Rethinking Markets

On the one hand, I’m deeply pleased that Congress is taking notice of Goldman’s sweetheart status vis-a-vis regulatory bodies. In particular, in order to take advantage of the free money the Fed is giving away, GS decided to file to become a bank holding company. And yet, they’ve asked for and received permission from the Federal Reserve to temporarily manage their capital requirements as if they were still an investment bank (actually they asked for special treatment for both market capital trading requirements and merchant banking credit risk requirements, and received permission for the former).

Now, a number of representatives are asking good, pointed questions about this exemption (the link is a .pdf):

In the fall, Goldman Sachs secured access to government funding by converting from an investment bank into an ordinary bank. Despite this shift, the CFO of the company, David Viniar, said last week that the company is continuing to operate as if it were still a high-risk investment bank: “Our model really never changed,” he noted in a quote to Bloomberg. “We’ve said very consistently that our business model remained the same.”

This statement seems accurate. Earlier this year, the Federal Reserve granted a temporary exemption to Goldman Sachs from standard bank holding company Market Risk Rules, allowing the company to continue operating as if it were an investment bank. The company and its employees have taken full advantage of its new government subsidies, and the retained ability to bet big. In its most recent quarter, Goldman Sachs earned high profits of $2.7 billion on revenues of $13.76 billion, with 78 percent of this revenue derived from high-risk trading and principal investments. It paid out much of this revenue in compensation, setting aside a record $772,858 for each employee at an annualized rate. The company’s own measurement of risk, its Value-at-Risk model, recently showed potential trading losses at $245 million a day, up from $184 million last May.

Despite its exemption from bank holding company regulations, Goldman Sachs has access to taxpayer subsidies, including FDIC-backed bonds, TARP money (since repaid), counterparty payments funneled through AIG, and an implicit backstop from the taxpayer that allowed a public equity offering in a queasy market. The only difference between Goldman Sachs today and Goldman Sachs last year is that today, the company is officially gambling with government money. This is the very definition of “heads we win, tails the taxpayers lose.”

The letter is a pdf, worth reading for some of their questions about VaR vs. SEC models of risk management. I guess we’ll see what happens.

In the meantime, although I am about as critical as anyone about Goldman Sachs, I was convinced by a friend (Doron) to rethink my complaints about GS compensation. He said that one thing he appreciates about Goldman is that they pay their workers the profits they generate. I may find the source of those profits objectionable, but the compensation itself should be something I should support. After all, if Wal-Mart directed much of its profits to its employees, I’d be happy about it – why shouldn’t the traders who make the dough get the dough? And you know what? He’s right. I’m still annoyed that their profits come at the expense of the rest of us, and that the company doesn’t give much of a crap whether its cutthroat activities put the financial system itself at risk. But by all means, pay your profit-generators your profits.