Oct 18th, 2009 at 8:27 am
Big Risks
This seems like a mighty strange choice of words:
A big reason for Goldman Sachs’s blowout profits this year has been the willingness of its traders to take big risks — they have put more money on the line while other banks that suffered last year have reined in such moves. Executives say there are big strategic gaps opening up between banks on Wall Street that are taking on more risks, and those that are treading a safer path.
It’s not really a “risk,” though, is it when you’re operating with an implicit government guarantee to pull your ass out of the fire if your bets blow up. The federal government is taking a risk on these Goldman trades, they’ve just given Goldman the bulk of the upside.
29 Responses to “Big Risks”
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October 18th, 2009 at 8:50 am
Two points. First, the path taken by the Administration worked, and worked quickly. And as a result, “confidence,” which is the key for the economy, returned quickly as well. Of course, we will never know the consequences if the Administration had taken the other path. But you must agree that, whatever the consequences, “confidence” would have been much more elusive and, hence, the risks much greater. Second, profiting from trading requires two sides, a seller and a buyer. Who, exactly, are the GS’s of the world trading with? I wouldn’t be surprised if the trades were “phantom” in the sense that it would not be easy to determine who is the seller and who is the buyer. “Complex” financial instruments, you know.
October 18th, 2009 at 9:18 am
Heads I win, tails you lose.
October 18th, 2009 at 9:26 am
raylward writes:
“First, the path taken by the Administration worked, and worked quickly.”
I assume by this you mean that we didn’t enter a Great Depression but of course I put that argument right up there with Saddam’s WMD.
And in any real world sense the Administration plan has not worked.
Just ask any of the unemployed what they think of Obama’s promise to keep unemployment under 8%.
Ask my neighboring businesses which are unable to get a line of credit from their banks.
Ask homeowners about the ongoing wave of foreclosures.
The only people the Administration has worked for are the already rich.
Just as health care reform is turning (as was predicted) into another giveaway to big business.
Wall Street and their bought and paid for President used the threat of economic mass destruction to fool the American people into paying off the bad bets of our OverLords.
Not for the first time.
And certainly not for the last.
October 18th, 2009 at 9:56 am
The administrations plan worked temporarily. The financial sector is still in trouble ( removal of mark-to-market allows them to live in denial), and will get worse as CRE fails and residential foreclosures continue to rise.
This has been a confidence bubble.
October 18th, 2009 at 9:56 am
Anyone who is remotely familiar with how GS operates would know that they are not reckless. Predatory, opportunistic SOBs? Yes. Reckless gamblers? Uh, no. They know the game and they play it well. The challenge lies in changing the rules of the game. And as inconceivable as it seem to some people here, some of what they do is crucial and important to our economy.
Rather than agonize over how much money GS made, maybe our time might be better utilized in thinking about solutions. Better regulation, higher capital requirements, breaking up big banks, more progressive tax rates, etc. As voters we could push for those things. Or we could spend all our time crying about how Wall Street owns every administration.
October 18th, 2009 at 9:58 am
What’s worth looking at are where they risked and what the payoff turned out to be.
Much of the risk came from purchasing plummeting stocks, selling them when they increased in value. Short-term gains from profit taking.
On the one hand, this is a transfer of wealth from stock holders who got out to protect their devaluing assets.
On the other, it created a floor for the slide of stocks, because there were well-funded traders.
I’m grateful for the floor. But I’m concerned about the ongoing transfer of wealth out of the middle class and up to the top 1% of earners.
October 18th, 2009 at 10:01 am
I bet anything that despite knowing about this state of affairs, Matt Y will be perplexed come 2012 as to how Obama managed to lose a Presidential election to some random hick.
I’m sure the administration will come up with a way to lie with statistics and claim a real recovery, but I don’t think that’s going to have the effect he hopes it will.
October 18th, 2009 at 10:37 am
(being stubborn) I’m posting this again from a thread below, cuz I still wanna know The Answer: when does this crap actually CREATE wealth?
Thank God MattY is at least lurching away from talking about all this in terms of ethnicity and religion. Why didn’t you dis women, while you were at it?
Goldman Sachs isn’t stupid — how many shares of Fannie and Freddie did they buy (with OUR money, after they’d gone under and we paid Goldman Sachs for their losses) at $1, which promptly quadrupled? A few dozen transactions like that, and you’re talking serious profits.
But so far as I can tell, what Goldman Sachs is doing is essentially identical to what it was doing before: playing the percentages rather than investing.
Somebody replied to my question about derivatives by arguing that a futures contract is a derivative (and thus creates wealth), and somebody else noted that companies seeking investors can sell shares. (imagine!)
Nice try, but epic fail: a futures contract is sorta kinda technically a derivative, the way tee-ball is sorta kinda technically like facing Mariano Rivera, but grownups understand distinctions.
Still, you at least tried to focus on the actual question (which has nothing to do with ethnicity, still less to do with giving bigots like Sailer a forum): a derivative is essentially a BET.
In the case of a futures contract, like Southwest made that the price of fuel last year would have x relationship with the price of fuel this year, the value of the bet depends on whether their price prediction was accurate. If fuel cost $30k for a flight last year, and they bought a futures contract to pay $35k this year, Southwest wins the bet if this year’s price for fuel is $40k per flight. The guy who sold the contract loses, cuz he has to supply the fuel at $5 less than it costs — today.
Likewise, if fuel costs $25k per flight this year, Southwest loses, and the guy who sold the contract wins, since now he gets to supply fuel at $10k ABOVE this year’s cost. The value of the bet (that fuel will cost $35k a flight this year) is the price of the futures contract.
Your argument is that this simple derivative, the equivalent of tee-ball, CREATED wealth. Bullshit.
The advantage to Southwest that you cite is that buying a futures contract meant that they were willing to risk that fuel costs would go down, and thus they would have committed to pay far too much for fuel this year, because they could at least plan this year’s flights KNOWING that the max they’d have to pay for fuel would be $35k a flight.
Helping ‘em plan, letting ‘em open new routes cuz they could be sure of fuel costs — yeah, well, maybe. But I’d argue, in this narrow context, a futures contract for fuel would only CREATE wealth if their bet was successful — that is, if the price of fuel went beyond the $35k they’d agreed to pay a year before, saving ‘em money (i.e., the value of the created wealth) which they would then have to use to open new routes, etc.
[In this sense, the guy who loses the bet would be in the position of the borrower who pays interest on a loan. Compound interest CREATES wealth, because the guy who borrows $1,000 and agrees to pay back $1,100 uses the original grand to start a widget business, making and selling $1,500 worth of widgets. So even after he pays back the principal and the interest, there is still $400 worth of widgets in the world that didn't exist before the loan with interest. Add a few zeros and several more years, the wealth-creating characteristic of compound interest is clear. But the guy who trades futures by betting the price will go down, but it goes up: it's hard to see the same kind of wealth-creating dynamic.]
In fact, IF Southwest had bet wrong and their competitors had the advantage of paying lower market prices (say, $25k a flight) for fuel, Southwest would have found it much more difficult to compete on new routes, not to mention the hit their investors would have felt. See the limits of using a futures contract as an example?
Which is why folks created REAL derivatives in the first place.
Likewise, when entrepreneurs offer equity stakes, or debt shares, that’s not a derivative, cuz the value is DIRECTLY related to the asset.
Contrast the way a Credit Default Swap works — say last year, Southwest (just to pick on ‘em) agreed to buy $10 million worth of fuel at $35k a flight this year. The transaction is worth $10 million, but the futures contract might be worth $3 million, IF the actual price of the fuel this year fell to $25k a flight. But if the price of fuel goes to $40k a flight, the futures contract is a dead loss of about $1.4 million. Very few transactions of this sort are self-financing, so there are loans at every step: the original Southwest loan for $10 million at 5% for buying fuel a year in the future; the guy who sells the futures contract borrows against the contract so he can buy the fuel at a range of prices, and so on. Everybody involved figures that Southwest is good for $10 million, even if that turns out to be way higher than the market price for fuel when they have to pay it. But what about the guy who contracts to borrow $11.5 million to buy the fuel, that he will have to sell for $10 million? Ain’t no market for a dead loss of nearly a million and a half.
That’s where a real derivative appears: there is a risk, which you can calculate, that the guy who sold the futures contract will default on the loan contract. Selling shares of that risk is also a bet — a thousand guys buy a share of what could be a $1.5 million loss, OR a $3 million profit, except that the various ways of structuring the bets might mean that somebody buying one kind wins when the guy DOES default, and somebody else buying another wins only if he doesn’t. What Goldman Sachs did before, and what they seem to be doing now, it taking profits on the first kind of transaction, and doubling down on the second: so long as the merry go round keeps turning, they can’t lose — and if it DOES stop (see: commercial real estate market, default rate), Uncle Sugar is ready to buy out their losses.
Again.
I’m asking: where does this crap generate wealth? I mean REAL wealth, like the capital to build highways and bridges (the stuff bonds used to finance), not the 0’s and 1’s that make “smart” guys fabulously rich cuz they get the cash when they win.but they managed to con the rest of us to pay for their risks when they lose.
Well? Can ANYBODY show me where these “innovative financial instruments” are worth anything real?
October 18th, 2009 at 11:10 am
What’s going on on Wall Street right now is the most egregious ass-fucking of the public interest I have ever seen in my sixty years on this planet.
October 18th, 2009 at 11:48 am
I’m a little puzzled. I may be disappointed in how little Obama has done to regulate Wall Street, but I am puzzled by reports like the one above.
I don’t trust an article that just says they are taking on more “Risk”. What does that mean?
I’m under the impression that we are in this mess because of a housing bubble along with selling worthless mortgages repackaged as investments that wiped people out. Then companies made stupid bets on the worthless investments and went bankrupt and this caused other companies they owed money to to go bankrupt, etc.
So excuse me if I don’t get very excited about some options trading. That didn’t bring down the economy.
I sure would prefer the government put more money into banks that actually would lend it out again and get the economy going. But this stuff here is just a side effect and I’m much more concerned about getting better policies enacted.
And, in reference to the earlier comment, I’m not sure who is going to defeat Obama in 2012. I can’t remember the last Republican candidate who didn’t cheer on big business profits, no matter the situation.
October 18th, 2009 at 11:56 am
Stupid question -
Given that the government is insuring the bets of some Wall Street investors, what control does it have over the riskiness of the bets being made?
Assuming that the proper way to chastise a Wall Street trader is with a guillotine, I wouldn’t be surprised if they spent half the bailout on lottery tickets, and the other half on performance bonuses.
October 18th, 2009 at 12:36 pm
Anyone who is remotely familiar with how GS operates would know that they are not reckless. Predatory, opportunistic SOBs? Yes. Reckless gamblers? Uh, no. They know the game and they play it well.
You realize that without government help, the “smart” “geniuses” at GS would be bankrupt today, right? A normal, small bank making the exact same bets as GS wouldn’t exist anymore without a direct line to the Fed and the Treasury.
It is easy to play the game well when you can’t lose, and you wrote the rules.
October 18th, 2009 at 12:59 pm
The Dow no longer needs us, no longer needs a functioning economy below it. It can perform magic in the clouds.
Good! I say good riddance. Let em go. Let them have their Casino in the sky and let’s build a separate system for ourselves.
But while we are doing that, let’s get as much money back as possible.
October 18th, 2009 at 2:04 pm
Re Kevin at 10: “So excuse me if I don’t get very excited about some options trading. That didn’t bring down the economy.”
—————
This, of course, is bullshit. The Five major US Banks are involved in about $170 TRILLION worth of derivatives. Which supposedly partially offset each other so everything winds down if EVERYBODY MEETS their obligations.
Question is: What happens to that house of cards if one of the cards collapses. Like a card called AIG, for example.
Goldman Sachs might very well be a smoldering pile of ashes today if the US government had not stepped in and put the US TAXPAYER on the hook to absorb AIGs massives losses and MAKE GOOD on AIG’s responsibilities to its counterparties. Including Goldman Sachs.
To be blase about $2 Trillion in federal funds being spent — and roughly $22 TRILLION more put at risk in the form of unsecured loans, federal guarantees,etc is outright fucking stupid. Especially when the Democrats like Max Baucus argue that we can spend a measly $500 billion on healthcare for the common citizens –over a fucking period of 10 years — unless we steal the money out of the Medicare Trust Fund.
Have we seen Obama indict anybody? Impose any financial regulations?
The fucking slow roll Larry Summers is doing will ensure that financial regulation doesn’t come up for discussion until either (a) the economy has fallen into the abyss, at which point we will have much bigger things to worry about or (b) the American people dig out of the rubble –paying 20 percent interest on their credit cards all the time — the economy recovers and fucking assholes like Summers argue that Democrats really shouldn’t mess with the magic of the free market.
October 18th, 2009 at 2:07 pm
What does Kevin think will happen to those $170 TRILLION in derivatives if US interest rates soar, Adjustable Rate Mortgages reset to higher rates, and the on going flood of mortgage defaults surges to a tsunami, making all those mortgages based securities worthless?
October 18th, 2009 at 2:13 pm
Trouble is, people don’t understand this stuff, but they don’t understand the stock market, either, so they figure it’s all the same: it’s not.
I’m thinking this is Credit Mobilier all over again. IIRC, when Union Pacific was building the transcontinental railroad, the principal investors weren’t content with simply making a reasonable profit on, yanno, a pretty profitable monopoly on the first East-West railroad, which they actually DID build.
So they created a phony company, which was essentially the original Union Pacific company in drag. Suckers who bought Union Pacific stock were set up to go broke, while the insiders who owned Credit Mobilier stock got rich — cuz the Union Pacific officers who were signing “contracts” with Credit Mobilier also OWNED Credit Mobilier, so they were “paying” themselves twice and three times what every transaction was worth: they were basically looting themselves.
But the immensely profitable (and largely legal) scam was that Union Pacific was a publicly held company, while Credit Mobilier was not: public risk, private profit.
Still, at least after that scam, there WAS a transcontinental railroad.
What real value is any of this derivative speculation creating? Anybody?
October 18th, 2009 at 2:35 pm
@14 Don Williams: “Have we seen Obama indict anybody?”
This is a very good question. How are the legal investigations going, anyway? For instance, when is Jim Cramer going to jail? He admitted on national television that he has repeatedly has been involved in felony conspiracies. BRAGGED ABOUT IT.
The FBI must be taking their time putting together a slam dunk case. Still, I have to wonder -what is taking so long? They have an uncoerced confession.
October 18th, 2009 at 3:58 pm
Well, I guess I’m not surprised by the response. And I assume I’m having a conversation with the dining room chairs, but I’ll give it another go.
None of the screaming, swearing, angry folks actually replied to the actual points I made.
No one disagreed with my statement on what caused the current crisis:
“I’m under the impression that we are in this mess because of a housing bubble along with selling worthless mortgages repackaged as investments that wiped people out. Then companies made stupid bets on the worthless investments and went bankrupt and this caused other companies they owed money to to go bankrupt, etc.”
But since this is apparently not what is going on today with GS or the other banks, then pretending it is the strikes me as silly and very unproductive.
I have read several blogs and articles about the recent profits on Wall Street, and they all talk about trading on the stock market or other regulated markets. Markets that require you to have money reserves and where you can calculate Risk pretty well and have no connection to AIG that I am aware of.
These markets did not cause our recent problems. Now it may well be the case that in addition to these trades, GS and others are still trading mortgages and their derivatives, but if they are this article didn’t mention it and none of the other things I’ve read mention them either. Reporters aren’t very good today and maybe they didn’t understand the difference and so didn’t mention it.
If you know of such an article that shows they are still trading mortgages, then the civil thing to do would have been to say “you are confused because you didn’t read this: xxx” and I would have thanked you for the link.
But this is the internet and many people don’t respond that way.
And no one responded to my other point about why these companies still have access to low interest government loans when they don’t seem to need them and aren’t loaning the money out again.
October 18th, 2009 at 4:35 pm
@18 Kevin: “These markets did not cause our recent problems”
Agree. In fact, I agree with most of your argument. But, what pisses some people off, including me, is failed organizations, like Goldman Sachs, were given funds to prevent them from collapsing so they could survive and not so much prosper, but help the overall economy.
At present, they may not be causing damage (although this remains to be seen), but they are most certainly not working their asses off to help anybody but themselves. They are using our money, tax payer money, as table stakes. They are well within their rights to do this, but at best it is unseemly and unproductive in relation to the health of the United States, and at worst, could prove disastrous for the country.
October 18th, 2009 at 5:50 pm
if Goldman Sachs just admitted it was fucking us all in the ass for fun, that’d be one thing; but they want to pretend we’re going to see a batch of beautiful babies nine months later….
October 18th, 2009 at 6:22 pm
Re Kevin at 18: ““I’m under the impression that we are in this mess because of a housing bubble along with selling worthless mortgages repackaged as investments that wiped people out. Then companies made stupid bets on the worthless investments and went bankrupt and this caused other companies they owed money to to go bankrupt, etc.”
But since this is apparently not what is going on today with GS or the other banks, then pretending it is the strikes me as silly and very unproductive.”
—————
1) Matt Taibbi at Rolling Stone explained it in his article “Inside the Great American Bubble Machine” at
http://www.rollingstone.com/politics/story/28816321/the_great_american_bubble_machine/print#
An excerpt:
“The first thing you need to know about Goldman Sachs is that it’s everywhere. The world’s most powerful investment bank is a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.
Any attempt to construct a narrative around all the former Goldmanites in influential positions quickly becomes an absurd and pointless exercise, like trying to make a list of everything. What you need to know is the big picture: If America is circling the drain, Goldman Sachs has found a way to be that drain — an extremely unfortunate loophole in the system of Western democratic capitalism, which never foresaw that in a society governed passively by free markets and free elections, organized greed always defeats disorganized democracy.
They achieve this using the same playbook over and over again. The formula is relatively simple: Goldman positions itself in the middle of a speculative bubble, selling investments they know are crap. Then they hoover up vast sums from the middle and lower floors of society with the aid of a crippled and corrupt state that allows it to rewrite the rules in exchange for the relative pennies the bank throws at political patronage. Finally, when it all goes bust, leaving millions of ordinary citizens broke and starving, they begin the entire process over again, riding in to rescue us all by lending us back our own money at interest, selling themselves as men above greed, just a bunch of really smart guys keeping the wheels greased. They’ve been pulling this same stunt over and over since the 1920s — and now they’re preparing to do it again, creating what may be the biggest and most audacious bubble yet.”
October 18th, 2009 at 6:27 pm
Taibbi notes Goldman Sachs role in promoting the Internet bubble, the Oil Price spike bubble, and the Housing bubble.
He also notes that its ridiculous to talk of the US government regulating this predatory behavior when Goldman Sachs OWNS the US Government as a minor subsidary.
And that is not just Taibbi’s opinion. From
http://en.wikipedia.org/wiki/Goldman_Sachs_International#Former_U.S._Assistant_Secretary_of_Treasury_claims_Treasury_works_for_Goldman_Sachs
“In an interview in July 2009, former Assistant Secretary of Treasury Paul Craig Roberts was asked “Does the US Secretary of the Treasury work for the people or does he work for the banking system on Wall Street?” to which he replied, “He works for Goldman Sachs.”
October 18th, 2009 at 6:42 pm
Where did Goldman Sachs get the capital to earn its profits?
1) Well, first it issued about $100 Billion of subprime mortgage-based securities in 2006 that have since turned to shit:
http://en.wikipedia.org/wiki/Goldman_Sachs_International#Goldman_Sachs.27_Alternative_Mortgage_Products
2) Next , in a display of extraordinary acumen, it shorted subprime mortgage securities in 2007, gambling that they would turn to shit:
http://en.wikipedia.org/wiki/Goldman_Sachs_International#Actions_in_the_2007-_subprime_mortgage_crisis
October 18th, 2009 at 9:38 pm
@20 Don Williams: “Next , in a display of extraordinary acumen, it shorted subprime mortgage securities in 2007, gambling that they would turn to shit:”
They say shorting is good and creates balance but I’m not convinced. Shorting creates its own downward pressure. It feeds on itself.
Not only that, but being able to play both sides equally, both up AND down, means the only thing you care about as a player is the angle of ascent or descent. You desire the angle to be both long and steep. If the market is making one long steady descent into the toilet, that’s FANTASTIC, because you short everything for months and months with NO worries and make a fortune.
The whole idea of aggressively playing both up and down is to force the market to become a rollercoaster. That is the ideal. Sweeping up and downs. Volatility. And with computers taking over, trading at unheard of speeds, it means mini-rollercoasters, wild daily swings, are not only NOT to feared, but allow you to take your shots -make big plays- every single day.
I’ve never traded or really even bought a stock, but I’ve been around gamblers my whole life. The life-blood of gamblers is not winning or losing -life is ACTION. Modern traders are nothing but action junkies. The last thing they want on this earth is a steady, boring market.
October 18th, 2009 at 9:57 pm
Hahaha, this is just the moral hazard playing itself out. GS is operating entirely rationally, given that they are not bearing any of the risk themselves.
How is this supposed to make anything better? Oh, I know, by giving the Fed (staffed by GS execs) more regulatory power to make sure GS doesn’t fail.
This is fascism, plain and simple.
October 19th, 2009 at 1:10 am
“The end of democracy and defeat of the American Revolution will occur when government falls into the hands of the lending institutions and moneyed incorporations.”
Thomas Jefferson
“I have two great enemies, the Southern Army in front of me and the bankers in the rear. Of the two, the one at my rear is my greatest foe.”
Abraham Lincoln
Smart lads, those two.
October 19th, 2009 at 1:21 pm
[...] huh? There were “risks” involved, somehow? As Matt Yglesias points out: It’s not really a “risk,” though, is it when you’re operating with an [...]
October 19th, 2009 at 1:22 pm
[...] huh? There were “risks” involved, somehow? As Matt Yglesias points out: It’s not really a “risk,” though, is it when you’re operating with an [...]
October 19th, 2009 at 2:52 pm
[...] Peter J. Wallison penned an op-ed for the Wall Street Journal in which he points a finger at the federal government for the mortgage crisis. Wallison points out that the predatory lending theory only tells half the story: Someone had to buy all these toxic assets; often as not, the buyers were government-backed agencies. Ilya Somin concurs and extends: Not only did government back the purchase of these bad mortgages, they also encouraged excessive risk-taking by the private sector. Kevin Drum is angered not by this, but rather because the banks are recovering faster than the rest of the economy because of further government intervention. And Matthew Yglesias says that we are repeating the pattern. [...]