Just one day after the U.S. Federal Reserve orchestrated JPMorgan Chase & Co.’s (JPM) high profile buyout of The Bear Stearns Companies Inc. (BSC), both Goldman Sachs Group Inc. (GS) and Lehman Brothers Holdings Inc. (LEH) beat analysts’ earnings expectations yesterday (Tuesday), restoring some of the investor confidence lost during last weekend’s troubling episode.

Goldman Sachs said first quarter net income fell to $1.51 billion, $3.23 a share, from $3.2 billion, $6.67 a share, a year ago. The 53% drop in profit was the largest in nine years for the world’s biggest securities firm, but still beat analysts’ expectations, which were dampened by the subprime mortgage meltdown and severe erosion of investor confidence.

Profit was weighed down $1 billion in high yield loans, with another $1 billion loss on mortgage loans and related securities and a $135 million drop in the value of Goldman Sachs’ stake in the Industrial & Commercial Bank of China.

One bright spot in Goldman’s earnings release was the 38% increase in revenue from the company’s securities services division, which brought in $722 million.

The collapse of asset-backed securities and a record level of credit defaults have cost banks and brokerage firms an estimated $200 billion in write-downs. But Goldman has managed to shield itself from the brunt of the impact, and faces the least amount of risk at this point.

“People have a tremendous amount of confidence in [Goldman Sachs] and that’s what it comes down to these days,” Ralph Cole of Ferguson Wellman Capital Management, told Bloomberg.

While the collapse of Bear Stearns resulted in a large scale sell-off in the financial sector, many analysts think Bear’s absence will provide Goldman with a greater market share.

After Goldman’s earning release, Wachovia Corp. (WB) raised its rating of the firm’s stock from ‘market perform’ to ‘outperform.’

“Goldman Sachs will benefit from a flight to quality as investors look to trade with parties they deem more creditworthy,” Wachovia analyst Douglas Sipkin said in a note to clients. “We also believe huge opportunities exist in the prime brokerage business.”

Wachovia set its share-price estimate for Goldman at $180 to $185. Shares of Goldman Sachs closed the day 16% higher at $179.59.

‘Lehman Is Not Bear’

Lehman Brothers also demonstrated its resilience by beating analysts’ estimates yesterday. Lehman reported first quarter net income of $489 million, a 57% drop from $1.15 billion a year ago.

Lehman was forced to take a $1.8 billion write-down from mortgage market volatility. However, equities revenue climbed 34% to $330 million, and investment management revenue soared 39% to $968 million.

Lehman has hit a few stumbling blocks during the credit crisis. In the past seven months Chief Executive Officer Richard Fuld announced the close of its mortgage units, resulting in 5,300 job cuts. Given Lehman’s setbacks, nervous investors bolted from the company afraid that as the fourth largest U.S. investment firm, it would be the next investment firm to fold. Shares tumbled 19% to close at $31.75 apiece Monday after sinking as low as $20.25 earlier in the day.

Investors stampeded back into Lehman yesterday after the report’s release, driving the stock up 43% to close at $41.51.

“Lehman is not Bear,” Mike Mayo, an analyst with Deutsche Bank AG (DB), said in a report yesterday. “It has more liquidity. It has support among major counterparties. Its franchise is more diversified.”

News and Related Story Links:

• Financial Times:Lehman and Goldman raise hopes
• Bloomberg:U.S. Stocks Gain on Goldman, Lehman Earnings, Fed Speculation
• Bloomberg:Goldman Share Rating Raised by Wachovia on Bear Stearns Sale
• Money Morning:With Bear Stearns Deal and New Game Plan, Fed Raises New Fears About Credit Crisis

Bullish Goldman Sachs Group Inc. (GS) strategist Abby Joseph Cohen, 56 – famous for being one of the first to predict the 1990s bull market – has been replaced as the bank’s chief forecaster.

Cohen stepped down from her post but remains on Goldman’s investment strategy team, becoming senior investment strategist and president of Goldman’s Global Markets Institute, The Wall Street Journal reported.

Replacing her is David Kostin, 44, a four-year veteran of Goldman’s U.S. Portfolio strategy team. Cohen said she picked him to lead the U.S. portfolio strategy team because of his “astute company analysis” and “macroeconomic understanding,” Bloomberg reported.

He boldly started his new job by predicting that the S&P 500 would fall 10% to 1,160 in the near term and finish the year near 1,380. He also said that investors should expect companies to cut earnings forecasts and report lower profits, Bloomberg reported.

“The consumer is more constrained today than ever before,” Kostin wrote in a research report Monday. Lower earnings industry-wide “will be the catalyst to drive the market lower.”

That’s certainly a major shift from Cohen, who in December predicted the S&P 500 would reach 1,675 in 2008. However, in her WSJ interview, she agreed with Kostin’s forecast.

Cohen’s Background

Cohen’s career began at the Federal Reserve Board, where she served as an economist from 1973 to 1977. From there, she worked as a research director and economist for T. Rowe Price Associates (TROW).

From 1983 until 1988, Cohen served as vice president in charge of investment strategy at Drexel Burnham Lambert Inc.

She joined Goldman as a vice president and co-chair of the Investment Policy Committee in 1990, and was promoted to managing director in 1996.

“One thing I made clear internally was that I wanted to start working on longer-term issues and didn’t want to do the day-to-day market analysis,” Cohen told the Wall Street Journal.

In 2005, she was ranked 19th on Forbes Most Powerful Women list – ahead of Mary McAleese, president of Ireland (No. 21), Ruth Bader Ginsberg, U.S. Supreme Justice, (No. 23) Sen. Hillary Clinton (No. 26) and Indra Nooyi, (No. 28) then-President now Chairperson of the Board/Chief Executive Officer of PepsiCo., Inc. (PEP) – because her bullish reports and frequent television commentaries often moved the market upward.

News and Related Story Links:

• Wall Street Journal: Goldman Replaces Cohen as Forecaster
• Bloomberg: Goldman’s Cohen Replaced as Chief S&P 500 Forecaster
• Wikipedia: Abby Joseph Cohen

India’s finance ministry said it has approved foreign direct investment proposals to allow the U.S.-based Goldman Sachs Group Inc. (GS) and Australia’s Macquarie Group Ltd. to invest $39.344 million (1.56 billion rupees) for as much as 40% in PTC India Financial Services Ltd., a subsidiary of PTC India LTD.

All told, India’s Foreign Investment Promotion Board (FIPB) has cleared 22 foreign direct investment proposals worth $128.9 million (5.11 billion rupees) , the government reported.

The key deal was the FIPB approval of a proposal of power trading firm PTC India to sell the 40% stake in its new financial services arm, PTC India Financial Services. The approval would make it possible for PTC India to sign definitive agreements with private equity firms Goldman Sachs and Macquarie Singapore for PTC Financial Services (PFS), subject to final clearance from finance minister P Chidambaram, official sources said.

PTC India, the country’s biggest electricity trader, would hold a 60% equity stake in PFS. The two foreign partners would hold 20% each. The power trading major has already secured a license from the Reserve Bank of India for PFS, which will function as a non-banking financial company.
 
In a developing market such as India, infrastructure needs are first and foremost among needs to be met. And power may be at the very top of that narrowed list of infrastructure needs. But the state can’t afford to finance them all by itself. It’s often better to bring in private-sector ventures and allow them to play such key roles as capital formation, deal making and risk-management.

These private sector ventures often end up with several members, each of which has unique geographic, market and technical specialties. And since they also each have their own profit incentive, they also represent a profit opportunity for This underscores just why infrastructure investments are such a great opportunity for global investors looking to capitalize on an emerging market.

Power trading is an excellent way to proceed. PTC India aims to provide financial services to power projects and also to pick up equity in power projects through PFS. The new entity would make direct and indirect investments in power units in consensus with partners.

Australian investment bank Macquarie has made its second move into infrastructure in an emerging market this year after buying a stake in an Indian power sector investment company with Goldman Sachs.

The acquisition comes seven months after Financial News reported that Macquarie had formed a joint venture to invest in Russian infrastructure with Moscow-based investment bank Renaissance Capital. The joint venture was created to invest in transport, utility and port projects across Russia and the Commonwealth of Independent States.

The investment in PTC India Financial Services means Goldman Sachs and Macquarie have followed JPMorgan Chase & Co. (JPM) and other financial institutions into India’s infrastructure sector. JPMorgan just last month said it was setting up a fund to invest in infrastructure projects in the country. UK-listed private equity company 3i Group PLC and U.S. investment banks The Blackstone Group LP (BX) and Citigroup Inc. (C) have also this year revealed plans to invest in Indian infrastructure, with 3i planning to raise a dedicated $5 billion fund.

News and Related Story Links:

• CNNMoney.com:
  Indian Govt Allows Goldman Sachs, Macquarie to Invest 1.56 Billion Rupees in PTC.

• The Economic Times:
  PE Firms’ Investment in PTC Arm Okayed.

• Financial News Online (U.S.):
  Macquarie Buys into Indian Infrastructure.

Subprime defaults and the ongoing mortgage crisis could have a "dramatic" impact on the overall economy, as banks and other financial institutions cut back their lending by as much as $2 trillion, according to an economist with Goldman Sachs Group Inc. (GS).

In a Nov. 15 report, Goldman Chief Economist Jan Hatzius said losses related to U.S. home foreclosures could reach $400 billion, as leveraged institutions will struggle to preserve their capital ratios. In that sense, the loss would not be an outright decline, but relative to the normal growth of lending.

"If leveraged investors see $200 billion of the $400 billion aggregate credit loss, they might need to scale back their lending by $2 trillion," Hatzius wrote. 

If this occurred within a one-year period, this could cause such a financial shock that it would result in a "substantial recession," Hatzius said. But if those losses were stretched out over a longer period, however, it would translate in a protracted period of sluggish growth.

Goldman’s forecast already assumes lending will fall by $1 trillion – half the potential decline – over the next two years.

"It’s basically another downside risk to the macro-economy at a time when the macro-economy already isn’t doing that well," Hatzius said in an interview with CNBC TV. 

Hatzius also said in the interview that this is yet "another reason for why the Fed will need to ease monetary policy," presumably when the policymaking Federal Open Market Committee (FOMC) meets again in December. The chance of the FOMC slashing rates by another quarter point at that Dec. 11 meeting stands at 86% according to futures prices on the Chicago Board of Trade, Bloomberg News reported.

But during a speech in New York Friday, Federal Reserve Governor Randall Kroszner talked down the chances of a rate cut.

"The downside risks to economic growth now appear to be roughly balanced by the upside risks to inflation," Kroszner said.

Kroszner said policymakers probably wouldn’t need to reduce interest rates further to help the economy weather a "rough patch" in the coming year.

Goldman Sachs was the only major financial institution to post a third-quarter profit, having limited its exposure to the subprime market and mortgage-backed assets before that market collapsed.

News and Related Story Links:

• Money Morning News:
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• Money Morning News:
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• Money Morning News Analysis:
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• Money Morning Investment Report:
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• CNBC:
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• Bloomberg News:
  Fed’s Kroszner Says ‘Rough Patch’ Won’t Warrant Cuts.

Goldman Sachs Group Inc. (GS) says it expects the Indian rupee to appreciate to 38 Rupees versus the U.S. dollar over the next 12 months, a currency move fueled by both strong economic fundamentals and an increasing inflow of foreign capital.

The Rupee was trading at 39.15 to the dollar yesterday (Thursday).

But Karim Rahemtulla, an expert on India who is the founder and investment director of the Xcelerated Profits Reports, as well as the editor of the Smart Profits Report newsletter, is projecting an even bigger move in the Rupee against the dollar. Rahemtulla just returned from an investing-research trip to India.

"It’s going to go higher – probably to 35 – unless the Indian government clamps down on foreign investment," Rahemtulla told Money Morning. "They would have to curb capital inflows, or lower interest rates. Faced with that choice, they will choose the curbs first. But if they do that [and restrict foreign direct investment], the Indian stock market could fall 40% overnight."

It’s almost a Hobson’s choice for India’s leadership, Rahemtulla says, since a strong move in the Rupee will have a similar effect. While most investors might assume a strong Rupee would be good for the India economy – since it could attract still more investment capital – a strong Rupee negates some of that investment because so many of the country’s leading companies do business with U.S.-based customers.

That forces India-based firms, and especially its high-tech players, into an ongoing search for ways to offset the losses from the currency swing. By ferreting out productivity gains, and employing currency hedges, companies can do that – but only for awhile, as neither of those are finite solutions. If the Rupee stays strong, the companies will eventually be forced to raise prices, hurting their competitiveness in the global-markets arena.
Right now, the impact of a U.S. Dollar/Rupee ratio of 38 or higher should not have a huge impact. But should the Rupee rise another 10% or so (into the mid 30s), there will be "pain all around," Rahemtulla said.

Goldman Sachs is forecasting real gross domestic product (GDP) growth of more than 8% annually over the next decade, thanks to favorable demographics, rising savings and investment, greater productivity growth and rapid urbanization. [For a recent investment travelogue that Rahemtulla penned on the Indian market - which includes several investment recommendations - please click here].

Goldman also conservatively predicts that India is on track to become the size of the U.S. economy by 2050, though noting that in per-capita terms, it will lag behind the U.S. market, instead appearing more like Korea is today

"The gains in the macro environment have reduced India’s vulnerability to shocks and the more difficult part of macro stability has now been achieved," Goldman Sachs reported.

News and Related Story Links:

• Money Morning Market Analysis:
  Snapshot From India: Advice on Stocks, the Rupee, High Tech and Real Estate.

• CNNMoney.com:
  Goldman Sachs Sees Indian Rupee Rising to 38 Rupees/USD Over Next 12 Months.

• Money Morning Investment Analysis:
  Why India Is Losing the Race with China – and What It Can Do to Gain Ground.

• Money Morning Economic Analysis:
  China Gets the Buzz, but India Gets the Cash, and Leads in Private Equity Infrastructure Investment.

The $8.4 billion write-down announced by Merrill Lynch & Co. Inc. (MER) last week was just the latest in a series of similar revelations by Bank of America Corp. (BAC), Citigroup Inc. (C), The Bear Stearns Cos. (BSC) and Lehman Brothers Holdings Inc. (LEH). And it underscores the key challenge investors continue to face: You don’t know what a company’s assets are really worth, so a company’s portfolio can explode into a mushroom cloud of red ink at any given time.

Even worse, the problem is not limited to the banks and brokerages that have already suffered explosive write-downs. It could well include the top-drawer institution, Goldman Sachs Group Inc. (GS), which hasn’t yet reported a big write-down. Later on, I’ll tell you why.

Until Wall Street cleans up its act in the risk-management area, there’s really only one smart thing to do: Stay as far away from the sector as possible – perhaps even seeking shelter in the Wall-Street-proof emerging markets.

Accounting for Future Assets

When the first round of write-offs came out, investors figured that one bad quarter would put the subprime mortgage problem in the rearview mirror, and allow Wall Street to get back down to business – making its routinely obscene profits and pulling down its even-more-stunning year-end bonuses. After all, modern financial reporting techniques forced banks to write their securities portfolios to market price, so if the market dropped the loss amounts should be clear. Furthermore, the new lower market price should reflect all the additional risks that had been uncovered, so there should be no reason to expect additional bad news.

Case closed. Right?

Not necessarily.

For small players, this is correct. Japan’s Nomura Securities Inc. (NMR) exited the U.S. mortgage business altogether, reducing its exposure from $2.4 billion (266 billion yen) in June to $120 million (14 billion yen) in mid-October, of which only $1 million is still related to subprime mortgages.

By writing off $610 million (73 billion yen), and recording a third-quarter loss, Nomura put its U.S. mortgage woes behind it, and can now focus on its very attractive core business of being the largest investment bank in the world’s second-largest market – the rapidly expanding economy of Japan.

For larger players, the solution isn’t quite so clear. For one thing, they can’t maneuver as quickly as Nomura because the Big Boys still have large holdings of financial rubbish on their balance sheets. That’s not easy to purge.

Starting Nov. 15, we will have a new arrow in our quiver to help us divine just how financial toxic waste a company is holding. The new accounting rule, Financial Accounting Statement 159 (SFAS 159), requires banks to divide their tradable assets into three "levels," according to how easy it is to get a market price for them.  Level 1 assets have quoted prices in active markets. At the other extreme are Level 3 assets, which have only unobservable inputs to measure value, meaning they must be valued by the bank’s own proprietary models.  

The problem with Level 3 asset pricing is quite obvious. Who writes the models that are used to value the assets: Bank employees, of course, the same bozos that get paid huge profits if the bank’s quarterly profits rise.  In the old days, assets were recorded on the books at historical cost, and their value was only changed if something bad happened, in which case the values were either written down or written off.

In today’s fine world, the values can actually be written up if their "market value" increases, even though that market value is determined only from a model that bonus-receiving employees have designed. In a bull market, of course, when assets generally go up in value, and there’s lots of money sloshing around, optimism naturally takes over and reported book values soar. In a down market, however, a bank with lots of Level 3 assets will give its shareholders a series of nasty surprises, or – in extreme cases – go bust.

Goldman’s Conundrum

I hate to depress you further about our finest financial brains, but this isn’t a small problem. Wall Street doesn’t have to report these numbers until its fiscal years starting after Nov. 15; so few banks have yet disclosed the amount of Level 3 assets in their balance sheet.

I would think they would be forced to do so in their first quarter results, typically the period that ends either Feb. 28 or March 31. However, Goldman Sachs, in the midst of preening itself about its remarkable write-off-free third quarter, disclosed its Level 3 assets: $72 billion. True that’s only 8% of Goldman’s assets. But it is twice the investment bank’s total capital of $36 billion.

Do you see where I’m headed with this? Not all Goldman Sachs’ Level 3 assets are subprime mortgages, of course. But not all Nomura’s mortgage assets were subprime mortgages, either. In fact, it was only 27%. Yet Nomura, to exit the business, wrote off 28% of mortgage assets, more than its entire subprime exposure. If Goldman Sachs is forced into pessimism, it too may have to write off 28% of the value of Level 3 assets, or even more. That would give Goldman a write-off of slightly more than $20 billion – or more than half its capital. Of course the Fed and all the other big banks would rally ‘round – to avoid a banking-system collapse – meaning Goldman would probably survive. But you wouldn’t want to be a shareholder.

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As other banking firms disclose their Level 3 assets, compare the total to the bank’s asset figures. Banks with Level 3 assets that are 50% of capital and lower are probably sound. Any higher and it’s probably time to sell. [At Goldman, Level 3 assets are 200% of capital].

Let Wall Street have its fantasies of wealth and sudden unexplained collapses, and put your money in markets and in businesses that don’t have the right to "invent" values for their asset portfolios. That’s true of the emerging markets, for instance, and especially those developing economies that are growing rapidly and that are highly liquid such as Korea and Taiwan, just to name a few. And in terms of developed markets that share the same fine financial characteristics, consider Nomura’s home market of Japan.

Profit Plays to Make

Indeed, if you want to be invested in financial services – and you should be – give Nomura a close look. Look also at Korea’s largest financial institution, Kookmin Bank (KB), which trades on the New York Stock Exchange as an American Depository Receipt (ADR). If you aren’t so keen on financial services, but want to benefit from economic growth that’s relatively untouched by Wall Street’s machinations, consider an exchange-traded fund (ETF), or a similar index fund for an economy that specializes more in high-tech than finance, such as the iShares MSCI Taiwan index (EWT).

The Taiwan economy includes such emerging high-tech stalwarts as Acer Inc., which just passed the Lenovo Group Ltd. (LNVGY) to become the world’s No. 3 personal computer vendor. It is also home to Hon Hai Precision Industry Co. Ltd., the world’s No. 1 contract-manufacturer of consumer-electronics products, and the company that makes the Apple Inc. iPhone (AAPL), motherboards for Intel Corp. (INTC), and all three of the rivalling computer gaming systems now duking it out in the world markets. Business Week has labelled Hon Hai as an "earnings machine." But because of restrictive Securities and Exchange Commission rules, the only way U.S. investors can buy into Hon Hai is through such vehicles as this ETF.

Not a bad move. You access greater growth than in the slumping U.S. market, earning profits from faster-growing companies. You’ll sleep better. And your early morning breakfast or daily stop at Starbucks won’t be ruined after you read of some new, and wholly unexpected write-offs in banks in which you’re a shareholder.

News and Related Story Links:

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• The Wall Street Journal:
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• Bloomberg News:
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• Google Finance Profile:
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• FREE Money Morning Investment Research Report:
  (With New Money Morning News Service Signup).

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Global investment banking firm, Goldman Sachs Group Inc. (GS), will purchase a $172-million majority stake in Sigma Electric, a low-cost maker of metal parts with manufacturing facilities in India.

The Goldman Sachs’ investment will accelerate Sigma’s plans for global growth as an Indian manufacturer of metal castings and components, a joint news release said.

Sigma founder and chairman, Sajjan Agarwal, will remain a significant shareholder and will focus on corporate strategy and key customer relationships, the Economic Times reports.

"We are pleased to be working with Goldman Sachs as we enter a new growth phase for our company," Agarwal said.

Sigma fabricates more than 1,500 products and partners with customers from design to delivery of its orders. Based in North Carolina, Sigma serves the electrical, utility, durable goods and transportation markets in North America, Europe and Asia.

Sigma also has manufacturing facilities in Indian cities Pune and Jaipur.

If the news and price tag sounds familiar, it’s because Sigma pondered a buyout from private equity firm Newbridge for $150 million last November. 

News and Related Story Links:

• Economic Times, India:
  Goldman Sachs to invest $172 million in Sigma Electric.

• Economic Times, India:
  Newbridge may acquire Sigma Electric for $150 million.

• Money Morning News:
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Shares of Bear Stearns Cos. Inc. (BSC) soared $2.36 each, or 1.96%, closing at $123.05 yesterday (Tuesday), after China banking giant Citic, a division of China Citic Group announced it was interested in acquiring a stake in the embattled U.S. investment bank.

Jiang Dingzhi, vice chairman of the China Banking Regulatory Commission, announced Citic’s intentions yesterday at the 17th Communist Party Congress in Beijing. China Citic will have to get in line if it wants a piece of Bear Stearns, however, as many companies and financial institutions flocked to the downtrodden giant perceived as a value buy.

Bear Stearns has reportedly been engaged in talks with Wachovia Corp. (WB), Bank of America Corp. (BAC), China Construction Bank Corp., and Warren Buffet via Berkshire Hathaway Inc. (BRK.A, BRK.B). So far only billionaire Joseph Lewis has been the only suitor to strike a deal when he offered $860.4 million for a 7% stake in Bear Stearns in September.

Bear Stearns survived the 1929 stock market crash as well as the Great Depression, but of the five largest U.S. securities firms it has been the worst performer this year.  Right now, Bear Stearns stock trades at 1.38 times its book value.  By comparison Goldman Sachs Group Inc. (GS) trades at 2.71 times its value and Morgan Stanley (MS) at 2.06.

According to Bloomberg, Bear Stearns President Alan Schwartz said October 4, that the company will "weather the storm," and denied looking for funds from an outside investor. On the same day Bear Stearns Chief Executive Officer James Cayne was quoted by Bloomberg as saying the group would consider a potential partner only if the deal "brings along geographic, strategic value."

Government restructuring and initial public offerings have left many Chinese companies with a large amount of cash on hand. Last year, Bear Stearns held talks with China Construction Bank but negotiations stalled. Now China Citic is stepping up to the plate after raising 5.4 billion in its IPO earlier this year. The Chinese government has been encouraging its banks to invest in foreign institutions, as a means of developing its own investment banking firms.

Combined with the recent purchase of 9.9% of San Francisco based UCBH Holdings Inc. (UCBH), the proposal has U.S. officials watching the Chinese investment carefully to make sure they are motivated strictly buy financial – and not political – interests. Chinese officials insist that because they are commercially motivated and conservative, Chinese investments in U.S. companies should be seen as a stabilizing influence.

News and Related Story Links:

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• Money Morning News:
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Goldman Sachs Group Inc. (GS) has its sights set on Japan.

Goldman and New York-based Aetos Capital LLC have joined forces and are looking to buy Japanese property company Simplex Investment Advisors for the equivalent of about $1.1 billion to $1.35 billion – a premium of about 65%. The bid is for at least 80% of Simplex, and it appears that Nikko Cordial, part of Citigroup Inc. (C) in Japan, is selling its 42.5% stake to the venture.

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Goldman Sachs has raised over $4 billion this year for property acquisitions. Japan experienced a property bubble of its own back in the late 1980s, and it’s only been in the past few years that the outlook for that market has improved. Goldman has been acquiring commercial and recreational properties in Japan for more than a decade, but this would mark a much-bigger move into the property market.

News and Related Story Links:

• Blogging Stocks: Goldman Sachs wants in on Japan’s Simplex Investment Advisors.