Wall Street would like you to believe that when investment banks take on risk they are largely doing it for the benefit of investors -- maybe even you and me.

Bankers say much of the capital that their firms put at risk each day is to complete trades for big corporations, mutual funds, pension funds, hedge funds and university endowments. And contrary to the conventional wisdom, proprietary trading -- bets made for a bank's own behalf -- is really just a small part of their business.

Lately, Wall Street's captains of capitalism have been aggressive in pushing the "we take big risks for our customers, not for ourselves" line of argument.

That's especially so in the wake of the public furor over the outsized trading gains at the big banks like Goldman Sachs Group, JPMorgan Chase and Barclays and even Citigroup, so soon after the collapse of Lehman Brothers.

The notion that risk is being taken for customers as opposed to for the firm's own benefit is somehow supposed to make it seem more palatable and somehow less risky.

Still, for many, the image persists that investment banks spend a lot of time and resources gambling on stocks, bonds, commodities or currencies to generate fat profits and big bonuses. And there's good reason for that image: Wall Street firms don't break out the dollars they take in from client trades versus those generated by prop trading.

Yet from the perspective of Wall Street bankers, it's perfectly logical to see much of their risk taking simply as part of trades for their customers.

Here's how:

Let's say a hedge fund calls up an investment bank and asks it to help buy a large block of shares, but it doesn't want to pay much more than a given sum and intends to finance part of the transaction. That may force the investment bank to commit some of its own capital to acquire those shares in a series of separate transactions, so as not to create an undue spike in the stock's price.

To protect itself from losing money, the investment bank may go out and enter into a number of other trades or derivatives transactions -- all intended to reduce, or lay off, its risk of a loss on the customer transaction.

And in all likelihood those follow-on trades will prompt the investment bank to engage in a series of other trades to minimize its exposure to something going awry with those hedges.

At the end of the day, what looks like a simple customer order to buy stock on margin may end up creating a daisy chain of transactions that the customer wasn't even aware were taking place. But in the mind of a Wall Street banker, all these follow-on trades are simply part of the process of completing the customer's order.

Not surprisingly, some of these follow-on transactions can rake in sizeable revenues for a bank's trading desk. That's how an ordinary customer request to buy stock can generate revenues far in excess of whatever fees the initial trade may have produced.

Of course, if things go wrong, an investment bank can just as easily lose money on some of these follow-on transactions, and that's why there's risk involved in the process.

It's hard to see what distinguishes some of these transactions from what an outside observer might label as prop trading -- a group of traders sitting around with a pile of firm capital to do with as they please. But that's not the way that bankers think about customer trades.

Maybe it's all just a case of semantics, and trying to make a distinction between customer trades and prop trading is fruitless. Ultimately, maybe all trading activities by investment banks should just be viewed as risky.

The key to taming the giant banks is to put them in a position where they must turn away customer business because of the potential risk associated with all these follow-on trades.

One way to do that would be to impose hard-and-fast caps on the size of bank balance sheets, as it would deter them from engaging in transactions that add to their assets and liabilities. To avoid any unfair advantage, the caps on bank balance sheets would have to be agreed by regulators and policy makers around the globe.

But a balance sheet cap would be easier to impose and monitor than the increased capital holding requirements Treasury Secretary Timothy Geithner is proposing for global banks.

And better yet, a balance sheet cap would have the added benefit of fostering more competition between banks by driving some business to smaller institutions.

Hard as it may be to believe, shares of beleaguered Citigroup are on fire.

The stock of the de facto U.S. government-owned bank is up some 300 percent after it cratered at around $1 back in early March.

The over-caffeinated stock maven Jim Cramer keeps calling Citi a "buy, buy, buy" on his nightly CNBC television show. Even the more sober-minded writers at Barron's are pounding the table a bit, predicting Citi shares could double in price in three years."

Time out! It's far too soon for anyone but stock flippers and fast money hedge funds to buy Citi right now.

That's because there's still a world of hurt for Citi in the $83.2 billion in subprime mortgage-backed securities, corporate loans, home loans and commercial real estate mortgages that the bank's finance team has stuffed neatly into something called the "Special Asset Pool."

But there's nothing special at all about these assets. This cesspool of toxic securities and floundering loans is the worst of the stuff that's been stinking up Citi's balance sheet.

And these rotting securities and loans represent a good chunk of the $300 billion in problem assets the federal government is guaranteeing under its bailout of the giant bank.

Yet what the cheerleaders for Citi sometimes forget is that the struggling bank must absorb up to $39.5 billion of the "first loss" on those troubled assets. To date, Citi says it has incurred $5.3 billion in losses on this pool of toxic assets -- meaning the bank has another $34 billion in losses to soak up before the taxpayers start footing the bill.

And the way things look today, Citi is looking at a good deal more losses to come from its Special Asset Pool.

For starters, Citi still sits on a rather sizable portfolio of subprime-backed collateralized debt obligations -- the dubious securities that helped spark the financial crisis.

At last count, Citi valued its CDO portfolio at $9.6 billion, a 56 percent decline from the value the bank placed on those securities last summer. To protect itself against a potential default on those CDOs, Citi has hedged its exposure with some $4.5 billion in credit default swaps.

But unfortunately for Citi, it didn't buy those insurance-like derivatives from American International Group, another big bailout recipient.

If Citi had been shrewd enough to have done business with AIG, it would have been able to sell its CDOs at face value to an entity set up by the Federal Reserve, just like Goldman Sachs, Deutsche Bank and Merrill Lynch and other big banks did. In a flash, Citi's CDO problem would have disappeared.

Citi, however, had the misfortune of purchasing its CDS from Ambac Financial Group, a bond insurer that many see as being on its last legs. The bond research firm CreditSights says Ambac "may run out of capital sometime in 2013."

Many others think Ambac's demise could come much sooner. On August 7, Ambac, which trades around $1, reported a larger than expected $2.4 billion second-quarter loss.

A collapse of Ambac would render the CDS that Citi holds on its CDOs all but worthless. (For related news click here).

To date, Citi, which declined to comment on its CDO exposure, has written down the value of those insurance-like derivatives by more than $1 billion, according to regulatory filings.

Even if Ambac survives in some fashion, Citi is likely looking at additional write-downs on those contracts, and potentially on the underlying CDOs they are supposed to insure.

Citi also could take more hits on some $6.2 billion in private equity investments and $8.5 billion in loans that financed debt-laden buyouts. The bank also reports having some $10 billion in Alt-A mortgages -- a home loan that's a step above subprime -- and $8.3 billion in still largely untradeable auction-rate securities.

To be fair, Citi has been aggressive in writing down the value of its $10 billion in so-called Alt-A home loans to $1.7 billion. The bank has been equally aggressive in reducing its exposure to commercial real estate loans. The bank has marked down the bulk of its $28 billion in commercial real estate-related assets to $5.1 billion.

So it would require substantial defaults in both categories of loans for Citi to incur large losses.

But to say Citi isn't going to suffer any more losses in this pool of toxic assets is way premature. And none of this analysis has focused on the $183 billion in loans to cash-strapped consumers on Citi's books that could still go bust.

In short, the safest bet on Citi shares is still a short one.

– Heidi N. Moore is a business writer in New York City. This article originally appeared in The Big Money. The views expressed are her own. –

Can one firm create a bubble? Can one firm create four bubbles?

Maybe, but it’s damn hard to prove. That’s why it’s so unimpressive that a fervent 10,000-word rant by Matt Taibbi in Rolling Stone’s July 9 issue-devoted purely to “Goldman’s big scam”-spent 12 pages on the subject of Goldman Sachs’ “Great American Bubble Machine” but never delivered any plausible proof. The mammoth article disappointingly failed to provide the smoking gun that so many people on Wall Street-who have envied and admired and hated Goldman for much of this decade-would have been delighted to see.

Context and good facts were in short supply in favor of a lively, if incoherent, narrative. As a fellow financial journalist put it: “If you read the article without knowing anything about finance, by the end you would still not know anything about finance-but you would hate Goldman Sachs.”

True. Goldman’s reputation is its own business-I’ve never owned any of its stock and don’t have any friends who work there-but as someone who’s written about Wall Street for a decade, it annoys me to see the public that wasn’t fully educated about the financial crisis before it happened get snookered again by misleading reporting afterwards.

Megan McArdle of the Atlantic apparently feels the same way, having dubbed Taibbi “the Sarah Palin of journalism” and pointing out intelligently that “[i]t’s not that everything he says is wrong, but the bits that are true aren’t interesting, and the bits that are interesting aren’t true. The whole thing dissolves into the kind of conspiracy theory he so ably lampooned in The Great Derangement. The result is something that’s not even wrong. It’s just incoherent.”

In his rebuttal, Charlie Gasparino of CNBC said the article made him “ill” in his “Stop Blaming Goldman Sachs” rebuttal to Taibbi. (Allegedly, Gasparino and Taibbi will settle their differences with the modern-day version of pistols at dawn, which is a dual appearance on Imus.)

Here’s why I’m on record as siding with the skeptics: Taibbi set himself an impossible task in trying to prove that one firm is that evil and that smart. The thing about bubbles is that they take a village-everyone has to become disinhibited, and greedy, on a mass scale to buy into a really bad idea.

The whole history of Wall Street is guys with homes in Greenwich complaining about guys with ranches in Telluride, billionaires bashing millionaires, and in the end, the whole Street is in on it together because they all get paid the same way. The idea that one person or firm could be behind any of it is at most a distant delusion. It is not a conspiracy launched in one place and foisted on others-it is people responding to the incentives we give them. (And, by the way, there are some good people in there, too, although that often gets forgotten.)

All Wall Street firms and their hedge fund friends played a part in fueling the tech bubble, got involved in unsavory amounts of trading in mortgage-backed securities, and toyed with credit-default swaps, because that’s how they could make money at the time. Wall Street almost always moves in lockstep. That’s why the bailouts that helped Goldman actually helped other firms even more: They’re too interconnected to fail.

Not too many people, however, have addressed the bulk of the actual factual and contextual inconsistencies in Taibbi’s Rolling Stone article. The facts won’t change the debate-as Barry Ritholtz points out, the Goldman article is more about having someone to blame for the credit crisis, one target, fair or not, for all of society’s frustrations-but it’s still useful to get them out there. So here’s a little factual perspective about Wall Street and its bubbles that I wish more readers had had with them as they were reading the Rolling Stone article.

Let’s start with the AIG (AIG) thing. Everyone has read about how Goldman received $12.9 billion from AIG to cover money AIG owed Goldman on credit-default swaps. That $12.9 billion, in turn, came from the government via the first bailout of AIG. The conspiracy theory says that the government paid out all of AIG’s debts because Goldman alone would have failed without that $12.9 billion in hand. That’s hard to believe: AIG’s bailout went to pay several firms, not just Goldman: Bank of America (BAC) Merrill Lynch received $12 billion, as did France’s Societe Generale and Germany’s Deutsche Bank. England’s Barclays Plc received about $6 billion, and Switzerland’s UBS received about $5 billion, all of your taxpayer dollars. Goldman says it would have been fine regardless (which is admittedly hard to believe, since $12.9 billion is, after all, real money). But whether Goldman would be fine is beside the point. The point is that when AIG collapsed-in fact, because AIG collapsed-it owed money to several banks, and when the government took over AIG, it owed that money to the banks, too.

Taibbi is equally misguided in his account of the technology bubble. Taibbi’s argument is that Goldman created and fueled the technology bubble. “Goldman quickly became the IPO king of the Internet era,” Taibbi writes darkly, calling the firm “a leading underwriter of stocks during the boom.”

This is giving Goldman way too much credit. Anyone who actually lived through the tech boom had to be flummoxed by this. Goldman? The IPO king? In tech circles, Goldman was often considered an also-ran in tech IPOs. What about Frank Quattrone at Credit Suisse First Boston, or Mary Meeker, “the queen of the Internet,” at Morgan Stanley (MS)? Quattrone himself may have earned as much as $100 million in a single year from his technology IPO exploits and is now making a comeback.

Taibbi argues that Goldman’s tech IPOs lacked “quality,” but, given the barnyard trough that was the tech bubble, that’s a ridiculous claim. Nearly all the tech IPOs, by all underwriters, became essentially worthless; in addition, IPOs work through syndicates of five to 20 banks that sell shares, and many IPOs are “led” by two or more banks that do the heavy lifting. The quality of each tech IPO reflects equally badly on all the banks involved, who all put their names behind the companies and sold the shares to people in the markets.

In any case, the “IPO king” label seemed definitely false. I requested data from Thomson Reuters to double-check how much Goldman dominated tech IPOs. I asked Thomson for the “league tables” of bank rankings based on the dollar value of the IPOs they backed. Just as I thought: Goldman was, for much of the tech boom, a laggard, generating significant (significantly? Or cut?) billions of dollars of business less than its rivals. If Goldman was profiting from a bubble, it wasn’t doing as well as others.

In 1997, Goldman Sachs was No. 4, behind No. 1 Deutsche Bank-then the home of Quattrone-and No. 2 Morgan Stanley-the home of Meeker. The next year, in 1998, Goldman Sachs was No. 5 in tech IPOs, with Morgan Stanley taking the crown as No. 1 and Credit Suisse hiring Quattrone to jump to No. 3 from its previous No. 8 rank. Where Morgan Stanley underwrote $51 billion of tech IPOs in 1998 and Credit Suisse underwrote $28 billion, Goldman underwrote just $19.9 billion.

In 1999-as Taibbi points out-Goldman finally started to compete, rising to No. 2 behind Morgan Stanley and just ahead of Credit Suisse. But that year, Morgan Stanley underwrote $62 billion of IPOs, while Goldman underwrote only $50 billion. In 2000-the last full year of the tech bubble-Goldman Sachs was No. 3, behind both Credit Suisse and Morgan Stanley. The tally that year: Credit Suisse, $136 billion; Morgan Stanley, $108 billion; Goldman Sachs, $97 billion. At the height of the tech boom, Goldman Sachs underwrote 29 percent less in dollar value than its most successful competitor, Credit Suisse.

Considering that banks make money on the percentage of the total IPO value they underwrite-around 7 percent-missing out on $39 billion of IPOs was nothing for Goldman to brag about. That would have been approximately $2.6 billion of fees that Goldman failed to put in its own pocket. Taibbi never explains why Goldman, the IPO king, would choose to do such a thing. The tech IPO boom clearly belonged to Morgan Stanley and Quattrone at Deutsche, then Credit Suisse.

What about Taibbi’s other charge that Goldman engaged in “laddering,” or promising shares of hot IPOs to insiders or “friends and family” who would buy more later? And “spinning,” or giving company executives super-cheap shares in exchange for the promise that they would buy more?

Yes, Goldman may have been involved in something like that. It helps, however, to point out that the class-action lawsuit on laddering included 55 underwriters as defendants. Including Goldman, yes, but also Morgan Stanley, Credit Suisse, Deutsche Bank, Salomon Brothers, Robertson Stephens, and literally every bank on Wall Street. The lawsuit-launched in 2001-was just settled this year, and it was all of $586 million for all of the banks as well as 300 of the failed companies they took public. That was an amount those banks and companies earned before afternoon tea on tech stocks during the boom year. The whole point of the lawsuits, however, is that the banks and companies were in it together-at least 355 entities in all. To single out one bank of 355 as particularly rapacious is ridiculous. What were the other 354 doing, then?

As for spinning, the best example is far from Goldman. It’s actually the “Friends of Frank” program presided over by Quattrone, who watched over technology investment banking, research and even the part of the brokerage business that sold shares to individuals. Quattrone was in good company, however; so many banks offered similar deals on IPO stocks that executives told The IPO Decision author Jason Draho that they could not have played favorites, since they got sweet deals from everyone.

Taibbi points out that the Internet bubble was “one of the greatest financial disasters in world history,” which is true. But there’s no way that Goldman alone created it-every investment bank was involved, because Wall Street offers crazy incentives to create bubbles.

So, what about Taibbi’s attack on Goldman for its alleged part in the $4-a-gallon gas disaster of 2008? Taibbi points out Goldman asked for-and received-an exemption to speculate in the oil markets 17 years ago when such speculation was limited to actual holders of oil. Taibbi mentions in passing that 14 other firms received the same exemption. That means that 15 banks over 17 years were speculating in the oil markets due to a regulatory exemption. When you have 15 firms doing the same thing for nearly two decades, how is the government playing favorites?

In addition, Rolling Stone bolsters its point by quoting Goldman’s research analysts on the price of oil. Research analysts are forbidden from communicating with much of the rest of the firm, according to a 2003 settlement; at many firms, you need special identification just to enter the floors where research analysts sit, just to make sure they stay independent. If Goldman’s analysts believe oil would rise to $100 a barrel, it’s a good bet that they actually, really believed it-unless there’s proof that they didn’t or that they were influenced by the firm’s management or traders. When that proof comes up, maybe there’s a conversation. It’s too bad, because Taibbi makes a good point about oil supply not tracking oil demand-a paradox of the oil bubble that would have been a great story in itself. Still, you can’t have a supply-demand curve for a major commodity like oil based on a single firm’s actions; the whole market has to skew those numbers.

Next, let’s look at the context of the housing crisis, where Taibbi alleges that Goldman underwrote collateralized debt obligations-little bundles of mortgages that are packaged with some good ones and some bad ones to spread the risk around. McArdle has already pointed out many of the flaws with his argument. Taibbi argues that Goldman both underwrote terrible-quality CDOs and “shorted” them, or bet that they would go down in value. That’s legal, but that’s beside the point.

The point is more that Goldman was in the middle of the pack when it came to much of the CDO market. Taibbi points out, for instance, that Goldman paid a $60 million settlement to Massachusetts, which accused the firm of promoting unsavory home loans. But, as the New York Times pointed out, Goldman barely cracked the top 10 and more often just barely (word repetition) made the top 20 financiers of subprime mortgages.

However, what most people in finance know is that most of Wall Street underwrote terrible-quality CDOs and did so far more egregiously and with far worse consequences for taxpayers than Goldman. Merrill Lynch and Citigroup (C) underwrote more CDOs-and suffered more deeply-than any other firms. Merrill and Goldman ranked No. 1 and No. 2 in CDOs, while Goldman just jangled around somewhere in the top 5. In fact, CDOs are a major reason that the government lavished hundreds of billions of dollars on Merrill and Citigroup. Bank of America later claimed $138 billion in government guarantees and direct aid, allegedly because of Merrill Lynch. Citigroup, the No. 2 underwriter of CDOs during the boom, later required a whopping $326 billion in taxpayer dollars and federal guarantees. Goldman, as Forbes recently pointed out, was different only because it “hedged” its mortgage investments, or designed them so that it didn’t lose more than it could afford.

And those firms, unlike Goldman, actually made an active effort to gobble up more and more risky CDOs, even knowing that they would never be able to make enough money to offset the loss later. And while Merrill and Citigroup were taking all this risk at the top, they were also holding on to a lot of Main Street, mom-and-pop money-Merrill Lynch has its famous 12,000-strong brokerage force, and Citigroup was the top holder of consumer bank deposits in the United States. Goldman is proud that it deals only with institutions-other, savvy high-level investors, like banks and companies and hedge funds.

Merrill Lynch is a great case in point and the closest thing to a poster child there is on the subject. In 2006, Merrill actually fired a top executive, Jeff Kronthal, for not taking enough risk on CDOs. One Merrill trader was known for racking up $5 billion to $6 billion of bad-quality CDOs every quarter to hold on Merrill’s own balance sheet.

The firm ended up taking over $25 billion in writedowns on CDOs before selling a bunch valued at $30.6 billion for less than 22 cents on the dollar.

Nor was Goldman’s bet against CDOs unusual. Hedge fund manager John Paulson (no relation to the former treasury secretary) bet against the mortgage market for years; it finally paid off in 2007, when he made so much money that his paycheck alone was $3 billion (or nearly the equivalent of Goldman’s most recent quarterly profit).

Goldman’s combination of underwriting CDOs and shorting the mortgage market is partly a result of Goldman’s isolated “proprietary trading” group, which makes investments for the firm’s own account. Yes, the right hand can act against the left hand. That’s standard on Wall Street, where information between units is tightly policed.

Does all of this context mean that Goldman is totally innocent? Of course not. You can never know what happens inside a firm. What it does mean is that if you’re going to label one big firm as a bubble machine, first make sure that the others aren’t.

More from The Big Money:

• The General’s Russian Drama
• John Hughes, Car Nut
• Cash for Clunkers, the Geithner-Bair Feud, and Recessionary Road

When I was 14, Warren Buffett wrote me a letter.

It was a response to one I'd sent him, pitching an investment idea.  For a kid interested in learning stocks, Buffett was a great role model.  His investing style -- diligent security analysis, finding competent management, patience -- was immediately appealing.

Buffett was kind enough to respond to my letter, thanking me for it and inviting me to his company's annual meeting.  I was hooked.  Today, Buffett remains famous for investing The Right Way.  He even has a television cartoon in the works, which will groom the next generation of acolytes.

But it turns out much of the story is fiction.  A good chunk of his fortune is dependent on taxpayer largess. Were it not for government bailouts, for which Buffett lobbied hard, many of his company's stock holdings would have been wiped out.

Berkshire Hathaway, in which Buffett owns 27 percent, according to a recent proxy filing, has more than $26 billion invested in eight financial companies that have received bailout money.  The TARP at one point had nearly $100 billion invested in these companies and, according to new data released by Thomson Reuters, FDIC backs more than $130 billion of their debt.

To put that in perspective, 75 percent of the debt these companies have issued since late November has come with a federal guarantee. (Click chart to enlarge in new window)

Without FDIC's debt guarantee program, even impregnable Goldman would have collapsed.

And this excludes the emergency, opaque lending facilities from the Federal Reserve that also helped rescue the big banks. Without all these bailouts, the financial system would have been forced to recapitalize itself.

Banks that couldn't finance their balance sheets would have sold toxic assets at market prices, and the losses would have wiped out their shareholder's equity.  With $7 billion at stake, Buffett is one of the biggest of these shareholders.

He even traded the bailout, seeking morally hazardous profits in preferred stock and warrants of Goldman and GE because he had "confidence in Congress to do the right thing" -- to rescue shareholders in too-big-to-fail financials from the losses that were rightfully theirs to absorb.

Keeping this in mind, I was struck by Buffett's letter to Berkshire shareholders this year:

"Funders that have access to any sort of government guarantee -- banks with FDIC-insured deposits, large entities with commercial paper now backed by the Federal Reserve, and others who are using imaginative methods (or lobbying skills) to come under the government's umbrella -- have money costs that are minimal," he wrote.

"Conversely, highly-rated companies, such as Berkshire, are experiencing borrowing costs that ... are at record levels. Moreover, funds are abundant for the government-guaranteed borrower but often scarce for others, no matter how creditworthy they may be."

It takes remarkable chutzpah to lobby for bailouts, make trades seeking to profit from them, and then complain that those doing so put you at a disadvantage.

Elsewhere in his letter he laments "atrocious sales practices" in the financial industry, holding up Berkshire subsidiary Clayton Homes as a model of lending rectitude.

Conveniently, he neglects to mention Wells Fargo's toxic book of home equity loans, American Express' exploding charge-offs, GE Capital's awful balance sheet, Bank of America's disastrous acquisitions of Countrywide and Merrill Lynch, and Goldman Sachs' reckless trading practices.

And what of Moody's, the credit-rating agency that enabled lending excesses Buffett criticizes, and in which he's held a major stake for years?  Recently Berkshire cut its stake to 16 percent from 20 percent.  Publicly, however, the Oracle of Omaha has been silent.

This is remarkably incongruous for the world's most famous financial straight-shooter. Few have called him on it, though one notable exception was a good article by Charles Piller in the Sacramento Bee earlier this year.

Buffett didn't respond to my email seeking a comment.

What saddens me is that Buffett is uniquely positioned to lobby for better public policy, but he's chosen to spend his considerable political capital protecting his own holdings.

If we learn one lesson from this episode, it's that banks should carry substantially more capital than may be necessary.  You would think Buffett would agree. He has always emphasized investing with a "margin of safety" -- so why shouldn't banks lend with one?

Yet he mocked Tim Geithner's stress tests, which forced banks to replenish their capital. Why? Is it because his banks are drastically undercapitalized?  The more capital they're forced to raise, the more his stake is diluted.

He points to Wells Fargo's deposit funding model being more robust than investment banks', but that's no excuse for letting tangible equity dwindle to three percent of assets.  At that low level, the capital structure would have collapsed were it not for bailouts.

And by the way, the strength of Wells' funding model is a result of FDIC insurance, among the government subsidies Buffett complains about in this year's letter.

To me this feels like a betrayal.  There's a reason he's Warren Buffett and not, say, Carl Icahn.

As Roger Lowenstein wrote in his 1995 biography of Buffett, "Wall Street's modern financiers got rich by exploiting their control of the public's money ... Buffett shunned this game ... In effect, he rediscovered the art of pure capitalism -- a cold-blooded sport, but a fair one."

But there's nothing fair about Buffett getting a bailout, about exploiting the taxpaying public for his own gain.  The naïve 14-year-olds among us thought he was better than this.

What would Ben Graham say?

– Jonathan Ford is a Reuters columnist. The views expressed are his own –

So, Goldman Sachs has a “Gordon Gekko feel to it” according to an executive at Brand Asset Consulting. In a survey of leading U.S. brands, the market research firm has reached the conclusion that the investment bank’s stature has been diminished in the eyes of the public by recent events.

Somehow, this fails to do justice to the emotions the name Goldman stirs in the breast of the average American.

Goldman’s stature isn’t diminished; the firm is becoming actively hated, and this emotion is going mainstream. When Rolling Stone recently published a cover story describing Goldman as a “vampire squid wrapped around the face of humanity”, its author, Matt Taibbi, was simply saying what a lot of people think — if more eloquently and memorably.

Normally, the good opinion of the wider world, or of its rivals, wouldn’t matter too much to the steely-eyed Wall Street firm. So long as Goldman continues to be supremely well-represented in the corridors of power, retains the respect (if not affection) of its clients, and is able to hire the brightest bankers, then what Joe Public thinks is surely largely irrelevant.

Goldman itself certainly seems to believe this. Despite public revulsion at the excesses of Wall Street, it has returned as quickly as possible to normal service sucking up cheap government and Fed funding, making pots of money trading for its own account and paying fat bonuses to staff. Meanwhile, it has liberated itself from the political fetters of the TARP.

But it’s conceivable that the great squid has miscalculated.

The risk it is running is not that clients will desert the firm. It is more that the hostility of the general public may make it vulnerable to a populist backlash. Quite what form this may take is unknown. But history provides an uncomfortable parallel from the thirties — the last time the public thirsted for revenge on Wall Street. In 1933, an equally well-connected and powerful firm, the house of Morgan, was broken up after a celebrated series of Congressional hearings that take their name from the committee’s counsel, Ferdinand Pecora.

Called upon to investigate the causes of the 1929 crash, Pecora mounted a populist attack on Morgan. Some of what he uncovered was scurrilous, such as the existence of a “preferred list” by which the firm rewarded influential friends (such as ex-president Calvin Coolidge) with shares in stock offerings at deeply discounted rates. But much was innocuous. True, Morgan partners paid no taxes in 1931 and 1932. But what was lost in the hubbub was that they did so because of heavy stock market losses.

So unpopular was Morgan with the public, however, that the bandwagon swiftly became unstoppable. The government had not planned to rope private banks like Morgan into new banking legislation designed to stop deposit taking “national” banks from underwriting securities. But when the national banks offered to accept the so-called Glass-Steagall restrictions without demur so long as Morgan was included, its goose was cooked.

As Ron Chernow observed in his book “The House of Morgan” the firm was vulnerable because it did not take the hostility it faced seriously until it was too late. Morgan believed public opinion to be largely irrelevant to men of business. Yet when opinion turned, not even its powerful friends could defend it from one determined district attorney.

This may be the mistake that Goldman too is making. The qualities that have allowed it to become so dominant in its industry could work against it in the public arena.  After all, would Lloyd Blankfein do any better on the stand than Jack Morgan?

There is no modern-day equivalent to Glass-Steagall on the horizon, and it is unclear what legislation could clip Goldman’s wings without damaging the rest of the investment banking industry. But Goldman has become identified in the public mind with a shadowy and greedy business that helped to trigger a vast crisis. That makes it vulnerable in a way it has not been in the past.

In the film Wall Street, the odious Gekko advises a novice trader to get a dog if he wants a friend. To date that has seemed to typify Goldman’s attitude. The bank could do with a few more friends — preferably of the human kind.

Is history repeating itself at Goldman Sachs?

In late 2006, Goldman shrewdly began backing away from the residential mortgage market. With little fanfare, the firm began aggressively hedging its exposure to home loans, in particular mortgages to borrowers with shaky credit histories.

This savvy and somewhat stealthy strategy enabled Goldman to pawn off lots of its soon-to-be toxic mortgages and mortgage-backed securities on other institutions -- forcing those foolhardy speculators to pay the price when the subprime market blew up.

And much to everyone else's chagrin, Goldman even made money off the housing meltdown when some of its hedges -- specifically a bet that a subprime mortgage index would plunge -- paid off handsomely.

It appears Goldman is following a similar script with U.S. commercial real estate, the next big asset class that many believe is on the verge of disaster.

Goldman recently reported owning $6.4 billion in commercial mortgage loans. It also is holding some $1.6 billion in commercial mortgage-backed securities, or CMBS. That's a big retreat from where it was just two years ago.

And in a sure sign that Goldman expects a good number of commercial real estate borrowers to default, the firm says it marked down the overall value of its commercial mortgages portfolio by nearly 50 percent.

By contrast, regional banks, many of which have disproportionately high exposures to commercial real estate, are being far less aggressive than Goldman in marking down their respective portfolios.

But Goldman, with a $950 billion balance sheet, can afford to take the lead in marking down loans and indirectly putting pressure on other lenders to follow suit, because its overall exposure to commercial mortgages is relatively light.

Goldman used to have a rather large footprint in the commercial real estate market, with some $16.27 billion in loans and $2.75 billion in CMBS on its books in late 2007. That year, Goldman ranked seventh in bundling commercial mortgages into securities, churning out $15.1 billion in so-called CMBS, according to Thomson Reuters.

By the end of 2008, Goldman managed to whittle its total commercial mortgage portfolio down to a less imposing $10.9 billion.

Goldman says in a regulatory filing that it was able to rid itself of a good deal of its "long positions" in commercial mortgages and CMBS through "dispositions," or sales of mortgages to other institutions and investors.

No doubt, Goldman also bundled some of it commercial mortgages into the nine CMBS deals it brought to market in 2007.

To be sure, Goldman has taken more hits on commercial mortgages than it did with residential real estate. The firm has taken at least $3.5 billion in write-downs. But Goldman has been able to easily absorb those losses by posting strong trading gains in bonds, stocks and commodities.

And there's the possibility that Goldman's strategy for hedging its remaining exposure to commercial real estate could pay dividends if the market collapses. Just as it did with residential real estate, Goldman says in regulatory filings that it relies on "cash instruments as well as derivatives" to reduce some of the firm's commercial mortgage exposure.

It should come as no surprise that Goldman won't talk about its hedging strategy. So there's no way to determine whether Goldman traders are betting that an index that serves as a derivative trade on the CMBS market will plunge, just as the one that tracked the subprime-backed securities market did.

So far, the main Markit indexes for tracking the performance of the highest-rated CMBS are off just 10 to 13 points from their respective par values. By comparison, the most widely followed Markit index for tracking the performance of subprime-backed debt dropped by more than 80 points at its nadir.

Right now, the odds of subprime-like collapse in CMBS valuations appear long and that's not good news for anyone selling the index short. But further declines would appear likely given the deep haircut Goldman has taken on its own portfolio of commercial mortgages.

No matter what, it would appear Goldman is in a better position than most banks to weather a further slide in the commercial mortgage market. It could even benefit if the market improves and Goldman gets to write up the value of some of the mortgages it's marked down.

And, if lightning strikes twice, Goldman might even profit while others feel only pain..

(Editing by Martin Langfield)

–Matthew Goldstein is a Reuters columnist. The views expressed are his own.–

Did someone try to steal Goldman Sachs’ secret sauce?

While most in the United States were celebrating the Fourth of July holiday, a Russian immigrant living in New Jersey was being held on federal charges of stealing secret computer trading codes from a major New York-based financial institution.

Authorities did not identify the firm, but sources say the institution is none other than Goldman Sachs .

The charges, if proven, are significant because the codes that the accused, Sergey Aleynikov, tried to steal are the secret sauce to Goldman’s automated stock and commodities trading business.

Federal authorities contend the computer codes and related-trading files that Aleynikov uploaded to a German-based website help this major financial institution generate millions of dollars in profits each year.

The platform is one of the things that gives Goldman an advantage over the competition when it comes to the rapid-fire trading of stocks and commodities. Federal authorities say the platform quickly processes rapid developments in the markets and using secret mathematical formulas, allows the firm to make highly-profitable automated trades.

The criminal case has the potential to shed a light on the inner workings of an important profit center for Goldman and other Wall Street firms. The charges also raise serious questions about the safeguards that Wall Street firms deploy to protect these costly-to-build proprietary trading systems.

The criminal case began to unfold on the evening of July 3, when Aleynikov was arrested by FBI agents at Newark Airport after returning from Chicago.

Aleynikov apparently had just started a job with another big firm in Chicago after leaving his previous employer in New York in early June. It appears that the financial institution allegedly victimized by Aleynikov had alerted federal authorities that its former employee might be up to no good.

On July 4, Aleynikov was processed on a “theft of trade secrets charge” in a criminal complaint. As of Sunday morning, he was still being held at the Metropolitan Correction Center in Brooklyn.

A Goldman spokesman declined to comment on the incident. A spokeswoman for the United States Attorney’s Office in Manhattan did not comment.

Sabrina Shroff, Aleynikov’s lawyer, says the facts will bear out that her client is innocent. She’s hoping he will be released from custody soon.

His wife, Elina, says her husband is innocent. Speaking in a phone interview from the couple’s New Jersey home, she says her husband worked hard for Goldman and has been a good citizen — noting he’s lived in the United States for 19 years. She seems mystified that federal authorities would arrest him on the eve of a holiday.

The Federal Bureau of Investigation, in charging Aleynikov, says he began working for the major financial institution in May 2007 as a computer programmer and left in early June. That matches the description of a man named Serge Aleynikov on the social networking site LinkedIn (the difference in spelling of the first name could not be immediately explained).

The biographical information for Aleynikov on LinkedIn says he joined Goldman in May 2007 and was vice president for equity strategy. The bio says he was responsible for “development of a distributed real-time co-located high-frequency trading platform.”

The case against Aleynikov may explain why the New York Stock Exchange moved quickly last week to stop reporting program stock trading for its most active firms.

Goldman was often at the top of the chart — far ahead of its competitors. It’s possible Goldman had asked the NYSE to stop reporting the number after it discovered that someone may have infiltrated the proprietary computer codes it uses.

Here’s the way the criminal complaint describes the Goldman trading platform:

“The Financial Institution has devoted substantial resources to developing and maintaining a computer platform that allows the Financial Institution to engage in sophisticated high-speed, and high-volume trades on various stock and commodities markets. Among other things, the platform is capable of quickly obtaining and processing information regarding rapid developments in these markets.”

Federal authorities appear to believe Aleynikov may have had help. The German website that Aleynikov is accused of uploading the stolen information to is registered to a person in London.

While the case is still unfolding, there is more information to unearth about Aleynikov. For instance, it appears he and his wife are competitive ballroom dancers — there are videos of them on YouTube.com.

Many questions remain.

Which Chicago firm hired Aleynikov? The job he took in Chicago, according to the criminal complaint, paid nearly three times more than his $400,000 salary at Goldman.

Also, there’s more to learn about anyone who might have been helping him and the fallout the case may have for Goldman. When he was arrested, Aleynikov told the FBI he “only intended to collect ‘open source’ files on which he had worked, but later realized that he had obtained more files than he intended.”

Quick, get this guy a good lawyer.

One question investors need to ask is whether this incident will have any impact on Goldman’s second-quarter earnings. The alleged wrongdoing by Aleynikov took place at the beginning of June — although it’s not clear if it had any material impact on automated trading.

Investing 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.

– Jonathan Ford is a Reuters columnist. The views expressed are his own –

Goldman Sachs wants to do its duty by the American people and give them their TARP money back. Some spoilsports have urged the government simply to say no because allowing the investment bank to repay the cash would make other banks look bad.

But this seems rather un-American. Why shouldn’t taxpayers get their money back if Goldman really doesn’t need it? The point to insist upon is that they get all of it back — and on commercial terms.

To be clear, that means not just the $10 billion of TARP-related preference shares the government subscribed for last autumn, but also the rest of the Federal assistance Goldman has received.

That includes the $29 billion of FDIC backed bonds that Goldman has issued at low coupons, without which — as Jon Unia observes in a snappy letter to the Financial Times on April 22 — it might have posted a first-quarter loss rather than a profit. Goldman has, as it points out, issued bonds without a guarantee since last autumn, so it’s not impossible. The full $29 billion would need to be refinanced on commercial terms. After all, either you’re a private sector player or you’re not.

Unia also observes that if Goldman wants to prepay the prefs, it should be charged by the taxpayer for the temporary loan of the Federal balance sheet. This, after all, is what a commercial lender like Goldman would do if the boot was on the other foot.

There is even a mechanism for it to happen. As part of any pref repayment, Goldman could be obliged to buy out the warrants it issued to the Treasury at the same time as the prefs at a price negotiated between the two. This payment could be the prepayment premium.

My suggestion would be that in any such negotiation Treasury Secretary Tim Geithner should select a Rottweiler of an adviser to act on the taxpayers’ behalf — one who could not be accused of being in Goldman’s pocket. Who could fill that role? How about Dick Fuld?

(Republished to clarify time period of data in fifth paragraph)

Patriotism, as Dr Johnson once observed, is the last refuge of a scoundrel. So when you hear words like “duty” drip from the lips of a senior executive at Goldman Sachs, you instinctively count the spoons.

You’d be right to do so too. Chief financial officer David Viniar’s observation that Goldman has a duty to repay the money it received last autumn from the U.S. government as part of the Troubled Asset Relief Program may be marginally less cynical than the apercu flung out recently by his boss, Lloyd Blankfein, that investment bankers should be paid less and shouldn’t be rewarded for failure.

But not much less.

And my, do Blankfein’s comments seem cynical in light of the bank’s first quarter results. After all, Goldman accrued 50 percent of its quarterly revenues (yes, that’s revenues) against payments it plans to make to its employees. That is broadly the same proportion that it paid out to them throughout the boom. No question, then, that Goldman’s bankers should do without to pay back the TARP money. With breathtaking cheek, Goldman has also used taxpayers’ cash to bail out Jon Winkelried, one of its wealthiest and most senior executives, after he lost too much money in its own hedge funds. And as for clawing back past rewards that turned out to be excessive — well what about that $70 million you got in 2007, Blankfein?

A SURVIVOR

But no senior Goldmanite ever says anything without a purpose. And so it is with Viniar. Goldman may have been through the wars like its rival investment banks — but it has survived. Because of its controversial hedging strategies (especially the enormous payments received from the taxpayer via AIG) it has thus far weathered the crisis better than rivals. Indeed it has been able to exploit a profitable niche borrowing money cheaply from the Fed and punting it on its own account. In the latest weekly data, for instance, the volume of Goldman’s principal equity program trades was 4.2 times the business it did for customers, according to the NYSE.. So much for serving the client. Meanwhile, along with its fellow survivors it has enjoyed the reduction in competition the slump has brought. It would like to make this reduction permanent.

“Mighty” Goldman is actually quite vulnerable to the changes that have taken place in the banking world. A large chunk of its shares are still held by employees, whose loyalty to the firm is unlikely to extend to bailing it out — even were they financially able to support a firm with $850 billion of liabilities. This is not a sound basis upon which to build a diversified financial services firm.

TARP STRATEGY

By repaying the politically-charged TARP money quickly, Goldman aims to draw a distinction between itself and other large recipients, such as Bank of America and Citigroup, which have no hope of paying back their government cash any time soon. Goldman can then get down to the serious business of lobbying Washington to widen the definition of activities that it is permitted to carry on while remaining a bank holding company. Deploying its $164 billion of resources to buy distressed debts with the financial backing of the U.S. Treasury is merely the start. In the long run, given its limitations, Goldman’s objective must be to persuade the government, in effect, to treat it as a “broker dealer” (a non-bank securities firm which is able to gear its balance sheet to a far higher level than any Fed-regulated institution) while continuing to enjoy the benefit of being a bank, including the yummy cheap funding. It is a sign of investors’ confidence in Goldman’s ability to swing this that it has been able to sell $5 billion of equity, at a mere 5 percent discount, much of it to new investors.

The strategy is an odd mixture of cunning and desperation. After all, Goldman genuinely needs to release itself from the TARP to ensure it can pay employees the vast sums they still expect. That requires a free hand to do what business it likes and to remunerate as it sees fit. Without those two preconditions, the firm could start to break up. Achieving either is not a certainty. Although the administration sees Wall St firms as important financial assets to serve U.S. companies around the globe, the AIG saga — especially the suggestion that Goldman may in effect have got paid twice by AIG because it hedged its counterparty exposure to the insurer by shorting its shares — is political poison. This is something Goldman should clear up before any decisions are taken about its future.

In any event, it would be a historic error to hand Goldman the “get out of jail” card it craves. American taxpayers may regard the repayment of a few billion of TARP money as a good result. But they should be careful what they wish for. They may pay a long-term price for Goldman’s “dutiful” act if it leads to a deal in Washington that results in higher prices for investment banking services and greater moral hazard.