-friendly, and the BJP’s prime ministerial candidate Narendra Modi (the current chief minister of Gujarat) as an agent of change. Current polls show Mr.Modi and the BJP as faring well in the five upcoming state elections, which are considered lead indicators for the general election next year. Even though the actual general election outcome is uncertain, the market could trade this favorably over the next 2 quarters, which argues for modifying our stance,” the Goldman Sachs note pointed out.
Every bull market has a theory behind it. But ultimately any market goes up when the amount of money being brought in by the buyers is more than the amount of money being taken out by the sellers. For the Indian stock market to continue going up, and for the so called “Modi” rally to continue, the foreign investors need to continue bringing in money into the country.
The foreign institutional investors have made a net investment of Rs 72,791 crore since the beginning of the year. During the same period the domestic institutional investors have net sold Rs 65,694 crore.
In fact, numbers for the month of November make for a very interesting read. The foreign institutional investors during the month have made a net investment of Rs 6108 crore. During the same period the domestic institutional investors have net sold stocks worth Rs 9376 crore.
Through this data we can conclude that foreign investors have been more bullish on Indian stocks than Indian investors. Why has that been the case?
A possible interpretation of this is that the domestic institutional investors are worried about the overall state of the Indian economy. The Goldman Sachs summarises these challenges well as “the macro challenges that India faces in terms of external and fiscal imbalances, high inflation and tight monetary policy.” And given this, they have been net sellers during the course of this year.
The foreign investors are not bothered about the state of the Indian economy and that is why they have been buying Indian stocks. Why is that? A possible explanation is the fact that they have access to all the “easy money” in the world at very low interest rates.
They have been borrowing and investing this money in the Indian as well as other stock markets all over the world. This has been possible because of all the money being printed by the Western central banks. This has led to a situation where there is enough money floating around in the financial system and hence, kept interest rates low.
So for the foreign investors to continue investing money in India, it is important that interest rates in the Western world continue to remain low. For that to happen the Western central banks need to continue printing money. And that is the most important condition for the so called “Modi” rally to continue.
In case of the United States, which has been printing $85 billion every month, the decision to continue the easy money policy rests primarily in the hands of Janet Yellen, who is currently the Vice Chair of the Federal Reserve of United States, the American central bank, and will take over as its next chairperson early next year.
So will she continue printing money? Jeremy Grantham, the chief investment strategist of GMO, and one of the most acclaimed hedge fund managers in the world, believes that Yellen will continue to print money, and follow her predecessors Ben Bernane and Alan Greenspan, and ensure that the Federal Reserve continues to run an easy money policy in the process.
As Grantham puts it in Ignoble Prizes and Appointmentshis most recent quarterly newsletter “My personal view is that the Greenspan-Bernanke regime of excessive stimulus, now administered by Yellen, will proceed as usual, and that the path of least resistance, for the market will be up.”
And this will mean stock market rallies not only in the United States but all over the world, including in emerging markets like India. “My personal guess is that the U.S. market, especially the non-blue chips, will work its way higher, perhaps by 20% to 30% in the next year or, more likely, two years, with the rest of the world including emerging market equities covering even more ground in at least a partial catch-up,” writes Grantham.
What is interesting is that another veteran of the US markets and one of its foremost investment newsletter writers Richard Russel has had something similar to say in the recent past. Russel in a recent note titled Get Ready for the Mania Phase explained that there are three phases to any bull market. In the first phase the wise and seasoned investors enter the market and pick up stocks which are going dirt cheap, because of the previous bear market.
In the second phase, which happens to be the longest and the most deceptive phase, retail investors flirt with stocks and buy them very carefully and not on a regular basis. In the third and final phase of the bull market investors really take to stocks. As Russel writes “The third or speculative phase of a bull market is characterized by a wild and wooly and ever-increasing entrance by the retail public. This phase is characterized by hot tips, hype and pure greed.”
This third and final phase of the bull market has started in the United States, feels Russel. “This is where I think we are now in this bull market. I believe that during the next 12 months we will experience a surprising and ever-expanding rush by the “mom and pop” public to enter the market. At the same time, veteran investors and institutions will seize the opportunity to distribute stock that they may have held for years,” he writes.
And this phenomenon along with the easy money policy of the Federal Reserve will lead to a global rally in stocks. As Russel puts it “All primary movements are international in scope, and this bull market will be no exception.”
The trouble of course is that this rally will not be based on any fundamentals, but just a lot of easy money chasing stocks. And that is something that cannot last beyond a while. The bubble will burst and there will be a lot of pain. As Grantham puts it “And then we will have the third in the series of serious market busts since 1999 and presumably Greenspan, Bernanke, Yellen, et al. will rest happy, for surely they must expect something like this outcome given their experience. And we the people, of course, will get what we deserve.”
The article originally appeared on www.firstpost.com on November 30, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
…And That's How Government Sachs Rules the World
Bruce Wiseman is a man who wears many hats. He writes detective fiction under the pseudonym of John Truman Wolfe (www.johntrumanwolfe.com). He runs a market research, survey and positioning company (www.ontargetresearch.com). He has managed money for many Hollywood stars through the investment firm Wiseman & Burke. And if all this wasn’t enough he has recently written a bestselling book on the financial crisis titled Crisis by Design, The Untold Story of the Global Financial Coup. In this interview he speaks to Vivek Kaul on how the investment Goldman Sachs rules the world.
You talk about an incestuous link between Goldman Sachs and the American government. Could you explain that to our readers?
The Rolling Stone magazine recently published an article called “The Great American Bubble Machine,” a masterful exposé by Matt Taibbi revealing Goldman’s greed and corruption in the creation of several investment “bubbles” that have made the firm and its partners—the term filthy rich comes to mind—but which have been devastating to Americans and to the U.S. economy. I have no problem with people making money—barrels of the stuff. Boatloads. But this needs to be done with some sense of ethics, some sense of morals, some sense of responsibility toward one’s fellow man.
Could you elaborate on that?
The all too coincidental participation of Goldman executives in the creation of the financial crisis is something that Machiavelli himself would be proud of. Taibbi laid bare the army of Goldman alumni that have turned up at critical decision points in the universe of credit, investment and finance. His orientation was such that he omitted a few that I will tell you about. My focus has been exposing the actual cause of the worldwide financial crisis. And our paths have crossed at a few key junctures. Junctures that bring to mind the great Gordon Gekko—Michael Douglas’s character in Oliver Stone’s Wall Street. Douglas shares the philosophy of the successful investment banker:“Greed is good. Greed is right. Greed works. Greed clarifies and cuts through and captures the essence of the evolutionary spirit.” Yeah, baby.
Could you give us an example?
I could start this part of the story with Henry Fowler, who, after serving as the 35thSecretary of the Treasury, in 1969 became a partner at Goldman after leaving office. But that’s not how things worked in the nineties and beyond. Oh no. The current sequence is very different. Pictures of Robert Rubin always remind me of the cartoon character Droopy. He seems to be in a perpetual state of sad worry. More to the point of our story, having served 26 years with Goldman Sachs, ascending to the position of co-chairman, Rubin came to Washington with the Clinton administration as the Assistant to the President for Economic Policy. Bill must have dug the Wall Street touch, because in January of 1995, he appointed Rubin the 70th United States Secretary of the Treasury. This could be called the start of what the New York Times has referred to as the modern era of “Government Sachs.”
Government Sachs?
Allow me to explain. The hallmark of Rubin’s years in Washington was deregulation—specifically, deregulation of the financial industry. Turn the financial industry loose. Let the big dogs eat. Let them earn. They have Porsche payments to make. Working with Greenspan, he kept interest rates implausibly low and ensured that regulatory safeguards were gunned down like victims in an L.A. drive-by shooting. The Glass-Steagall Act is a prime example. A piece of the Great Depression-era legislation that kept investment banks and commercial banks from committing fiscal incest, it was repealed—charged with being out of touch with the global financial structure. What it was out of touch with was an agenda to open the floodgates to unbridled speculation by banks that set the industry up for a financial Hiroshima.
Would you like to add to that?
When Rubin was co-chairman of Goldman, the firm underwrote billions of dollars in bonds for the Mexican government. When the Mexican peso tanked a few years later, Rubin, as Secretary of the Treasury, arranged a multibillion-dollar taxpayer bailout, which, according to reports, saved Goldman a cool $4 billion. Even today, Goldman’s former co-chairman is advising Obama behind the scenes and his acolyte Timothy Geithner is in charge of the U.S. Treasury.
But Geithner never worked for Goldman Sachs…
Geithner worked for Rubin at Treasury during the Clinton administration and was a Rubin favorite. He then snagged the powerful presidency of the New York Federal Reserve Bank. It was Rubin who got Geithner the gig at the New York Fed and it was Rubin who hooked him up with Obama, who appointed him as his Secretary of the Treasury. In addition to Rubin, another former Goldman chairman,the controversial Jon Corzine, has been a top economic advisor to the current American President Barack Obama.
That’s quite a link…
Yup. And there is more to come. Given that Goldman employees gave more money to Obama ($994,000) than any other commercial enterprise in the United States, and that the White House is awash in Goldmanites. Even with the White House under control, Geithner beefed up his Goldman staff at Treasury. He named yet another Goldmanite as his chief of staff. Mark Patterson was selected to help him run the government’s financial circus. Patterson gave up his plum position as the vice president for Government Relations at Goldman—meaning he was the investment bank’s chief lobbyist—to become the number two man at Treasury.
What about Henry Hank Paulson, the Treasury Secretary of the United States, when the financial crisis broke out?
Before the news of the financial crisis began to go mainline in 2007, a new Goldman CEO descended from his throne on Wall Street to come to Washington and help his government manage the nation’s financial affairs. We love you, Hank. Viewed from the board rooms of Wall Street, Henry Paulson’s blitzkrieg of the nation’s capital was nothing short of stunning: a George Patton(a famous American World War II General) in pinstripes—except Patton was fighting a real enemy, not one that he himself had created. At first, he used PR spin to calm the multitudes. As the crisis began to unravel, in August 2007 Paulson assured the American people that the subprime mortgage problems were nothing to be concerned about, that they would remain contained due to the strong global economy. The stock market peaked two months later followed by a crash that wiped out trillions. In a television interview on Meet the Press on August 10, 2008, Paulson stated that he would not be putting any capital into Fannie Mae or Freddie Mac. Three weeks later, he took them over and committed $200 billion in bailout funds. When I was growing up, we’d call this kind of guy a “bullshit artist.”
Can you get into a little more detail?
Perhaps nothing so demonstrated this scam as the government bailout of American International Group (AIG), the country’s largest insurance company. On September 16,2008, Paulson coughed up $85 billion of your tax dollars to take control of AIG. The $85 billion loan got the government 80 percent ownership of the insurance giant. Just what I always wanted from my government, a bankrupt insurance company. It turns out the $85 billion wasn’t enough. AIG has continued to hemorrhage losses and Uncle has now poured a total of $182 billion into the insurance company. Sticky constitutional issues aside, many have found it more than curious that when the government granted the loan, AIG turned right around and paid it out to the investment banks to which it owed money. The bank that got the largest payout was . . . of course, Goldman Sachs—a cool $13 billion. The money simply passed from your paycheck to the U.S. Treasury, from the Treasury to AIG and from AIG to Goldman (and other banks). Paulson made sure the transfers would occur without any objection from AIG or unseemly negotiations with the banks. To do this, he tapped Goldman Sachs board member Ed Liddy to be the new CEO of AIG. The good-hearted Mr. Liddy took the gig for a dollar a year in salary from AIG. But he held on to his $3 million in Goldman stock.
That was one round about transaction…
Yup. Goldman made billions from AIG earlier as well. AIG didn’t know this. Neither did Goldman’s clients. You see, despite the fact that they had collected enormous fees selling financial products that were “insured” by AIG, Goldman simultaneously sold AIG short. You get this? On the one hand, they sold financial instruments to their clients, which carried high investment ratings because AIG insured the buyer against loss. At the same time, they made investment “bets” for their own account against AIG. Estimates are that they made $4.7 billion betting against AIG while selling the AIG-guaranteed products to their clients.
Anything else that you would want to point out?
Paulson pushed the Troubled Asset Relief Program (TARP) through the House and Senate—winding up with a cool $700billion to “save” the banks. Congress’s actions remind me of a bad Godzilla movie, with masses of panicked Japanese citizens fleeing the fire-breathing monster, which is lumbering through the city toppling buildings and devouring cars. The legislation drafted by our elected officials sounds like something issued to Stalin by the Politburo. They granted Paulson complete dictatorial powers over the bailout money. The TARP read in part: “Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.”
But where does Goldman fit in here?
Calling the multibillion-dollar bailout a “stimulus” program is but a cruel joke. This was nothing more complicated than a coup—a transfer of hundreds of billions of dollars from American taxpayers into the Armani-clad arms of major Wall Street banks. You won’t be surprised to learn, I’m sure, that Goldman Sachs got a cool $10 billion of TARP funds. And if you followed the billions pouring from your paychecks to Wall Street, you might remember that Bank of America at first received $25 billion. Then, in the midst of the chaos, they agreed to purchase Merrill Lynch. As it turned out, however, Merrill’s losses were $15 billion more than Bank of America had expected. This was due in part to $4 billion in bonuses paid out by Merrill’s CEO, John Thain, who pushed the bonuses through his books just before the Bank of America deal closed. Bank of America was taken by surprise by the losses and the purchase of Merrill Lynch started to go shaky, to which Comrade Paulson coughed up another $20 billion of your tax dollars. You guys are so cool bailing out these banks. I mean it. It brings tears to my eyes. Oh, I should mention that John Thain, the guy who pushed through the last-minute billions in bonuses, had been the president and co-chief operating officer at Goldman Sachs before becoming the president of Merrill Lynch.
So Goldman Sachs is everywhere?
Yup. Pretty much. Joshua Bolten, was the Chief of Staff of former President George Bush. Bolten had become Chief of Staff in April of 2006 and is credited with persuading the President to recruit Paulson as the Treasury Secretary. No surprise, since Bolten had been the executive director, Legal & Government Affairs for Goldman Sachs International before joining the Bush 2000 presidential campaign. The president of the World Bank is Robert Zoellick. Prior to joining the World Bank, Zoellick served as vice chairman, international, of the Goldman Sachs Group. Incest doesn’t begin to say it. From the White House to Treasury, from the New York Fed to AIG, from the Commodity Futures Trading Commission to the New York Stock Exchange, Goldman is there.
You talk about 19 men controlling the financial affairs of the whole world. Who are these people?
They are the Board of Directors of the Bank for International Settlements. They are listed on the Bank’s website, but Helicopter Ben Bernanke and Tim Geithner are on the Board, as was Greenspan. And it is the newly created Financial Stability Board, operating as an arm of the Bank for International Settlements, that now structures and dictates the rules and regulations to be carried out by the central banks of the world. And given the fact that central banks essentially operate independently of their national congresses or parliaments, the FSB now controls the monetary policy of the planet. It is now, for all practical purposes, the Politburo of international finance.
Where is Goldman Sachs in this?
Who is the chairman of this little known entity based in Basel, Switzerland? Mario Draghi. Draghi was a partner at Goldman Sachs until, like Henry Paulson, he left Goldman in 2006. Paulson took over the U.S. Treasury and Draghi became the governor of the Bank of Italy (Italy’s central bank) and in April of this year, chairman of the Financial Stability Board. Draghi is also a member of the board of directors of the Bank for International Settlements. In fact, the BIS board reads like a Goldman reunion committee. Mark Carney had a 13-year career with Goldman Sachs, where he became the managing director of Investment Banking before becoming the governor of the Bank of Canada and a member of the BIS board. William Dudley, president of the New York Fed and former partner at Goldman Sachs, is also a member of the board, along with Draghi.
So they are there everywhere…
Yup. Gary Gensler the current head of the Commodities and Futures Trading Commission in the United States spent 18 years at Goldman Sachs. In May of 2007, the granddaddy of stock markets, the New York Stock Exchange (NYSE), bought Euronext (a pan-European stock exchange with subsidiaries in Belgium, France, Netherlands, Portugal and the United Kingdom), which, now branded as NYSE Euronext, operates the largest securities exchange on the planet. To run the show, the newly combined entity brought in Duncan Niederauer and appointed him chief executive officer. Niederauer had been a partner and managing director at Goldman Sachs before joining NYSE Euronext. And there you have it. Complete financial control of U.S. financial policy and markets, from the White House and Treasury to the New York Fed, the New York Stock Exchange and the Commodity Futures Trading Commission (Control of the World Bank along with the most powerful member of the International Monetary Fund (the US Treasury Secretary Timothy Geithner), and at the top of the fiscal food chain, the Bank for International Settlements and its Financial Stability Board.
(The interview was originally published in the Daily News and Analysis(DNA) on June 25,2012. http://www.dnaindia.com/money/interview_how-government-sachs-rules-the-world_1706239)
(Interviewer Kaul is a writer and can be reached at [email protected])
Facebook is a corporate dictatorship.
When the whole world was going gaga about Facebook’s Initial Public Offering (IPO), there was one man who did not fall for all the hype, looked at the numbers of the company, asked some basic questions and concluded “they don’t know how they are going to make money.” Looks like, he was proved right in the end. The stock was sold at a price of $38 per share, and has fallen since then. Aswath Damodaran was the man who got it right. “In hindsight everybody will tell you that they were bearish on Facebook. Nobody will admit to buying the shares,” points out Damodaran. He is a Professor of Finance at the Stern School of Business at New York University where he teaches corporate finance and equity valuation. In some circles he is referred to as the “god of valuation”. In this interview he speaks to Vivek Kaul.
Excerpts:
Let us start with Facebook, you have been critical about their IPO pricing?
The trouble with Facebook is figuring out, first what business they are going to be in, because they haven’t figured it out themselves. How are they going to convert a billion users into revenues and income? And second, if they even manage to do it, how much those revenues will be, what will the margins etc. They don’t know how they are going to make money. Whether they are going sell advertising to these users? Whether they are going to sell products to these users? Services to these users? I think all they know right now is that they have a lot of users.
But if they have no idea of what to do with their users, how did they make the $4billion in sales that they did last year?
They are selling. 12% of that came from selling stuff for Zynga (The maker of popular games such as “FarmVille” and “CityVille,”). The remaining 88% did come from very subtle advertising. The question is that whether they can scale that up? Because right now it is kind of invisible. You can’t see it because it is relatively small. But if they want to generate the kind of revenues they want, you are going to see it on your Facebook page. And it is going to be very very clear that they are using what they know about you to pick those ads. And I am not sure people will be comfortable with that knowing that they are seeing not just your profile but your interactions. So they can see how old you are. What political party your support? What sports you like? It is all going to go. And that’s their selling point.
So it will be some sort of invasion of privacy?
It is not some sort of invasion of privacy. It is an invasion of privacy. The question is can they do that without people getting pissed off and saying I am leaving Facebook and going elsewhere. And that I think is the big unknown. Because let’s face it, they have not just a billion users, but they know more about these users than any other company on the face of this earth. If you want a company to find 35million people who fit a specific demographic characteristic, the place to go is Facebook. They can show it to you. The only question is that if you did advertise through Facebook to those 35million is this the kind of forum were they are inclined to click on an ad.
How does it compare with Google?
In case of Google it is a much more direct business model. It’s search. You click and that’s it, everybody could see what they were doing. Facebook is a much more subtle model. On Facebook you are talking to your friends, which is a private conversation between you and your friends, but when you see these intrusive ads on the side, you realize you are not just talking to your friends, you are talking to your friends and somebody at Facebook is monitoring you at the same time. That’s a very tricky challenge. So they have made the $4billion, but at the value (the market capitalization of the Facebook stock) they have they have to make $35billion. And that’s a very different game because that would mean a lot more ads on every page directly focused in on what the users are doing.
In face very frankly I didn’t realize there are ads on my Facebook page for a long time…
It is pretty subtle right now because they don’t have that much advertising. If you think of revenue of $4billion spread out across a billion users, you are going to see a very few ads because it is still on the sides. And sometimes it doesn’t even look like an ad. Right. It’s a Facebook friend with GM. You click on it and before you know it you are looking at GM’s product offerings. So it is very subtle right now. But it can’t stay subtle for them to make the kind of revenues they have to make to justify their price now. The kind of scary thing here is that Mark Zuckerberg has said that he wants to build a social enterprise and not a business enterprise.
What does he mean by that?
What he means by that is he built Facebook so that people could talk to each other. He didn’t want ads on it. For a long time he refused to take ads on Facebook until he was told that if you can’t take ads there is no other way to make money in this. So I am not sure how willing he is to go the distance because it is going to be a fight. It’s going to be a fight against not other social media companies but against the big players. The Googles and The New York Times of the world. This is a tough game to fight and you got be willing to act like a business and I am not sure is willing to yet.
You called the business model of Facebook, a Field of Dreams. Why is that?
Yeah. You ever seen that movie? Field of Dreams.
No.
In the movie Kevin Costner moves to the American Midwest and he is walking through this cornfield. And hears this voice and it says “if you build it he will come”. He being Shoeless Joe Jackson, a baseball player from a 100 years ago. On the faith that these old baseball players will show up, he builds this baseball field in the middle of Iowa and everybody asks him, why are you building this huge baseball field in the middle of nowhere? And he tells them, if I build it they will come. And that in a sense is what social media companies are doing right now. They are building this place where there are lots of users and they are telling people trust us if we build this, they will come. They being advertisers, product sellers, they will come. But in the Field of Dreams they did come but I am not sure in these companies that they will.
Talking about the current price of Facebook how do you see it? Yesterday is closed at around $33.(The interview was conducted on Thursday, May 24,2012) Has it fallen enough?
I think it fell enough in those two days that you are going to get a consolidation. The next run on them will tell how far they might go back. The low 30s are close enough to my intrinsic value that I wouldn’t call them massively overvalued. I think there is enough potential in the company. If it dropped to $15 then it’s pretty much a bargain. At $31-32 its pretty close to intrinsic value
The intrinsic value you calculated for Facebook was $29?
Yeah.
So why was the stock valued at such a high price of $38 per share when it was sold to the public?
It wasn’t valued. It was priced.
So why was it priced at such a high price?
Remember they weren’t pricing it on a blank slate. They could see transactions happening in the private share market where people were buying and selling Facebook shares. And there the prices were going at about $42-43. So they said if people are buying and selling at this price, these are real transactions.
What sort of stock market was this?
For the last two years Facebook has been on what’s called a private share market where people who owned shares of Facebook were allowed to trade.
So is it like over the counter?
Not even over the counter. They are actually beyond the counter. These are private companies that are not incorporated. So this is a completely unregulated share market. Like Goldman Sachs could sell shares. Players in this market are pretty big institutional investors they are not individual investors. Transactions here have particular merit because these are two informed investors transacting and they are coming to a price. And investment bankers saw that price and they said if they are paying $42, then we should be able to sell it at $38. And they also got onto the phone and they called institutional investors. They tried to gauge demand until Thursday evening (May 17,2012). And that’s why they set the price at 4 o’clock on Thursday because that’s how late they were pushing this off to make sure that there was enough demand.
Wasn’t this a throwback to the days of the dotcom bubble?
This is how all pricing is done in IPOs. IPOs are always priced they are never valued because essentially your job as an investment banker is to sell at that price. What was unusual here was that demand and supply that they gauged collapsed. They didn’t realize how thin the market was until one hour into the offering when they saw the price collapse. It started at $38, it went to $43, and then very quickly it kind of collapsed. My theory is when you price things you are building in market perceptions, what you think will happen etc. You are basing it in on momentum. That’s a very fragile thing. You don’t want mess with it. Even people who are buying based on pricing and momentum like to tell themselves that they are buying based on value. So they look for a good story and they don’t want to have their face rubbed at the fact that they are buying because everybody else is paying the price.
In case of Facebook it was quite the opposite…
If you look at what the investment banks and Facebook insiders did in the last week they almost rubbed the investors faces in this. They rubbed it in the sense that they kept hiking up the offering price, saying we know you are suckers. At the same time the insiders were selling the shares in the week leading up to the offering. If I had been the investment banker I would have spent the last week talking about the user base, and advertising because that would have given the momentum investors a crutch. I am purely buying it because of advertising revenues. Instead it was all about pricing. They made it very transparent that they were not valuing the company. It was all demand and supply. I have a feeling that if you point to midday on Friday (May 18,2012) and say that was the time when the momentum on social media companies, not just on Facebook, shifted. And if you look at what has happened since it is not just Facebook which has seen its price collapse. It’s Groupon. It’s LinkedIn. It’s the entire sector. And I wager that there are IPOs lined up to go to investment banks of social media companies, that are either being pulled right now or being dramatically repriced.
You have said in the past that Facebook has huge corporate governance issues. Can you elaborate on that?
It has got voting shares and non-voting shares. Zuckerberg has got the voting rights. It is also incorporated as a controlled corporation which basically means that you don’t have to follow the corporate governance rules (like the Sarbanes Oxley Act) that publically traded companies need to do. They can have insiders on the board.
Is that allowed?
If you are controlled corporation it is. And Facebook has been very open about that they are going to be a controlled corporation.
How does regulation allow for something like that?
As long as you make it public. If it is a controlled corporation investors have to make a judgement as to whether they care. In case of Facebook initially it looked like they didn’t care. Right from the beginning Facebook has been very open that they are not really going to be a publically traded company and that really they are a private business that wants the capital that public markets give them. But it is going to be Zuckerberg’s company.
So they won’t give out much information?
They might give out the information but you will have no say in what they do. So if they do an acquisition…
Did they overpay for Instagram?
They paid. I don’t know whether they overpaid. But the paid and there was no accountability. Zuckerberg basically decided to pay a billion (dollars) then he told the board that I have bought the company and I have paid a billion. This is not the way a company should be bought. A CEO shouldn’t be deciding what to pay overnight and you shouldn’t be telling the board of directors after you have bought a company that I just bought a company for a billion and I just want you to know.
This is like how mom and pop shops down the road operate…
It is a way a dictatorship operates. Facebook is a corporate dictatorship.
So who influenced Zuckerberg to do what he is doing?
Google set the framework that Facebook is using right now. The voting shares, non-voting shares. Sergey Brin and Larry Page are the models that Zuckerberg is using.
Can you elaborate on that?
Until Google came along, US companies generally did not have two classes of shares. Voting shares and nonvoting shares were for a long time banned by the New York Stock Exchange. So most companies didn’t even try. So if you look at Apple, you look at Microsoft they had only one class of shares. Google essentially did two things. They did their IPO through an auction rather than through investment banks. And secondly they decided to have voting and nonvoting shares. If institutional investors had risen at that point of time and said we are not buying these shares because we don’t have enough voting rights, then Google would have been forced to go back to drawing board and then come back. Institutional investors were okay with Google doing that. Once they opened that door every social media company you look at LinkedIn and Groupon, they follow what Google did.
So these shares are listed on NASDAQ?
Yes. NASDAQ allows for voting and nonvoting shares that is the part of the reason for listing on it. The New York Stock Exchange because it is in competition with NASDAQ has now also started relaxing, they want the money, they want the listings. So they will take Facebook even if it’s voting and nonvoting shares. So this will be a race to the bottom.
So the shares sold to the public were nonvoting shares?
They are low voting shares. The shares that Zuckerberg owns have 10 times the voting rights, which means he has 57% of voting rights with 35% of the shares. And he will always make sure that remains above 50%.
So he can go ahead and buy anything without requiring clearance from the board?
Google for instance recently issued new shares which have no voting right at all. So that is the third layer. You have ten voting rights shares. One voting rights shares. And no voting rights shares. Zuckerberg can go out and raise as much capital as he wants. If he issues no voting rights he will always have 57%. He going to lock in that voting percentage.
But how is something like this allowed in a developed market like the US?
I don’t think it should be banned. Let the investors decide for themselves. Lots of countries you have two classes of shares. Its par for the course. And you just price it in.
It’s just that it hasn’t happened in the US for a long time?
I think you will wake up one day and see I wish I had voting rights. But you chose to be a part of this game. I am not feeling sorry for the institutional investors in Google who are crying about the fact that Google does things they don’t like. You bought the stock you live with it.
(The interview was originally published in the Daily News and Analysis(DNA) on May 28,2012. http://www.dnaindia.com/money/interview_facebook-is-a-corporate-dictatorship_1694603)
(Interviewer Kaul is a writer and can be reached at [email protected])