I don't know if Goldman did this, but Morgan Stanley did: they sold silver bullion to their clients, then charged them an ongoing storage fee to hold the bullion on their behalf in their vault.
Problem was, as it came out, that MS never actually bought the bullion and thus was charging storage fees on non-existent items. If you went to remove or claim your silver, they just gave you cash as settlement, making the scam opaque.
The cynic in me says GS will do something similar, like put a very high valuation on the FB units they sell, both marking them up a great deal over what they paid FB for it AND inventing some of the units out of whole cloth (i.e. issuing 10,000 units for sale when they only bought enough FB for 1,000 units), then, over time, the FB units will be seen to "decline" in value and GS will pocket the profits twice, first on the markup of the units, then on the decline.
This process is essential to what the banking industry does. Banks are one of the few institutions authorized by law to do this.
When you deposit money in a bank, they create 9X the loans of what you've deposited.
I'd bet if you read the fine print on the MS offering it would tell you that this is exactly what they were doing. MS & GS are too smart and too big of a target to engage in outright fraud.
I think the poster is talking about re-deposits and how, recycled, that can end up being a multiple of what is deposited.
Example: you deposit $1000 in a bank with 10% reserve policy ($100 set aside as capital reserve of the bank).
Bank loans out $900 to customer for new office furniture; then that money is used to pay the office store, which is another depositor at the bank - which then counts as another deposit, 10% of which is set aside as reserve ($90). Another loan of $810 is then made, etc.
If I lend 20 bucks to my friend, then he lends it to his friend, who lends it to his friend, that's the same kind of multiplier. The total outstanding loans is $60. I really don't get what people make a big deal out of this. I guess it's b/c they aren't economists.
Except that's not the same kind of multiplier at all. I don't understand why you would make a comment without doing any research. I guess you're not an economist.
The total loans in existence is a multiple of the starting money. Same thing. And also the same is refusing to subtract the total debt for some reason. Unless you have some kind of, you know, argument?
The banks are only required to hold reserves of something like 10% of what they've lent out, depending on the country. That means, effectively, that when you deposit $1000, the bank then turns around and lends $10,000. Most of the money in the world exists only on balance sheets.
You mean, if a bank lends you money, then you deposit it in the same bank, then they loan it to you again, then you despot it again (or something equivalent) then that "creates" lots of money even though at any given time only one guy has each of the dollars...?
Not quite. The bank's total reserves must equal at least 10% of their outstanding liabilities, which includes customer savings and checking accounts, in the same way that outstanding gift cards are considered liabilities for retailers. When a bank lends you money, they're really just signing a piece of paper that says, "we've given this person X dollars", thus it counts as a liability, in that somebody could come calling for that money.
When you deposit physical cash, the bank gains an asset, ie: that cash. It gains an equal liability, ie: the amount it credits your account. Thus the sum total of the amounts deposited and the amounts loaned must not exceed 10X the amount it either has in its safes, or that it has stored with the central bank.
When a bank lends you money, they're really just signing a piece of paper that says, "we've given this person X dollars", thus it counts as a liability, in that somebody could come calling for that money.
Sorry, does not parse. When the bank lends you money, it's an asset for them. Like you mentioned elsewhere in your comment, deposit accounts are liabilities for the bank, because somebody (the depositor) could come calling for the money.
Let me rephrase that. The money they've promised you is a liability, the money you owe them is an asset. Remember, often when someone takes out a loan, they don't withdraw the money immediately. Until they do, that loan is a liability for the bank.
The Reserve Requirements (or Cash Reserve Ratio) is a Central bank regulation that sets the minimum reserves each Commercial bank must hold to customer deposits and notes i.e the amount that the bank surrenders with the central bank. ... As of 2006 the required reserve ratio in the United States was 10% on transaction deposits.
If you read further down, it seems to show that the banking system as a whole can expand $100 into $1000 with a 10% reserve requirement:
"Reserve requirements affect the potential of the banking system to create transaction deposits. If the reserve requirement is 10%, for example, a bank that receives a $100 deposit may lend out $90 of that deposit. If the borrower then writes a check to someone who deposits the $90, the bank receiving that deposit can lend out $81. As the process continues, the banking system can expand the change in excess reserves of $90 into a maximum of $1,000 of money ($100+$90+81+$72.90+...=$1,000), e.g.$100/0.10=$1,000."
it's just saying that money+loans IGNORING DEBTS instead of subtracting debts can be a multiple of money. if in addition to adding loans u also subtract debts then you'll find nothing happened.
Please be aware that this is blatantly false. The bank can only loan out less than the amount they have on hand (after subtracting the reserve percentage).
What happens is that you loan the money, it gets spent, and ends up in your deposits again. THEN, you are effectively counting a dollar as: "Owe $ to original depositor, Get $ from person taking the loan, Owe $ to new depositor". Adding up to 1 dollar. Except when reporting dollars on deposit, you say 2.
Individual banks don't "create" money. But as a quirk of lending and taking deposits, the banking system creates money, at least on the books.
The cynic in me says that GS will go to AIG and have them underwrite an "insurance" policy which guarantees that if anyone wants to redeem more FB shares than they have on hand, AIG will cover the remainder.
Back when Berkshire Hathaway only had Class-A shares worth thousands of dollars, there were a few investment firms at work on similar vehicles to allow ordinary investors to buy fractions of a share at smaller prices. Berkshire responded by issuing their own fractions, at 1/30th of a Class-A share (since split to 1/1500th), because they wanted investors, not investment firms, owning the shares.
It's interesting that now Facebook is doing a sort of converse of Berkshire's actions; that the pain of a public company is so onerous that having a bank involved is apparently seen as an advantage.
Alternatively, FB may just want to keep financials a secret because they are worth a lot more when people are wildly speculating than they would be if they had to be as open as a public company.
(Goldman probably got a look under the hood, but I doubt they will pass that along to the investors they hope to sell Facebook investments to, so both FB and Goldman will benefit from uninformed speculation.)
Any prospectus put together by Goldman will have significant disclosure and results of their internal audits. Despite the hoopla, this is a pretty regulated area of commerce.
As to who will read such a prospectus, that's likely a different beast altogether.
It's my belief that FB is more likely to be in a pre-IPO Google situation right now, that is, that they're sitting on more than people realize, not less. I recall Google routinely requiring academics to cut the server and request numbers by a factor of 10-100x when giving talks about what was going on, pre-IPO. A luxury I'm sure they would appreciate still having.
that the pain of a public company is so onerous that having a bank involved is apparently seen as an advantage
Let's be specific about this "pain". What I recall from various articles, Facebook is very reticent to have it's actual revenue numbers floating around.
One might argue that there is too much regulation of public companies in general but the specific regulation that a public company has to engage in public disclosure seems sound to me. Facebook's skirting of this regulation seems questionable to say the least.
They're not a public company, or even effectively a public company, even with Goldman facilitating, if you still need to be a RegD accredited investor to buy a share.
If you read the Berkshire annual reports from back then, I think Buffet would have strongly preferred to do what FB is doing now, if he could have, or the vehicles existed.
He knew his mom-and-pop investors needed liquidity, and wasn't able to buy them all out himself, so he went for the market option. But, he was clearly ambivalent about it. I believe his first instructions to his floor trader were that he hoped there would be no transactions in the first year of listing.
At the time, Berkshire was already public. Buffett maintained the high share price because he wanted his owners to be serious about owning the stock, the test of seriousness being the high cost of ownership. When investment firms threatened to remove this barrier, Buffett went ahead and preempted them.
Buffet definitely was already in control of the company when he decided to list on the NYSE, in fact, recall that he bought the company largely out of pique at getting 'chiseled' on price by the existing management team during a private purchase of shares..
The only reason he listed was to get his current shareholders some liquidity; he's quite clear about this in his annual letters from the time. He had no need for or interest in the liquidity himself, and was, I would say judging from his actions over the next 20 years, pretty happy with his then-current disclosure situation. He did pretty much everything he could to keep Berkshire out of the drive for quarterly investment earnings game for public companies, and worked hard to reduce any requirements for reporting on what was going on at Berkshire.
Also, agreed, that high share prices helped him make a point that he spent many decades beating the drum on: value over price.
The SEC is where they always are, fighting the last war. Investments create return because there is risk, not every investment is going to be a winner. When investing in startups with new business models there is a lot of risk and hence a lot of return. Hopefully the SEC stays out of it because the combination of the SEC, Federal Reserve and Federal Gov't create untold havok in the market. Even a GIC has risk because of the underlying fractional reserve system. The same thing that allows the economy to expand faster than the rate of gold mining also allows the leverage to unwind just as fast.
The Fed, SEC, and Federal Gov't collude to prevent the free market from working and bad ideas from failing. Look at a graph of global IPOs vs. IPOs on american exchanges since Sarbox was passed. You'll see how the overly onerous regulations prevent the market from functioning properly and create an environment of moral hazard where undue risks are taken, and investors who correct the market have their returns taken away from them. The investors who shorted AIG, Bear Stearns, GS, Citigroup, BOA, etc and recognized their impending fiscal collapse should be handsomely rewarded for their prescient view of the market. Having your company collapse is the right way to handle reckless investing.
Hopefully the SEC stays out of it, an ETF/Shell corp for Facebook shares is the ideal balance between public money and few onerous requirements. If an investor feels that the lack information available for Facebook prevents an informed decision from being made then perhaps they should not invest.
Yes, you may lose your shirt investing in Facebook, but you might also make a lot of money. I don't see a problem with either outcome.
But this hack that GS created -- bypassing the 500 shareholder limit by creating a company that owns a stake in FB and then selling shares of said company -- completely undermines the law.
This is a temporary loophole that will be fixed. I don't begrudge facebook a thing. They get most the upside of an IPO with nearly none of the downside. But to act that it's perfectly alright because, hey, caveat emptor... i disagree strongly with that.
I don't want to disagree with your main point, but it's wrong to link risk and return so closely, as though one always brings the other. Just because there is a lot of risk doesn't mean there will be a lot of return. Risk is simply the likelihood that you will get your original money back, plus any return. The higher the risk, the higher the chance you won't get any return or indeed your original capital. While this often means that people will only take on risky investments if there is a chance of high return, the way it reads is that all you need to do is create some risk and your returns wil flow. It's entirely possible to have high risk, low return and low risk, high return.
However I agree entirely that SEC always fights the last war like the French building the Maginot line, and that this type of innovation is just a response to the Sarbox rules.
This particular SEC reg is designed to protect the investors, not the integrity of the market. Are we now expected to believe that Goldman --- or any private client of Goldman --- is getting snookered by Facebook?
The same logic used by the SEC suggests that every limited partner of every VC that invests in any startup should also count to the total number of investors.
Yes, Goldman's private clients are getting snookered.
This is exactly how Goldman managed to be so successful in the subprime crisis. When they decided to unload their holdings, they were sold to their clients. There is a strong conflict of interest at Goldman between shareholders and clients.
My understanding is that Goldman can do two things to make money here: 1. charge fees on transactions and 2. decide when and how to sell/buy shares for themselves.
Whether the clients should be protected by the SEC is another matter.
You're missing my point. The SEC protects non-accredited investors by forbidding companies from selling them shares. Goldman doesn't trade for non-accredited investors. If you are a Goldman private client, you are by definition outside the purview of those protections.
Starting a big long thread about how Goldman is a vampire squid or whatever Taibbi called them is a waste of time, because I'm not arguing that Goldman is a good company or a bad company or that its interests are aligned with its clients.
I'm saying that the logic that assails Goldman's Facebook vehicle is nonsensical; Goldman is doing nothing more sinister than creating an ad-hoc venture capital fund and using it to invest in Facebook. Does every California public employee also count as a Facebook shareholder if CalPERS is an LP of a VC that invests in Facebook?
"Goldman is doing nothing more sinister than creating an ad-hoc venture capital fund and using it to invest in Facebook. Does every California public employee also count as a Facebook shareholder if CalPERS is an LP of a VC that invests in Facebook?"
A venture capital fund is diversified over many investments -- that's why it's a fund. A venture capital "fund" that invests only in Facebook is a fund in name only.
Also, unless you're a lawyer specializing in securities law, I doubt you know the answer to your own question. State employees can (and do) initiate lawsuits against CALPERS, and CALPERS has sued public companies on behalf of state employees. The pensioners clearly have some rights as investors.
By your logic, CalPERS can't invest in any fund that invests in private companies, as that investment would instantaneously tip the company over the "500 investor" limit.
Meanwhile, what does diversification have to do with the structure of a venture capital fund?
"By your logic, CalPERS can't invest in any fund that invests in private companies, as that investment would instantaneously tip the company over the "500 investor" limit."
No, that's not what I said. I said that the investors clearly have rights -- presumably including the right to know the financial prospects for their investments. CalPERS invests some money in private equity funds and limited partnerships, but that just begs the original question. I don't know what the disclosure requirements are for companies involved in that kind of investment, but then, I'm not a securities law expert.
Do you actually know the answer, or are you just asking rhetorical questions in the hope that people will interpret your questions as statements of fact?
"Meanwhile, what does diversification have to do with the structure of a venture capital fund?"
You made a straw man argument that drew me into a straw man argument and here we are arguing about something totally irrelevant. Nobody is saying that investors have no rights.
Are you saying that if Matasano took funding from a VC that had CalPERS as a limited partner, we might have to make additional SEC-mandated disclosures to account for CalPERS investors? You're right: I can't tell you that I know that we wouldn't; I can only call "BS" and wait for someone else to add facts.
"You made a straw man argument that drew me into a straw man argument and here we are arguing about something totally irrelevant."
Not really. You argued that Goldman Sachs created a venture fund, and that therefore, Facebook is immune from disclosure laws. I'm saying that there's a substantial practical difference between a venture fund and what Goldman appears to be doing here (not the least of which are issues of investment diversity) and that, even if that weren't true, it's not clear that financial disclosure laws can be bypassed so easily (the CalPERS digression was yours). Other experts happen to agree on these points, so I don't think I'm coming out of left field.
But since I'm not one of those experts, and you don't seem to have any special knowledge beyond your own opinions on the matter, this thread is more heat than light. I'm done with it. Counterarguments aren't "straw men" just because they don't directly refute your original points.
I'm not saying anything about whether the SEC should address this. My last sentence should certainly make that clear.
But, yes. Given everything that has happened in the last 15 years, we should be expected to believe that the private clients are getting screwed by Goldman/Facebook.
Creating an ad-hoc venture capital fund to invest in Facebook can be both legal and sinister.
Do Goldman's clients know they are getting snookered? (How can they not?) And if you know you're going to get snookered, are you still getting snookered?
Although the SEC considers itself the "investor's advocate," it usually steps back and allows "accredited investors" and "qualified purchasers" (terms it uses for "rich investors") to invest on their own. So if Goldman Sachs and its clients are truly rich and sophisticated, I don't think the SEC will view protecting them as a good use of its time.
That being said, Goldman Sachs and its investors will likely insist on financial disclosures from Facebook and maybe even some governance rights that, while not quite public company-strength, will lead to Facebook disclosing more information to more people than it had previously.
You can bet that Goldman would have got hold of Facebook's financial statements from it before making that investment. You don't invest a few hundred million dollars before kicking the tires first.
But isn't it the responsibility of the sub-investors to do their own due diligence? After all, the entire purpose of accrediting investors is to get them to acknowledge that they are being given less protection from the SEC.
It's a process where the SEC asks the investor, "OK, you have a million dollars. Are you sure you know what you're doing?" And the individual says, "Yes, I'm willing to accept the additional risk that comes along with less oversight (ie. more flexibility)".
If an investor is putting money into the pot based on just the "Very Good Valuation" argument, and they've acknowledged the risks, they are not eligible for certain protections (because those protections also limit certain financial vehicles).
In a similar vein, I feel no sympathy for the majority of the people who gave their money to Bernie Madoff. I do, however, believe that there should be legal consequences for money managers who make those types of investments without proper due diligence.
You try to acquire the relevant information and data. You ask your broker (GS, here), what the information is that they have, rather than just accepting their "Good Value" label. If that information doesn't meet your requirements for "due diligence", then you don't invest in that company.
Also, it's not particularly important to be able to claim due diligence.
That's a valid point, but there is some validation investors get from Goldman and DST investing at that valuation. I think that DST is investing as principal, so it says something that they think it is worthwhile at that valuation (and DST is not a first time investor so they are familiar with FB's financials).
Just to clarify (its in the comments) too but as the law stands, FB does not have to go public anyway but only disclose financial results. http://www.sec.gov/about/laws.shtml (Corporate Reporting)
The only thing that's really left for one of these private share vehicles to do is pull a reverse shell merger with an OTC listed firm and let joe retail investor start day trading the result. Now that's the bubble I remember.
I think people are missing an angle in this story. I don't think the interesting part is the $450 million they invested or the vehicle they're setting up for investors. It's Facebook's future IPO and Goldman likely just bought themselves the primary role in issuing that IPO -- of which they stand to make billions off of.
That's right. If they can hype Facebook enough, Goldman will cover their investment easily. It's less about what Facebook turns out to be actually worth in the long term than what GS can help make people believe it's worth in the near term.
This is a fantastic, precedent setting move and a response to the political sector's irrational laws (see: Sarbanes-Oxley). It was presaged by the DST style investments over the last few years, and we can only hope that more companies follow suit.
If you want to reduce speculation and uninformed trading, at least one way to do that is to give companies rights over who trades their shares and under what circumstances. You're not forced to sell your house to anyone, so why should you be forced to sell your company to anyone -- particularly day traders who will just introduce volatility and aren't in it for the long haul?
A long overdue organic reaction to the silly laws passed in the wake of the last financial crisis. No doubt we will see similar workarounds for the work of art that was "FinReg", though those workarounds may take the form of debuting on the Hong Kong Stock Exchange rather than the NYSE.
It's a little known fact, but Google also made use of certain legal workarounds to avoid going public for as long as possible (among other things, they split the company into two units of 499 people apiece, or so I recall).
While I get your point about volatility, I'm not so sure I agree with the idea that large companies ought to have absolute control over who owns their shares. That's fundamentally contrary to the idea of open markets, and sets up too much potential for abuse. It's not hard to envision a marketplace where pervasive use of this technique concentrates wealth even further than it already is.
> It's not hard to envision a marketplace where pervasive use of this technique concentrates wealth even further than it already is.
Don't see how that follows. If you are restricting the market to only a fixed number of sellers, you are leaving a potentially significant amount of money on the table.
You're doing that to prevent the abuse of your company's shares by investors, who generally have more money than you do.
Imagine if you didn't have the right to turn down a VC who only wanted to put in money once you got hot, and then came to your board meetings as a shareholder and caused problems. Or to be criminally responsible if an accountant somewhere in your organization makes an error. That's what it is to be a public company in the post-Sarbox/Finreg US. This is about protecting the entrepreneur, not about protecting the old money.
correct me if I'm wrong, but aren't they not forced to sell their shares to anyone? once they pass the 499 shareholder mark they have to disclose financial information, at which point most companies go public, but if they have enough interest from private investors, I don't believe they have to.
Once a company has a certain number of shareholders (investors and employees with options, for example) then they are forced to complete a lot of the paperwork that makes being a public company so onerous. They are not forced to go public, but they are forced to pay the costs of being a public company whether or not they are actually traded on the open market.
a company I recently left ran up against this same 500 shareholder rule. To get back down comfortably below 500, they performed a substantial reverse split, which caused many former employees to be taken down below 1 share. Apparently at that level, the company can cash them out as you can't hold only a fraction of 1 share.
Once those former employees were rounded into nothingness, they performed a forward split to restore everything to their previous levels.
Indeed. Investment banks do not make money with some magic computer program that buys low and sells high eight billion times per second. They make money by buying something, "adding value", calling up clients and asking them to buy it, and then taking a cut when they do. In some cases, this has changed the way the world works; consider options.
(In general, it's really not as evil as it sounds. I write software to help price interest rate swaps, and those don't really ring any ethical alarm bells: http://en.wikipedia.org/wiki/Interest_rate_swap
I don't think the Goldman/Facebook thing is particularly evil, either. The government says that normal people can't buy Facebook shares, but normal people want to. Goldman invented a solution to the problem, and will profit from doing so. "Adding value" like this is great when it's a way to sell ads to web 2.0 users, but not when it's a bank? Why?)
I really can't imagine that this is the first time this particular move was tried.
Google had been a dominant search engine for years before they went public, and I can't imagine they turned down many $50 billion funding rounds simply to avoid turning public before their IPO.
The Securities Exchange Act of 1934 sets forth certain requirements for companies to register their shares with the S.E.C.
Specifically, Section 12(g) requires that a company register its securities with the S.E.C. if it “has total assets exceeding $1,000,000 and a class of equity security … held of record by five hundred or more … persons…”
Sounds to me like this law has been around for a while.
That statement might mean, "The Securities Exchange Act of 1934 as amended," because laws are often named by their original date of enactment, but amended subsequently.
Facebook has proven itself since them. When TV stations start promoting their facebook pages rather than their own websites you know they're onto something.
Problem was, as it came out, that MS never actually bought the bullion and thus was charging storage fees on non-existent items. If you went to remove or claim your silver, they just gave you cash as settlement, making the scam opaque.
The cynic in me says GS will do something similar, like put a very high valuation on the FB units they sell, both marking them up a great deal over what they paid FB for it AND inventing some of the units out of whole cloth (i.e. issuing 10,000 units for sale when they only bought enough FB for 1,000 units), then, over time, the FB units will be seen to "decline" in value and GS will pocket the profits twice, first on the markup of the units, then on the decline.