Bethany McLean

Was Geithner ‘forceful’ on Libor?

Bethany McLean
Jul 27, 2012 21:45 UTC

“Exceptional.” “Very forceful.” “Early.” Those are the words used by Treasury Secretary Tim Geithner recently to describe what he did in the spring of 2008 to address problems with the key interest rate known as Libor. During Geithner’s congressional testimony this week, New York Senator Charles Schumer called Geithner “proactive.” Not to be outdone, White House Press Secretary Jay Carney chimed in after Geithner’s testimony, calling what Geithner did “aggressive.” The key piece of what he did, of course, was to send a memo dated June 1, 2008 to Bank of England Governor Mervyn King suggesting changes to improve the credibility of Libor.

Plenty of commentators, and especially Republicans, have given Geithner a hard time about his lack of other action. That’s not entirely fair because Geithner didn’t completely ignore the Libor problem; in addition to his memo, he also brought it up to the President’s Working Group on Financial Markets and to the Treasury. But at the same time, the lavish praise is hard to understand. How can it have been exceptional, forceful, early or aggressive for Geithner to have sent a memo across the Atlantic, when the press and the financial research community had already written not just about the problem with Libor but also about its potentially far-reaching consequences?

Consider that six weeks before Geithner’s memo, the Wall Street Journal’s Carrick Mollenkamp wrote an April 16, 2008 story entitled “Bankers Cast Doubt on Key Rate Amid Crisis.” The piece noted that Libor – which is supposed to be the average interest rate at which banks make short-term loans to each other and which serves as a basis for trillions of dollars in other loans – had become such a fixture in credit markets that many people trusted it implicitly. Mollenkamp quoted a mortgage banker who said he depended on Libor to tell him how much he owed his bank. Concerns about Libor’s reliability are “actually kind of frightening if you really sit and think about it,” the banker told Mollenkamp. On May 29, the Journal followed up with another, even more detailed analysis, which crunched the numbers to show just how much the banks might be understating Libor.

Even before the initial Journal piece appeared, on April 10, 2008, a research analyst at Citigroup named Scott Peng wrote a report headlined, “Special Topic: Is LIBOR broken?” Peng concluded that Libor could understate actual interbank lending costs by 20 to 30 basis points. Ironically enough, he based his evidence in part on the fact that the Fed itself was providing short-term loans to banks at a higher rate than Libor.   Not incidentally, Peng (whom Mollenkamp cited in his story) wrote the following: “LIBOR touches everyone from the largest international conglomerate to the smallest borrower in Peoria … the functionality and relevance of LIBOR is of primary importance to the global financial system … if LIBOR, now the most popular floating-rate index in the world, loses credibility because it no longer represents true interbank lending costs, the long-term psychological and economic impacts this could have on the financial market are incalculable.”

And even before that, in March 2008, in another report Mollenkamp cited, two economists at the Bank for International Settlements wrote their own report raising questions about Libor. They said that banks might have an incentive to provide false rates to profit from derivatives transactions, and that although the practice of throwing out the lowest and highest groups of quotes was likely to curb manipulation, Libor rates could still “be manipulated if contributor banks collude or if a sufficient number change their behavior.”

Should Goldman Sachs go out of business?

Bethany McLean
Jul 9, 2012 21:02 UTC

Among those who believe that Goldman is basically the devil’s spawn, there’s of course only one answer to the above question: Yes! But there’s another group that seems to be asking the same question, and that’s investors.

Consider that in the past year, Goldman’s stock has fallen some 30 percent. It trades for just 0.7 times book value, which says that investors either think that Goldman can’t earn enough to cover its cost of capital, or that its assets are overstated or liabilities understated. Consider this: Except during the financial crisis, Goldman’s market capitalization was last around $50 billion back in the fall of 2005. Back then, Goldman had $670 billion in assets, and $27 billion in shareholders’ equity. Today, Goldman has $951 billion in assets, and $72 billion in shareholders’ equity.

Goldman Sachs stock price, July 1, 2011 - July 1, 2012

Another way to think about Goldman’s valuation is that the firm effectively has $300 billion in cash and close cash equivalents on its balance sheet. You can get to that figure by adding cash, Level 1 assets, and Level 2 assets that could be easily liquidated. Goldman has total long-term and short-term debt of $220 billion, and a market value of $50 billion. In other words, the market is giving Goldman very little credit for the ongoing earnings of its business, and Goldman has a lot of dry powder relative to the opportunities it has. (A caveat: Goldman’s immense derivatives business would gobble up lots of cash were the firm to be hit with credit downgrades.)