Detailed explanation required.

What Was Up with Wall Street? The Goldman Standard and Shades of Gray

Humble Roots

Goldman Sachs was founded in 1869 with the humble purpose of being both an originator and a clearinghouse for commercial paper. Marcus Goldman, a German immigrant, founded the company along with his son-in-law, Samuel Sachs. The company's strategy was to provide loans for small businesses and then create market for the loans through the sale of commercial paper. But the stodgy negotiable instruments market proved insufficient to attracting new talent so the firm began a gradual drift from its founders' influence and its basic roots in tangible one-on-one business loans. In the late 1920s, Goldman undertook an investment strategy that would contribute to the 1929 market crash. Goldman launched the investment trust, a vehicle by which anyone could invest small or large amounts of money and hold shares in the trust, which then purchased a portfolio of stocks. The trust income then came from the returns on the stocks in the portfolio.

Investment Strategy

The 1920s and Layering

Even in its initial foray into the layered investment strategies that would still be in play a century later, Goldman was using its own customers to make money. The layering strategy, formulated in the late 1920s, works like this: Goldman creates an investment company and buys 90 percent of the shares in that company with its own money. Because the shares have sold so well, the public (not realizing that Goldman itself had purchased the shares and driven the price up) wants a piece of the company. So, the shares that Goldman initially bought for, say, $100, it is able to turn around and sell to the public for $110. But, Goldman would continue to buy shares on the secondary market, and the price would climb to $120 and then $150 and so on. With the money Goldman made on this initial corporation, it would create new corporation and use the same strategy to drive up the price, moving on to another new corporation with more demand and higher share prices. However, all the layers in the chain are completely dependent upon the market continuing to grow and the solvency of Goldman because, as one writer has described it: Goldman invests $1.00 and borrows $9 (through the sales to the public); Goldman then takes the $1 investment and the $9 borrowed (for a total of $10) and borrows $90 with an investment of only $10 and from there moves onto $100 and $900.53 Diagrammatically, the leveraged deals are shown below.

Corporation of TrustA IPO $100 par share- Goldman buys 90 percent public buys 10 percent Secondary sales Goldman sells its shares for $1 10 Cash used Corporation or Trust B IPO:$200 par share-Goldman buys 90 percent; public buys 10 percent Bocondary sales-Goldman sols its shares for $220 Cash usedGoldman puts together deal for Paulson ACA puts together the of CDOs/Sells CDOs to its clients underlying mortgage"* pools Goldman pays AIG $11 million premium to insure The CDOG Investors purchase $000 million in CDOs from Goldman* Goldman soils its CDOs go insurance bet to a south hodge fund (swaps) AIG Balout