April 16, (Reuters) – Goldman Sachs Group Inc was charged with fraud on Friday by the U.S. Securities and Exchange Commission in the structuring and marketing of a debt product tied to subprime mortgages.
Shocked? Most of the subscribers to Elliott Wave International’s monthly Elliott Wave Financial Forecast probably weren’t. In the November 2009 issue, the EWFF co-editors Steven Hochberg and Peter Kendall published a careful study of Goldman Sachs’ history — and made a grim forecast for the firm’s future.
In this special three-part series, we will release the entire Special Report to you. Here is Part I; come back Wednesday for Part II.
Special Section: A Flickering Financial Star
At the Dow’s all-time peak in October 2007, Goldman Sachs Group Inc., was the undisputed heavyweight champion of the financial markets. And, thanks to its bailout by Warren Buffett and the U.S. Treasury as well as the liquidation of rivals Bear Stearns and Lehman Brothers, its reign lives on. Come December, earnings and bonuses will reputedly approach the record levels of 2007. If the market can hold up, it might happen. But as the stock market retreat grabs hold, Goldman Sachs will experience an epic fall.
To understand the basis for this forecast, we need to review the firm’s history in light of socionomics.
At the beginning of the last century, Goldman Sachs originally made a name for itself with its first initial public offerings, United Cigar and Sears Roebuck. The deals came as the stock market made a multi-year top in 1906. Within months, the panic of 1907 was on, and a U.S. Interstate Commerce Commission investigation of the Alton Railroad Company bond offering, in which Goldman participated, was in full swing. According to The Partnership, Charles Ellis’ history of Goldman Sachs, the deal was “long remembered as ‘that unfortunate Alton deal’.” The bond issue allowed a considerable cash surplus to be paid out to shareholders in the form of a one-time dividend, a standard financial maneuver in the preceding bull market. In fact, the deal was unknown to the public until it came before the ICC in 1907. “Then, probably to the surprise of the syndicate, the verdict was practically unanimous against them. They were tried before the bar of public opinion and found guilty,” said author William H. Lough in Corporation Finance. Lough added that syndicate members “ought not be too severely criticized for they merely acted in accordance with the custom of the period.”
So it goes when social mood, and concurrently the market’s trend, changes; customary Wall Street devices are invariably recast as the instruments of evil financiers.
Another bear market problem is that Wall Street firms are just as susceptible to negative mood forces that tear away at even the most close-knit social units. From 1914-1917, a major rift emerged between the founding Goldman and Sachs families, and the Goldman side of the partnership left the firm. The tension endured through several generations, and as late as 1967 it was said that “hardly any Goldmans are on speaking terms with any Sachses.”
Larger degree social-mood reversals create larger bear-market complications. The firm’s biggest and most devastating setback came after the Supercycle degree top of 1929.
Leading up to the market high, Goldman Sachs Trust Company took off, playing a role in the then-financial mania similar to the one that hedge funds perform today. With the help of successively higher levels of leverage, GSTC issued a quarter billion dollars worth of new shares the month before the September 1929 peak (many of which were held in its own account), leaving it completely exposed to the decline that followed. The firm survived only because a quick-witted former mailroom employee, Sidney Weinberg, took charge and used the stock market rally in early 1930 to jettison many of the firm’s equity positions. Weinberg also turned out to be an investment banking savant. While the firm made no money for the next 16 years, he served on the war production board and carefully cultivated key relationships in business and government. In the middle of Cycle wave III in 1956, Goldman completed the largest IPO in history, delivering Ford Motor Company into the public’s hands.
The firm was not yet a major force on Wall Street, but by hiring MBAs from top schools, fostering a reputation for fair dealing and maintaining a partnership structure that aligned the ownership of its principals with the long-term success of the firm, Weinberg laid the foundation for rapid growth. In the words of Gus Levy, Weinberg’s successor, Goldman Sachs was “long-term greedy.” Another Levy secret was to be certain that positions exposing capital were “half-sold” before they were entered into.
Come back Wednesday for Part II of this three-part Special Report from Elliott Wave International (EWI). In the meantime, get more free and insightful analysis from EWI in the Market Myths Exposed eBook. The 33-page eBook takes the 10 most dangerous investment myths head on and exposes the truth about each in a way every investor can understand. You will uncover important myths about diversifying your portfolio, the safety of your bank deposits, earnings reports, investment bubbles, inflation and deflation, small stocks, speculation, and more! Learn more about the free eBook here.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.