August 17, 2009

Worrying about Goldman

After my post last month regarding Goldman's earnings, I got an email from a friend who sent me the link to this article over at Salon. Reich gets pretty close...

But in another respect, Goldman's resurgence should send shivers down the backs of every hardworking American who has lost a large chunk of retirement savings in this economic debacle, as well as the millions who have lost their jobs. Why? Because Goldman's high-risk business model hasn't changed one bit from what it was before the implosion of Wall Street. Goldman is still wagering its capital and fueling giant bets with lots of borrowed money. While its rivals have pared back risks, Goldman has increased them. And its renewed success at this old game will only encourage other big banks to go back into it.

"Our model really never changed, we've said very consistently that our business model remained the same," Goldman's chief financial officer tells Bloomberg News. Value-at-risk -- a statistical measure of how much the firm's trading operations could lose in a day -- rose to an average of $245 million in the second quarter from $240 million in the first quarter. In the second quarter of 2008, VaR averaged $184 million.

Meanwhile, Goldman is still depending on $28 billion in outstanding debt issued cheaply with the backing of the Federal Deposit Insurance Corp. Which means you and I are still indirectly funding Goldman's high-risk operations.

This actually hits on some of my issues with GS right now. First off, the inordinate dependence on proprietary trading. This isn't making commissions executing trades (small and large) for investors and funds. This is Goldman's traders playing with Goldman's money. And they have to make a lot of money to compensate for higher costs of funding (from all that government-backed debt which we'll get to in a moment) which means they have to make some really large, directional bets. That's OK for an insurance company with a large float of paid in capital (or, in industry parlance, float) from premiums, not good for an investment bank. Which leads me to think the VAR is way understated. I'd love to see the actual numbers used to calculate the VAR.

As for the debt, GS has issued a lot of debt guaranteed by the FDIC since they are now a depository. That's long term capital which means they aren't as dependent on commercial paper (CP) and repo agreements, most of which can dry up quickly. Which is what happened in the wake of the disastrous decision to let Lehman go to BK... it wasn't that Lehman represented systemic risk (it's book was unwound fairly painlessly), it was the shock to the funding market that meant the government may not step in to save anyone. Which made the CP and repo's go away and caused a cash crunch at Goldman as they suddenly could not longer use that money to float their balance sheet. Technically, this isn't a horrible thing but it definitely means their cost of funding has gone up which means, again, they have to take outsized risks.

One other thing that's worried me is the fact that Goldman is now a depository. They have no retail network and no experience in retail banking. Further, considering their business model, would YOU feel comfortable keeping your checking account there?

Finally, GS management seems almost proud of the fact that they are not returning to their fee based roots. In short, they are doubling down and turning their backs on what made them successful. While it's not a prescription for disaster, it sure as hell doesn't leave me with an excessively high comfort level.

Posted by mcblogger at August 17, 2009 11:30 AM

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