I spent most of Friday thinking about the news of Goldman Sachs record $550 million fine from the SEC (here's the detail of what they were accused of).
The last fine of any consequence the SEC levied like this, in my memory, is the $100 million fine of UBS back in 2004 for supplying dollars to Iraq.That was pretty serious and yet this fine is almost six times more six years later. So it could be thought of as a big deal ...... but it’s not.It’s actually peanuts.It’s chump change.
In fact, it’s irrelevant.It’s irrelevant because this case is all about politics, money and morals.Politically, it is obvious that the case was purely introduced to assist in getting the financial reform bill through the senate. The SEC accusations were announced on 16th April, just as the financial reform bill was sent to the upper house, and then it was resolved on 16th July just as the upper house signed off on the bill.Obama and his team are arch politicos, and so they thought the bill needed an extra push to get through the upper house.This is because the Bill is pretty draconian, with the idea of prop trading being banned and speculative investing being confined to the pure speculator community – hedge funds and private equity firms.This is the Volcker rule – the bit that sends us back to the 1930’s and Glass-Steagall, or near enough.Everyone thought the Volcker rule would be thrown out or watered down but, by having the Goldman Sachs case on the go during the process of dialogue in the Senate, Obama got his way.
Which brings us to money.
This case is about money.
It’s about lots of money.Not the fine, where Goldmans is only paying a $550 million fine. That’s two week’s profit, based on the $12 billion they made last year. In fact, it’s less than two week’s bonuses, as they paid out $16 billion in bonuses last year.To put that in context, imagine you’re earning £16,000 ... this fine would be £550. About the level of a fine for being drunk and disorderly.Is that what the SEC thinks of Goldmans’ actions?They were just being drunk and disorderly all over the markets?OK, lesson learned. Big deal.
No, this was about bigger money.
For example, their stock price tanked 20% to just $140 in the months since the fraud investigation began, losing about $15 billion in Goldman's shareholders pockets, many of whom are Goldman's staff.
Since the fine was resolved, the share price has bounced 10% and will soon be back to pre-SEC charges levels.
But the market capitalisation the bank lost – about $15 billion worth – was a far bigger fine than the $550 million the SEC required. With that gone, it’s going back to the good old times again, which brings us to the final point: morals.Does Goldman Sachs have a moral compass?Goldmans make money at the expense of punters like AIG and Royal Bank of Scotland, by selling them sh*t and saying it’s your risk if you buy it.It actually appears like Goldmans were the bookie who not only took the bets but fixes the race.You don’t believe that.Well the Committee for the Fiduciary Standard released a video of Goldman Sachs executives squirming under questioning from Senators this spring, as hearings over the SEC lawsuit were held.The video shows Senator Carl Levin asking Lloyd Blankfein, Goldman CEO: “Do you think (investors) care that something is a piece of crap when you sell it to them?”Blankfein’s answer is no. As far as he’s concerned, the investor is purely concerned about the level of risk.In other words, the investor and his broker have no relationship related to suitability or appropriateness – core mandates under MiFID – but purely that the punter has to understand the risk, not their dealer, and they have to be happy to take on board that risk even if their broker is selling them a piece of crap.Great.So RBS et al lose billions and get offered a token amount in return.Of the Goldmans fine, RBS is being offered $100 million. They lost over $800 million. Those numbers don’t work in my book, and now that Goldman has been found guilty and, more importantly, ADMIT to misleading clients through their marketing materials in this deal, expect several high profile court cases to follow.
I’ve just received this month’s Banker magazine which the editor, Brian Caplen, describes as their most important issue of the year as it covers the latest Bank 1000 listings.
This year’s listings show a surprisingly stable crew of American and British banks.
World Bank Tier One Pre-tax Rank Capital profit $m $m 1 Bank of America Corp 160,387.77 4,360.00 2 JP Morgan Chase & Co 132,971.00 16,143.00 3 Citigroup 127,034.00 -8,445.00 4 Royal Bank of Scotland 123,859.00 -4,366.29 5 HSBC Holdings 122,157.00 7,079.00
Considering the crisis was meant to have killed these banks, you may find it surprising to see that Citigroup and RBS have maintained their leading positions.
This is down to the fact that the Banker measures a bank’s strength by its Tier 1 Capital, and so their positioning is more of a reflection of the sheer size of these firms than by their brand or market capitalisation, which is used in some other studies of size.
The Banker’s data is fascinating though, as the database also contains profitability, revenue, cost-income ratio and more, so it’s a useful tool in all senses. And the online data goes back to 1996, so you can do some useful comparisons.
Mind you, my data - old Banker magazines - goes back even further so I quickly took a snapshot of a few useful year’s – 1994, 1999, 2004, 2008 and 2010 – to see how things have changed. Mapping out the Top 20 banks of the world for each year makes for an interesting picture (doubleclick the picture to see a larger version):
Back in 1994, Japan ruled the world.
Then their economy went South and Origami Bank folded, Sumo Bank went belly up, Bonsai Bank cut back their branches and something fishy went on at Sushi Bank where staff got a raw deal.
Post-Japan’s slump, the Anglo-American financial system ruled. So you would think that, as that system failed, it also would have gone South.
Not the case.
Maybe that’s a reflection of the sheer scale of investment American and European firms have put into these economies to avoid such a crash.
Well worth spending time looking at the data and looking forward to playing around with it further.
Some years ago, I delivered a presentation as a keynote with the title: “All Bankers are Criminals”.
I actually didn’t mean “all”.
The chicken feed, battery farmed, commercial, transactional and retail bankers are pin-stripe suited, humble pie, nice guys.
I was talking about the evil animals of Wall Street and the City.
These jungle animals hunt you down, rip out your wallet and tear your money apart note-by-note.
OK, I exaggerate a little, but you get the idea.
The first time I gave this presentation was back in Summer 2005 at a European Conference, and repeated it again in Spring 2006, as an Associate Director of TowerGroup.
The theme of the presentation mainly came from Frank Partnoy’s excellent book Infectious Greed, which traces the growth of weapons of financial destruction: derivatives, as named by Warren Buffett in his 2002 shareholder letter.
It is quite clear from this book that unchecked investment markets will run free of scruples and morals. This is what happened with Frank Quattrone of Credit Suisse and the dotcom boom and bust, along with many other examples through history.
It is not necessarily as true when we talk about arbitrage strategies and the John Meriwether’s of this world. However, these people are far more dangerous because they create financial markets systemic risk that can bring down companies and countries.
For example, in case you are wondering who John Meriwether is, he was one of the first arbitrage players and built Salomon Brothers into the big swinging dick master of the universe world so brilliantly depicted in Michael Lewis’s book Liar’s Poker.
With his colleagues, the use of arbitrage instruments led to the downfall of Salomon Brothers – they were subsequently merged into Citigroup – and Meriwether went on to create Long Term Capital Management (LTCM).
In 1998 LTCM lost $4.6 billion in less than four months and became the leading case study for how systemic risk created by derivatives products, combined with massive leverage
and arbitrage risk-models, creates a financial deck of cards. A deck that can rise and fall in the blink of an eye, with the latter potentially ruining companies, markets, countries and governments, as happened in the most recent crisis.
Anyways, not to be dissuaded from his cause, Meriwether went on to found JWM Partners, another highly leveraged "relative value arbitrage" firm. Yet again, he built leverage through this hedge fund from its opening with $250 million under management in 1999 to a massive $3 billion firm by 2007. Of course, it was all just on paper as the latest crisis battered the fund, losing almost half of its value between September 2007 and February 2009. The deck of cards strikes again. It closed in late 2009 and guess what? Meriwether’s about to launch yet another hedge fund, based upon just the same concepts.To me, this is the criminality of the financial system in action. Firms that build highly leveraged derivatives instruments for short-term arbitrage, with unproven skills and massive risk.Not that I’m calling Meriwether a criminal, as it’s all perfectly legitimate under SEC and FSA Rules.Or it was.It may be that the Goldman Sachs furore will change all this.You see, Goldman Sachs, like Meriwether, is very good at taking leverage and risk and managing the markets to gain short-term profit. Like Meriwether, Goldman Sachs succeeded in using these tools and instruments to generate massive profits. They achieved a record 131 trading days last year, in which the bank made at least $100 million net trading revenue each day.
Unlike Meriwether, Goldman Sachs managed to offload and hedge their risks back to others, such as AIG and IKB, such that when the markets collapsed their clients, suppliers and partners got burnt, but not them.Nothing wrong with that, as it’s all perfectly legitimate under SEC and FSA Rules. Unless the SEC and FSA find Goldman Sachs guilty of fraud.But how can they be guilty of a crime that was not a crime at the time it was committed?There’s the rub.I’m sure the SEC will aim to build a bulletproof case, and their cause is a worthy one: clean up the financial system. Is it worthy to do this so publicly?Not sure.Is it worthy to name the defendant up front, when the burden of proof has yet to be proven?Not sure.The Goldman Sachs case is actually more like watching a rape trial in action, where the defendant is a shifty looking guy who probably seems guilty whether guilty or not.For example, if you name someone like Jack Tweed in the UK, you might still associate him with being a rapist even though he was found not guilty.The guilt sits there, and that’s what will happen with Goldman Sachs.Whether guilty or not – and they’ve hired the best team possible to defend themselves, including “Master of Disaster” Mark Fabiani – we will always associate Goldman Sachs with something smelly for the foreseeable years to come.Ho-hum.At least all of this seems to inspire some humour. For example, in an April episode of hit comedy US TV series This American Life (TAL), they tell the story of a hedge fund that comes up with an elaborate plan to make money. It sponsors the creation of complicated and ultimately toxic financial securities while, at the same time, betting against the very securities it helped create. TAL commissioned a Broadway song to go along with the story:
The only thing that really gets me, in finishing this blog entry, is Warren Buffett.The Sage of Omaha has made his billions through prudent focus upon ‘value investing’. That means investing in strong and robust businesses like Coca-Cola, American Express, Gillette and the Washington Post. So when he referred to derivatives as ‘weapons of financial destruction’ in his shareholder letter of 2002, I respected the man and his integrity of thought.Now, having found Goldman Sachs under attack, he has stepped up to their defence, and I wondered why.Warren Buffett is an intriguing character, as we all know. The friend of kings and kingmakers, he walks a path separate to most.He knows the dangers of arbitrage, derivatives and leverage, because he had to step into Salomon Brothers in 1991 to clean up Meriwether and his colleagues mess.An extract from Carol Loomis’s in-depth review of Buffett’s experience at Salomon’s:
“You may reasonably ask what was going on in Salomon's stock while all of this was transpiring. It was emphatically down, from above $36 per share on Friday to under $27 on Thursday, when the second press release rocked the market. But the stock was only the facade for a much graver matter, a corporate financial structure that by Thursday was beginning to crack because confidence in Salomon was eroding. It is not good for any securities firm to lose the world's confidence. But if the firm is "credit dependent," as Salomon was to an extreme, it cannot tolerate a negative change in perceptions. Buffett likens Salomon's need for confidence to a mortal's need for air: When the required good is present, it's never noticed. When it's missing, that's all that's noticed.
“Unfortunately, the erosion of confidence was occurring in a company grown enormous. Salomon in August of 1991 had bulged up to $150 billion in assets (not counting, of course, huge off-balance-sheet items) and was among the five largest financial institutions in the U.S. Propping the company on the right-hand side of the balance sheet was--are you ready?--only $4 billion in equity capital, and above that was about $16 billion in medium-term notes, bank debt, and commercial paper. This total of about $20 billion was the capital base that supported the remaining $130 billion in liabilities, most of these short-term, due to run off in one day to six months.”
The result meant that Warren Buffett had to actually take over physically as manager of Salomon Brothers for a nine-month period, and it was emotionally exhausting for him.
Switch to 2010.
Warren Buffett invested heavily in Goldman Sachs in September 2008 – when Lehman Brothers, Merrill Lynch and Morgan Stanley were all imploding – buying $5 billion of preferred stock at a 10 percent dividend. These investments earn him $950 a minute, or $500 million a year today. No wonder he claims to be in love with that investment.
Trouble is that the alleged fraud at Goldman Sachs has really hit their share price. For example, Standard & Poor's downgraded Goldman
shares to "Sell" and lowered their target price by $40 to
$140 the other day.
Thinking back to Salomon's - if the firm is "credit dependent," as Salomon was to an extreme,
it cannot tolerate a negative change in perceptions - Buffett must be seriously worried about Goldman Sachs losing its credit worthiness, especially as it depends on good credit.
Oh yes, and having called derivatives ‘weapons of financial destruction’, guess what? Berkshire Hathway, Warren Buffett’s investment firm, has a massive portfolio of derivatives investments. From the Wall Street Journal last week: “Democrats took a step toward their goal of overhauling financial regulation, reaching a tentative deal to set restrictions on trading in exotic financial instruments known as derivatives. Among the considerations still in the balance: A big provision being sought by Warren Buffett in recent weeks ... the provision, sought by Berkshire and pushed by Nebraska Senator Ben Nelson in the Senate Agriculture Committee, would largely exempt existing derivatives contracts from the proposed rules. Previously, the legislation could have allowed regulators to require that companies such as Nebraska-based Berkshire put aside large sums to cover potential losses. The change thus would aid Berkshire, which has a $63 billion derivatives portfolio, according to Barclays Capital.”
Hmmm ... maybe that greed is infectious, although Morningstar Analyst Bill Bergman supports Mr. Buffett's exemption by stating that: "claiming Berkshire poses a risk to the financial system is a difficult
case to make."
Either way, the US movement towards an approval of a Financial Reform Bill to handle the issues of banks that are 'too big to fail' yesterday, takes it one step nearer to the American system taking a lead role towards a new financial architecture.
Derivatives are next ... and Warren Buffett, like Lloyd Blankfiend at Goldman Sachs and all of those current and former bankers and brokers who dealt in toxic derivatives across the world, must be worried.
Postnote: here is Berkshire Hathaway’s full commentary on derivatives from that shareholder letter back in 2002:
Charlie and I are of one mind in how we feel about derivatives and the trading activities that go with them: We view them as time bombs, both for the parties that deal in them and the economic system.Having delivered that thought, which I’ll get back to, let me retreat to explaining derivatives, though the explanation must be general because the word covers an extraordinarily wide range of financial contracts.Essentially, these instruments call for money to change hands at some future date, with the amount to be determined by one or more reference items, such as interest rates, stock prices or currency values. If, for example, you are either long or short an S&P 500 futures contract, you are a party to a very simple derivatives transaction – with your gain or loss derived from movements in the index. Derivatives contracts are of varying duration (running sometimes to 20 or more years) and their value is often tied to several variables.Unless derivatives contracts are collateralized or guaranteed, their ultimate value also depends on the creditworthiness of the counterparties to them. In the meantime, though, before a contract is settled, the counterparties record profits and losses – often huge in amount – in their current earnings statements without so much as a penny changing hands.The range of derivatives contracts is limited only by the imagination of man (or sometimes, so it seems, madmen). At Enron, for example, newsprint and broadband derivatives, due to be settled many years in the future, were put on the books. Or say you want to write a contract speculating on the number of twins to be born in Nebraska in 2020. No problem – at a price, you will easily find an obliging counterparty.When we purchased Gen Re, it came with General Re Securities, a derivatives dealer that Charlie and I didn’t want, judging it to be dangerous. We failed in our attempts to sell the operation, however, and are now terminating it.But closing down a derivatives business is easier said than done. It will be a great many years before we are totally out of this operation (though we reduce our exposure daily). In fact, the reinsurance and derivatives businesses are similar: Like Hell, both are easy to enter and almost impossible to exit. In either industry, once you write a contract – which may require a large payment decades later – you are usually stuck with it. True, there are methods by which the risk can be laid off with others. But most strategies of that kind leave you with residual liability.Another commonality of reinsurance and derivatives is that both generate reported earnings that are often wildly overstated. That’s true because today’s earnings are in a significant way based on estimates whose inaccuracy may not be exposed for many years.Errors will usually be honest, reflecting only the human tendency to take an optimistic view of one’s commitments. But the parties to derivatives also have enormous incentives to cheat in accounting for them.Those who trade derivatives are usually paid (in whole or part) on “earnings” calculated by mark-to-market accounting. But often there is no real market (think about our contract involving twins) and “mark-to-model” is utilized. This substitution can bring on large-scale mischief. As a general rule, contracts involving multiple reference items and distant settlement dates increase the opportunities for counterparties to use fanciful assumptions. In the twins scenario, for example, the two parties to the contract might well use differing models allowing both to show substantial profits for many years. In extreme cases, mark-to-model degenerates into what I would call mark-to-myth.Of course, both internal and outside auditors review the numbers, but that’s no easy job. For example, General Re Securities at yearend (after ten months of winding down its operation) had 14,384 contracts outstanding, involving 672 counterparties around the world. Each contract had a plus or minus value derived from one or more reference items, including some of mind-boggling complexity. Valuing a portfolio like that, expert auditors could easily and honestly have widely varying opinions.The valuation problem is far from academic: In recent years, some huge-scale frauds and near-frauds have been facilitated by derivatives trades. In the energy and electric utility sectors, for example, companies used derivatives and trading activities to report great “earnings” – until the roof fell in when they actually tried to convert the derivatives-related receivables on their balance sheets into cash. “Mark-to-market” then turned out to be truly “mark-to-myth.”I can assure you that the marking errors in the derivatives business have not been symmetrical.Almost invariably, they have favored either the trader who was eyeing a multi-million dollar bonus or the CEO who wanted to report impressive “earnings” (or both). The bonuses were paid, and the CEO profited from his options. Only much later did shareholders learn that the reported earnings were a sham.Another problem about derivatives is that they can exacerbate trouble that a corporation has run into for completely unrelated reasons. This pile-on effect occurs because many derivatives contracts require that a company suffering a credit downgrade immediately supply collateral to counterparties. Imagine, then, that a company is downgraded because of general adversity and that its derivatives instantly kick in with their requirement, imposing an unexpected and enormous demand for cash collateral on the company. The need to meet this demand can then throw the company into a liquidity crisis that may, in some cases, trigger still more downgrades. It all becomes a spiral that can lead to a corporate meltdown.Derivatives also create a daisy-chain risk that is akin to the risk run by insurers or reinsurers that lay off much of their business with others. In both cases, huge receivables from many counterparties tend to build up over time. (At Gen Re Securities, we still have $6.5 billion of receivables, though we’ve been in a liquidation mode for nearly a year.) A participant may see himself as prudent, believing his large credit exposures to be diversified and therefore not dangerous. Under certain circumstances, though, an exogenous event that causes the receivable from Company A to go bad will also affect those from Companies B through Z. History teaches us that a crisis often causes problems to correlate in a manner undreamed of in more tranquil times.In banking, the recognition of a “linkage” problem was one of the reasons for the formation of the Federal Reserve System. Before the Fed was established, the failure of weak banks would sometimes put sudden and unanticipated liquidity demands on previously-strong banks, causing them to fail in turn. The Fed now insulates the strong from the troubles of the weak. But there is no central bank assigned to the job of preventing the dominoes toppling in insurance or derivatives. In these industries, firms that are fundamentally solid can become troubled simply because of the travails of other firms further down the chain.When a “chain reaction” threat exists within an industry, it pays to minimize links of any kind. That’s how we conduct our reinsurance business, and it’s one reason we are exiting derivatives.Many people argue that derivatives reduce systemic problems, in that participants who can’t bear certain risks are able to transfer them to stronger hands. These people believe that derivatives act to stabilize the economy, facilitate trade, and eliminate bumps for individual participants. And, on a micro level, what they say is often true. Indeed, at Berkshire, I sometimes engage in large-scale derivatives transactions in order to facilitate certain investment strategies.Charlie and I believe, however, that the macro picture is dangerous and getting more so. Large amounts of risk, particularly credit risk, have become concentrated in the hands of relatively few derivatives dealers, who in addition trade extensively with one other. The troubles of one could quickly infect the others.On top of that, these dealers are owed huge amounts by non-dealer counterparties. Some of these counterparties, as I’ve mentioned, are linked in ways that could cause them to contemporaneously run into a problem because of a single event (such as the implosion of the telecom industry or the precipitous decline in the value of merchant power projects). Linkage, when it suddenly surfaces, can trigger serious systemic problems.Indeed, in 1998, the leveraged and derivatives-heavy activities of a single hedge fund, Long-TermCapital Management, caused the Federal Reserve anxieties so severe that it hastily orchestrated a rescue effort. In later Congressional testimony, Fed officials acknowledged that, had they not intervened, the outstanding trades of LTCM – a firm unknown to the general public and employing only a few hundred people – could well have posed a serious threat to the stability of American markets. In other words, the Fed acted because its leaders were fearful of what might have happened to other financial institutions had the LTCM domino toppled. And this affair, though it paralyzed many parts of the fixed-income market for weeks, was far from a worst-case scenario.One of the derivatives instruments that LTCM used was total-return swaps, contracts that facilitate100% leverage in various markets, including stocks. For example, Party A to a contract, usually a bank, puts up all of the money for the purchase of a stock while Party B, without putting up any capital, agrees that at a future date it will receive any gain or pay any loss that the bank realizes.Total-return swaps of this type make a joke of margin requirements. Beyond that, other types of derivatives severely curtail the ability of regulators to curb leverage and generally get their arms around the risk profiles of banks, insurers and other financial institutions. Similarly, even experienced investors and analysts encounter major problems in analyzing the financial condition of firms that are heavily involved with derivatives contracts. When Charlie and I finish reading the long footnotes detailing the derivatives activities of major banks, the only thing we understand is that we don’t understand how much risk the institution is running.The derivatives genie is now well out of the bottle, and these instruments will almost certainly multiply in variety and number until some event makes their toxicity clear. Knowledge of how dangerous they are has already permeated the electricity and gas businesses, in which the eruption of major troubles caused the use of derivatives to diminish dramatically. Elsewhere, however, the derivatives business continues to expand unchecked. Central banks and governments have so far found no effective way to control, or even monitor, the risks posed by these contracts.
Charlie and I believe Berkshire should be a fortress of financial strength – for the sake of our owners, creditors, policyholders and employees. We try to be alert to any sort of megacatastrophe risk, and that posture may make us unduly apprehensive about the burgeoning quantities of long-term derivatives contracts and the massive amount of uncollateralized receivables that are growing alongside. In our view, however, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.
Fascinating report in the FT this week about Global Brands, with the financial sector bouncing back the strongest of all. MasterCard and Visa led the financial pack, although Goldman Sachs saw a 25% growth in brand value over the last year ... I wonder how much they lost this year?
Anyways, considering banks had the worst results ever last year and lost all brand momentum, it’s no surprise I guess to see they’ve bounced back this year, and even beat beer as a sector for brand improvements:Year-on-year growth in 17 categories Category Brand value growth (%)Financial Institutions 12% Beer 10% Technology 6% Fast Food 1% Retail -1% Soft Drinks -1% Mobile Networks -1% Bottled Water -2% Gaming Consoles -3% Spirits -3% Luxury -3% Apparel -4% Personal Care -4% Coffee -6% Insurance -7% Cars -15%Source: Millward Brown Optimor (including data from BrandZ, Datamonitor and Bloomberg)
Strange how and why insurance is languishing down the bottom though ... maybe it's their lack of ability to cover Toyota's these days, which is why the car sector sits at rock bottom.
All in all, a big contrast between this and the Harris Interactive Reputation Survey I blogged about earlier this month ... so brands and reputation have nothing to do with each other, do they?
What surprised me is the list of the top 10 brands in our sector (doubleclick picture to enlarge):
Wow! ICBC from China, the #1 bank brand in the world!
In fact, they’re the 11th best brand in the world, just behind Google and Apple:
A great report from the FT again, and well worth a read if you have the time ...
Three headlines today relate to Goldman Sachs results, more on the implications of the Lehman Brothers collapse and recommendations for a new bank tax regime from the IMF
There are so many articles and analysis into Goldman Sachs practices at the moment ...
... that I’m not going to write a lengthy analysis to add to all of these, but have picked a few of the best articles at the end of this blog entry.
What I would like to say is that the Goldman Sachs area of this blog shows that the SEC’s actions announced last Friday could be easily anticipated. From their near admittance of market manipulation in July 2009, followed in August 2009 of talk about the SEC looking at their flash trading practices; to the comments I made in January about the fine line “between making markets and moving markets that Goldman walk. It will be interesting to see how Goldman and company make markets in the future, between the Obama tax and the new regulatory regime.”This was followed by the way they had to defend themselves recently, as evidenced by Chief Executive Lloyd Blankfiend’s letter to shareholders earlier this month.
Now the USA’s SEC has announced their formal investigation of Goldman Sachs, followed by the UK FSA's agreement to coordinate this investigation across borders.
There has to be a concern about their future.
Here’s my take on it.The case for Goldman Sachs
They are the world’s most successful investment bank
They are able to create incredible profits from complex instruments
They are the preferred choice of most clients for investment advice for these reasons, and this is why they maintain their success
The case against Goldman Sachs
They are the world’s most successful investment bank ... and most of their brethren – Bear Stearns, Lehman Brothers, Merrill Lynch have imploded through this crisis
They are purely driven by greed and pay massive bonuses
They manipulate markets in their own favour
Sure the list could be longer, and sure we can argue the toss over some of these points, but overall there could be a case of saying the investigations into the bank are all driven by schadenfreude and political motivations. For example, Barack Obama presents his financial reform bill to the Senate this week, so what better timing.Nevertheless, for the SEC to have “Pit Bull” Richard (Rick) Simpson in there litigating against the bank, means that there has to something in this and that must be a worry for them. Equally with the share price dropping 13 percent on Friday and further again today, even with their stunning results of $3.6 billion profits and $5.5 billion in bonuses for the last quarter, the reputation of the bank is taking a battering.The core of this debate is the question: does Goldman Sachs make stunning profits – over $100 million every day for 131 trading days last year – by betting against clients?If the answer is yes, then it’s more a case of Sack Goldmans rather than Goldman Sachs.Best of the media coverage from The Week, via the NY Times, Reuters, Naked CapitalismWhy the SEC is going after the Wall Street powerhouse, and what it means for the financial industryThe Securities and Exchange Commission took on Wall Street titan Goldman Sachs on Friday, filing a potentially explosive civil lawsuit accusing the investment bank and one of its mortgage traders, Fabrice Tourre, of fraud. (Watch a CBS report explaining the SEC's charges.) Here's a brief rundown of the charges, and what they could mean for Goldman, Wall Street, and financial reform legislation:
What is Goldman accused of?
The SEC says that Goldman created and sold a package of mortgage-backed securities to investors in 2007 without telling them that the person who picked or approved the securities, hedge fund manager John Paulson of Paulson & Co., was betting heavily that they would fail. Goldman brought in independent fund manager ACA Management to help pick the portfolio, allegedly to make the deal seem more trustworthy. But the SEC says Goldman misled ACA, too, not disclosing that deal "sponsor" Paulson was betting against, not on, the investments. Paulson's role was withheld from investors, too.
What's Goldman's defense?
That the investors who bought the securities were given "extensive information" about the securities they were investing in, and were "sophisticated" enough to know that somebody was going to take the opposite side of their bet. Also, Goldman says that while it earned $15 million in fees, it lost $90 million in the deal, although it didn't explain how.
Who else lost, and made, money on the deal?
The investors collectively lost $1 billion, with the primary losers being ACA Capital and German bank IKB. Paulson & Co. earned almost $1 billion in profit.
Is Paulson being charged?
No. Legal scholar Alan Dershowitz thinks that was a somewhat arbitrary choice by the SEC, though, saying in The Daily Beast that Paulson "could easily have been charged with conspiracy to defraud."
How damaging is this for Goldman?
Analysts say the hit to Goldman's "seemingly invincible" reputation could be much worse than any punitive damages. Given how important trust is on Wall Street, "it's very bad for business" if your clients think "you are doing shady things," says NYU law professor Marcel Kahan. And while any SEC fine would be "really small potatoes" for the firm, Goldman's stock price tumbled 13 percent on the news Friday, erasing more than $10 billion in market capitalization. Also, Britain and Germany are mulling their own investigations, based on the SEC allegations.
Are other Wall Street banks facing similar SEC charges?
It's certainly possible. SEC enforcement chief Robert Khuzami says the agency is stepping up its anti-fraud actions, and specifically looking at "similar deals" involving other Wall Street firms. Until Friday, Goldman employees were able to "sleep soundly after collecting their huge bonuses," says The New York Times in an editorial. Since Goldman wasn't the only bank betting against its own mortgage products, "others on Wall Street may have a harder time sleeping" now, too.
What are the politics of this case?
The SEC is an independent agency, but political strategists and banking lobbyists say the Goldman fraud allegations could help the Democrats pass a financial reform bill. The House passed its version last year, and the Senate finance committee recently sent its version to the full Senate (on a party-line vote) for debate this week. Some Republicans and TV pundits suggest that the announcement was timed to help secure the bill's passage. Business Insider's Henry Blodget says the SEC also might have rushed out the lawsuit to divert attention from a damning internal review of the agency's enforcement over the past few years.
After the long analysis of Jamie Dimon’s 36-page shareholder letter, we now have an 8-page shareholder letter from Goldman Sachs.
I cannot remember such letters being of such interest in the past, and wonder if the let’s tell-all letter writing from Bank CEOs is the new fashion for the teens (or 2010s if you prefer).
Alternatively, Goldmans just don’t like being called names, since this is their longest shareholder letter ever. If anything, it appears to be a direct response to the accusation of being a Vampire Squidlobbed at them last year by Rolling Stone’s Matt Taibbi (who I’m sure will have something to say about this letter).
Mind you, if I had just dished out $16 billion in bonuses for last year, for an average pay of $500k per staffer, you could call me anything you want.
It’s noteworthy that the letter refers to ‘clients’ on at least 56 occasions. A good example being: “We are responding to our clients’ desire either to establish, or to increase or decrease, their exposure to a position on their own investment views. We are not ‘betting against’ them.”
Yea, right.
That’s why Goldman Sachs managed to generate over $100 million in pure profit every day for over 131 days of trading last year I guess, a new record.
It also defends the bank’s controversial employee bonuses, relationship with AIG and role in short-selling the mortgage market.
Here’s a summary of the really juicy bits (the last three pages):
“In July 2007, as the market deteriorated, we began to significantly mark down the value of our super-senior CDO positions.
The letter refers to Collateralized Debt Obligations – click here to find out background on this stuff.
July 2007 was a key point as Goldmans had just lost billions on their Alpha Fund, due to their algorithmic systems messing up.
“Our rigorous commitment to fair value accounting, coupled with our daily transactions as a market maker in these securities, prompted us to reduce our valuations on a real-time basis which we believe we did earlier than other institutions.
They would do this on a real-time basis because their systems are controlling ahead of the markets.
“This resulted in collateral disputes with AIG. We believe that subsequent events in the housing market proved our marks to be correct — they reflected the realistic values markets were placing on these securities.
“Over the ensuing weeks and months, we continued to make collateral calls, which were based on market values, consistent with our agreements with AIG. While we collected collateral, there still remained gaps between what we received and what we believed we were owed. These gaps were hedged in full by the purchase of CDS and other risk mitigants from third parties, such that we had no material residual risk if AIG defaulted on its obligations to us.”
What this implies is that, acting as an intermediary in the markets and as a market maker, Goldman Sachs could see the ensuing implosion in the housing markets and specifically in Credit Default Swaps (CDS) and CDOs, in real-time.
These complex derivatives were integral to their trading strategies for hedging purposes, as well as being a prime broker of these risk instruments at the same time. Therefore, they were using these hedging strategies to cash-in their insurances with AIG to get out of any risk positions early.
This is why: “In mid-September 2008, prior to the government’s action to save AIG, a majority of Goldman Sachs’ exposure to AIG was collateralized and the rest was covered through various risk mitigants. Our total exposure on the securities on which we bought protection was roughly $10 billion. Against this, we held roughly $7.5 billion in collateral. The remainder was fully covered through hedges we purchased, primarily through CDS for which we received collateral from our market counterparties. Thus, if AIG had failed, we would have had the collateral from AIG and the proceeds from the CDS protection we purchased and, therefore, would not have incurred any material economic loss.”
So they aren’t saying they screwed AIG, but they legitimately ensured they weren’t screwed by insuring someone else was. All perfectly legal and above board. Only the fittest and strongest survive and all that.
The letter then goes on to talk more generally about their involvement in the mortgage securitisation market.
“The markets for residential mortgage-related products, and subprime mortgage securities in particular, were volatile and unpredictable in the first half of 2007 (which is why they unravelled their position with AIG). Investors in these markets held very different views of the future direction of the U.S. housing market based on their outlook on factors that were equally available to all market participants, including housing prices, interest rates and personal income and indebtedness data. Some investors developed aggressively negative views on the residential mortgage market. Others believed that any weakness in the residential housing markets would be relatively mild and temporary. Investors with both sets of views came to Goldman Sachs and other financial intermediaries to establish long and short exposures to the residential housing market through RMBS, CDOs, CDS and other types of instruments or transactions.
“The investors who transacted with Goldman Sachs in CDOs in 2007, as in prior years, were primarily large, global financial institutions, insurance companies and hedge funds (no pension funds invested in these products, with one exception: a corporate-related pension fund that had long been active in this area made a purchase of less than $5 million). These investors had significant resources, relationships with multiple financial intermediaries and access to extensive information and research flow, performed their own analysis of the data, formed their own views about trends, and many actively negotiated at arm’s length the structure and terms of transactions. We certainly did not know the future of the residential housing market in the first half of 2007 any more than we can predict the future of markets today. We also did not know whether the value of the instruments we sold would increase or decrease. It was well known that housing prices were weakening in early 2007, but no one — including Goldman Sachs — knew whether they would continue to fall or to stabilize at levels where purchasers of residential mortgage related securities would have received their full interest and principal payments.
“Although Goldman Sachs held various positions in residential mortgage-related products in 2007, our short positions were not a ‘bet against our clients’. Rather, they served to offset our long positions. Our goal was, and is, to be in a position to make markets for our clients while managing our risk within prescribed limits.”
In other words, Goldman Sachs puts everything down to prudent accounting and intelligent risk management.
Maybe ... but the fact that both clients selling and buying mortgage products and complex instruments (which no-one understood except Goldmans traders and a few others, such as JPMorgan Chase, creators of Credit Default Swaps) came to Goldmans, meant that they could see very early on that more people were getting out of the housing and mortgage markets than getting in.
Why are they coming to Goldmans?
Because Goldmans market manipulating systems for high frequency trading give them the best price. This resulted in Goldmans getting out of the mire before everyone else got into it, and is why they cashed in their positions with AIG before everyone else.
They were almost acting as a primary market in and of themselves and, as a market, therefore had much greater knowledge of what was being bought and sold.
Then, as not just the market but also an investor, they invested when everyone was getting out (buy low) and were selling when everyone was getting in (sell high).
The only difference with this market being that it just happened to be the whole US housing market, based upon leverage and funding fuelled by AIG's insurances and complex hedging instruments.
The result is that Goldmans is the nimblest firm at avoiding bubbles bursting and bandwagons rolling.
It’s not illegal of course. It just means they’re far more likely to be onto a sure thing than anyone else.
So, Matt Taibbi’s claim that Goldman Sachs is “a great vampire squid wrapped around the face of humanity” is obviously wrong, and their bonuses are fully justified.
The classic article of last year "Inside the Great American Bubble Machine" by Matt Tiabbi in Rolling Stone, where he coined the term 'vampire squid' in his description of the bank Goldman Sachs, has been visualised in this 10-minute YouTube stream:
It seems that I’m having a long whinge and rant all week, but I’m trying not to.
What I’m really trying to do is to get some answers to this crisis of confidence in the banks and, consequently, the banking system. This is nothing to do with the credit crisis, but the response of the banks to the credit crisis, which is to trash all trust and confidence in their ethics and approach.This is why there is this non-stop bleating about bonuses and interest rates. The banks justify this behaviour on the basis of all the other kids on the block are doing it so, if we didn’t, we would just get beaten up in the banking playground by the bonus bullies. This is what Stephen Hester said today:Mr Hester warned “that employees are leaving because it was offering lower bonuses than City rivals. He also said that profits at the bank, which is 84 per cent owned by the taxpayer, would have been about £1 billion higher if it had managed to stop staff leaving. The bank said it had ‘paid the minimum necessary to retain and motivate staff who are critical to the recovery of RBS’.”Trouble is, this doesn’t cut the mustard.MPs warned that the public would be astonished that the bank was paying £1.3 billion in bonuses given that it today reported a £3.6 billion loss for last year.
“Vince Cable, the Liberal Democrat Treasury spokesman, said: ‘Stephen Hester is trying to justify the unjustifiable. Most bankers owe their jobs to the taxpayer. His comments will just reinforce the view of bankers in many people's minds as greedy and selfish.’
“Shadow chancellor George Osborne echoed the views of Mervyn King, the Governor of the Bank of England, by telling BBC radio: ‘I do think the level of payment in the banking sector has got completely out of kilter with the rest of society. It is totally disproportionate to what doctors are paid, people working in industry are paid, teachers are paid and the like. We need to bring down pay across the sector — not just in one bank, across the sector — and things like a bank tax, internationally agreed, might help do that.’”
Oh yes, and I love the photograph the Evening Standard chose to run with that report.
Hmmm ... Hester, the fox killing, horse and hound man.
Nice.
Meanwhile, in the same paper, Chris Blackhurst writes about how we've blown our chances to rein in the banks:
“We somehow think that the bankers will take it upon themselves to lie down on the steps of St Paul's and seek forgiveness — and reform their ways and slash their incomes. They won't. They're human. Yes, they're pariahs, but they will carry on taking the money until they're forced to stop, until the authorities say bank licences will be relinquished if bonuses are paid.”But none of these arguments raging in the media address the real issue here.The real issue is not bonuses, profits, lending or interest rates.The real issue is a lack of internal market leadership within the banking industry.Nothing to do with regulators, politicians or press. The most significant failure has been the inability for the industry to act as a cohesive hole (sic: whole) to respond to the issues arising under their watch.Instead we act as a fragmented group of a thousand voices.Individual voices stand up and are counted, and some count more than others such as the Jamie Dimon’s, John Varley’s and Stephen Green’s. But nothing is co-ordinated or arranged in a way that makes sense or alleviates the public anger and distrust in the system.Take the example of the past week of banker’s bonuses.Initially, one bank – Barclays – set an example of waiving bonuses payments, as their leaders chose to repeat the actions of a year earlier and declined the multimillion pound pot they were entitled to. Reluctantly the rest then followed with RBS, Lloyds and now HSBC one-by-one agreeing not to award their leader’s bonus.The result is that they were accused of being lame sheep in doing so, just following the lead of one, and it just looked limp.It also rang of insincerity anyway, in that several of these leaders are purely deferring bonuses and have taken large swags of cash via other means (e.g. Bob Diamond’s $46 million payout on the sale of Barclays Global Investors last year) or just don’t need it as most are on million-pound plus packages. In fact, one cynic said that there would just be a top-up of their pension pots to compensate, and so no-one sees these token gestures as being anything other than that- ‘token’.Does this justify the payouts to their investment banking teams by making such sacrifices?No.Does it restore faith and trust and displace the anger and mistrust?No.So all it’s done is served as some form of internal justification for the continuance of mega-bonus payments to investment banking staff.The issue still lies with the press, politicians and regulators however: in this land of 1,000 voices, where no-one coordinated single voice resonates, where is the leadership to change the system?Take the example I’ve just given.What bankers should have done is worked together to create a co-ordinated plan across the sector pre-emptively and early on.For example, Stephen Hester (RBS), John Varley and Bob Diamond (Barclays), Eric Daniels (Lloyds) and Michael Geoghegan (HSBC) see each other often enough in front of Treasury Select Committees to be able to co-ordinate their responses.So why didn’t they all agree upfront to defer leader’s bonus payments, and announce this as a co-ordinated approach pre-results season?A joint announcement of rationale and reasoning would have been far more powerful than the sheep mentality manner of following the leader.Equally, Jamie Demon Dimon (JPMC), Vikram Pandit (Citi), Lloyd Blankfein (Goldman Sachs), Brian Moynihan (Bank of America) and John Mack (Morgan Stanley) see each other all the time in front of Federal Committees. So why didn’t these leaders co-ordinate responses to bailouts and bonuses?You may say they did, but not from an observer’s viewpoint externally.It looks like maverick individual actions and approaches, with no single voice to rally the industry to a resolution.Why these ‘leaders’ cannot organise themselves is beyond the ken.After all, if these global CEO’s of banks had created a co-ordinated and rational campaign to cap bonuses, waive their own, provide charitable donations, show how bank lending and bailouts had been atoned, then the media, public and politicians would not be baying for their blood.The fact that: (a) there is no single voice of leadership that is co-ordinated across these banks speaking on their behalf; and (b) these leaders have allowed banks to behave without change, as they were before and as if nothing had happened, is going to lead to a showdown.That showdown is not far away and, according got all my sources, will be far more draconian and vicious than any action that would have been taken if the industry had spoken with one voice, rather than thousand.But then, this industry’s ability to self-regulate with transparency and integrity historically has been pretty poor so this comes as little surprise.
Meanwhile, you only have to look at the fact that our poor old Queen has been forced onto the tube these days, to realise how hard times are in Britain ...
Great article in this month’s Bloomberg Markets Magazine on High Frequency Trading (HFT) which, according to Tabb Group, has increased from almost nothing to account for 61% of US stock market activity and 70% of individual trades since 2005. The SEC announced it is to review this area of trading last month but the focus of the article is what this means in reality from a broker dealer view.
Working with Ancero, Bloomberg has compiled a list of the best brokers using their global trade execution prices between July 2008 and June 2009. This is anannual review, and shows the impact of HFT upon the brokerage community as Goldman Sachs is the clear winner for brokers handling over $25 billion in trades annually.
According to Ancerno, Goldman is the closest at getting orders filled nearest to the price when the order is received whilst JPMorgan, last year’s #1, has fallen to joint fourth with Barclays Capital, behind Bank of America Merrill Lynch and Morgan Stanley.The World’s Best Brokers Loss in basis points*#1 Goldman Sachs -27.5 #2 BoA Merrill Lynch -32.7 #3 Morgan Stanley -33.6 #4= JPMorgan Chase -34.2 #4= Barclays Capital -34.2 #6 Investment Technology Group (ITG) -35.6 #7 UBS -36.3 #8 Deutsche Bank -38.8 #9 Citigroup -39.7 #10 Credit Suisse -41.3
A basis point is 0.01%, so Goldman Sachs' 27.5 = 0.275% or just over quarter of one percent. This means that, for a client who placed an order for 50,000 shares at $10 each with Goldman Sachs, they would get the shares for an average price of $10.275 cents; whilst Bank of America would fill the order at an average price of $10.327 cents; Morgan Stanley at $10.342 cents; and so on.
[Figures represent the difference between the executed stock price and the price when the order was placed for brokerage clients in the four quarters ended on June 30th 2009, according to Ancerno]
Why have Goldmans won?According to Roger Freeman, an analyst covering brokerage houses and exchanges at Barclays plc, because “they have the most developed and advanced electronic systems” and “can get some of the fastest execution times on trades.”This is why latency is so critical and illustrates the point well.For example, per day, the US exchanges averaged trading of 10.4 billion shares daily during the year to June 30 2009, with institutional investors globally paying $28.2 billion in trading commissions compared to $30.7 billion in 2008 and $26 billion in 2007.Interestingly, the basis point difference varies quite widely by region:Loss in basis points* USA Europe Asia Goldman Sachs -25.4 -32.6 -24.0 JPMorgan Chase -34.1 -35.8 -31.1This may be a reflection of the early state of low latency in Europe at that time, and demonstrates why Chi-X has succeeded so fast.
If you haven't seen it yet, here's Richard Curtis's (he of Four Weddings and a Funeral and Love Actually fame) short clip with Bill Nighy for the Robin Hood Tax campaign:
... well worth a look.
The idea of the campaign is to charge 0.05 percent per £1,000 transacted by
banks between each other, and that would raise about £250 billion
globally per year to help aid global poverty and climate change. Interesting to see that it has gained more than 16,500 supporters since it launched two days ago.
Oh yes, this was interesting as well (from today's Times):
The [Robin Hood tax] poll had to be
suspended shortly after 3.41pm when the "no" vote went from 1,400
to more than 6,000 in five minutes. Suspicious organisers suspended the ballot while they removed what they saw as
fake votes from the record. Their data revealed that the mystery “no” votes
came from two IP addresses — one privately-owned and hard to trace, the
other, it is claimed, registered to a computer at Goldman Sachs.
I’m continually impressed and amazed by the speed of change in the technology of the investment markets.
For example, last year was all talk about low latency and lit versus dark pools. This year, it’s all about private cloud-based services based upon colocation and proximity services. Next year, it will be all about real-time liquidity and settlement. Equally, the change from old to new trading venues is quite surprising. I was chatting with one of the MTFs yesterday for example. An MTF is a Multilateral Trading Facility, a new class of exchange introduced by MiFID, the Markets in Financial Instruments Directive. The conversation reminded me that only two years ago, everyone was saying that liquidity doesn’t move and there would be no threat to traditional exchanges from these new trading venues.
Two years later, Chi-X has more trading and market share than the London Stock Exchange (LSE); BATS is in the Top Ten ...
... LSE has acquired Turquoise and completely changed strategy and direction; Euronext has launched a major dark pool; Deutsche Bourse is heavily expanding in ultra low latency connections, targeting latencies under 3.3 milliseconds for Frankfurt-Amsterdam, under 4.5 milliseconds for Frankfurt-Paris, under 40 milliseconds for Frankfurt-New York, and under 49 milliseconds for Frankfurt-Chicago ...
... and so it goes on.
Just two years ago, many exchanges thought that seconds were fine. Today it’s milliseconds. Tomorrow it’s microseconds. And then what?Is it to achieve the ever elusive cross-asset class trading system? The one where a paired equities trade can be combined with an FX hedge across a global arbitrage? Nah, we’ve already got that.Is it to innovate new instruments, even when the last set of instruments – Structured Investment Vehicles, Credit Default Swaps and Collateralised Debt Orders – screwed up the world’s economies? Nah, we’ve already got that too.Is it to bring on board new exchanges and focus on emerging markets?Nah, we’ve already got emerging markets, cross-asset class structure exchange products.So what is the next wave of major change in trading systems and markets, and how will governments manage to derisk the next wave of innovation?Well, if the move does become one where real-time execution is combined with real-time settlement and real-time risk management, as I’ve stated before, then the challenge for broker-dealers will be to bring added value to clients through arbitraging across venues and instruments.But hey, that’s what they do now isn’t it?Of course.It’s what broker-dealers and market-markers have done for all time and will be what they do for the future. You see, the challenge is to keep up with the innovations of a Goldman Sachs and it is the reason why Goldmans made $100 million profits for every day of trading last year.Now there’s a fine border line between making markets and moving markets, and that’s the line Goldman walk.It will be interesting to see how Goldman and company make markets in the future, between the Obama tax and the new regulatory regime.But the key will be to continue to innovate with technology ... and they are and will be.That is why we are moving towards an almost seamless order flow through execution through settlement system, thanks to smart order routing combined with execution management systems.That’s one of this year’s big buzzes in trading tech, especially as Asia has followed Europe and America’s approach with Japan clearing the way for new Alternative Trading Systems and venues.So perhaps the big buzz will really be about arbitraging across venues and instruments using global smart order routing, combined with real-time execution and settlement in microseconds.
Hmmm ... sounds risky to me.
Will governments be up to the job of regulating all of these new innovations?
So yesterday’s big news is the new Financial Crisis Responsibility Fee, the FCR fee or f****r fee as the bankers are calling it. This is Obama’s big idea to get back lost TARP funds, by introducing a tax of $1.5 million per billion dollars of liabilities on a bank’s balance sheet.
The aim is to raise $117 billion to make up for the losses during the financial crisis. The way it will work is that the banks pay this 0.15% on liabilities and, according to Goldman Sachs, there are around $5.5 trillion of liabilities on American banks’ balance sheets so that’s around $8 billion per year. The tax will apply for ten years, until 2020, or until the TARP fund losses are repaid.The fee will be applied to only the largest banks, those with more than $50 billion worth of assets, and 60% of the tax will be paid for by the largest banks: JPMorgan, Citi, Bank of America, Wells Fargo, Goldman and co. In fact, the biggest banks will be paying about $2 billion a year for this tax. There’s also about $1 billion a year that will be paid by UK banks Royal Bank of Scotland (who own Citizens and Charter One Banks), HSBC (who own Household) and Barclays (who bought the US operations of Lehmans).Sounds bad, but it’s not so bad.US banks made $250 billion in earnings last year, so paying back up to $10 billion a year in tax ain’t so bad. In fact, I was amazed to find a figure that states that Goldman Sachs made $100 million a day in earnings last year every day for over 200 trading days. So a billion here or there in taxes ain’t so bad, especially if you’re paying billions in bonuses and annoying everyone.The FCR fee is stirring stuff therefore, and very populist as it ensures that Barack Obama “recovers every single dime the American people are owed”, and hits at the heart of the anger everyone has with bankers making “massive profits and obscene bonuses”.In some ways, it’s a good idea. It targets leverage and borrowings that banks tap into in the wholesale markets, which is where Lehmans and Northern Rock got scuppered and where Goldman Sachs and Morgan Stanley plough their trough.The FCR fee also positions itself as the insurance fee which the banks should have paid to get themselves bailed out. They didn’t pay any insurance but then found they were too big to fail so the Fed insured them. This is now payback time. But it won’t work.First, it hits at the banks but the banks have paid back TARP. $165 billion of TARP funds were repaid by US banks last year, with an average return to the US taxpayer of an 8% yield. That’s why the Fed made a $45 billion profit last year, through bond purchases and interest on the emergency loans made to financial institutions. It was General Motors, Chrysler and AIG that lost the $120 billion of funds that Obama wants to recoup.Second, the banks will just pass on the cost of the tax to their customers and investors. Jamie Dimon, CEO of JPMorgan, made the comment straight off that “all businesses pass costs on to customers”, and it is highly likely that the banks will find some way to hide this tax in the costs of doing business. The result is that the proposed tax will be rejected by Congress, who see any tax on the taxpayer as being untenable. The tax has to be directly on the bank.Third, Geithner ruled out a Tobin Tax on bank transactions at the G20 Finance Ministers summit in Gleneagles last November for the reasons outlined in point two above. The trouble is that the FCR fee is a variation of a Tobin Tax and needs to be better thought out. Obama had and has until 2013 to find a way to get the lost TARP funds repaid, and so he doesn’t need to do something this fast or ill conceived.
Finally, this does not address the two biggest issues: bankers’ bonuses and being too big to fail.
Obama claims it gets at "massive profits and obscene bonuses" ... how? I don't see it.
If these are the major issues that lie at the heart of the post-crisis bubble of media and public bile, then these need to be addressed and the FCR fee doesn't do it. The FCR fee purely repays TARP.
In fact, if bonuses and too big to fail are the core issues then, as mentioned the other day, these issues need to be addressed through a G20 agenda, not a unilateralist position whether it be in the UK, USA, France or elsewhere.
Therefore, it is far more likely that the FCR fee will be rejected by Congress and Geithner and Obama end up working with Barnier, Darling, Brown, Sarkozy and company on clawbacks and taxes on banker’s bonuses, along with a variation of Glass-Steagall to bring back a return to ‘narrow banking’. In other words, split the risky investment markets from the retail depositors.This last point is the key act forecast to happen over the next year or so, and is far more likely to be operable and implementable than a FCR fee.
Wow! As the debate rages on, it amazes me how the topic I chose in February for the Gresham lecture has just become so topical.
For example, everyone on London and Wall Street are now talking about the social purpose of banks, whether God and banking is compatible, and whether they are good or bad.
“If there is to be a recovery, it will be a trade recovery and banks will have a crucial role in funding that trade through their commercial and investment banking arms. That’s their “socially useful” purpose.”
Nov. 4 (Bloomberg) -- Barclays Plc Chief Executive Officer John Varley stood at the wooden lectern in St. Martin-in-the- Fields on London’s Trafalgar Square last night and told the packed pews of the church that “profit is not satanic.”
But the one that made me laugh and frown the most has to be Maureen Dowd's commentary in the New York Times:
The Great Vampire Squid has gotten religion.In an interview with The Sunday Times of London, the cocky chief of Goldman Sachs said he understands that a lot of people are “mad and bent out of shape” at blood-sucking banks.“I know I could slit my wrists and people would cheer,” Lloyd Blankfein, the C.E.O., told the reporter John Arlidge.But the little people who are boiling simply don’t understand. And Rolling Stone’s Matt Taibbi, who unforgettably labeled Goldman “a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money,” doesn’t understand.Banks, Blankfein explained, are really serving the greater good.“We help companies to grow by helping them to raise capital,” he said. “Companies that grow create wealth. This, in turn, allows people to have jobs that create more growth and more wealth. It’s a virtuous cycle. We have a social purpose.”When Arlidge asked whether it’s possible to make too much money, whether Goldman will ignore the people howling at the moon with rage and go on raking it in, getting richer than God, Blankfein grinned impishly and said he was “doing God’s work.”Whether he knows it, he’s referring back to The Protestant Ethic and The Spirit of Capitalism — except, of course, the Calvinists would have been outraged by the banks’ vicious — not virtuous — cycle of greed and concupiscence.Blankfein’s trickle-down catechism isn’t working. Now we have two economies. We have recovering banks while we have 10-plus percent unemployment and 17.5 percent underemployment. The gross thing about the Wall Street of the last decade is how much its success was not shared with society.Goldmine Sachs, as it’s known, is out for Goldmine Sachs.As many Americans continue to struggle, Goldman, Morgan Stanley and JPMorgan Chase, banks that took government bailout money after throwing the entire world into crisis, have said they will dish out $30 billion in bonuses — up 60 percent from last year.The saying used to be, whatever happens, the lawyers win. Now, it’s whatever happens, the bankers win.Under pressure from regulators, who were trying to ensure that long-term performance was rewarded, the banks agreed to award more in stock, deferring cash payments.But as The Times reported this week, the Goldman executives who got stock options instead of bonuses last year, at market lows, got a windfall — so it had nothing to do with bank employees’ performance.“The company gave its general counsel, for example, 104,868 stock options and 14,117 shares in December, when the bank’s stock was around $78,” Louise Story wrote for The Times. “Now the bank’s shares have more than doubled in value, making that stock and option award worth nearly $12 million.”As one former Goldman banker told Arlidge, the culture there is “completely money-obsessed. ... There’s always room — need — for more. If you are not getting a bigger house or a bigger boat, you’re falling behind. It’s an addiction.”It’s an addiction that Washington has done little to quell. President Obama has not been strong on the issue, and Timothy Geithner coddles the wanton bankers whenever they freak out that they might not be able to put in their new pools next summer.The bankers try to dismiss calls for regulation as populist ravings, but the insane inequity of it cannot be dismissed.No sooner had the Senate Banking Committee Chairman Chris Dodd announced his plan to overhaul financial regulation Tuesday than compensation experts declared it toothless.The banks and their lobbyists wheedled concession after concession out of Washington and knocked down proposed inhibition after inhibition. Now the banks are laughing all the way to the bank.“Saturday Night Live” was tougher on Goldman Sachs than the government, giving the firm flak about commandeering 200 doses of the swine flu vaccine — the same amount as Lenox Hill Hospital got — while so many at-risk Americans wait.“Can you not read how mad people are at you?” demanded Amy Poehler. “When most people saw the headline ‘Goldman Sachs Gets Swine Flu Vaccine’ they were superhappy until they saw the word ‘vaccine.’ ”Seth Meyers chimed in: “Also, Centers for Disease Control, you sent the vaccine to Wall Street before schools and hospitals? Really!?! Were you worried the swine flu might spread to the Hamptons and St. Barts? These are the least contagious people in the world. They don’t even touch their own car-door handles.”
And as far as doing God’s work, I think the bankers who took government money and then gave out obscene bonuses are the same self-interested sorts Jesus threw out of the temple.
This week, it's Q3 results time for US banks and the story appears to be one of two good banks and two bad banks.
The good are JPMorgan and Goldman Sachs, who have both delivered stonking results. The bad are, you guessed it, Bank of America and Citi who are both struggling with domestic credit market losses.
In particular, JPM has impressed as, even with the absorption of WaMu and Bear Stearns, they delivered a $3.6 billion net income for the quarter and build upon consistent Q2 and Q1 profits.
Goldman are the same, although their profits were slightly below expectation as their investment banking part of the business was a disappointment. That’s why the share price took a hit but they can still afford to give everyone a jolly good bonus.Both banks have paid back TARP funds and are well on their way to a return to the good times, much to the annoyance of the taxpayer.Even more annoying for the taxpayer is the two banks left.
Like HBOS and RBS in the UK, Citi and Bank of America are still plagued with consumer and business debts and defaults. Particularly worrying is the continuing impairment of mortgage lending, and now consumer and corporate lending. One example is credit cards where default rates are now rising above 10% according to JP Morgan’s latest results.
Finally, Citi and Bank of America are also still plagued with TARP repayments, the Troubled Asset Relief Program. As a result, Ken Lewis was told not to take any pay this year by the US Payments Czar who can order such actions due to the debt owed to the government.
As JPM and Goldman have paid back their TARP, they've set aside over $37 billion in bonus payments so far this year. Whilst Citi and Bank of America have this TARP burden to bear they really cannot compete and, instead, are easy targets for taking star traders, clients and profits.
Aw shucks.
Here's a brief summary of the key news and views:
JP MORGAN CHASE
$26.6 billion revenues, up 81% on same period in 2008 with fixed income driving profits in investment banking, including a $400 million gain on leveraged loans and mortgage-related securities that the bank had previously marked down
The second-biggest US bank made a net income of $3.6 billion (£2.5 billion) up 72% on equivalent quarter last year ($527 million)$1.9 billion net profit from investment banking division
Strong performance in its investment banking division cancelled out losses on credit cards and consumer loans.
The consumer lending business posted a net loss of $1 billion, up from $659m in the same period of last year.
Card services made a net loss of $700m, which was an improvement on the $992m lost in the third quarter of 2008.
Investment banking business made net income of $1.9 billion, up from $1 billion in the third quarter of 2008.
JPMorgan said it had also benefited from the impact of buying most of the assets of Washington Mutual, which it acquired in September 2008 after it had been seized by regulators.
$2 billion set aside for consumer credit losses, taking total to $31.5 billion as more than 10% of credit card customers failed to pay debtsThe bank repaid its $25 billion of US government rescue funds in June.
$7.3 billion set aside for bonuses taking this years tally to $21.8 billion
GOLDMAN SACHS
Goldman Sachs' net earnings for the three months to 25 September were $3.19 billion (£1.96 billion), up from $845m in 2008, just before the Lehman collapse.
The profit figure was up from the same period in 2008, but it was lower than the $3.44 billion that Goldman made in the previous three months. The bank paid back the emergency loan it had received from the government in July this year.
It has come through the financial crisis relatively well, having been less exposed to the mortgage-related debt that crippled many of its peers. Goldmans is doing particularly well thanks to the revival in world financial markets with most of its money from trading in stocks, bonds, currencies and commodities – a high risk, high reward strategy which other banks cannot replicate Revenue from its mergers and acquisitions operations fell sharply from the previous quarter, reflecting the continuing lack of activity. This caused investment banking revenues to fall to $899 million, 31% worse than same quarter last year and 38% down on last quarter due to declines in bond underwriting
Increased this year’s bonus pool to $16.71 billion (47% of net revenue)
CITI $101 million net income but $529 million losses on continuing operations before taxesNet revenues up 25% to $20.39 billion although revenues in the Securities and Banking Unit were down a third to $4.89 billion$100 billion in writedowns and consumer credit losses so far $8 billion in credit losses, compared with $4.9 billion in same quarter last year Citi made $101m in the period, down from $4.28 billion in the previous quarter but up from a $2.82 billion loss in the same period of 2008. In Q2, Citi reported a $4.3 billion second-quarter profit because of gains on its Smith Barney deal but its primary banking businesses continue to suffer from rising credit losses.
Citi is more exposed to consumer loans and has more bad debts.
It got a $45 billion bailout from the US govt - The Treasury Department now owns a 34 percent stake in the bank after converting a portion of the $45 billion in rescue funds Citi received last year.
BANK OF AMERICA
Bank of America posted a $1 billion third-quarter loss compared with a profit of $1.18 billion a
year earlier.
Total revenue increased 32% to $26.4 billion.
Results were helped by profits from Merrill Lynch with gains
from trading bonds, stocks and currencies. Losses on home
lending and insurance widened to $1.6 billion from $724 million,
and the loss on credit cards expanded to $1.04 billion from $167
million.
The bank said the provision for credit losses was
$11.7 billion, with $9.6 billion of loans considered
uncollectible.
Reserves for future losses increased by $2.1
billion, compared with a $4.7 billion addition in the previous
quarter. The bank’s reserve is now 4% of total loans, compared with 4.7% at JPMorgan and 5.9% at Citigroup.
Net write-offs of uncollectible loans
rose 11% from the second quarter to $9.62 billion. The
bank wrote off $3.2 billion of home loans, including home equity
loans, during the quarter, up 10% from the second
quarter. Charge-offs on credit cards increased 5% to
$2.17 billion.
CEO Ken Lewis is stepping down at the end of the year and his abrupt resignation and the lack of clarity on his successor are contributing some uncertainty surrounding the stock.
Bank of America earned $3.2 billion last quarter.
Bank of America needs to clarify its position on TARP. It would be a very positive sign to pay down some of their TARP as they have only paid $1.83 billion of the $45 billion due.
The Finanser is sponsored by VocaLink and Cisco: For details of sponsorship email us.
It’s been nice having a break, and feeling like the banking system isn’t the only thing I care aobut in this world. Nevertheless, the eye wasn’t completely off the ball as several grumblings and mumblings have been taking place during the last two weeks.
The obvious and biggest story being the need to sort out bankers’ bonuses.
I’ve blogged about this stuff before, putting the arguments for and against big bonuses ... but seriously, there is nothing the governments of the world can do about bankers’ bonuses.
For a start, Barack Obama thought about a cap of $500,000 earlier this year. Various newspaper headlines screamed: “Obama imposes $500,000 ceiling on bailed-out bank bosses”, and this was seen as a good thing ... but only by the naive new incumbent of the White House that is who, like most of the populous, wanted to do the obvious thing and clip the wings of the evil banking system.
It just isn’t that simple.
Sure, bankers making ‘obscene’, ‘outrageous’ and ‘vulgar’ amounts of cash out of a failed system is a source of retribution to be sought, but not by making your country unattractive to the very people who fuel your economy.
That’s why Obama was rapidly shot down by those who understand these markets. Their argument went something like:
“OK, OK. So you’re a bit pissed with the banking system, as are all of us. But you gotta see it our way. The banking system is the fuel of the economy. If the system fails, the economy fails, you fail. You know that. That’s why you bailed us all out.
“Now then. What makes the banking system work? Having the brightest talent who totally understand and get these complexities of trading.
“Now you know how complex trading has gotten. That’s why we had these issues in Credit Default Swap Derivatives. In fact, the more derived a product is, the more complex it gets, the more risky it gets but, if you have guys who understand those risks and can trade in them effectively, then you make massive amounts of profit.
“That’s how the ‘vampire squid’ Goldman Sachs works, and that’s how all of us want to work. And it did us good for the past decade or so, didn’t it?
“So, you cap bonuses and you effectively are saying: the best and the brightest traders, go trade elsewhere. And they will.
“Just look at the dead meat on Wall Street and London.
“Royal Bank of Scotland for example. Lost a load of traders to BarCap and others overnight.
“Or UBS? Same thing.
“A bit of weakness in the system and stellar rewards await elsewhere for the best and brightest as can clearly be seen.
“So go on Mr. Obama. Put a cap on our ability to attract, retain and incentives the best and the brightest traders and you’ll soon see all your banks that are working fail. We will all fail because all the guys will be in some other country with some other bank.
“Oh yea, and you throw in a few things like: ‘working with the G20 in a co-ordinated fashion and we avoid this’. Sure. You think China and Russia would really see the opportunity to steal your main strength in the financial system – the knowledge – as something they would ignore or see as being just fair dues?
“We don’t think so.
“Your choice, Barack, but you stifle our competitiveness in salaries and bonuses and you sign our death warrant.”
In other words, the core of the financial system involves having top trading talent who understand their markets intimately in order to be able to deliver profits.
That’s why Citibank are arguing for $100 million bonus for their top trader Andrew Hall, and why Royal Bank of Scotland are paying Brian Hartzer $4 million as a signing on fee.
I liken it to footballers.
Do you really think that Christiano Ronaldo is worth or not worth £80 million?
Does it matter what you think because Real Madrid think he’s worth that and, if they have the money, they get the man.
This is how banks work and it may be economies they are kicking around rather than footballs, but the talented few who have proven track records deliver the greatest profits.
That is why America and Britain have fought Germany and France so hard over this matter, as America and Britain have the financial markets as the core of their economies and economic strength or, more recently, weakness. But to cede these markets now, as they move into recovery, would be to place a nuclear bomb in the heart of Geithner and Darling's Treasury operations.
It just will not happen.
Governments therefore have learnt that they have to protect their banks, that are too big to fail, and their bankers, who are too bright to lose.
Finally, on this last point, do the brightest really deliver the greatest profits ... or is it their firm and environment?
In a fascinating study by Harvard Business School’s Professor Boris Groysberg of over 1,000 stock analysts who worked for 28 American investment banks between 1988 and 1996, he found that when a company hires a star away from another firm: 46% did poorly in the year they switched jobs and their performance remained lower even after five years; there is a decline in the performance of the group the star analyst joins; the market value of the company hiring the star falls; and the star doesn’t stay with the new employer for very long.
Grosyberg concludes that hiring stars does not do much for a firms’ or the star’s performance, and that everyone would be better off by growing talent inside the firm.
Hmmmm .... it's good to be back.
The Finanser is sponsored by Vocalink and Cisco: For details of sponsorship email us.
I had a chat with a couple of people last week about the hot topics in capital markets. Along with our regular talk about liquidity risk, new EU regulations and USA and EU focus upon OTC Derivatives, clearing and settlement, another subject has recently come to the fore.
The use of broker–dealer capabilities to leverage latency and electronic liquidity to gain a buck at the expense of the buy–side, better known as ‘flash trading’.
This has become a hot topic because the regulators recently learnt that this can cause issues, especially when we’re talking about dark pools where large block order trades can be executed with zero visibility to the wider markets.
It's also been a focus of conversation for a while. For example, at TradeTech in April we talked about 'gaming' using the buyer’s key indicators of trading activity electronically. These are based upon two messages: an Indication of Interest (IOI) and Immediate or Cancel Order (IOC); and these are the source of concern within the industry.
“The misuse of IOIs and IOCs is a hot debate topic, as many dark pools use this information badly to allow leakage and hence ‘gaming’. For example, you receive 16 orders for 62,500 IBM shares from one fund manager or broker dealer and you know that a million shares are moving, probably on the basis of news or views of one player.
“Using IOIs and IOCs, other traders can then game those IBM shares, moving prices using dark pools. Then combine IOIs and IOCs with latency arbitrage and you can see how complicated this all gets.”
Before we get too complicated, it is probably best to explain some of the lingo used here.
The IOI is the buyer’s message saying that they might want to place an order for so many shares in a stock and the IOC is used to cancel the order.
In the case of flash trading, the high speed processing means that some brokers can use systems to see a trade coming into the market, and raise the price artificially by processing a series of other buy requests before the order is executed.
The New York Times explains flash trading well in this chart (doubleclick chart to see larger version):
In other words, the combination of high frequency trading using super fast, low latency systems that are highly automated, allow the market making firms to use a ‘flash’ order which is visible for let’s say half a second, to make a few dollars.
Half a second is 500 milliseconds or 500,000 microseconds (there are 1000 milliseconds in 1 second; 1000 microseconds in 1 millisecond; and so on) which is why speed is so important, and the automated market-making firms with naked access can use a flash order to advantage for this reason.
This has been discussed by the Finanser before, as well as at the Financial Services Club, with a panel last March explaining why low latency is so important.
But it’s not just low latency.
It’s the use of technology, algorithmic trading, co–location and proximity-hosted, high frequency, low value trading, combined with low latency that makes this all so darned complicated ... and the more complicated, the more likely and capable are those who understand the markets able to make a buck.
That’s why Goldman Sachs were so worried when they lost one of their programmers, and potentially their program code, last month.
This has now raised the regulatory radar, with the USA the first to crack down.
According to several reports last week, the SEC is making moves to ban flash trades, and NASDAQ and BATS are also moving to block flash trades.
That’s all well and good.
However, all exchanges are struggling to find volume and liquidity right now and just as some may introduce restrictive practices, others – such as Euronext - build new capabilities to incentivise high frequency traders and trading.
Result: there will be more moves to restrict this type of trading using regulatory restraints.
Result + 1: the market makers and exchanges will create even more convoluted technologies and program trading capabilities to evade these restraints.
And so the cycle goes ...
*
The Finanser is sponsored by Vocalink and Cisco:
For details of sponsorship email us.
Paul Kedrosky's Infectious Greed is always a great read, and today he's posted some blurb fromScience Magazinethat's worth repeating here.
The Science article is called Economic Networks: The New Challenges
by Frank Schweitzer et al. in Science, July 24, 2009. Here's the abstract:
"The current economic crisis illustrates a critical need for new and fundamental understanding of the structure and dynamics of economic networks. Economic systems are increasingly built on interdependencies, implemented through trans-national credit and investment networks, trade relations, or supply chains that have proven difficult to predict and control. We need, therefore, an approach that stresses the systemic complexity of economic networks and that can be used to revise and extend established paradigms in economic theory. This will facilitate the design of policies that reduce conflicts between individual interests and global efficiency, as well as reduce the risk of global failure by making economic networks more robust."
The bit that Paul picked out is a graphic that shows the flow and liquidity of trading between banks, as follows:
Node colors express different
geographical areas: European Union members (red), North America (blue),
other countries (green). The identifiers in the nodes represent major financial institutions
and the links are both directed and weighted and represent the
strongest existing relations among them.
Even with the reduced number of links
displayed in the figure, relative to the true world economy, the
network shows a high connectivity among the financial institutions that
have mutual share-holdings and closed loops involving several nodes.
The Finanser is sponsored by Vocalink and Cisco: For details of sponsorship email us.
"Goldman Sachs was AIG’s biggest banking client, having bought $20 billion in credit-default swaps from the insurer back in 2005…
"By
that weekend in September, Goldman Sachs had collected $7.5 billion
from its AIG credit-default swaps but had an additional $13 billion at
risk—money AIG could no longer pay. In an age in which we’ve become
numb to such astronomical figures, it’s easy to forget that $13 billion
was a loss that could have destroyed Goldman at that moment.
"Hank Paulson and then–New York Fed chief Tim Geithner called an emergency meeting for the following Monday morning…"
Recent Comments