Blithe Blankfein

By Felix Salmon
October 13, 2009
Lloyd Blankfein's op-ed in the FT today doesn't break much in the way of new ground, but it's still worth reading closely. That's the only way you can notice where his logic falls apart:

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Lloyd Blankfein’s op-ed in the FT today doesn’t break much in the way of new ground, but it’s still worth reading closely. That’s the only way you can notice where his logic falls apart:

An institution’s assets must also be valued at their fair market value – the price at which willing buyers and sellers transact – not at the (frequently irrelevant) historic value. Some argue that fair value accounting exacerbated the credit crisis. I see it differently. If institutions had been required to recognise their exposures promptly and value them appropriately, they would have been likely to curtail the worst risks. Instead, positions were not monitored, so changes in value were often ignored until losses grew to a point when solvency became an issue.

At Goldman Sachs, we calculate the fair value of our positions every day, because we would not know how to assess or manage risk if market prices were not reflected on our books. This approach provides an essential early warning system that is critical for risk managers and regulators.

The problem here is that Goldman’s mark-to-market system only works because other banks don’t follow suit. Think about what Blankfein is and isn’t saying here. He’s not saying that mark-to-market can stop credit bubbles from happening, because they can’t. In fact, if you mark your risk assets to market during a credit bubble, then the asset side of your balance sheet rises, and you look safer than if you marked to par. As a result, you’re likely to take more risk, not less.

So what happens when the bubble bursts and markets turn south? There are basically three options:

  1. The banks all mark to par. This is the brave-it-out approach, which actually works very well in mild recessions.
  2. The banks all mark to par, except Goldman Sachs, which marks to market. When there’s a major disruption this works well for Goldman Sachs, which can start selling as soon as the markets start turning, even as the rest of the market tries to brave things out.
  3. The banks all mark to market. This risks being disastrously procyclical, with all the banks running to the exits at the same time.

Blankfein would have us all believe that option 3 makes sense, and that somehow all the banks could sell all their assets at the same time and before they declined so far that solvency was imperiled. But who does he think they’d sell their assets to?

Blankfein also thinks it’s easy to get investment banks to hand over to regulators extremely sensitive and valuable market intelligence:

We have to build a culture whereby firms are required to share concerns about systemic risks with regulators…

Regulators could establish a multi-firm business practices committee to examine issues such as underwriting standards. If practices slip, regulators would be among the first to know. They should ask questions such as: “Where are policies being stretched and pressures building? Where are you seeing concentrations in risk, crowded trades or one-way bets?”

The insight here makes sense, and I agree with it: regulators should ask questions, and banks should volunteer information when they see systemic risks. But a large part the reason that the banks have this information in the first place is that they are trusted by their counterparties to keep secrets: that’s one of the reasons that all banks bang on so incessantly about putting clients first. What happens when you get confidential information from a client which would be of great interest to your regulator?

The fact is that there are a lot of hard questions here, and Blankfein’s blithe assurances that conceptually it’s quite easy to answer them ring false to me. Especially when he never mentions the too-big-to-fail elephant in the room. Because he knows that any action on that front would harm, rather than help, Goldman Sachs.


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TBTF Banks, henceforth known as “The TubbyTuffs”

Goldman is evil through and through.

They have abused government power and leveraged their big government positions to ensure they win whether they manage their risk well or not.

Goldman entered contracts with AIG. No one forced them to. And Goldman got paid back in full for THEIR risks.

Taxpayers (people losing houses) paid for THEIR risks because Goldman can call the Treasury. People lost jobs but Goldman got government cash. It is despicable how big government welfare Goldman is.

Posted by anon | Report as abusive

I find it amusing that 1) The editorial reads like an advertisement for Goldman Sachs (“We make money the old-fashioned way…”), and 2) It is published just before Meredith Whitney downgraded Goldman stock.

To be fair, Blankfein probably did not know about the impending downgrade when he wrote it, but presumably he has known, for some time, the factors that led to the downgrade.

I blogged at TPM Cafe about this Blankfein Op-ed – I was somewhat harsher than you, referring to this as Blankfein concern-trolling the regulation of investment banks.

You can’t understate the chutzpah attached to his “fair market value” call to action, when last year Goldman used the Level 3 bucket like no other firm in the industry.

I do have grudging respect for some of the ways Goldman run their business, but the call for transparency is utter bull. And his point about the regulatory fora where systemic risk can be discussed… I used to participate in one, and Goldman got disinvited because they contributed jack-squat to the debate and treated it purely as intelligence gathering on competitors.

That’s how they roll, regardless of what Van Praag and co want you to believe.

Posted by Ed | Report as abusive

I think you miss some of Blankfein’s point on m2m. Lots of credit was extended in 2007, when banks should have been reining in their positions. They were marking to either par or fantasy for that year. Look at when delinquincies started happening, and then at home prices. You see your income stream fall, and the collateral backing fall in price. Case-Shiller in Miami stopped increasing in May 2006! If for all of 2007 risk was reduced instead of being double and tripled down, things would not have gotten so bad. Loans written in 2007 are close to the worst performing, and they were written because of a failure to recognize mounting losses.

Posted by winstongator | Report as abusive

Salmon’s logic is indisputable here. And if I didn’t think Blankfein was a liar about marking to market (despite all the self-superior talk, who knows what his accountants really do in their cubicles?), I would be prepared to go very short GS at the next downturn. I wonder if Buffett is on board with whatever Blankfein is doing?

I also wonder if Blankfein’s actions don’t amount to the criminal level. GS supposedly did a study on the effects of mark-to-market back in the ’90s. They found that revenues would fluctuate severely, up 80-90% for two years, then down 40-50% the next two. Blankfein would surely be aware of these as CEO, and if he is not, that is surely utter incompetence. He is going against his shareholders’ fiduciary interests.

I will leave off here pointing out that Salmon’s point #2 demonstrates the old bit of wisdom about how the people who put on the most do-gooder airs are the very people sucking off the system. Parasitism and formal altruism go hand in hand. Never trust a do-gooder.

Posted by WM | Report as abusive

Ed, I just read your blog over at TPM, and it was brilliant.

Posted by WM | Report as abusive

So, we’re counting on a mild recession to allow banks to use the “brave it out” approach successfully? I’m sure holding assets at par that are worth less than 50 cents on the dollar is fair to investors trying to make sense of a bank balance sheet, right?

Essentially you’re saying that because banks are secretive we should have them mark all assets to par value, cost, or mark to a number pulled out my ass? How is the investor supposed to make any sense of a bank’s balance sheet then.

The reality is that investors should know what the liquid worth of a bank is. As we’ve seen liquidity can dissapear in a heartbeat, and investors should know what a bank can sell its assets for now if needed. The idea that we can prevent liquidity crises from happening is a pipe dream, as there will always be new ways for investors to get scared brainless.

Let investors decide for themselves if the assets on a bank’s balance sheet are going up because of a bubble or because true economic worth is being created. In your world, no one gets to analyze anything, because no one has to bother to know anything. Everything is just marked to par until some analyst figures out what crap the bank is holding.

Posted by Structured Products Guy | Report as abusive

+1 Structured Products Guy

If there’s a problem, its the capital rules not M2M.

Posted by thruth | Report as abusive

“If there’s a problem, its the capital rules not M2M.”

There’s no one single problem, but there is one way to make a lot of these problems less systemically serious – by putting a hard limit on leverage. Canada does that, and it seems to work for their banks.

No need to explain why Goldman would not be a fan of such a limit.

Ps. WM, glad you enjoyed my ZeroHedge audition

Posted by Ed | Report as abusive

My answer to too-big-to-fail and any and ALL financial/banking bailouts in the future: As soon as you take government (taxpayer) money, your pay structure goes GS. At the top (Blankenfein), you are now a GS-13 with payscale to match. No bonuses, no perks, nothing. Plain Jane GS pay. Don’t like it? Tough titty. You other option is to lose the entire shebang and go bankrupt.

Bankruptcy laws altered so that ALL the wealth of the execs that did the stupid is on the block to pay back investors. Not just corporate assets are up on the chopping block, but PERSONAL assets.

You want to go stupid and crazy and try for the solid gold ring? Ok, but if you fail as craptacularly as they ALL did in the meltdown, then they not only don’t get the gold ring, they also cough up EVERYTHING they obtained in the lead up to the shit hitting the fan.

Posted by Praedor Atrebates | Report as abusive

I like Praedor’s idea, but would apply it to anyone taking even just govt guarantees – FDIC insurance included – gets teh GS payscale.

Posted by winstongator | Report as abusive

@ Praedor

Nice idea but…. not really. Following the switch over to a new payscale, almost all of your key employees who can go elsewhere, or can afford to take a few years off, just leave. I know, I know, “they caused the mess so we’re better off if they leave.” WRONG! This is a completely ignorant statement, and if you think it’s a good way to go about unwinding and liquidating failed firms, it shows your ignorance as to how derivatives and securitizations work. In any unwinding or liquidation of a firm, you NEED former employees, even ones who caused the mess! They are the ones who have the most intimate knowledge of the crap that is on the balance sheet and how to get rid of it. If you think they can’t find jobs elsewhere.

So go ahead, and bring in outside workers, almost of all whom didn’t work on the Street because they were too dumb to make the cut in the first place. Great idea. Take that AIG bailout of 180 billion and round it up to 200+ billlion if you practice your idea. yeah, it sucks to keep paying these guys good money for costing us billions, but the alternative is even worse.

Posted by Structured Products Guy | Report as abusive

There is another solution. You can mandate that banks hold loans to maturity. “Hold to maturity” seems to me a good starting point. To be sure, an inevitable byproduct of restricting securitization or proprietary trading is that they can and will reduce a bank’s profitability, but the regulation keeps them aligned with public purpose — namely, providing an ongoing, stable basis for lending, independent of market conditions — while avoiding the incentive for banks to game the higher capital requirements via questionable accounting scams.

Securitization has generally increased risk enormously, and misallocated it, without providing long-run advantages. It is true that eventually we will probably have to cover everybody, not just the banks, if we are to rely on a “hold to maturity” standard. The unregulated non-prime speciality mortgage lenders proved this. It has been rationalized based on potential increased bank risk adjusted profitability, which is outside of the public purpose behind banking – namely a government public/private partnership. Banks are set up and supported by government for the further benefit of the macro economy via providing a payments system and lending in a way that is specifically defined by regulators. The public purpose of banking is NOT to provide profits per se to shareholders. Rather, the provision of the ability to earn profits is only a tool used to support the attendant public purpose.

I think the problem with Blankfein’s column is that he’s confusing two kinds of systemic risk: systemic liquidity risk and systemic credit risk. Central banks are only responsible for systemic liquidity risk. The private sector is responsible for systemic credit risk — at least in a functional financial system.

I find it fascinating that Lord Bankfiend feels compelled to trumpet Goldman’s greatness right now – were he wiser, he’d shrink off into the depths of the GS cave and hide out until the angry mob forgets they are upset and goes back to watching American Idol.

Felix, I disagree with your assessment that LB should be concerned about any sort of regulation, TBTF or otherwise. Surely Mr Blankfein is more than aware that he and his firm are protected from any sort of inconvenience like regulation. TBTF? Sure, everyone but Goldman.

Leave TBTF to the peasants, this is Goldman we’re talking about here.

Let’s see when Goldman Sachs is broken up by anti-trust law and the anti- too-big-to-fail policy works to dissolve the remaining “big” financial institutions into debris.

Posted by Rose Eli | Report as abusive

Thank you very much Lloyd. You are scaring everyone into socialism.

Borrowing as a bank at nothing from the Fed discount window and then using the proceeds to trade is taking taxpayer money.

Dealing in derivatives where blowups are a concern of the government is taking taxpayer money.

Taking 12B of AIG bailout funds is taking taxpayer money.

HFT used for frontrunning legitimate investing, using advantageous relations with the treasury for profit, these are taking public money without providing a service.

Goldman does a lot of useful and important business activity, no question. We need the good things they do. But they are souring the public to capitalism through activities which, while perhaps legal, are not moral or fair.

Blankfein’s assertion that the bailout money was not needed is laughable. If there is a systemic collapse all investment banks would fail. They were levered substantially like everyone else. If you are highly levered, your do not withstand a depression, full stop.

Posted by Dan | Report as abusive