The Boat Is Getting Lower In The Water (Goldman)


The Boat Is Getting Lower In The Water (Goldman)

Posted by Karl Denninger

Have a look at the SEC’s archives for Goldman (NYSE:GS), and their 8K:

Those are a bunch of shareholder derivative complaints, that is, lawsuits.

These are piling in, and it’s likely just the start. 

The allegations vary but are generally along the line of dissipation (“waste” in the legal vernacular), breach of duty and unjust enrichment.

Derivative actions are nasty things.  They’re essentially a shareholder suing a third party, which often is a director or officer of the company (but may not be) in the name of the corporation for some harm that the company has suffered when the firm has failed to bring the suit itself.

This may seem odd but when you think about it shouldn’t – the shareholders are the owners, and the board serves at their discretion.  Since the shareholders are the ultimate owners of the company they have rights – including the right to protect the asset they own (the firm itself.) 

In any event these sorts of suits are nasty, as they are effectively lawsuits against people that the company’s management, for whatever reason, doesn’t want to go after.  Often these suits are dismissed but when they’re not they can be highly damaging because they are by definition actions that the corporation’s board does not want to pursue.

When the Goldman story first broke (the SEC complaint) I said that I believed that there was a roughly 20% chance that Goldman itself would fail as a consequence somewhere down the road.  The most-obvious way would be if there was to be a criminal complaint that comes out of the investigations charging not just specific individuals but the firm itself.  That sort of charge, if it occurs, is likely a kiss of death, just as it was for Anderson.

But this is another way that the firm can find itself in serious trouble.  Remember, Goldman, like all investment banks that do not have a commercial banking “arm”, has no deposit base that it can use to hold itself together.  That is, it does not survive based on its deposit base that it can loan out at interest, since it doesn’t have a deposit base.  It survives or dies as a direct consequence of it’s ability to attract clients to perform various investment-banking functions, including the underwriting of stock and bond transactions.  If the confidence of those clients is lost, no amount of “pump monkeying” by anyone will matter – the cash flow that the firm relies on will disappear instantly, and so will the company.

On Thursday last week I had a “stink bid” in for January 2011 $60 PUTs – a pure play on a business failure.  They didn’t fill, and Friday, during the huge sell-off, their value nearly doubled.  Today I don’t like the risk:reward on any of available strikes (the potential payoff was quite close to 100:1 on a “full strike” event Thursday and is about half that now) but that has a lot to do with the fact that my speculative philosophy on events that I see as relatively low-probability but high-impact (e.g. 10 or 20% chance of occurring) needs to have an extraordinary payout for them to be worth it.  Others may see it differently for a play like this, but due to the escalation of premium in these (partly due to Goldman’s recent price dump, partly due to expansion of implied volatility) I won’t be taking this trade at the present time.

Nonetheless, the potential market risk on a macro level, should the load in the boat get too high and the gunwale go underwater, remains considerable and, in my opinion, bears close attention.