Commentaries

Giving props to Wall Street’s risks

Wall Street would like you to believe that when investment banks take on risk they are largely doing it for the benefit of investors — maybe even you and me.

Bankers say much of the capital that their firms put at risk each day is to complete trades for big corporations, mutual funds, pension funds, hedge funds and university endowments. And contrary to the conventional wisdom, proprietary trading — bets made for a bank’s own behalf — is really just a small part of their business.

Lately, Wall Street’s captains of capitalism have been aggressive in pushing the “we take big risks for our customers, not for ourselves” line of argument.

That’s especially so in the wake of the public furor over the outsized trading gains at the big banks like Goldman Sachs Group, JPMorgan Chase and Barclays and even Citigroup, so soon after the collapse of Lehman Brothers.

The notion that risk is being taken for customers as opposed to for the firm’s own benefit is somehow supposed to make it seem more palatable and somehow less risky.

Still, for many, the image persists that investment banks spend a lot of time and resources gambling on stocks, bonds, commodities or currencies to generate fat profits and big bonuses. And there’s good reason for that image: Wall Street firms don’t break out the dollars they take in from client trades versus those generated by prop trading.

Yet from the perspective of Wall Street bankers, it’s perfectly logical to see much of their risk taking simply as part of trades for their customers.

Nerdy thought on the Fed balance sheet

Looking quickly at the Fed balance sheet, I stumbled upon the “off balance sheet” quirk of its mortgage-backed security holdings. The Fed reports this week that its holdings through Wednesday Sept. 2 stand at $625 billion. But we know from the NY Fed data released yesterday that the central bank has bought $817.6 billion MBS so far this year.

The discrepancy, which I had forgotten but a kind source reminded me of, is because the Fed is buying mortgage pass-throughs before they settle, those purchases won’t show up right away. Here is the table that shows there are $164.7 billion MBS essentially off balance sheet. So there’s still a whole lot more coming onto the Fed’s balance sheet, even if they stopped purchasing MBS tomorrow.

Barclays’ yo-yo balance sheet

Talk about deleveraging. By far the most striking number in Barclays’ first-half profits concerns its balance sheet:

Our total assets decreased by £508bn to £1,545bn over the first half of 2009.

Given the stated desire by regulators – and investors – for banks to shrink their balance sheets, a 25 per cent reduction in total assets in the space of just six months has to be applauded, right?

Not so fast. While it is true that Barclays’ asset base has shrunk since last December, it’s still higher than it was a year ago, when total assets were £1,366bn. So all that has happened is that its balance sheet, which ballooned in the second half of last year, has shrunk to something approaching its former size.

It’s not entirely clear what is going on. When it reported full-year results in March, Barclays attributed the explosion in its balance sheet largely to the devaluation of sterling, which boosted the value of its giant dollar-denominated derivatives book.

Derivatives are also the culprits this time. Total derivatives assets on Barclays’ balance sheet collapsed from £982bn at the end of December to £555bn at the end of June. Investors perplexed by this change will have to turn to page 97 of Barclays’ earnings announcement, where it offers the following one-sentence explanation:

The £428,757m decrease (2008: increase of £584,793m) in the gross derivative assets has been predominantly driven by movements in market rates and initiatives to reduce the derivative balance.