Goldman share issue raises $5 billion

The share price responds positively to the dilutive sale, raising the question of what the outcome may have been if it û and other recent confidence-building measures û had come much earlier?
The news last night that Goldman Sachs had raised $5 billion from the public share offering it announced after the close of US trading on Tuesday shows investors are confident that this is a Wall Street institution that will survive the current crisis. Goldman sold 40.65 million new shares at $123 apiece, which translates into a discount of only 1.6% to TuesdayÆs closing price. Even so, it was able to raise twice the amount flagged in the initial announcement.

Investors were likely comforted by the fact that Warren BuffettÆs Berkshire Hathaway had agreed to invest $5 billion in the company û a move that was announced at the same time as the equity offering. Buffett, a seasoned investor and savvy negotiator, has clearly secured an attractive deal for his investment firm û it is buying perpetual preferred stock with a 10% annual dividend and will receive warrants to acquire another $5 billion worth of stock at a price of $115 per share at any time within the next five years û but even so, the fact that the firm is getting involved is a strong sign of support.

In a written comment, Buffett described Goldman as an ôexceptional institutionö and went on to say that that it has ôan unrivalled global franchise, a proven and deep management team and the intellectual and financial capital to continue its track record of outperformanceö. Strong words of praise indeed, although one would hardly expect otherwise from someone who has just forked out $5 billion to buy shares in the company in question.

GoldmanÆs share sale, which includes an over-allotment option of 6.1 million shares that could take the total proceeds to $5.75 billion, also came amid hopes that Congress will pass this week a bill that will enable the creation of the $700 billion bail-out vehicle proposed by Treasury secretary Henry Paulson. The vehicle will be charged with buying toxic assets off the balance sheets of US banks in order to allow them to improve the quality of their overall assets and bring more certainty to the valuation of their holdings. The fund is modelled on the Resolution Trust Corporation that was set up to take over bad loans following the savings and loan crisis in the late 1980s, but details of how it will actually work are still sparse. For example, it is not known at which price the vehicle will buy these illiquid assets from the banks, what types of assets it will buy and whether it will start to sell them off immediately or act primarily as a warehousing facility for the next few years.

The purchase price is a tricky issue because if it is set at what is perceived to be the current ômarketö price it may result in more write-downs for the banks, causing further losses and potentially a renewed sell-off of financial sector shares. And if the price is perceived to be set above market, the government may be accused of using taxpayersÆ money to subsidise bank profits.

Until these issues become clear and the bail-out vehicle is actually approved, the financial markets are unlikely to stage a significant and sustainable recovery.

GoldmanÆs share sale was the latest in a series of measures orchestrated by it and Morgan Stanley over the past few days to assure investors they have adequate capital and liquidity to stay in business. The measures, which have been announced at an almost frantic pace, include substantial infusions of capital from third parties û apart from BuffettÆs investment in Goldman, Morgan Stanley has struck a deal that will see Mitsubishi UFJ Financial Group buy up to 20% of the bank at a maximum cost of Ñ900 billion ($8.4 billion). Earlier in the week, the two investment banks also received approval to transform themselves into bank holding companies.

The latter will give them permanent access to liquidity provided by the Federal Reserve and the ability to broaden their funding sources, putting them on an equal footing with the commercial banks. They will even have the ability to set up their own deposit-taking banks under the holding company or indeed buy an existing bank, although it isnÆt clear whether they will actually take the transformation that far at this point. In return they will come under the supervision of the Fed (and various other bodies) which will mean stricter regulations in certain areas, including the amount of leverage they can take on.

As noted, there are still a number of uncertainties keeping Wall Street on edge but the forceful actions by the two remaining standalone investment banks (or whatever they ought to be called in their new guises) appear to have helped to halt the rapid slide in financial stocks. Sure, the decision by the US Securities and Exchange Commission to ban short-selling of financial stocks at the end of last week (believed to be a temporary measure) can take some of the credit for removing the panic element out of the selling, but the impact of the quick actions taken by Goldman and Morgan Stanley in terms of calming the overall market, should not be underestimated.

However, their performances were mixed over night amid the ongoing wrangling in Congress over the $700 billion bail-out programme. GoldmanÆs share price was up 6% following a 3.5% gain on Tuesday, while Morgan Stanley fell 11.5% after adding 3.4% on Tuesday. The Dow Jones Industrial Average index spent the session hovering both sides of the previous close before finishing down 0.3%.

On the other hand, one could argue that both banks û as well as their industry peers û should have acted much earlier and that the courting of potential strategic investors took place only as they were being pushed ever closer to the edge by events partly out of their control. This means neither bank was able to negotiate a deal out of a position of strength, despite both of them having reported third quarter earnings last week that exceeded expectations.

True, Morgan Stanley did secure a $5 billion investment from China Investment Corporation in December last year, which gave the recently created sovereign wealth fund a stake of up to 9.9%. The investment came as Morgan Stanley announced a $9.4 billion mortgage-related write-down for the fourth-quarter. Since then it has attempted to ride out the storm on its own and Goldman hasnÆt sought a capital injection from any external parties until this week.

While clearly hypothetical now, the question remains whether the crisis over the past couple of weeks, which has wiped billions of dollars in market capitalisation from the US market as a whole and sent most financial stocks to multi-year lows, could have been avoided had the industry taken more forceful action to boost their capital and remove toxic assets from their books in March when the takeover of Bear Stearns by J.P. Morgan through a Fed-brokered deal was offering real proof of the seriousness of the situation.

It isnÆt clear whether the lack of more widespread action in terms of securing capital had anything to do with the fact that Bear Stearns was bailed out rather than allowed to go into bankruptcy, but it is certainly not inconceivable that some players got the impression that the Fed would step in as a last resort should any other banks end up in similar trouble.

Earlier this week CLSAÆs chairman, Rob Morrison, told reporters at the annual CLSA InvestorsÆ Forum that a different response from the Fed could well have elicited a more pro-active response from the investment banking industry.

ôIn my view,ö Morrison said, ôthey should have let Bear Stearns go bust as that may have evoked a much quicker response from some of the other investment banks who may then have felt that æboy, we really do need to sort this out quickly because there is no lifeline from the Fed anymoreÆ.ö

As it were, the Fed appeared to have little choice but to set the record straight by refusing to do the same for Lehman Brothers, forcing the 158-year old investment bank to file for Chapter 11 two weeks ago. In recent days, Treasury secretary Paulson has said there had been sufficient warnings about the situation at Lehman to allow parties holding Lehman debt and various other instruments issued by it to reduce their exposure, thus there ought to be little systemic risk in allowing market forces to prevail.

In theory perhaps, but in reality the bankruptcy sent ripples through the financial markets and led to an even tighter credit situation which ultimately resulted in the US government having to extend a lifeline credit facility to insurance giant American International Group to prevent it from going the same way as Lehman (although the terms of the facility were quite onerous). And now, Paulson and Fed chairman Ben Bernanke are ferociously arguing that the $700 billion buy-out emergency vehicle is crucial for putting out what they describe as a fire ripping through the entire financial system.

It is possible that events would have unravelled in much the same way had Bear Stearns been allowed to collapse. Indeed, the fact that Merrill Lynch CEO John Thain was ultimately forced to negotiate a sale of the investment bank to Bank of America despite a series of pro-active capital injections and even a sale of collateralised debt obligations to US private equity firm Lone Star Funds for $6.7 billion, suggests that little could have been done to retain investor confidence and prevent the meltdown of the past couple of weeks.

But we will never know for sure.
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