Felix Salmon

The curious case of Goldman’s disappearing December

Felix Salmon
Apr 15, 2009 15:40 UTC

As far as its financial statements are concerned, Goldman Sachs’s 2008 ended in November. Its 2009 began in January. In between was possibly the worst month in its history.

Heidi Moore is charitable:

The move effectively eliminated a very ugly month from Goldman’s official annual financial results for both 2008 and 2009, although that was likely not the bank’s intent.

John Hempton is less so:

Am I surprised that Goldies had an “orphan month” and stuffed the bad news in it? No. If you were – then obviously you are new to investment banking.

I suspect that when it comes to bonus time at Goldman, December 2008 will never matter. The 2008 bonuses will be paid based on the 2008 fiscal year, while the 2009 bonuses will be paid based on the 2009 fiscal year. And those $1.3 billion of losses in December — losses which will never show up in any annual report — will be conveniently ignored by the compensation honchos.

Attention Eliot Spitzer: just when you think things can’t get any more shameless, they do. Your hopes that stakeholders will finally start throwing their weight around when it comes to compensation will never come to pass.

Update: Goldman tells Floyd Norris that “the change in fiscal year was required when it converted to a bank holding company”. But as Norris notes, relegating the December results to “a table deep in the announcement” was not in the requirements.


I am completely agnostic as to whether GS evil or honorable, but you guys are really INSULTING THE INTELLIGENCE of REAL investors. Firstly, I have known GS will have a bad Dec for months. It’s such an old news! Most analysts touched on December as they projected the 1st quarter earnings estimates. Secondly, on the earnings conference call, GS CFO spent the first several minutes reviewing their December numbers before he kicked off the quarterly earnings report.

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Should Bernanke be explaining US policy?

Felix Salmon
Apr 15, 2009 14:50 UTC

The WSJ leads today with a story on what it calls “Bernanke’s PR Push“, saying that the Fed chairman “is waging a public-relations offensive” and conducting a “campaign for openness”. This is good in the short term, but I’m not sure it’s good in the long term.

Alan Blinder gets the problem exactly right:

“The American public is seeing things happening that it doesn’t like and doesn’t understand and nobody is really explaining it to them,” says Alan Blinder, a Princeton professor and former Fed vice chairman. “That was true in the Bush administration and it remains largely true in the Obama administration. The Fed is filling the void.”

The only really good communicator on Obama’s economic team is the president himself. Summers is bad at talking in public, with his remarks being ill comprehended by the American people up to and including the faculty of Harvard. Geithner famously flubbed his first major presentation as Treasury secretary so badly that his do-over was conducted far from any television camera. And so it falls to Bernanke to provide the clear explanations of economic policy that the American public so desperately wants.

The problem, of course, is the one of Fed independence: if Bernanke becomes the person best able to explain the Obama administration’s economic policy, it becomes much more difficult for him to credibly say that he is genuinely independent of the White House. As Greg Ip explains:

The controversy also comes at a delicate moment for the Fed. Two governors’ seats are vacant and Ben Bernanke’s four-year term as chairman ends next January. The Fed also needs favours from Congress: it would like authority to issue debt securities to soak up the excess liquidity its rescue operations have created, or for the Treasury to have authority on its behalf. The Treasury is seeking to revamp financial rules and give the Fed more sway over the financial system. Hostile congressmen could seize on such initiatives to impose changes that the Fed doesn’t want.

What’s more, Bernanke is far from secure in his job:

Friends and associates of the central bank chief were appalled in November when word leaked out of Mr. Obama’s transition team that Mr. Summers could be a successor to Mr. Bernanke.
“It was a terrible thing to start lame-ducking the chairman of the Fed a year before his term is over,” says Mr. Blinder.

In many ways, Bernanke is taking on responsibilities which should properly be those of the Treasury secreatary rather than the Fed chairman. Maybe, if Summers gets his way and takes Bernanke’s job, Obama might consider moving Bernanke to Treasury? Geithner’s not an economist by training so maybe he shouldn’t just fill the empty position at the NEC, but it does make sense to put him in more of a technocratic advisory role — where he shines — as opposed to his current executive role, where he does seem to be struggling.

In any case, I’m glad that Bernanke is coming into his own and putting his professorial skills to good use: having someone with the ability to speak English is surely better than having no one.


I have nothing but respect for Christie Romer, but she has not done well on TV.

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Goldman’s hubris

Felix Salmon
Apr 15, 2009 13:13 UTC

Any interest in buying shares in a highly-opaque financial institution which has been receiving billions of dollars from the US government but doesn’t want to do that any more; which is happily diluting itself in the midst of a hugely volatile and nervous market; and which generally acts in the imperious we-know-best, don’t-ask-questions tradition of all the best Ponzi artists? No? Well, you’re in good company: after the bank sold $5 billion of stock at $123 a share yesterday, the shares promptly plunged to close at $115 apiece, making everybody who participated in the offering feel like something of a schmuck.

Indeed, Goldman’s share offering yesterday is particularly distasteful in that in came fresh on the heels of Goldman’s first-quarter earnings report — a report which, according to no less an authority than BlackRock’s Peter Fisher, was mostly made up of one-off AIG-related earnings.

The AIG tale is important to keep in mind here, because the money flowing from the US government, through AIG, and ultimately to Goldman in January and February is possibly only half the story. The other half is Goldman’s famous counterparty hedging. Goldman is well known for having a more sophisticated counterparty hedging operation than any other bank; it claims — and I believe it — that all its AIG exposure was hedged. But what exactly did these famous counterparty hedges consist in? We can speculate endlessly about CCDS and the like, but there’s a rumor going around that a significant part of the hedge was a simple old-fashioned short position in AIG stock. And if that’s the case, Goldman ended up getting paid out both on the default protection it bought from AIG and on the hedges it took out against AIG being unable to make those payments. Talk about non-recurring earnings.

In the absence of much real-world primary-markets activity, Goldman’s prop desks are working hard to keep the firm’s profits up: according to my colleague Jonathan Ford, the value of Goldman’s principal equity trades in the first quarter principal equity program trades in the latest weekly data was an impressive 4.2 times the business it did for customers. In other words, Goldman is reverting to being the overgrown hedge fund which we thought was being quietly wound down when it became a bank holding company.

So yes, on the one hand the government has no business supporting a systemically-highly-risky hedge fund like Goldman Sachs with TARP money and bank charters. At the same time, Goldman has no business saying “thank you very much” for the financial-system bailout, but politely trying to decline participation in it by handing back the TARP funds. Like it or not, Goldman is a central part of the financial system, which means that it’s a central part of any bailout strategy. It can’t unilaterally say no to that, and I hope that it gets slapped down by Treasury as definitively as it was slapped down by the stock market yesterday.


I enjoyed Ben’s explanation of the recent bank earnings announcements and where to look for the support. Most banks are pointing to their trading divisions as the source of their earnings with the exception of the one time gain from the sale of assets or the gains made by accounting for the changes in the assets they are holding (mortgages).

I still would like to know this: if the banks can reprice what is essentially my debt on their books (an asset) to what it will ultimately pay, why can’t I reprice my mortgage (an asset) for refinancing purposes to what my property will be worth in 30 years?

As Ben said, this could go on until/if the fed were ever to lose control of the yield curve. The risk is the longer it goes on the more the yield curve will price in inflation which is where the fed and the banks get the squeeze. Borrow short and lend long..not bad when you do this spread and the counterparty (taxpayer) who is the same on both sides of your trade…good for you, bad for the counterparty. In the normal course of business this entity would go bankrupt.

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Tuesday links get bailed out

Felix Salmon
Apr 14, 2009 22:19 UTC

Wells Fargo Q1 Profits Packed with Accounting Gain: Cowen comments.

New bond trading rules target disclosure on pricing: In Canada. Doing it elsewhere wouldn’t be such a bad idea either, retail investors often get ripped off in the bond markets.

Eye on the Bailout: A new blog from ProPublica, tracking bailout funds.


I know enough finance to be dangerous (gee that’s an uncommon theme in these times), but I’m just an ordinary joe who likes this stuff. So what is going on with WFC stock? If i had any I’d have sold it as soon as earnings were announced.. I can’t believe the W acquisition didn’t saddle them with some serious pain. Ah well, I don’t like to stand under daggers anywho, I haven’t been near bank stocks in over half a year.

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Do Moody’s downgrades matter?

Felix Salmon
Apr 14, 2009 22:17 UTC

Can anybody tell the difference between a level and a direction any more? Not at the FT, it would seem, which ran a story yesterday under the headline “Credit quality of global groups at 25-year low”. Here’s how it begins:

The credit quality of global companies has deteriorated to levels not seen for more than a quarter of a century, according to Moody’s Investors Service.

The ratings agency said the ratio of companies having their credit ratings cut versus the number of companies being upgraded – an indicator of declining credit quality – had reached its highest level since 1983.

Of course, just because the rate of decline of ratings is at a 25-year low does not mean that the absolute credit quality of global companies is at a 25-year low.

And even the rate of decline doesn’t seem to be all that bad, once you read on:

During the first quarter of 2009, the rate at which borrowers were having their ratings cut reached 13.8 per cent, highlighting the negative credit climate in the first part of the year, analysts at Moody’s said.

“This downgrade rate is higher than pre-economic crisis figures,” said Jennifer Tennant, Moody’s analyst. For the whole of 2006, the downgrade rate was 10.2 per cent, and the average rate from 1983-2009 was 12.5 per cent per year.

All of these numbers seem to be annualized rates, and if the downgrade rate was 10.2% in 2006, at the height of the Great Moderation, then a rise to just 13.8% today seems positively modest — especially when the long-term average is 12.5%.

But the story is confusing: it goes on to say that the long-term upgrade rate is just 7.9%, which would seem to imply that on a net basis, credit quality has been deteriorating steadily for a quarter of a decade at least, with downgrades nearly always outnumbering upgrades. Is that really true? After its first two paragraphs, I don’t trust this FT story to enlighten me on such matters.
And more to the point, does anybody even care what Moody’s thinks any more? Wouldn’t it be better to just look at default rates and credit spreads, rather than ratings, which are horribly lagging indicators even at the best of times?


I am a commercial credit rating expert and the only way for them to regain any credibility is to “show the why” behind their rating … be transparent.

Rate the “5 Cs of Credit” separately to show those individual opinions.

Asking questions of Larry Summers

Felix Salmon
Apr 14, 2009 22:10 UTC

Larry Summers just gave an interview to CNBC’s Maria Bartiromo in which neither side was particularly impressive. Bartiromo managed to go the entire interview without asking Summers about about the fact that he seems to be bought and paid for by Wall Street. And Summers proved himself incapable of even answering Bartiromo’s softballs:

BARTIROMO: And it leads me–it leads me to sort of a more thoughtful, broader idea here, and it feels like there’s a bit of a competition going. On the one hand, the government is saying to the banks, `Look, you need to lend more,’ lend, lend, lend, get the credit moving again,’ since credit has been stripped in this economy, literally, five quarters. On the other hand, the government is saying, `We’re performing stress tests and you need to get your capital levels at an appropriate level.’ So why would a bank lend when they know that they’ve got to get their credit level–they’ve got to get their capital levels up?

Mr. SUMMERS: Well, I think the focus of the stress test is going to be on levels of capital rather than capital ratios. And so the focus is going to be on making sure that institutions raise capital or take other kinds of steps to assure that they have capital that enables them to support their existing loans and puts them in a position–puts them in a position to expand. And that’s really where focus–really where the focus is going to be. Nobody’s looking to use the stress test as a vehicle for forcing institutions to deleverage and reduce their lending activity. Rather, the action’s going to be on the capital side, and that’s where you’re supporting a stronger economy and more lending that enables more growth.

“The focus of the stress test is going to be on levels of capital rather than capital ratios” means nothing — it’s utter blather. Summers, here, is simply bloviating: he’s not even attempting to answer the question. Does the government want the banks to lend freely, or does it want them to hunker down behind fortress balance sheets with vast amounts of tier-one capital? You’ll get no insight from Larry Summers on that front.

But at least he’s smart enough to pick an interviewer who won’t ask him the really tough questions, like whether his actions as Treasury secretary helped to pump up the financial-services bubble whose implosion we’re all now suffering through, and whether he owes the American people an apology. Instead, he’ll continue to simply ignore the irate.


When did Mario ask anyone anything but a softball question. Part of the crisis was created by CBNC and all their models,…I mean journalists.

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Chart of the day, pirate edition

Felix Salmon
Apr 14, 2009 21:09 UTC


(This is doing the rounds, not sure where it started, but possibly here.)


It’s amazing how many crazy opinions a pretty simple funny chart can bring out.

New Yorker is probably #1 – what is Obama going to say about pirates other than sending SF to shoot them? Do we need a speech about why pirates are bad? “Obama might be a Muslim” will go in future textbooks on racism right next to the blood libel.

Coastal Pirate thinks that what the world needs is MORE of the USA kicking the **** out of some tiny country that no one cares about rather than less. I suppose you think that if we had only bombed Vietnam harder we could have won that one too? What makes you think that raw US military force can pacify a place as awful and chaotic as Somalia? Please enlighten us as to how tanks prevent corruption, sea piracy, and starvation.

And then there’s sven, making me embarassed to be a liberal, which is hard to do (I love liberalism even if I don’t like most Democrats). I’m all for seeing both sides of an issue, but if any group in the world lacks redeeming qualities, it is pirates. You can make a case that Palestinians have no other way but terrorism to resist Israeli militarism/imperialism (I’m not saying I agree, but you can make a case). Pirates are not the same: these are people who hijack food aid shipments for profit and murder hostages without any coherent political message or goal other than personal gain. They don’t have a legitimate argument. There are avenues to address grievances like oceanic territorial disputes and pollution. Pirates don’t care because they are at war with civilized society. If a soldier has to shoot them in the head to free a hostage, he is engaging in one of the most defensible forms of warfare. A certain amount of moral relativism is fine, but if your moral relativism recognizes the legitimacy of amoral piracy as a political strategy you’re over-applying your freshman ethics course.

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Economic prognosticator of the day

Felix Salmon
Apr 14, 2009 20:04 UTC

This is my new favorite Amazon page: it lists the top books by Harry S Dent. It’s best read countdown-style, from the bottom up. The top three are great: in third place is “Bubble After Bubble in The Ongoing Bubble Boom: Oil Bursts, the Housing Bubble Fades and Now Stocks Emerge Into a Greater Bubble that Finally Ends in 2010“. That one was published in 2005. Then in second place comes Dent’s 2006 book, “The Next Great Bubble Boom: How to Profit from the Greatest Boom in History: 2006-2010“. Finally is his most recent book, published in January this year: “The Great Depression Ahead: How to Prosper in the Crash Following the Greatest Boom in History“.

But don’t worry, you don’t need to buy his books. If you register by April 20, you can attend Dent’s seminar in Scottsdale, Arizona for a mere $1,045! Hear Harry talk — in person — about how to “protect your finances” from the current “spike in energy costs”! Of course, he doesn’t tell you how to protect your finances from snake-oil salesmen. But maybe you can learn that the hard way.

(HT: Lex)


Could someone post the chart from his Roaring 2000′s book that showed how demographics would lead to Dow 32000? We were amused.

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Can you stop banks acting like lemmings?

Felix Salmon
Apr 14, 2009 15:28 UTC

The great Larry Lessig emails me to point to a Newsweek article he wrote back in October, which I missed at the time. It’s entitled “Why The Banks All Fell Down”, and Lessig asks whether there’s a connection between his theory there, on the one hand (properly Lessig ascribes it to Avinash Persaud), and my story about the Gaussian copula function, on the other.

Here’s Lessig:

The models governing our financial system were developed in the 1950s. They were built, as Persaud explains, upon the assumption that “each user is the only person using them.” That assumption may have made sense when only the Rand Corporation (which developed the models) had the data to act upon them. But as Persaud wrote in the Financial Times in March, in “today’s flat world, [where] market participants from Argentina to New Zealand have the same data,” the assumption is nothing short of nuts. As the market shifts, the models used by all the major investment banks “throw up the same portfolios to be favored and those not to be.” This is the Heisenberg uncertainty principle for financial markets: by being observed, the observed gets changed. The global, simultaneous and practically instantaneous “adjustments” lead “the herd” (a.k.a. our financial system) right off the cliff.

The financial system is indeed full of models which make sense if only one person uses them, but which become extremely dangerous if everybody starts to use them. Here’s the relevant bit of my Wired story:

The real danger was created not because any given trader adopted it but because every trader did. In financial markets, everybody doing the same thing is the classic recipe for a bubble and inevitable bust.

The financial markets were reminded of this in the summer of 2007, when simultaneously all the formerly-very-successful quant and stat-arb hedge funds all blew up at the same time. Bryant Urstadt wrote the definitive article on the blow-up for the MIT Technology Review, which is hidden behind a registration firewall here; the gist is that all the funds were following much the same strategy (something called “pairs trading” is mentioned), and that as a result asset classes become highly correlated which were never correlated in the past.

In 2007, the damage was limited: there was a lot of fallout in the world of hedge funds, but the stock market continued to rise, and the systemic implications seemed to be contained. But the adoption of the Gaussian copula function was much more widespread than a bunch of hedge funds: it was embraced at pretty much every CDO origination and trading desk on Wall Street. And when the entire financial system starts using essentially the same model, the systemic devastation which can result is enormous.

So yes, when Persaud talks about “the market-sensitive risk models used by thousands of market participants”, he’s very much referring to things like the Gaussian copula function, which proved to be one of the best ways ever invented of shunting risk off into the tails. He’s probably also talking about the near-universal adoption of Value-at-Risk, which as Joe Nocera explains does a great job of allowing managers to ignore the tails, no matter how much risk is in them.

Persaud says that there are important implications for regulatory policy:

This brings us to the philosophical problem of the reliance of supervisors on bank risk models. The reason we regulate markets over and above normal corporate law is that from time to time markets fail and these failings have devastating consequences. If the purpose of regulation is to avoid market failures, we cannot use, as the instruments of financial regulation, risk-models that rely on market prices, or any other instrument derived from market prices such as mark-to-market accounting. Market prices cannot save us from market failures. Yet, this is the thrust of modern financial regulation, which calls for more transparency on prices, more price-sensitive risk models and more price-sensitive prudential controls. These tools are like seat belts that stop working whenever you press hard on the accelerator.

The problem is that it’s very unclear what the alternative is. The lesson of the failure of Basel II is, indeed, that you can’t trust banks to judge their own internal risks very well. But the whole reason why Basel II was created in the first place is that financial instruments are so complicated these days that it’s very easy to do an end-run around simpler regulations.

My feeling is that the best way to go is to set some very clear and simple rules, much as the Spanish central bank did, and refuse to allow banks to build enormous businesses doing things that the regulators don’t understand. And secondly to place a cap on banks’ balance sheets — I think something around $300 billion is reasonable, and that there’s no reason why any bank should be bigger than that. Alternatively, if you are bigger than that, then you have to become much more constrained in what kind of activities you’re involved in: you should basically just be doing plain-vanilla deposit-taking, borrowing, and lending.

That wouldn’t prevent future financial crises outright. But it would probably stop them from causing a major global recession.


Ian, man, chill. If you don’t like it, don’t read it. I like physics too, but I’m not going to dump on Felix for using a famous but widely misunderstood principle to communicate with the majority of his audience a bit better. I thought it was clever. Felix, I don’t mind seeing this point made again and again (and I’ve seen similar discussions before.) It’s valid and pertinent to the Global Crisis.

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