Why is Goldman willing to lose so much on deposits?

Mar 19, 2010 17:29 UTC

Writing my Hotel California column earlier this week, I came across the following interesting tidbit in Goldman’s 10-K (page 206):

The amount deposited by the firm’s depository institution subsidiaries held at the Federal Reserve Bank was approximately $27.43 billion and $94 million as of December 2009 and November 2008, respectively, which exceeded required reserve amounts by $25.86 billion and $6 million as of December 2009 and November 2008, respectively.

This seems a good indicator of the lack of lending opportunities in the economy. But I’m curious: Goldman is probably losing a lot of money parking customer deposits on reserve at the Fed. Why do it?

But first let me try to explain what’s happening here…

Goldman has a bank subsidiary — GS Bank USA — which collects deposits via brokerage accounts. It doesn’t have any bank branches anywhere. And Goldman has grown these deposits a fair bit, from an average of $13 billion in 2007 to $35 billion in 2009.

This is odd for two reasons.

First, Goldman doesn’t have much use for deposits that I can see. They can’t be used to fund investment banking activities.

And clearly they don’t see many good lending opportunities for these deposits. If they did, they wouldn’t park such a big proportion at the Fed, where they lose money.

[Aside: a common misconception is that holding reserves at the Fed is profitable for banks since the Fed now pays interest on reserves. But this ignores the other side of the balance sheet. Banks, after all, have to pay for the deposits that they then put on reserve at the Fed. Math in next paragraph]

Excess reserves held on deposit at the Fed pay 0.25%. But the average interest rate Goldman paid on U.S. deposits in 2009 was 1.06%, implying a negative net interest margin of 0.81%.

Multiply -0.81% by total excess reserves of $25.9 billion held at December 2009, and you get an implied annualized loss of $210 million. That’s a decent chunk of change.*

Another reason these deposits might not make good loans is old-fashioned asset-liability maturity mismatch. Brokerage deposits aren’t sticky like retail deposits. They chase the highest return in the market. Short duration (“hot money”) deposits tied up in longer-duration illiquid loans is a recipe for bank failure.

Now, certain folks might use this as an excuse to bash Goldman (“why aren’t they lending to the real economy!”), but that’s wrongheaded. Don’t get me wrong: I’m no fan of Goldman Sachs. But the problem isn’t that banks are lending too little today, it’s that they lent way too much yesterday. The chief lesson of the financial crisis is that irresponsible lending has dire consequences for the economy. Better that banks err on the side of safety and soundness….better that they lose money parking reserves at the Fed than chase risk making dodgy loans.

But the original question still stands. If Goldman can’t find anything profitable to do with deposits, why keep collecting them?


*A couple caveats here. The rate Goldman is paying on deposits could be lower today than the average in 2009. Also, to lose $210 million, Goldman would have to hold this balance at the Fed — at a NIM of -.81% — for a full year.

(ht frog)


shame on the fake democracy of US,It’s all about money not politics

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Morning Links 1-27

Jan 27, 2010 15:26 UTC

Note: Apologies for no links yesterday. Busy day writing columns!

SEC to vote on new money fund rules (Johnson, WSJ) Unfortunately, the SEC won’t do away with $1 NAVs, price fluctuations will be published on a 60 day lag. So investors will continue to treat money funds as cash equivalents, even though they aren’t, and the systemic risk they pose won’t really go away.

Fed weighs interest on reserves as new benchmark (Lanman, Bloomberg) This will be a key interest rate to watch whether or not the Fed makes it the benchmark. The expansion of the Fed’s balance sheet over the past year+ has stuffed banks full of excess reserves, reserves that banks will lend out if the economy — and loan demand — picks up. The Fed needs to keep those excess reserves sequestered in order to prevent inflation. To do so, it may have to pay higher rates. For a fuller explanation see this previous column.

Failed Senate vote on budget commission shows difficulty in cutting deficits (Faler, Bloomberg) So much for a fiscal commission based on the base-closing commission…

After three months, only 35 subscriptions to Newsday’s website (Koblin, NY Observer) Print subscribers get free online access. But this is still not a good showing for selling online only subscriptions. The NYT needn’t worry that it’s pick up will be this small when they put up their pay wall. I, for one, will pay for their content, as I pay for WSJ. I ‘d subscribe to FT too if their website wasn’t so slow…

Top English central banker supports splitting banks (Thomas, NYT) This should come as no surprise. A speech by Mr. King in October laid out his support for steps similar to those Obama just released.

Roubini: Greece is bankrupt (Khan, CNBC) Thank you, Captain Obvious. ;)

Obama aims to ax moon mission (Block/Matthews, O.S.) There’s no constituency for budget cuts, so Obama deserves support from budget hawks for moves like this. We all like the moon I’m sure. But I like things like veterans benefits much more.

Iraqi government spends $85m on dowsing rods sold as “bomb detectors” (Hawley/Jones, BBC) Those not familiar with dowsing rods, see Wikipedia.

Wait, how much snow? (YouTube) No. He didn’t.



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Fed walks the tightrope

Jul 29, 2009 20:52 UTC


(Cartoon from The Economist, click to enlarge)

NEW YORK, July 29 (Reuters) – The sound money set remains concerned that the Federal Reserve’s emergency actions to corral collapse could ignite hyperinflation.  In particular, they point to the explosion of excess reserves inside the banking system, which they call dry tinder just waiting for the spark of recovery.  Bill Dudley, president of the Federal Reserve Bank of New York, says this isn’t an issue because the Fed now pays interest on excess reserves.  It’s a good argument, but only in the short run.


To liquefy the banking system, the Fed drastically expanded its balance sheet, which, as you can see in the chart to the right, has led to an explosion of excess reserves at banks.

(Click chart to enlarge in new window)

For decades they never rose above $10 billion. Now they’re above $700 billion. To understand why this level of excess reserves has some worried about hyperinflation, it helps to understand what they are.

The Fed requires banks to keep a certain level of assets in reserve against deposits, either cash in the vault or reserves held at the Fed.  Reserves held over this required amount are referred to as “excess” reserves which banks are free to lend out.

When banks lend money into the economy, the money borrowed typically ends up as a deposit in another bank.  Say I borrow to buy a house; the mortgage I get from the bank is money I give to the seller, who then deposits the cash in his own bank.

Lent money turns into a new deposit, which turns into more lent money, which turns into another deposit, and so on.  As the supply of money multiplies, you get inflation.  If it multiplies too quickly, you get hyperinflation. The multiplication of money that might come from banks lending out over $700 billion of excess reserves is the stuff of inflationary nightmares.

But banks aren’t lending it out.  Why not?  As Dudley points out in his speech, it’s because the Fed is now paying them an interest rate.

Before last October, banks lent out all their excess reserves.  After all, excess cash in the vault earns the bank no profit.  But then Congress gave Ben Bernanke the power to pay interest on excess reserves, which means banks now can earn a return by keeping them on deposit at the Fed. Money that could be lent isn’t, inflation remains a potential threat, not a kinetic one.

But there’s a catch. When the economy recovers banks won’t any longer want to keep their excess reserves on deposit at the Fed, not unless the Fed is willing to pay a much higher interest rate.

Walker Todd of the American Institute of Economic Research argues that “the economy won’t be able to handle the high interest rates the Fed will be forced to charge in order to keep excess reserves immobilized in its vault.”

The Fed argues it has other tools to shrink its balance sheet when the time is right. For one, its emergency lending facilities are priced high enough such that banks will stop drawing on them when the economy recovers. But even after its lending facilities are wound down the Fed acknowledges the level of excess reserves will still be huge. To keep them immobilized will require substantially higher rates.

But raising rates will cause asset prices to plummet. Weak balance sheets will collapse and the financial crisis could return in full force. This is the conundrum the Fed faces.


What bothers me about this sort of economic analysis, and as a layman find less than helpful, is the presumptive wisdom of the central banking system, whose tinkering and manipulation of interest rates and the money supply has all but destroyed the free-market. Speaking as a consumer, thanks to commodity profiteering, there is, as far as I can tell, no longer a discernable, predictable, rational, cause-and-effect relationship between supply, demand, and the prices we pay at check-outs and gas pumps. So, so much for the free-market. We were told the bailout was going to be used to save Main Street. Instead, at taxpayer expense, it sits idle, generating interest for the banks. In other words, we were lied to. As suggested in the article, bailout money can’t stay at the Fed forever. Sooner or later it WILL enter the economy, in drops or by the bucket, inflating dollars already in circulation. That much we can predict. I guess what I’m really wondering is, how can you guys be so calm and rational about this — while we’re all being robbed?

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