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Sunday, 19 July 2009

A Deal with the Devil

There has been a lot of talk lately in the media about Goldman Sachs and how they have corrupted and taken over our government. I would like to throw out a theory of my own and its implications as it relates to trading.

First off, let's examine the charges pundits have been leveling on Goldman Sachs and the main evidences they cite to support their claims. Pundits charge that back in the fall of 2008, former Treasury Secretary Hank Paulson, who also happened to be the the former CEO of Goldman Sachs, let Bear Stearns and Lehman Brothers fail in order to eliminate major competitors to Goldman Sachs. The circumstances behind Bear Stearns' run on liquidity to this day remains suspicious with fingers all pointing to rumor mongering originating from Goldman Sachs. The Feds allowing Lehman Brothers to fail was especially suspicious because 1) the Fed denied Lehman Brothers application to become a bank holding company, hence denying them access to much needed liquidity that could have potentially averted Lehman's insolvency and 2) the Feds bailed out AIG the very next day after Lehman declared Chapter 11. AIG apparently was the counter party to $12-13 billion of Goldman Sach's CDS trades and had they not been bailed out, Goldman would had to have eaten those losses, which may have led to Goldman's own demise. In addition to the above, Goldman's CEO Lloyd Blankfein was in the Fed's AIG meeting. Although the evidences cited here are circumstantial, I believe they are valid and compelling: Goldman Sachs influenced the outcomes of Fed meetings that led to bankruptcy and bailouts of various firms through their connections with Hank Paulson.

After Lehman's demise, it became apparent that other investment banks were also over leveraged with risky assets and would face liquidity problems themselves. Without additional liquidity, these banks too would have to file for Chapter 11, including Goldman Sachs. Regardless of whatever they claim today, these banks were toast last fall. They were, however, able to successfully lobby the Federal Reserve and Treasury to grant them bank holding status, thus allowing them access to needed liquidity through TARP, TSLF, Fed Funds Rate and Discount Window. The circumstance in which TARP was passed itself was suspicious and how the money was allocated and used by the banks is another mystery. But the point here is, when Goldman Sachs needed liquidity, they were able to successfully lobby for bank holding status that neither Bear Stearns or Lehman Brothers could get.

There are other evidences pundits cite against Goldman Sachs, but the ones cited above are the main evidences people have been talking about. So this got me asking myself two questions. 1) Why does Goldman Sachs get everything it wants? It seems like Goldman never losses. The simplistic answer is, they own the government and have alumni in powerful decision making positions. Although this explanation may very well be valid, it is far from complete. As powerful as Goldman is, they do not own everyone. So when they make their pleas for bank holding status, AIG bailout, etc, they must still argue their positions and win over those they do not control. 2) Why does the Federal Reserve and Treasury give Goldman Sachs everything it wants? Although this question may seem the same as the first one, it isn't. What are the motives behind supporting Goldman Sachs? Zerohedge recently stated that Goldman Sachs has preferential treatment, or rather an exemption, from applying traditional VAR calculation to their books. What are they trying to hide? Could it be... Goldman Sachs is the anointed leader of the Plunge Protection Team (PPT) as many traders believe?

From the evidence I have seen, I deduced that the Fed and Goldman have a very special-symbiotic relationship. I believe Bernanke and the White House know we are in the mother of all poo storm. I am willing to go as far as, I believe Bernanke and the government know we as a nation are bankrupt. They believe we are most likely heading into a Great Depression which may lead to uncontrollable situations, such as civil unrest, secessionist movements and other unimaginable horrors. Goldman Sachs must also realize that if we indeed head into GD II, it too is finished as a firm. All its investments will plummet forcing the firm into bankruptcy and there will be absolutely no prospects of growth for years to come, assuming the United States as a nation state survives. Knowing this, I believe Bernanke & Co and Goldman Sachs & Co, struck a deal. The Federal Reserve will provide liquidity for Goldman to prop up the stock markets, hopefully long enough for a recovery to take off. In return, Goldman Sachs will get a significant cut of any profits made from PPT activity, preferential treatment and an implicit government bailout in the event the firm were to fail.

Why is propping up the equity market so incredibly important? The stock market is the most visible barometer everyday Americans use to evaluate the direction of this country. In fact, if equities were to collapse, it would become clear to everyone we are finished. Those who responsibly saved and invested for retirement would be left with very little. The evaporation of life-time savings could motivate those individuals to engage in activities that are detrimental to the interest of our government. On the corporate side, a collapse in equity would precipitate violations of debt covenants and lead to a domino collapse in companies across industries. In this scenario, you will see companies filing for bankruptcies without end and official unemployment rate rocket pass 20% with ease. By inflating the stock market and running green shoot propaganda 24-7, the Fed is trying to lift morale and hope long enough so that, just maybe, all those stimulus (and more to come) and Fed intervention will lead to a recovery. Remember, they already believe the nation is bankrupt, so if this Hail Mary of an intervention fails, they would be in the same position they were in last fall. In some respects, they may already be slightly better off than they were last fall because the government by now must have prepared contingency plans should all hell break loose.

As much as we like to hate Goldman Sachs, I believe it is very much the servant as it is the master of our government. Goldman Sachs is a corrupt organization that is excellent at what it does in the financial markets. The United States as a whole is bankrupt. In my opinion, the Fed had no choice but to cut a deal with the Devil. All was already lost; but through lies and deceit, not everyone has realized it yet, or perhaps they choose not to accept the truth. When the money runs out, which it ultimately will like all ponzi schemes, this house of cards will come crashing down. In the meantime, as long as the printing press has ink, the Fed, via Goldman Sachs, will NEVER let this market collapse on its own because a minority of traders already see through the lies. Remember, most large funds and institutional money managers don't make money from being right, but from tracking the index so they can continue to clip their fat management fees. It will take a crisis of extraordinary magnitude to bring us to THE point of reflection that will ultimately reveal the Fed's hole cards: we were all-in with deuce-seven off suit the whole time.

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