When Goldman Sachs hates marking to market

By Felix Salmon
February 3, 2010
Goldman Sachs, protesting against proposals that money-market funds should be marked to market. But first let's remember what Goldman CEO Lloyd Blankfein has to say about marking to market:

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The most ridiculous sentence I’ve read today comes from Goldman Sachs, protesting against proposals that money-market funds should be marked to market. But first let’s remember what Goldman CEO Lloyd Blankfein has to say about marking to market:

For Goldman Sachs, the daily marking of positions to current market prices was a key contributor to our decision to reduce risk relatively early in markets and in positions that were deteriorating. This process can be difficult, and sometimes painful, but I believe it is a discipline that should define financial institutions. We mark-to-market, not because we are required to, but because we wouldn’t know how to assess or manage risk if market prices were not reflected on our books.

Now read this, from his employee James McNamara:

We do not believe that disclosing shadow prices or market-based prices of portfolio securities would be informative to investors… Investors who perceive a NAV differential between two money market funds may wrongly assume that the fund with the lower market NAV is experiencing a material credit or liquidity problem. This may result in destabilizing — and unnecessary — levels of redemption activity in that fund, which could infect other funds managed by the same adviser or other funds as well. The Commission should be mindful of this type of unintended consequence before adopting regulations mandating the disclosure of market-based NAV’s and market-based pricing of portfolio securities.

When Goldman Sachs reduces its positions as a result of declining market prices, then, that’s a necessary, if difficult and sometimes painful, discipline. When investors in money-market funds do the same thing, however, that’s destabilizing and unnecessary. Alles klar?

David Reilly makes short shrift of such hypocrisy in his column today, and adds something important:

The industry’s case against floating values is that investors would pull cash out of money-market funds because they want investments with a stable value. That, the argument goes, would deprive American companies of a vital source of funding, since money-market funds are big buyers of short-term commercial paper issued by companies.

That is a well-worn ploy from the financial-services industry to counter any change that cuts into business. Banks used this tactic effectively in 2003 and 2004, for instance, to pressure the Financial Accounting Standards Board to water down rules that would have limited banks’ ability to use off-balance- sheet vehicles.

The result was out-of-control securitization and under- capitalized banks, both of which played huge roles in crashing the financial system.

The fact is that higher short-term funding costs for large corporations are a feature, not a bug, in terms of moving money-market funds to floating NAVs. Goldman might like to bellyache about “the diminished supply of short-term credit to corporations” that might result, but short-term credit is always the most systemically-dangerous form of credit, since it can dry up with no warning and cause a major liquidity crisis.

More generally, it’s both silly and far too easy for banks to cry “more expensive credit!” every time that anybody proposes tightening regulations on anything from credit cards to prop trading. Yes, it is true that decades of financial-sector deregulation led to cheaper credit, in the financial industry, in the housing market, in the private-equity world, and elsewhere. This was not a good thing. $1 NAVs obscure the risks inherent in money-market funds, and a sensible regulatory overhaul would put an end to them.

4 comments so far

perhaps this would be best looked at as GS pleading to preserve a valuable information assymetry. They agree mark to market is valuable information for managing risk (ie they would trade on it) and they don’t want counterparties to have it (ie their customers shouldn’t be able to use it to trade on) what could be more consistent than that?

Posted by micromeme | Report as abusive

Perhaps Lloyd ought to talk with Gerry Corrigan, who wrote in 1982 a piece called “Are Banks Special?” It can be found at http://www.minneapolisfed.org/pubs/ar/ar 1982a.cfm

Corrigan argued that banks should be regulated because they were special, and that this specialness arose from their singular ability to create demand deposits that traded at par.

In discussing retail MMMF, Corrigan wrote “However on close inspection it appears that such instruments whether—MMMFs, retail repurchase (RPs) agreements … do not, at least in a technical sense, in fact possess the characteristics associated with the bank issued transaction account. However, as is discussed later making the distinction is particularly difficult in the case of MMMFs. In all of these cases, including money market mutual funds, instruments which appear to have bank transaction account characteristics take on those characteristics in part because the acquisition or disposition of such assets involves, at some point, the use of a transaction account at a bank. However, technology makes it possible to manage these financial assets in a way in which their ultimate dependence on a bank account is not apparent to the individual holder of the asset.”

And more specifically:
“The issue of whether money market mutual funds fit the definition of a bank—even at a conceptual level—is not so easy to deal with. Many such funds certainly appear to have all the characteristics of bank transaction accounts. In the case of the money market mutual fund, the critical distinction relative to a bank transaction account appears to be the extent to which the liabilities in question are payable at par. In the case of a bank deposit, deposit insurance, the capital of the bank, and the banks’ access to alternative sources of short-run funding provide assurances that a depositor can withdraw dollar-for-dollar from the bank the principal amount deposited—even when changes in interest rates may have reduced the market value of bank assets.

In the case of the money market mutual fund the ability to pay out dollar-for-dollar the amount of the initial “deposit” is less certain. The fund itself does not have capital as such, and in the short-run it cannot easily tap alternative sources of liquidity to pay out to some shareholders thereby buying time for assets to mature or for interest rates to reverse course. As a related matter, the fund is not insured so that even though the risk of loss to the individual shareholder is small, it does exist.”

Simply stated: MMMF are not bank deposits; they do not have capital support, or backup liquidity arrangements.

Posted by Carter | Report as abusive

One might also want to think through the amount of “moral hazzard” risk that the USG’s decision to guarantee institutional MMMFs has created.

Posted by Carter | Report as abusive

Mark to market makes sense to me, but maybe it needs to be strengthened.
Consider the following. Goldmans bought “insurance” from AIG, but AIG was ultimately unable to fulfil the contract and so the US Govt bailed AIG out and gave Goldmans billions.
Both Goldmans and AIG report quarterly under SEC rules, so at various points in the year they would have been assessing their exposures to each other, presumably under mark to market.
My suggestion is that if either party believes an exposure is greater than a threshold amount (say the lower of 10% of capital and reserves for either party, or $1 billion), then this needs to go to a “clearing” function in the SEC to verify it is reasonable and sustainable.
AIG would probably still have collapsed, and possibly earlier, but I think it would have alerted Goldmans and others to look elsewhere for insurance or rein in their exposures, and it would certainly have cost the taxpayer a lot less.
So I say lets have mark to market, but lets have it applied consistently and then make use of it.

Posted by Guyr | Report as abusive
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