Goldman Partners Punk'd on Margin

You think your portfolio is hurting? Yesterday, CNBC revealed that some partners at investment banking superpower Goldman Sachs (NYSE: GS  ) may have you beat by a long shot.

Apparently, there are partners at the Golden One who borrowed against their Goldman Sachs stock holdings through their Goldman Sachs brokerage accounts to put money into alternative investments like hedge funds. This was probably a fantastic plan while everything, including Goldman stock, was flying high, but now that Goldman's stock has lost around 60% of its value, the firm is in the awkward situation of having to make margin calls on its own partners.

Certainly this is a great example of the role that greed has played in the current financial crisis. From top to bottom, we've seen people who have gotten themselves in over their heads trying to get rich quick -- with disastrous results. In the case of the Goldman partners, it appears they'll end up taking out loans for millions or tens of millions of dollars to cover the margin call. I can't imagine that does great things for the ol' bottom line.

The other lesson, though, is that for most people, playing around with margin is about as wise as climbing Yosemite's El Capitan without ropes. As a refresher, the way margin works is that you borrow money against equity holdings to increase your total investment in an effort to bolster your returns. The catch is that the value of the equity has to remain a certain percentage of the total value of the investments, or else you get hit with the dreaded margin call.  A margin call requires that you either sell out of your investments, or add money to your account so that the equity gets back to the required levels.

As with any leveraged investment, a successful margined position can make big money, but on the downside, things can get really bad, really quickly. For example, in the case of Goldman's partners, if they had leveraged their holdings 2-to-1, the drop in Goldman's stock from its peak would have wiped out their entire equity stake and then some.

Goldman's partners aren't alone in taking a margin-induced black eye, either. Late last year, Sumner Redstone, whose holding company owns stakes in Viacom (NYSE: VIA  ) and CBS (NYSE: CBS  ) , ran into a similar situation. Even worse was the debacle from Chesapeake Energy's (NYSE: CHK  ) CEO Aubrey McClendon -- he had to sell pretty much his whole 5% stake in the company to satisfy margin calls.

I think these blunders cast a pretty foreboding light on the companies with which these execs are involved. Members of the Motley Fools CAPS community seem to be more forgiving, though, particularly in the case of Chesapeake. Though some members saw fit to give the stock a thumbs-down for McClendon's mistake, many more saw it as an opportunity to pick up the stock at a depressed price. Today, Chesapeake sports a perfect five-star rating on CAPS.

As for Goldman, the woes of the financial services industry have already inspired CAPS members to keep the stock sitting at a mediocre three-star rating. Though these margin calls are certainly an embarrassment, the firm as a whole still looks like Babe Ruth playing against Little Leaguers, as compared to Bank of America (NYSE: BAC  ) and Citigroup (NYSE: C  ) -- oh, and of course, Lehman Brothers and Bear Stearns, may they rest in peace.

Further Financial Foolishness:

Fool contributor Matt Koppenheffer owns shares of Bank of America, but does not own shares of any of the other companies mentioned. Chesapeake Energy is a Motley Fool Inside Value pick. The Fool's disclosure policy has never once been caught with its pants down. Of course, it doesn't actually wear pants ...


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