Earlier today the general public got one of its first public disclosures of what Goldman believes its prop trading operation contributes to the firm's top and bottom line. For those uninitiated with banker lingo, prop trading is basically the profit that Goldman makes by transacting exclusively as a hedge fund: this is not agency or facilitation revenue, but merely principal positions that represent balance sheet risk for the firm. Of course, with the Fed having made clear that America would fail before Goldman does, the definition of risk as it applies to Goldman is laughable. Yet considering that Goldman must disclose a trading VaR, or value at risk on a quarterly basis, which over the past year has averaged over $200 million, one can back into what the actual prop capital and revenue generated by prop strategies is (VaR is simply a statistical calculation of how much Goldman would stand to lose if a "one in twenty" event occurred. It is not the maximum loss risk that Goldman has exposure to - a good example of a terminal event, i.e., one which would leave the firm bankrupt overnight, or a VaR of infinity with a narrower confidence range, would be something like the recently notorious "what if" of an aborted AIG bankruptcy, courtesy of Tim Geithner). Goldman's head of PR claims the Goldman's prop trading accounts for only 12% of net revenue. Zero Hedge disagrees, and we would like to pose a question to Mr. van Praag which we hope Goldman will answer for us in order to refute our observation that Goldman may be disingenuous in its public statements.
A month ago Zero Hedge presented a unique glance into Goldman's prop trading activities courtesy of the 2008 tax filing of the Goldman Sachs Foundation. Using some back of an envelope math, and some extrapolations based on portfolio allocation, we concluded that just in Russell 1000 futures in 2008 Goldman may have generated $1.2 billion in losses. Furthermore, this analysis excludes numerous other products in which Goldman has prop exposure including S&P 500 E-Mini, Dow Jones Mini, Russell 2000 Mini, 2 Year UST Futures, 5 Year UST Futures, 10 Year UST Futures, Treasury BD Futures, 10 Year Swap Notes Futures, Credit Default Swaps, Interest Rate Swaps and Futures, F/X Swaps and Futures, and many, many others. We are confident that merely extrapolating the P&L of the Russell 1000 prop exposure immediately invalidates van Praag's claims that prop trading accounts for 12% of net revenues (or, in this case losses).
Which brings us to our few simple questions for Mr. van Praag:
- Goldman disclosed that it had $352.2 billion in fair value of principal trading instruments at September 30, 2009. How much of this is considered allocated to prop if this is in fact a distinct strategy from principal?
- Does the firm's FICC revenue line have absolutely no prop trading embedded within it? Goldman made $20 billion in FICC year to date: is none of this $20 billion due to capital at risk, or is it all due to wide bid/ask spreads?
- What was the pro rata allocation to Goldman Sachs Foundation as a percentage of capital per each trading ticket in 2008? Does GSF have a dedicated trading silo within Goldman?
- Why did the Goldman Sachs Foundation not participate in Goldman's prop CDS trades?
- How much did Goldman's prop operations lose in 2008 trading Russell 1000 futures?
- How much did Goldman's prop operations lose trading all equity, credit and commodity products?
- When will Goldman clearly and distinctly segregate on its income statement the prop trading profit and losses, if these are in fact unique from "principal" trading as defined, and attach an MD&A to all relevant disclosure?
- Lastly, we are still hoping to get a seating chart of Goldman's trading floor (via legitimate channels) which clearly discloses flow and prop traders' seats in order to disclose to the general public that flow and prop traders do not share the same information flow, especially that emanating from core clients who tend to move markets the second they announce their trading axes to Goldman's flow traders.
Our intent with this line of questioning is to disclose Goldman is i) spuriously disaggregating revenue streams, or as the case may be, losses, and ii) Goldman is providing not nearly enough information in public filings to disclose what the true risk embedded in principal or prop trading strategies is. Because what Goldman is insinuating is that the firm's prop trading really carries virtually no risk. Really? Ignoring the example of AIG, where Goldman basically left all its eggs in one risk basket, we present some KPMG materials that seek to clarify how management teams attempt to confuse and fool an unsuspecting public of the firm's risk exposure, until such time as the pent up risk blows up in everyone's face. And while this particular case study is focused on hedging in the context of Natural Gas, the observations are more than relevant to the world's biggest hedge fund, Goldman Sachs. KPMG's take home questions, which we would also like to pose to Mr. Viniar, are as follows:
- How do you define market risk?
- Do you take fixed price positions?
- Are you exclusively a hedger or do you “optimize” your assets?
- Do you have a risk policy?
- How do you monitor trading/hedging limits?
Once we receive the responses by Mr. van Praag and Mr. Viniar, we will immediately notify our readers. If we are wrong, and it ends up that Goldman's prop/principal exposure is grossly overestimated, and as a result Goldman's entire net revenue is simply a function of Goldman's monopoly in the fixed income and interest rate markets courtesy of a now defunct Lehman, Bear and Merrill, we will promptly apologize for our wild specuations, even as we double our efforts to highlight Goldman's market monopoly to Christine Varney.
And one last question to Mr. David Viniar, who recently said that the firm doesn’t benefit from any implicit government guarantee. Goldman, as presented here, benefits directly from $21 billion in FDIC (taxpayer)-insured bond issues. How does Mr. Viniar reconcile this particular fact with his spurious claim? And also, will Goldman withold paying $20+ billion in bonuses (either in stock or cash) until such time as Goldman calls all taxpayer-backed issues and recreates the capital shortfall by accessing the private markets (at a cost of several hundred basis points in interest expense)?
Goldman is fully aware how to contact us in order to satisfy these outstanding questions.