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Goldman's Facebook Deal Highlights the Dangers That Wall Street is Creating For Main Street

[Editor's Note: Former global merchant banker Martin Hutchinson warned investors about the dangers that subprime mortgages posed to the U.S. housing market -and to the U.S. economy. Find out about a special report that details what he and our other experts are predicting for 2011.]

Goldman Sachs Group Inc.'s (NYSE: GS) $2 billion deal to finance Facebook Inc. combines the worst features of the last two speculative manias – the dot-com bubble of 1999-2000 and the Wall Street financing bubble of 2006-08.

At 25 times revenue and more than 100 times earnings, Goldman's Facebook deal smacks of the "dot-bomb" debacle. And the fact that this financing deal came to pass after a major Wall Street firm effectively drove a truck through two central features of securities regulation is more than a little reminiscent of the investment-banking shenanigans that fed into the global financial crisis.

The fact that history is repeating itself on Wall Street shouldn't surprise us. Nor should the fact that the Wall Street "rent-extraction machine" is once again operating in high gear.

One thing's for certain: One day the bubble will burst; and when that happens, the great bulk of the costs will be borne by ordinary Americans – as was the case back in 2008.

A "Classic" Wall Street Deal

The Facebook deal was a classic of its kind. Its $50 billion valuation was justifiable only by assuming massive future revenue growth, which is highly unlikely. Granted, the service already has 500 million users – and that may be only 7% of the world's population – but it's well over half the upscale affluent population that advertisers are interested in.

Achieving penetration in urban China may be of great interest, but that has already been achieved; achieving penetration in Bangladesh or Congo features much less in the way of business appeal.

Then there's Goldman's typical insouciance about the laws that others must live by. For instance, there's a U.S. Securities and Exchange Commission (SEC) that's been around in its present form since 1960 – and that's existed in principal since 1934 – that says that companies with more than 500 shareholders must go public and disclose full information to shareholders.

Goldman's attempt to get round this rule by having investors buy shares in a holding company is transparent and needs to be stomped on. A market in which favored insiders get special deals while ordinary shareholders must put up with the leftovers is not one that's going to function well in the long run, and is certainly not one that I want to participate in.

Finally, there's the so-called "Volcker Rule," which prevents banks (which is what Goldman Sachs technically now is) from buying large-scale equity participations for their own account. Since that rule's actual implementation was delayed until 2013, Goldman's Facebook deal was technically legal – assuming that is the position can be sold before December 2012.

Another Bloody Boom on Wall Street?

The Facebook deal is only one example of a Wall Street deal flow that is coming close to matching the boom levels of 2007 and has the potential to do as much damage as that unhappy era.

According to Thomson Reuters statistics, global investment banking fee income totaled $84 billion in 2010, up 9% on 2009 and below only the peak years of 2006 and 2007. For comparison, 2002 fee income totaled only $49 billion.

There are very few businesses that have seen revenue nearly double in the past eight years. Wall Street's performance is even more stunning given that most of the players in the investment-banking business experienced the financial equivalent of a near-death experience in 2008.

The reality is that the flood of ultra-cheap money since 2008 has inflated another bubble – not only in the broader global economy, but in the investment banking business as well.

Not only is fee income on a strong upward trend – despite the deep recession in the G7 countries – market practices also are returning to the speculative excesses of the Internet days of 1999 and the investment-banking boom-and-bust era of 2006-08.

While a modest percentage of "deals" add genuine economic value, most of them – whether they are mergers, securitizations or derivatives transaction – are little more than organized looting. The investment banks play with complex deal structures and excessive leverage in order to extract "rents" from the productive part of the economy.

As usual, what is good for Wall Street is bad for the rest of us. While the U.S. stock market remains below its 2007 peak and housing remains depressed, other markets – and especially commodities – are at record levels.

This reality is bound to cause trouble, and in two forms:

  • It will summon the scourge of inflation, first to emerging markets such as Brazil, India and especially China (where it is already accelerating), and then to the world as a whole.
  • And, even more important, its collapse will cause yet another financial meltdown, during which we as taxpayers will be asked to bail out Wall Street yet again – and after which the world will go into another deep job-destroying recession.

This time, we need to say no to the bailout – and if much of Wall Street files for bankruptcy, so be it. We will be very much better off without most of it. And the modest amount of the investment-banking business that genuinely adds value can be taken care of by the surviving medium-sized banks and brokers that have remained conservative.

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  1. J.Patrick Hickey | January 14, 2011

    Thank you, Martin! I believe you have discussed this before, but why is this sort of sociopathological fraud allowed to continue? Is the President attached to the hip of these mobsters? What has happened to "government by the people and for the people"?

    It is heartbreaking to see how far from the finer capabilities of humanity these corporatist megaliths have gone. Run amuck and still running on as though nothing has changed.

    I'd love to see Goldman and Wall Street crash and burn, once and for all! I can't for the life of me figure out why they were rescued the first time.

    I suppose the people don't understand where the profits Goldman and others have been generating to pay back government loals. I don't really comprehend it, but the profits seem to be coming out of thin air.

    This country needs a fresh start without the corporate/government predomination that is usurping the wealth of this once-great nation, and the Western World, as well.

    I still feel rather ignorant about how these things work, but I really do appreciate what my good man, Martin Hutchinson continues to share! Thank you!

  2. King Ralph | January 14, 2011

    I don't see GS getting bailed out if they lose money on their Farcebook or any other investment. This is a stock investment in another company and no one is going to bail them out if FB blows up due to a ctazy valuation.

    LBO's have been around for awhile and some work while others don't. Banks like BAC and C are still working off their bad housing loans and trying to get their houses in order.

    Some commodities are at record levels because of increases in worldwide demand therefore I don't see a bubble being created. The solution is to increase production in those commodities to meet the demand. Another good idea would be to get off the U.S. dollar as a reserve currency and create a basket of currencies with some precious metals thrown in as the reserve. This would decrease volatility in commodity prices.

  3. Roger North | January 14, 2011

    The reason this is being allowed to happen is that the Obama administration is full of avowed socialists and Communists who would like nothing better than to see our economy fall off a cliff so they could rebuild the USA as part of a socialist one world government. The leftist media (e.g., Media Matters, NPR), who are attacking Glenn Beck and anyone who opposes Obama, are being funded by "spooky dude" George Soros himself who admits to wanting a "New World Order" and would like nothing better than to collapse our currency, as "the man who broke the Bank of England" has done so many times before. Soros already has made several trips to the White House to give advice to Obama. Finally, did you ever wonder why Obama would force the stoppage of drilling for oil in the Gulf and yet give Brazil $2B for offshore drilling? It's all part of his socialist, anticolonialist mindset as extensively detailed in Dinesh D'Souza's book, "The Roots of Obama's Rage."

  4. Werner Strohmeier | January 14, 2011

    I can only share J. Patrick's opinion. I would add however, that I consider the present and previous US governmet to be a simple puppet of the financial industry. The American citizen is being screwed all way long. As to the private data that risk falling into Russian hands, I would consider that wont make much of a difference with US governments/CIA hands.
    Thus my advice is, keep your fingers off Facebook alltogether, not to speak of the possible IPO where you would just lose your hard earned money.
    A a non US resident and non US citizen, I am grateful to Martin for his inisghts which at least warns everyone to be careful investing in the US. Corruption is going on worldwide, but one might have a better control of nearby events, rather than thousands of miles away.

  5. Doug Stevens | January 19, 2011

    TERM LIMITS NOW!!!!! Limit the damage these fools do to us!!!!!!!!!!!!

  6. its the inflation stupid | March 1, 2011

    the valuations are based on the nominal value of the dollar…

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