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.

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