Goldman still puzzles

June 25, 2009

Matthew GoldsteinInvesting in Goldman Sachs still requires a leap of faith in the investment firm’s ability to out-trade, out-wit and out-muscle everyone else on Wall Street.

Sure, the bulls will say that with fewer competitors and with the Federal Reserve keeping bank borrowing costs near zero, Goldman’s traders should be able to print money. But here’s the thing: The post-federal bailout version of Goldman is as much of an investing riddle as the pre-crisis Goldman that many critics called a giant hedge fund or an inscrutable black box.

Even after becoming a bank holding company last fall, Goldman still doesn’t make it easy for investors to get their arms around all the firm’s many moving pieces. Trying to get a clear picture of how Goldman makes all that money and where the risks to its profitability may be lurking is like embarking on a treasure hunt with a ripped map.

Here’s an example. Go to the section of Goldman’s most recent 10-K where there is a list of the firm’s “significant subsidiaries.” There you’ll find the names of some 115 companies and where each was incorporated.

That may sound like a lot, but that figure just scratches the surface. In all, Goldman has more than 800 subsidiaries operating around the globe. But Goldman never discloses the identities of the vast majority of those subsidiaries anywhere in its annual report.

Now technically, Goldman, which declined to comment, doesn’t have to disclose information about so-called insignificant subsidiaries. Securities and Exchange Commission regulations, relying on a complicated formula, only require companies to disclose the identities of subsidiaries that account for a “significant” percentage of a company’s income. But not all financial firms play it so close to the vest. Morgan Stanley, for instance, lists the names of every single one of its 1,300 subsidiaries in its 10-K. The list is so long it takes up 26 pages.

Actually, there is a place to find a more detailed list of all of Goldman’s subsidiaries and that’s in the regulatory filings for its small insurance firm, Commonwealth Annuity and Life Insurance Company.

Here’s a case where regulatory arbitrage actually works to the benefit of investors, since insurers are statutorily required to provide periodically a fuller accounting of a parent company’s subsidiaries. It’s in those SEC regulatory filings for Commonwealth, that Goldman also has to provide a brief description for everyone of its more insignificant subsidiaries. It’s worth a look.

Let’s just focus on one subsidiary that Goldman deems insignificant — Archon Group. This Dallas-based real estate investment and management firm employs some 2,000 people worldwide, or more than 4 percent of Goldman’s entire workforce.

Archon almost never gets mentioned in any Goldman regulatory filings, but it’s a critical actor in the investment firm’s many real estate ventures. Archon manages and helps buy and sell commercial and residential properties for Goldman’s Whitehall Street Real Estate funds, a series of well-known investment funds for which Goldman has raised some $31 billion since 1991.

But there’s much more that Archon does. The Dallas firm is the parent of Avelo Mortgage, a Goldman subsidiary that was a onetime originator and servicer of more than $10 billion in home loans — many of them of the subprime variety. Archon, according to its website, manages “approximately 25,000 apartment units … 1,500 hotel rooms and more than 1,200 acres of land.”

Want an Archon/Goldman apartment in Oceanside, California? No problem. There are some three bedroom apartments currently available at the Missions at Rancho Del Oro luxury housing complex.

None of this is to say that Goldman is doing anything wrong by not including Archon on its list of “significant subsidiaries.” The company apparently doesn’t meet that legal description because it invests little of its own capital and makes most investment decisions under the direction of its Goldman masters. A top executive at Archon can make a good living. But it’s not the path to becoming a managing director at Goldman.

Still, outside of the real estate world, few have ever heard of Archon. And that’s a shame. Maybe if investors and financial analysts were more aware of Archon, there’d be a better understanding today of why Goldman still classifies some $59 billion in assets — many of them real estate-related — as untradeable and all but impossible to price Level 3 assets.

It’s likely that some of the “real estate fund investments” and “less liquid mortgage whole loans and securities” that Goldman labels Level 3 were either acquired, managed or serviced by Archon.

And this is part of the broader problem with understanding complex financial companies like Goldman — there’s so much hidden from plain view that investors can never really know all the risks. Sometimes, it’s the seemingly most insignificant things that can end up making all the difference.


Comments are closed.