Tag Archives: goldman sachs

Goldman Sachs Concedes Existence Of Too Big To Fail

By Simon Johnson

Global megabanks and their friends are pushing back hard against the idea that additional reforms are needed – beyond what is supposed to be implemented as part of the Dodd-Frank 2010 financial legislation.  The latest salvo comes from Goldman Sachs which, in a recent report, “Measuring the TBTF effect on bond pricing,” denied there is any such thing as downside protection provided by the official sector to creditors of “too big to fail” financial conglomerates.

The Goldman document appears hot on the heels of similar arguments in papers by such organizations as Davis Polk (a leading law firm for big banks), the Bipartisan Policy Center (where the writing is done by a committee comprised mostly of people who work closely with big banks), and JP Morgan Chase (a big bank).  This is not any kind of conspiracy but rather parallel messages expressed by people with convergent interests, perhaps with the thought that a steady drumbeat will help sway the consensus back towards the banks’ point of view.  But the Goldman Sachs team actually concedes, point blank, that too big to fail does exist — punching a big hole in the case painstakingly built by its allies.  Continue reading

Could Goldman Sachs Fail?

By Simon Johnson.  This link to MIT Sloan’s website provides a partial transcript and video covering the points made below.

If Goldman Sachs were to hit a hypothetical financial rock, would they be allowed to fail – to go bankrupt as did Lehman – or would they and their creditors be bailed out?

I asked this question on Sunday to four leading experts (Erik Berglof, Claudio Borio, Garry Schinasi, and Andrew Sheng) from various parts of the official sector at the Institute for New Economic Thinking (INET) Conference in Bretton Woods – and to a room full of people who are close to policy thinking both in the United States and in Europe.  In both the public interactions (for which you can review video here) and private conversations later, my interpretation of what was said and not said was unambiguous: Goldman Sachs would be bailed out (again).

This is very bad news – although admittedly not at all surprising.  Continue reading

Goldman Sachs: “We Consider Our Size An Asset That We Try Hard To Preserve”

By Simon Johnson

To great fanfare, this week Goldman Sachs unveiled the report of its Business Standards Committee, which makes recommendations regarding changes for the internal structure of what is currently the 5th largest bank holding company in the United States.  Some of the recommended changes are long overdue – particularly as they address perceived conflicts of interest between Goldman and its clients.  

What is most notable about the report, however, is what it does not say.  There is, in fact, no mention of any issues that are of first order importance regarding how Goldman (and other banks of its size and with its leverage) can have big negative effects on the overall economy.   The entire 67 page report reads like an exercise in misdirection.

Goldman Sachs is ignoring the main point of the debate made by – among others – Mervyn King, governor of the Bank of England, regarding why big banks need to be much more financed by equity (and therefore have much less leverage, meaning lower debt relative to equity).  On p.10 of his Bagehot Lecture in October 2010, for example, King was quite blunt: Continue reading

Why Is The US Taxpayer Subsidizing Facebook – And The Next Bubble?

By Simon Johnson

Goldman Sachs is investing $450 million of its own money in Facebook, at a valuation that implies the social networking company is now worth $50 billion.  Goldman is also apparently launching a fund that will bring its own high net worth clients in as investors for Facebook.

On the face of it, this might just seem like the financial sector doing what it is supposed to – channeling funds into productive enterprise.  The SEC is apparently looking at the way private investors will be involved, but there are some more deeply unsettling factors at work here.

Remember that Goldman Sachs is now a bank holding company – a status it received in September 2008, at the height of the financial crisis, in order to avoid collapse (for the details, see Andrew Ross Sorkin’s blow-by-blow account in Too Big To Fail.)  This means that it has essentially unfettered access to the Federal Reserve’s discount window, i.e., it can borrow against all kinds of assets in its portfolio, effective ensuring it has government-provided liquidity at any time.

Any financial institution with such access to such government support is likely to take on excessive risk – this is the heart of what is commonly referred to as the problem of “moral hazard.”  If you are fully insured against adverse events, you will be less careful. Continue reading

Thoughts On The Macroeconomic Impact of Goldman Sachs

By Peter Boone and Simon Johnson

The influential Goldman Sachs economist Jan Hatzius has a new research note out (with Sven Jari Stehn), “Thoughts on the Macroeconomic Impact of Basel III,” arguing that the move to raise capital standards for banks will put a serious crimp in growth in the United States – knocking 1.5 to 2 percent off gross domestic product in the next few years. Their findings are questionable, but in any case we should broaden the discussion to consider exactly how banks like Goldman Sachs affect our macroeconomic dynamics going forward – particularly if they are able to effectively lobby against higher capital. Growth based on risky banking has a tendency to prove illusory.

There are three issues. First, what is the short-term impact of raising capital requirements? Second, how should capital be increased? And third, and perhaps most important, do we really need global banks like Goldman Sachs to operate in their recent “high risk – highly variable returns” mode?

In their note, which is not in the public domain, Mr. Hatzius and Mr. Stehn are willing to acknowledge that raising capital standards can help make banks safer and that this is good for sustained growth over a sufficiently long period of time (think a decade or more), as the Bank for International Settlements suggests. But they make the case that raising capital – at least in the form that this is likely to take place – can slow growth over the next several years. Continue reading

What Is Goldman Sachs Thinking?

By Simon Johnson

The next financial boom seems likely to be centered on lending to emerging markets.  Sam Finkelstein, head of emerging markets debt at Goldman Sachs Asset Management, summed up the prevailing market view – and no doubt talked up his own positions – with a prominent quote in Monday’s Financial Times (p.13, front of the Companies and Markets section):

“Debt-to-GDP ratios in the developed world are about double those in emerging markets and they’re growing.  This makes emerging markets interesting because you’re pick up incremental spread [higher interest rates compared with developed world rates], and in return you’re actually taking less macroeconomic risk.”

This is a dangerous view for three reasons. Continue reading

Update on ABACUS

Read the “synthetic, synthetic CDO” post first if you haven’t already.

The reasonable counterargument, for example here, is that because these are derivatives, there logically speaking must have been someone on the other side of the trade from the buyers, and the buyers should have known that — who that is doesn’t need to be disclosed. I think this is true to a degree, but not to the degree that Goldman needs it to be true.

Take an ordinary synthetic CDO. Back in 2005-2006, a bank might create one of these because it knows there is demand on the buy side for higher-yielding (than Treasuries) AAA assets. To do this, the CDO has to sell CDS protection on its reference portfolio to someone. That someone could in the first instance be the bank. But then the bank’s “short” position goes into its huge portfolio of CDS, which may overall be long or short the class of securities (say, subprime mortgage-backed securities) involved.The bank is constantly hedging that portfolio via individual transactions with other clients or other dealers, so there’s no one-to-one correspondence between the long side of the new CDO and any specific party or parties on the short side.

Let’s say for the sake of argument that the bank, prior to the new CDO, was exactly neutral on this market. The new CDO makes it a little bit short. So the bank will go out and hedge its position by finding someone else to lay the short position onto. But first of all, there’s a good chance it will divide up the short position and hedge pieces of it with different people. Those people may be buying the short position not because they want the subprime market to collapse; they might be partially hedging their own long positions in that market. Second, there’s an even better chance that it won’t sell off exactly the short position it just picked up from the CDO; it will buy CDS protection on a bunch of RMBS that are similar to the ones it just sold CDS protection on (which ones will depend on what the market is interested in), so in aggregate it comes out more or less the same.

So ultimately the “short” side of the CDO gets dispersed between the bank’s existing CDS portfolio and the broader market. So yes, there must be a short interest out there that is exactly equivalent to the long interest. But there doesn’t have to be a party or even an identifiable set of parties who have exactly the short side of the new CDO and want it to collapse, let alone a party that helped structure the CDO because it wanted to be on the short side. There’s a big difference between the market as a whole and one hedge fund.

Now, are things different with a synthetic synthetic CDO, as I have called it? Maybe. The pro-Goldman argument would be that ABACUS was so highly structured — basically, each tranche was a single complex derivative with a long side and a short side — that the long investors must have realized that there was a single party, or a small number of parties, on the other side. But that doesn’t necessarily hold. Just like a synthetic CDO, Goldman could have whipped this thing together because it thought it could sell it, and Goldman could have planned to hedge it the usual way — partially with its inventory and partially through a lot of small transactions dispersed throughout the market.

As always, I draw on Steve Randy Waldman.