Commentaries

Goldman, liquidity and VAR

Goldman Sachs’ second-quarter earnings release showed a continued increase in the amount of market risk held on the firm’s trading book. Its risk appetite has continued to expand at a time when extreme turbulence has forced others to scale back.

True, Goldman’s publicly reported figures may overstate its actual positions. But the Wall Street bank also appears to be taking advantage of its access to liquidity from the Federal Reserve to increase risk.

Total value-at-risk (VAR) averaged $344 million, on a gross basis before diversification effects, up from $303 million in the second quarter of 2008 and $226 million in the second quarter of 2007. 

Click chart to enlarge in new window.  Additional data available here.

(VAR is a crude measure of the worst loss the firm would expect to report on 19 days out of 20, given prevailing volatility in the market.)

Like other banks, Goldman reports VAR on a net basis after taking account of a “diversification effect”. The diversification effect reflects the fact that risks in different parts of Goldman’s book are not perfectly correlated.

The bank would not expect to lose the maximum amount on all its positions at the same time. So net VAR for the book as a whole is less than the sum of the VARs for the individual components (which Goldman reports as currencies, interest rates, equities, and commodities). Goldman’s net VAR in the second quarter averaged $245 million, up from $184 million in the second quarter of 2008 and $133 million in the second quarter of 2007. (more…)

Niche broker-dealer ready to trade IOUs

For those eager to buy or sell California IOUs, SecondMarket, a niche broker dealer that specializes in hard to trade assets, will launch its trading platform for the warrants on Wednesday.

But that doesn’t necessarily mean that trading will start tomorrow.

Buyers such as municipal debt portfolio managers, hedge funds and institutional investors are lining up for the service, according to SecondMarket spokesman Mark Murphy, but sellers not so much.

It’s still early days for the IOUS and there’s no guarantee that it will ever turn into a robust market. California could clean up its budget mess, for one.  And SecondMarket doesn’t have a track record of pushing through large trade volumes. In the last 12 months, SecondMarket transactions have totaled only $1 billion.

But it could signal something bigger if the budget stalemate drags on and other broker dealers join in.  California will issue around $3 billion IOUs this month if the status quo in Sacramento holds.

The downside, of course, is it could take the pressure off the state to come up with a solution to sort out its $26.3 billion budget gap. Voters are less likely to gripe if they can get cash for their IOUs. Many commercial banks have stopped accepting them for this reason, though the LA Times reported Bank of the West has agreed to keep depositing the IOUs indefinitely while Citi said it would exchange them for cash until this Friday.

Bank of Goldman

Lloyd Blankfein, chief executive officer of Goldman Sachs and banker-in-chief of the US/world, didn’t disappoint as his investment firm once again proved that it’s second to none on Wall Street when it comes to printing money and profits.

By now you know the headline news that Goldman generated blowout second-quarter earnings on record net revenues of $13.8 billion. Net revenues from trading and principal investments were $10.78 billion, up 93% from the year ago period.

Remember that trading code theft case with Sergey Aleynikov? No worries here.

The firm exceeded even the most widely optimistic analyst forecasts and demonstrated that the financial crisis, which pushed Goldman’s stock down to $51 last November is a distant memory–for Goldman at least. BTW, Goldman’s stock is now trading around $150. Talk about stock appreciation.

And it looks like maybe Goldman will be able to pay those fat year-end bonuses afterall. In the quarter, compensation and benefits expenses were $6.65 billion. That amount is higher than the second-quarter of 2008 because of higher net revenues. Fatter Goldman bonsues will make all those luxury real estate brokers in Manhattan happy.

But while everyone is singing Goldman’s praises, let me point out a few blemishes–albeit small ones.

First, Goldman continues to do investors no favor by failing to publish a detailed financial supplement along with its earnings release (something every other big bank does) to help decipher its quarterly numbers.

Goldman should disclose more

Goldman Sachs doesn’t report second-quarter earnings until Tuesday, but some Wall Street analysts aren’t waiting to sing the giant investment firm’s praises.

What’s impressing the analysts the most is Goldman’s ability to again print money like no one else — especially when it comes to trading stocks, bonds, commodities and currencies. Bank of America analyst Guy Moszkowski sounded almost giddy the other day in predicting blowout trading revenues for Goldman, describing the firm as “arguably the most well-respected investment bank.” Moszkowski now expects net trading revenues to top the record $25 billion raked in by Goldman in 2007.

It makes one fear that analysts will again start prefacing their questions during the firm’s scheduled conference call with comments like “Great quarter, guys.”

Please don’t.

Before everyone starts crowning Goldman the king of trading, is it too much to ask that analysts ask more probing questions of the firm’s executives? Investors deserve more disclosure about where all those dollars are coming from.

A question or two about how much of the trading revenues was related to client trades versus proprietary trades for the firm’s own account would be a good place to start. Don’t let Goldman executives get away with the firm’s standard answer about how most of its risk-taking is for clients, without ever quantifying that risk.

Now given Goldman’s general animus to the notion of fuller disclosure, I wouldn’t expect its executives to say much if pressed by analysts. So it probably will require the power of the Federal Reserve — Goldman’s new overseer — to lean on the investment bank to force it to provide more detail about the firm’s trading prowess.