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Goldman is Ratcheting Up VIE Risk!!! More So Than the Top of the Bubble! Many Thought the Enronesque Days of “Hide the Sausage” Accounting Games Were Over
- Asset-Backed Securities
- Ben Bernanke
- default
- ETC
- Eurozone
- goldman sachs
- Goldman Sachs
- Irrational Exuberance
- KKR
- Market Conditions
- Matt Taibbi
- Monkey Business
- Morgan Stanley
- Prop Trading
- Real estate
- Reality
- Recession
- Reggie Middleton
- Risk Management
- Simon Johnson
- Sovereign Debt
- Stress Test
- Volatility
Note: Go through your sell side
analyst’s quarterly update and if you don’t find these tidbits of
information thoroughly explained, but instead see a Goldman fan boy(girl) cheering section, come back and subscribe to BoomBustblog. At the very least, we tell it like it is!
My opinion and updated valuation for Goldman and its 3rd quarter
performance is available for download to all paying subscribers: 
GS 3rd Quarter 2010 Update.
I will also be releasing large portions of our proprietary modeling to professional subscribers in the very near future to enable further analysis of Goldman and their fellow big banks. While I can’t spill the beans on the entire contents of the
subscription document, there are a few issues and observations
(as usual) that I would like to make public.
To begin with, I must commend Goldman’s management. They do a helluva
job massaging numbers and attempting to right their ship, particularly
in relation to some other banks. Anecdotally, I’m aware of their losing
some talent on the equities side but I am sure they have no problem
replacing it. There is also the issue of their subprime servicing unit,
Litton Loans, which I am sure will bring them nothing but heartache in
the near to medium term, but at least that aspect of the business has
been recognized by the sell side, if not under appreciated in terms of
potential risk. Despite its small size in relation to Goldman’s
aggregate operations, it carries with it material reputation risk as
well as the prospects for significant litigation and more.
Now, on to the aspects which the sell side decided not to cover – or
somehow overlooked. Goldman was applauded for having strong accounting
earnings. In Four Facts That BANG JP Morgan That You Just Won’t Hear From The Sell Side!!!,
I warned of the danger at looking at accounting earnings as if they
were actually a legitimate barometer of a companies actual economic
value. If that were the case, wouldn’t accountants be the best investors
in the world? I will delve into the folly of relying strictly on
accounting earnings later on this missive as well, particularly in
regards to a company with management as crafty and capable as Goldman –
but before I do let’s realize that even those accounting earnings were
down significantly from previous periods…
Trading revenues under pressure
Goldman Sachs posted Q3 net revenues of $8.9bn, a y-o-y decline of
28%. This is despite strong growth recorded at its investment banking
and the asset management division which grew at 24.5% and 7.0%,
respectively. The decline was principally led by dismal performance of
the trading and principal transaction segment which declined 36% y-o-y
as a result of weak market conditions. The decline in overall revenues
despite strong growth recorded elsewhere underscores the importance of
trading revenues in Goldman Sachs overall performance. Historically,
trading and principal transaction segment contributed c60-65% of total
revenues underpinning inherent risk in Goldman’s business model which is
nothing short of a corporate hedge fund. We have expended considerable
ink in demonstrating the overvaluation of Goldman Sachs and the
volatility inherent in its revenues, particularly as they have been so
dependent on trading – as many hedge funds are. As a matter of fact, I
have been issuing this GS warning since 2009 when Goldman had perfect
trading quarter and record trading profits. Reference last quarter’s
quarterly update: The BoomBustBlog Review of Goldman Sach’s 2nd Quarter, 2010 Performance: I Told You So!
About three months ago, Boombustblog forewarned that GS will
stand out to be the worst hit in the event of trend reversal in the
financial markets and the company will have little means to escape the
implications of the same on its profitability and solvency. The company
generates 60-70% of the revenues from trading activities which is
largely dictated by the unpredictable turn of financial events. While
the financial markets were celebrating the US officially coming out of
recession in the 1Q10, the subsequent Eurozone crisis (see the Pan-European Sovereign Debt Crisis
series) and the slowdown of expectations in 2Q10 has beaten down the
irrational exuberance and the markets experienced spurt in volatility
and drop in prices. The consequent softening of trading revenues in 2Q10
vis-à-vis 1Q10 drove 31% drop in revenues and 82% drop in net income.
The chart below demonstrates how the
volatility of the revenues from the trading and principal investments
trickles down into volatility of the total revenues and profits of
Goldman Sachs. I don’t call Goldman the world’s most expensive federally insured hedge fund for nothing!
Given the regulatory pressures pertaining to banks’ prop trading as a
result of Dodd-Frank regulation and the Volker rule, Goldman Sachs is
shrinking its propriety trading business. Recently, Goldman Sachs closed
its proprietary trading desk in New York with Kohlberg Kravis Roberts
(KKR) hiring nine traders from Goldman Sachs. With the egression of prop
trading, GS would definitely lose some of its charm (premium multiples)
and more fundamentally speaking the impact of bottom-line would be
material considering the dependence of prop trading on the bank’s
aggregate results. According to Bloomberg, it is estimated that nearly 10% of total revenues are derived from proprietary trading.
Goldman, unlike the rest of the street and practically the
rest of the I banking world, is ratcheting up off balance sheet risk!!!
Why is BoomBustBlog the only one inquiring as to WHY??? We have a few
reasons in mind… And to think, many thought the Enronesque days of off
balance sheet “hide the sausage” games have come to an end…
Although,
Goldman Sachs capital ratios have improved it has nothing to do with
reduction in risks weighted assets. Risk weighted assets to the
corollary have increased to $444bn as at end Sep 2010 from $409bn and
$380bn as at end Sep 2009 and end Sep 2008. One of the key reasons for
the increase in capital ratios have been dilutions. To give a
perspective, Goldman Sachs diluted shares outstanding have increased by
c25% since beginning of 2008.
Click to expand…
VIE loss exposure still increased compared to pre-crisis levels
Maximum loss exposure from unconsolidated VIE has increased compared
to pre-crisis levels. Although loss exposure as proportion of VIE assets
have declined due to dramatic increase in assets,
absolute loss exposure has actually increased. In addition, we are also
concerned about dramatic increase in GS’ VIE assets during a time when
companies globally are talking about de-leveraging. Goldman Sach’s VIE
assets have increased to $110 billion as of June 30, 2010 from $67bn as
of December 31, 2009 while maximum loss exposure from unconsolidated VIE
have increased to $18.5bn as of June 30, 2010 from $18.1bn as of
December 31, 2009. Maximum loss exposure from unconsolidated VIE as
proportion of tangible equity was 30% as of June 30, 2010, a marginal
decline over Dec 2009 due to an increase in shareholders’ equity.
Is Goldman Ratcheting Up Its Risk Profile In and Attempt To Recoup
the Nearly Guaranteed Loss of Bonus Earning Power of FICC and the Prop
Desk??? If So, the Equity Owners Will Be the Bag Holders (Again) If the
Shit Hits the Fan (Again)…
As excerpted from Four Facts That BANG JP Morgan That You Just Won’t Hear From The Sell Side!!!“
…accountants have not been – and
currently are not, trained in the economic realities of corporate
valuation. They are trained to tabulate business operations data. There
is a marked and distinct difference. That difference is as stark as
night and day for investors, yet despite this stark difference, Wall
Street still reports corporate performance metrics strictly in
accounting terms, and the media (both mainstream and the more
specialized financial media) simply follow suit. Hence we
hear much about easily manipulable and manageable accounting earnings,
revenues, operating margins, earnings per share, etc. These measures
are highly flawed in a variety of ways, with the primary flaw being
that they do not account for the efforts both required and undertaken
to achieve them. Basically, they measure JUST HALF (and coincidentally,
the positive half may I add) of the risk/reward equation that should
be at the root of every investors move. Long story short, they do not
account for, nor do they EVEN RESPECT, the cost of capital. This
concept ties in closely with Chairman Bernanke’s current course of
action as well as the ZIRP discussion later on this missive demonstrates
(capital offered at zero cost causes reckless abandonment of risk
management principles which eventually causes crashes – yes, more
crashes). Acknowledgment of the cost of capital enforces a certain
discipline on both corporate management and investors/traders. Without
respect for such, it is much too easy to create and portray a scenario
that is all too rosy, since we are only looking at rewards but never
bother to glance at the risks taken to achieve said rewards. I reviewed
this concept in detail as it relates to bonuses and compensation on
Wall Street in The Solution to the Goldman (and by Extension, the Securities Industry) Compensation Dilemma.
Net revenues, net profits, and
earnings per share are totally oblivious to what took to generate them.
As a result, anyone who adheres solely to these metrics is probably
oblivious as well to what it takes to generate these measures. It’s
really simple, put more money into the machine to get more money out –
damn the risks taken, or the cost of the monies used. This has been the
bane of Wall Street for well over a decade, is the direct and sole
reason for this current crisis, and is the reason why bonuses based
upon revenue generation alone engender systemic risk. Just sell more,
do more, to get a bigger bonus. It doesn’t matter what you sell or who
you sell it to, as long as it blows up AFTER the bonus is paid. This
short term-ism is now so deeply ingrained within the investor psyche as
to allow companies’ to rampantly destroy economic shareholder value
with the abject blessing of the shareholders, with cheer leading by the
analysts – as long as those accounting earnings per share keep rolling
in higher and higher!
Ignoring the cost of capital inflates
returns by default, because those returns were never costed in the
first place. The problem is, ignoring something does not make it go
away. Capital does have a cost whether you acknowledge it or not, and
if you ignore that cost you may skate for awhile but eventually it will
come back to reassert itself, and often with a vengeance towards the
wayward investor.
This material tilting of the risk/reward equation would be obvious to
most and many, if they would look at the true economic numbers and stop
following accounting numbers!
In What Do Goldman Sachs and B.B. King Have in Common? The Thrill is Gone…,, I made the following note:
GS’s considerable leverage provides a
means (the lever) of high returns to shareholders when asset prices
are appreciating but the same becomes a very material economic concern
when the asset prices lose value. With low trading revenues, GS has
little cushion to absorb write-downs on these assets, leading to
erosion of equity. As of March, 2010, the GS’s investments portfolio
amounted to $339 billion (nearly 566% of the tangible equity).
Referencing my previous posts, “Can
You Believe There Are Still Analysts Arguing How Undervalued Goldman
Sachs Is? Those July 150 Puts Say Otherwise, Let’s Take a Look” and “When the Patina Fades… The Rise and Fall of Goldman Sachs???“,
we can reminisce over the fact that Goldman BARELY earns its cost of
capital on an economic basis, and that’s before considering the
potential horrors which may (and probably do) lay on the balance sheet
(for more on BS horror, reference Reggie Middleton vs Goldman Sachs, Round 2) .
Click here to subscribe to our premium research and opinion.
Recommended recent reading from Reggie Middleton’s BoomBustBlog in the investment banking space…
- Did Reggie Middleton, a Blogger at BoomBustBlog, Best Wall Streets Best of the Best?
- A Step by Step Guide to Exactly How Much Derivatives Risk Each of the 5 Big Banks Actually Have, and How It Could All Go Boom!
- JP
Morgan’s 3rd Quarter Earnigns Analysis and a Chronological Reminder of
Just How Wrong Brand Name Banks, Analysts, CEOs & Pundits Can Be
When They Say XYZ Bank Can Never Go Out of Business!!! - Four Facts That BANG JP Morgan That You Just Won’t Hear From The Sell Side!!!
- We’ve Been Bamboozled by the Banking Industry, but the Chickens Are Coming Home to Roost
- The
Robo-Signing Mess Is Just the Tip of the Iceberg, Mortgage Putbacks
Will Be the Harbinger of the Collapse of Big Banks that Will Dwarf 2008! - Are We In a “Banking” Depression?
- As Earnings Season is Here, I Reiterate My Warning That Big Banks Will Pay for Optimism Driven Reduction of Reserves
- The
Truth Goes Viral, Part 2: Italian Towns Damaged by Derivatives,
Downtown Brooklyn Real Estate, Goldman Sachs, JP Morgan, Europe’s
Overbanked Status, Reggie Middleton, Matt Taibbi, and Simon Johnson –
All in One Video - Re: Morgan Stanley’s Q2 2010 Results – The Mainstream Media May Be Hazadous to Your Wealth!
More on Goldman Sachs
- The BoomBustBlog Review of Goldman Sach’s 2nd Quarter, 2010 Performance: I Told You So!
- On Goldman’s Latest Earnings Results…
- What Do Goldman Sachs and B.B. King Have in Common? The Thrill is Gone…
- A Realistic View of Goldman Sachs and Their Latest Quarterly Results
- The Brown Stinky Stuff is Splattering Off the Fan Blades and Landing on That Shiny New Building on the West Side Highway.
- No One Can Say I Didn’t Warn Them About Goldman Sachs, Several Times…
- Subscribers can find our most recent Full Forensic report on Goldman Sachs here - GS 4Q09 Final Review and Updated Valuation, current as of January 2010, the month I started reiterating my warnings about this company’s drastic overvaluation.
- Reggie Middleton vs Goldman Sachs, Round 2
- Reggie Middleton Personally Congratulates Goldman, but Questions How Much More Can Be Pulled Off
- Get Your Federally Insured Hedge Fund Here, Twice the Price Sale Going on Now!
- Reggie Middleton on Goldman Sachs’ fourth quarter, 2008 results
- Goldman and Morgan losses in the news, about 11 months late
- Blog vs. Broker, whom do you trust!
- Monkey business on Goldman Superheroes
- Reggie Middleton asks, “Do you guys know who you’re messin’ with?”
- Reggie Middleton on Risk, Reward and Reputations on the Street: the Goldman Sachs Forensic Analysis
- Reggie Middleton on Goldman Sachs Q3 2008
- § As Reality hits, the Masters of the Universe are starting to look like regular bank employees
- Reggie Middleton’s Goldman Sach’s Stress Test: Breaking Ranks with the Crowd Once Again!
- Who is the Newest Riskiest Bank on the Street?
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Reggie,
You are absolutely right to point out the inherent volatility in Goldman Sachs' trading revenues.
But I'd pull this post.
Your lack of forensic accounting skill and training is showing...
First, GS and every other investment bank out there is in the business of making money acting in markets and between market participants. If those market participants decide to trade like crazy (like they did in 2009), investment banks will print money hand over fist. If both volumes and volatility drop significantly (like in 2010), investment banks will make less money. This is life.
Second, "trading profits" is everything that an investment bank makes other than fees (investment banking fees, underwriting fees, sales/distribution fees, and commissions. When you buy a bond, GS will try to take a small (or large) spread from you. They will see a price in one place, and sell you the bond at a higher price. This is like a store doing the same thing. In a bank it is called "trading profits." When a store does it, it is called "doing business" or "making sales." If customers at the store suddenly stop buying things, the store will make less money. Welcome to the New Economy.
If you buy or sell an OTC derivative, any and all spread is trading profits (losses). If there is not a single proprietary trade of any kind at GS other than the principal trades to cover the risk of customer service trades (you cannot go to the store to get on the waiting list for a brand new widget and expect to get it when it comes in unless the store sources it), there will still be large trading profits because bond and OTC trades are, by definition, trading operations. Bond and derivative trading is a high volume business. High volumes of notional multiplied by spread earned per trade less financial cost to carry positions (interest or commissions paid out) is "trading revenue." Volumes x spread is a much larger number in FICC than commissions x traded notional is in equities. This is just a fact of life.
As to your 'analysis' of Goldman Sachs increasing its 'off-balance sheet risks'
From your section on 'Four Facts that BANG JP Morgan...'
Actually, accountants are trained in corporate valuation, just not the kind which most investors know how to deal with. They are not trained to tabulate business data. Spreadsheets do that. Accountants tell the owners of the spreadsheet how they have to treat the various bits according to the rules. Wall Street reports corporate performance metrics in accounting terms because that's what people ask them to do, specifically their regulators, auditors, investors, and the accounting rules. Wall Street also reports its VaR per asset/trading category, and the amount of 'diversification benefit' is available because of offsetting correlation and dispersion.
If you are hearing about easily 'manipulable and manageable accounting earnings', or 'operating margins' in any presentation about Goldman Sachs' earnings, you are missing the important stuff. Revenues and earnings per share are important, because for a broker, revenues is equal to net revenues (i.e. if they buy $1bn of stock and sell it for $1.01bn, they don't say "we had $1.01bn of revenues", they say "we had $10 million of revenues"), and earnings per share are important because it EPS less dividend payments is the same thing as "added capital"
Your diatribe has nothing to do with GS or banks. It has to do with what listed companies are required to report by exchanges, auditors, and accounting rules. Companies are not required to do your leg work for them.
"Cost of capital" is determined by INVESTORS, not investment targets. Anyone who looks at a bank or brokerage stock and who does not understand that bank or broker's cost of capital from their standpoint is just a punter. Banks and investment banks are REQUIRED to present the 'easily manipulable and manageable accounting earnings'. The financial statements are clear about showing literal costs of capital (interest costs and dividend payments). Banks (or any other company for that matter) are not required to tell investors what investors should think about the riskiness of choosing that investment over another (which is embedded in a standard investor viewpoint 'cost of capital.'
As to 'respecting that cost of capital', that's what an investment bank's trading operation actually does all day long every day. They try to generate as much revenue as possible and take as little risk as possible. Taking good risk which turns bad is unfortunate. Taking stupid risks gets you fired.
Come on Reggie...
I think your lack of mark to reality skills is starting to show. Both volumes and volatility spiked in 2008, and Goldman lost money trading hand over fist as well - more than it ever did - This is just a fact of life.! Your assertions does not stand universal. The banks tend to only print money trading hand over fist when the markets spike upward. Of course, and as usual, if I am wrong I'll admit it, simply show me.
The $1.1 trilion was a typo. It was meant to read $110 billion, which was hopefully easily gleaned from the context of the sentence. It was a type nonetheless, so I will correct it. The rest of the statement supports my point. They ballooned.
Some VIEs (effectively controlled) are to be consolidated on balance sheet via FASB. I will check to see if all VIEs were included in this calc or just the ones that were required to be brought on balance sheet. If you read the "diatribe" it does say "unconsolidated" doesn't it? But there is always margin for error.
As for bring the sausage out into the open and parade it around, I query exactly where is the sausage and what is in it? There is sparse indication, on a granular basis, of what the actual contents of the VIEs are - consolidated or unconsolidated. If I am wrong here I'll admit it. Simply post the content here on a granular basis. Otherwise, its hide the sausage, isn't it?
Which is effecively what I said. "accountants have not been – and currently are not, trained in the economic realities of corporate valuation." If the accountants were trained so well and so effective, why aren't they the leading investors in the markets???
RIIGHTTT!!! Like I probably missed the presentation about the Abacus RBMS vehicles! How about the valuation and liquidity issues in their other MBS related products gorged upon at the height of the bubble?
And here you totally blow it. You miss the entire point, and make it very clear your are a bank rep. The discussion that centers primarily on revenues without taking into consideration the risk assumed in generating those revenues is highly, highly misleading!!! They also don't say had $10 million of revenues but assumed $XXX of risk in generating said revenues. EPS less dividend payments, less assumed risk is what shuold be added to capital, becaue over timet the assumed risk will catch up to you. This is not even to be argued, for it was clearly demonstrated about two years ago - without a doubt!
They compensate their revenue generating employees in the exact same fashion. So what you say? Well, whenever you need more revenues, you simply ratchet up the risk! This is exactly what they did with their RMBS business that created that monster of a deal, Abacus. They needed more product, so they purchased Litton Loans to fulfill the pipeline. The entire process was laden with risk, yet all was good since they only reported "revenues" as you so eloquently put it. Listen, I commended Goldman management, particularly in relation to some other banks, but let's not pretend there is a systemic risk in the way numbers are presented and employees are rewarded. There is!
Spoken like a true banker, trying their darndest to be forthright in their reporting to their investors and regulators! Companies are not required to state that they feel they are doing God's work, either, but some of them go that extra mile and do :-) I am not faulting banks for not reporting the economic risk along with the reward, but that still does not make the reporing accurate, even if it is the investors' responsibility to calculate such. As a matter of fact, you just contradicted yourself. If you admit that revenue reporting is done as per minimum regulatory requirements, an that costing of capital is a must for investors, then revenue should be marked to capital cost! So, how is my diatribe irrelevant. Again, I never said that banks are required to report this, that does not mean that what banks report is accurate information. Just because you followed the rules doesn't mean you did the right thing. Banks are also not required to inform investors that they act against the equity investors best interests by paying out large bonuses based on revenue production at the obvious top of a market bubble either. But they do pay those bonuses. This ties in with your risk management assertion. If banks were so good at risk management, how in the world did they increase increase production in bubbled assets, at the top of the asset bubble? Why did every single bulge bracket bank need a bailout, except for the ones that were sold for pennies, forced merge or went bankrupt? Recent history flies in the face of your assertion.
Really? Why didn't Goldman need a federal bailout for the 200+ years it was trading using its own capital versus the 8 years or so when it was able to use public shareholders capital. Stop!!! Let me answer that question for you. It is because when they were a private partnership they did try to generate as much risk adjusted revenue as possible while risking as little as the partners capital as possible. That is not the case in today's day and age, and for you to sit back and assert that means that you are literally so close to the Kool Aid pitcher as to have cherry red stains on your lips or you are disingenious. Your comments are to high end for me to conclude that you are not smart enough to see something so simple.
Was the architect of the Abacus deal fired? How about the Litton Loan purchase that failed to oversee the admin of document signing? Was the entire team of the GS RE fund that lost 92% of investors equity fired? You don't get fired for taking stupid risk with shareholder's money. You get fired for losing partner capital, which probably wasn't even lost in the RE fund, at least not as drastically as its investors. To bad for the investors, though.
Was the bubble very easy to see coming in 2006 and 2007, yes: The housing market crash in September of 2007: Correction, and further thoughts on the topic and How Far Will US Home Prices Drop?
Was the CRE crash easy to see coming in 2006 and 2007, yes: BoomBustBlog.com’s answer to GGP’s latest press release and Another GGP update coming…
Was the investment banking collapse easy to see coming in late 2007 and 2008, yes: Is this the Breaking of the Bear? How about the firm that GS kept a buy on Is Lehman really a lemming in disguise?
As a matter of fact, Goldman's own problems were crystal clear to forecast very early in 2008: Reggie
Middleton on Risk, Reward and Reputations on the Street: the Goldman
Sachs Forensic Analysis
So, after all of that, do you deem it possible that Goldman's risk management just might have some holes in it!!!????
Oh yeah, believe it or not, those companies with the highest risk adjusted profits are the one's whos market prices do the best over time. Raw, unadjusted profit can spike share prices during bubbles, but longer term investors with brains tend to look for a little more permanancy.
For once, I am speechless. Deep breath.... But don't worry it's only temporary... :^)
Your original headline was that "GS is ratcheting up VIE risk!!! (can't forget the multiple exclamation points!!!). That implies an effort to do so, and an increase in actual risk taken on VIEs. It did not say "Goldman's Accounting Balance of VIEs Rose 75% Percent Due to A Change In Accounting Rules Which Also Affected Every Other Bank But Risk Change Due To That Accounting Change Is Negligible Or Not Analysed!!!"
From there, you railed against accounting and the reporting of accounting. Then you rail against GS not providing forward-looking self-serving statements regarding expected returns and appropriate cost of capital return measures as should be viewed by investors. And you use a slew of anecdotes which are outside the mean to prove that the moving mass of the whole is a terrible thing.
Right.
Holding 2008 up as "proof of the pudding" is kind of beside the point. Strictly speaking, it was not so much the 'trading' business as the 'being-in-business business' which did badly. Outlying data points are however, just that - outliers. If you want another one, GS made money hand over fist in Q1 2009 when the SHTF (large spike downward: exception proven). If you look at how much GS lost for the whole year of 2008 vs their capital at the start of 2008, it is not a very large amount of money. LOTS of other non-financial business did worse.
Saying that the numbers ballooned because for a change in accounting regulations is slightly different than saying "Goldman is Ratcheting Up Off Balance Sheet Risk to Record Levels!!!" but perhaps you don't see the difference.
As to VIEs, the 'ballooning' is due to on-balancing of previously unconsolidated according to the rules of GAAP. Every bank is subject to this. It still does not change the risk exposure one iota. I will admit that increased risk because of new VIE trades would be 'ratcheting up risk' but show me one. Find me an investor who will buy me one of those products... please!
Regarding accountants and their valuations, I will leave you to your opinions. I know plenty of top-notch investors who trade long and short who are excellent accountants. The best accountants make excellent investors if they want to. The best fundamental investors deeply understand accounting too.
As to...
I am not sure where you see the problem in GS' risk management here. GS did not gorge themselves on RMBS products as a principal nearly as much as they facilitated others gorging themselves on RMBS. They were a little late to go short, but when they did, they did. There are plenty of liquidity issues in RMBS at the height of the crisis, but I expect you will find that they were able to extract collateral from trading counterparts when the risk of those RMBS-linked securities and derivatives dried up (mostly because when the liquidity dried up, the price changed too).
I don't see it. Not sure what a 'bank rep' is. I did not deny understanding risk is important. I said positively that EPS is important. I do not see where the discussion 'centers primarily on revenues without taking into consideration the risk assumed in generating those revenues'. It is accounting. Accounting is the methodology by which investors can understand the data in a certain format. It does not make judgments or comparisons. It is simply data. It is pointless to blame banks, or any company for that matter, for following the accounting rules, and the reporting rules of being a listed company. It is not the job of a listed company to describe to investors in excruciating detail every single piece of quantifiable and non-quantifiable risk which may impact net income. In terms of running a bank, it is largely irrelevant what the risk of a given trade making $10mm is as long as the revenue generated from a collection of risks is appropriate AND the overall risk is appropriately sized vs the capital.
I am not sure how one adds "EPS less dividends less assumed risk" to capital. Are you assuming that GS should take zero risk with its capital and any risk above zero should be accounted for in some way as a deduction from capital? By whom? The investor? Some new accounting standard? I don't se how this works.
Official reporting is undertaken by all listed companies according to the benchmarks provided by the accounting rules, auditors interpretations, the exchanges. There is some room to comment and if you read between the lines, you can glean quite a bit, but I will admit, most banks (and companies) don't completely open their kimono. This is the same way you don't show everybody the breakdown of income generated by your blog on a weekly basis.
I most certainly did NOT contradict myself. Reporting companies (banks and GS included) are required to report according to a specific format. That's it. They are free to report more, but they HAVE TO report that format. The revenue is, as I stated a few times elsewhere in my post, EXPLICITLY costed for every actual cost borne in the income statement. 'Cost of capital' is an invention of the investor side made to be able to compare one investment against another. Cost of debt capital is easy - it's interest cost (and you can find it on the income statement). The 'cost of equity', taken literally, is the dividend (and preferred share distributions). However, the standard analysis of 'cost of capital' also deals with the required return on the equity capital due to risk taken, and the 'required return' on retained earnings basis. This analysis MUST be performed by the investor because it is forward-looking. Different investors have different estimates of what the 'equity risk premium' is vs other investors, and different assumptions of covariance within the investable universe and one's portfolio selection. Every investor will come up with his own required base return from which marginal investment in that investment/stock, on a risk-adjusted basis, is a good investment (because the Expected Return will exceed the estimated Cost of Capital). Neither the 'Expected Return' nor the assumption of what the equity risk premium is at any given time is something companies should even be allowed to give out on their own stock and equity base. If they stood up and said "Investors should rate us using a Cost of Equity of 3% for dividends and an Equity Risk Premium for the Sector of 4% and a stock specific add-on of 2%, and Investors should use an Expected Return for their Goldman Sachs investment over the next horizon period of 14.3%" and reasonable analyst would laugh at them for making such a statement. It's not that the assumptions are wrong - hell they could turn out perfectly right, based on absolute knowledge and insight. It is simply ridiculous for a company to make that assumption on behalf of the investor.
Management is not required to act in the best interest of shareholders. However, as shareholders vote for directors and directors can hire and fire management, it usually pays to listen to shareholders to a certain degree. Every company out there has the right to act like an ass. Shareholders have the right to sue directors for abandoning their fiduciary duty. Whether it is in the equity investor's interest to not pay employees is up to shareholders, directors, and management to sort out. Auto companies are not required to not give out sweetheart deals to autoworkers and their families. The government is not required to pay thousands of dollars for toilet seats. Baseball teams are not required to pay a player $25mm a season for the next ten years and then have him injure himself.
My risk management assertion regarding bailouts (which every single mega-bank that received them has now paid back, with interest, and capital gains) has ALWAYS been that banks were not 'brought down' by risky assets. It is extremely difficult (but not impossible) to bring down a bank by pure asset depreciation. What brought the banks to the brink of extinction was a sudden change in the nature of funding and money markets. Those who observed the piping and how money flows were effected between major counterparts were absolutely flabbergasted at the total stoppage in late 2008 and again in early 2009. Banks act as 'transformers' of money flows, operating on the assumption that monetary systems will not simply cease functioning. When they did, someone had to step in. It was pure Bagehot. If there was even a hint of mismatch, it can be devastating as rumors swirl based on anything. The bailouts were largely to stop the rumors. The "risks" that the major banks ran into were not market risks, or asset risks, or even counterparty risks. They were systemic risks. What happens when the system completely stops functioning? I guess we found out. In terms of bailouts to cover bad risk decisions... Even Citi did not require the 'tangible common equity' forced upon it by analysts and regulators. Citi raised $70bn in equity BEFORE it lost a sum total of $30-odd billion in toto. The pref share conversion, forcing Tier 1 into TCE was irrelevant. If the bank was going under, the prefs were effectively already TCE. If the bank wasn't going under, the extra TCE was not needed (look at it now - so much capital it is a waste).
I will agree that risk-adjusted returns under the partnership model were probably better than under public ownership. So be it. Housing was a better deal in the 50s too. Hell, the Yankees were better. Everything was better. Long live the 50s. Many firms NEEDED the bailout. They didn't need the equity. They needed the government's symbolic move to restore confidence in the market as a functioning ecosystem ("if you as a depositor need your money, it will be there"). GS probably could have survived without the bailout, but who knows... the operating principle when you are in a black swan tail event is that you have absolutely no idea how bad it could get. How do you hedge against Armageddon? You don't. Because noone survives it. It's irrelevant.
The problem with these three examples is that you are picking anecdotal examples. Look at the mass of risks taken, not the anecdotes. Analysing a trader's book by saying "you stupid git, you lost huge on your short when the market went up in spring 2009" when he had a long against it which went up even more is kind of pointless.
I stand by this. Anecdotes do not prove the rule. They prove the exception. Once again, the problem of dealing with tail risk is that it is impossible to predict how bad it could get. Understanding the direction of the risk was not the problem. It was understanding how relationships between things would work and with what timing and impulse value (perhaps best exemplified by Howie Hubler's issues at MS - which AFAIC were just plain stupid risk management).
Yes. But not because of the 'reasons' you show regarding your remarkable prescience on GS and the evolution of every and any part of the financial system and its risks over the past few years.
The biggest single risk to GS now is probably "irrelevance of markets" risk. What happens if people simply stop trading financial products because they don't see the point? What does GS do then?
You have written a lot, and I don't have tie to respond, or even to read it all, but I will try.
For one, the original assertion is correct. GS's exposure to loss from VIEs has ballooned. It is not apparent using accounting numbers such as EPS, but in aggregate it is higher which is what the original article said if I'm not mistaken I had to check since we could have always made a mistake, but we didn't. that should address your first few paragraphs.
Next... I didn't rail avaunt GS or anyone else concerning the use of accounting figures, I railed against the incomplete picture that they project. That should address your next few paragraphs..
honestly, I can stop my reply here since you said, and I quote ""Management is not required to act in the best interest of shareholders." The best interest of the shareholders is the preeminent mandate of corporate management. this is the problem, they don't always follow this mandate.
you also state that every single mega bank has paid back the bailouts. really? Did GS relinquish their expedited financial holding company (bank) charter? did they pay the tax payer back for QE ala MBS purchases? how about zirp? the full face value payment of highly distressed BSC assets? i can go on for a while. there are so many false facts in your statement and it is so long that I can't address them now. I will be back though or we can hash these out on my site.
I assume the prudent man rule must not apply to investment banks!
"Goldman is Ratcheting Up VIE Risk" is false and misleading. The risk has not ballooned. The balance sheet treatment has increased. This is not new news. It was signalled in 2009 and everyone I knew who understood banks and accounting saw this coming in 2008.
Railing against the incomplete picture 'projected' by accounting data is like newlywed brides railing against the sex-ed schooling of her new husband's junior high school. It is kind of beside the point. As to GS not presenting all the data you want, why don't you ask them for it? Or why don't you show me how any listed company has ever presented enough? But the point is that you are selling your wares, which are purported to analyse what those nasty companies won't tell investors.
Management is indeed not "required" to follow their mandate. If you read what I wrote, you would note that I said that people are free to be asses and to get sued for it. I did not say anything about what was appropriate.
This is the same way that you are not required to deliver content to your subscribers. It may be part of a written contract, or a social contract, but breaking a contract is not a criminal action, it is tort. Breaking a social contract is not even that.
I bet GS would relinquish their BHC charter in a second if they could. 'Highly distressed BSC assets are an issue. Not much I can say about that which doesn't sound banksterish. Properly said, JPM got a deal. I guess the Fed decided it was worth spending money to save money. When the rest of us do it, is called insurance. Sometimes it pays off, sometimes it doesn't. Most of us really would rather not have our insurance pay off.
As to "repaying ZIRP" and "repaying QE"... It is kind of a rich idea. I wonder how one applies that to the rest of us...
I am astonished GS would try to mislead the investing public...Lloyd appears to be such a nice soft-spoken gentleman that would help any poor soul in need.
"Believe it or not, risk management is actually taken seriously by financial institutions, and history shows..."
Based on what models ? Is your history view censored by "LTCM" filter ?
This response looks like coming directly from GS's propaganda office, good luck, I doesn't work on this forum.
Not sure how an "LTCM filter" is (i.e. what is supposed to reference LTCM risk management in what way) but my history goes considerably further back than LTCM.
As to GS, I'd count the large up P&L days vs large down P&L days per quarter and see whether on average the up/down ratio is something you expect even a quite good investor to beat on a regular basis. Measure net income return on VaR and figure out what you think the Sharpe/Treynor/Jensen/Information ratios are for those results and tell me most good equity investors do better. Look at net revenue before tax and incentive payments as being "net business P&L" and tell me that those results measured against VaR are not impressive.
Disclosure: I have not ever worked at GS nor ever owned any piece of the capital structure of the organization. It does not mean I cannot admire their attention to risk and detail.
Goldman earnings pressures likely means the "Visible Hand" of the Fed's Ponzi scheme to make the markets will be quick to seek safe harbor when prices go against their algorithmic insanity.
Remember, they are doing "God's work."
I take that to literally mean, Armageddon.
Reggie,
Always enjoy your material. If I understand your accompanying chart, a correction is needed regarding VIEs:
"$1.1trillion as of June 30, 2010 from $67bn as of December 31, 2009"
Your chart suggest $1.1T should read $110B
You're right. Typo. Thanks.
Doesn't GS decide which way the market goes anyway? With the Feds role as king of private banking and GS having fully infiltrated the UST. There are two opposite scenarios that can be played out.
1) GS call of needing 4 trillion in QE2 is a telegraphing of what TPTB will be doing from 11/3 until the end of days.
2) GS has decided to go short and the Fed plays along. Zero hedge continues to hilight GS recommendations as contrarian opportunity plays. So if the 4 trillion QE2 opinion is a GS ploy to go short then the US markets are toast.
Personally, I think anything is better than watching the 3 pm melt up every day for the past 23 months.
Best forecast I have heard of how soon it will be. Soon, very soon.
Reggie, thanks for the confirmation and documentation of what is felt by many, but difficult to "prove" by some. Doing the leg work is appreciated.
Brilliant work as always but I would offer one minor technical correction: "hide the sausage" is usually a game for consenting adults while "hide the ball" is more closely associated with accounting gimmickry. Thanks for brightening my morning with that metaphor, though...
Thanks for the heads-up, Reggie. Looks like our Crazy Uncle Sachs has put another gun to the other side of his head that he will threaten to kill himself with should he not be allowed to continue molesting the kids.
I sure wish people would stop marketing this meme of resignation that "we'll have to bail them out again" on behalf of such criminal sickness.
It may seem like simple "realism," but every time it's said it promotes that result. With such "enemies", Sachs only needs their few friends in Congress to make it happen.
Looks like plenty more brass plaques will be adorning uspoilt countryside in the future from a caring organisation.Sell their Granny for a dime.
Reggie, more confirmation that the fix is in. "
Wall Street Proprietary Trading Under Cover: Michael Lewis http://www.bloomberg.com/news/2010-10-27/wall-street-proprietary-trading... Wall street will be mining all of the Dodd-Frank bill and will continue prop trading. Guess who will have pay when it all blows up again?Reggie, more confirmation that the fix is in. "
Wall Street Proprietary Trading Under Cover: Michael Lewis http://www.bloomberg.com/news/2010-10-27/wall-street-proprietary-trading... Wall street will be mining all of the Dodd-Frank bill and will continue prop trading. Guess who will have pay when it all blows up again?Um.. I have to admit - I don't know what "hide the sausage" refers to...?
Bend over and pick up that Krugerrand on the floor there and you'll find out.
"many thought the Enronesque days of off balance sheet “hide the sausage” games have come to an end…"
Really?
I just thought this is officially sanctioned now.
Mark to Unicorn helps... and since the Vampire Squid Goldman Sachs magically became a bank i wonder where one can get a Goldman Sachs checking account and debt card. How many branches does this bank have? Oh yeah, we are talking legalized fraud. Nevermind.
Yes...never mind...That's the ticket!