< Return to Bulls pageMaking money out of level 3 assets
As on March 5th, the weakness in the overall economy has brought a wave of selling, cutting the best performing market stocks, contracting P/E ratios and pessimistic earnings outlooks have been the main culprits over the last quarter and Goldman Sachs has been no exception. Although Analysts still hold a high regard for the company, it has been difficult getting any momentum back for the shares. Falling from a high of over $250 to its current values makes for a 40% valuation hit. While that is in line with virtually all of its peers in the financial business Goldman has proven with its track record to just simply be more flexible, better managed, and in fact smarter than the other Investment Firms. While earnings expectations have been toned down this year to around $19-$20 and $22-$23 next year, there is no reason for Goldman to be trading in the 7 P/E range. Even though 2008 profitability is expected to be lower than 2007, it still only values Goldman with a FP/E in the 8/9 range. This is a company that had over a trillion dollars worth of assets on its balance sheet at the end of 2007. It made almost $12 billion in profit on revenue of $88 billion.
Moreover, they are trying to make money over the credit crunch as well. There are Level1, Level 2 and Level 3 assets. Level 1 assets are the easy to price, liquid holdings on the banks balance sheets. Think US Treasuries. Level 2 assets may be less liquid, but they are priced according to comparable marketable assets, even if they arent' actively trading themselves. Level 3 assets, though, are the illiquid holdings that have gotten everyone in trouble lately - the mortgage backed structured products, derivatives, all that toxic waste. Those are illiquid, and have been priced according to "mark to model" theoretical pricing programs. Basically they are prices made up out of thin air. Keep with us here - last month there was an offer to the investment banks to come to the discount window of the Fed (something not done for over 70 years) and use those level 3 assets for collateral for 100 cents on the dollar FULLY LIQUID, US TREASURY-NOTE BASED LOANS. Now think about that! It's truly turning lead into gold with this type of accounting alchemy.
We saw, in most banks quarterly earnings releases, huge transfers of assets from "level 2" into "level 3", basically (we suspect) to take advantage of this total windfall of taxpayer cash to the banks. And yes, you can thank Henry Paulsen (of Goldman Sachs pedigree) for this $200 billion taxpayer funded program. Morgan Stanley has $32 billion now in Level 3 assets (it increased by 45% in Q108) and Goldman themselves added $27 billion to make their "level 3" pile $96 billion. WOW!
Setting aside the discussion of the morality / ethicality of bailing out the Wall Street banks with taxpayer money, this happened last month and we have to figure out how to make an investment return on it. The Wall Street investment banks are now in a position to swap off the worst toxic waste on their balance sheets for US Treasury notes. That's exactly what they're doing, and there's nothing you or I, or Congress, or the President of the United States can do about it. As a matter of fact, they're looking at this $200 or $300 billion program as the cost of maintaining our financial system's integrity. I guess every once in a while the roots of the tree of global finance have to be replenished with the US taxpayers' capital. (Apologies to Thomas Jefferson's great quote regarding the tree of Liberty).
