Goldman Sachs is using its new taxpayer-subsidized status to bring increased risk to the financial system, a group of House members charged Monday. They want to know why the Federal Reserve is allowing it.
The group on Monday sent a letter to the Fed asking for an explanation of why Goldman Sachs is being allowed to speculate wildly even while officially redesignating itself a bank holding company, which theoretically means stricter regulation. The bank designation gives Goldman access to dirt-cheap Federal Reserve loans.
Goldman initially applied for the new designation last fall, so that it could access bailout funds (since paid back). Because bank holding companies, unlike investment banks, have access to a host of valuable taxpayer subsidies, they are required to reduce the risk associated with their investment activity. But Goldman then applied to the Federal Reserve for an exemption to the rules, saying that it takes time to alter a business model. The exemption was granted in February -- and Goldman went on to take even greater risks. Its Value-at-Risk model, a widely used measure of the risk of loss, recently showed potential trading losses at $245 million a day; in May 2008, it was $184 million a day.
The bets paid off in the most recent quarter as the market rose and Goldman posted stellar earnings. Morgan Stanley, meanwhile, was similarly given an exemption by the Fed but did what it said it would do and reduced its risk. The company lost money, largely as a result of that decision.
The likely result: Other players on Wall Street will follow Goldman back toward the cliff they dangled over just months ago. In announcing its lousy earnings, Morgan Stanley assured that it will increase the risk it takes in the future. Citigroup is racing to increase its exposure, too, handing another billion dollars worth of chips to its riskiest traders, bringing its hedge fund operations to close to $2 billion. On the brink of collapse, it had scaled such investing down to around $800 million.
Lucas van Praag, a Goldman spokesman, declined to respond directly to the charges in the letter, but said that the firm is working to reduce its exposure.
"We're very cognizant of risks inherent in risk taking. We have one of the highest capitalizations of any bank," said van Praag. He said that the Value-at-Risk numbers, while the only publicly released measure of risk, are only one metric and that internal measures show the bank has reduced its exposure over the past year.
He also took a dig at other Wall Street players who have avoided using mark-to-market accounting in an effort to fluff their balance sheets. Earlier this spring, banks lobbied Congress and the Financial Accounting Standards Board to soften mark-to-market rules. The new rule allowed banks to inflate their balance sheets by claiming that an asset was worth more than it could fetch on the market because the market was frozen. Goldman Sach, said van Praag, doesn't use that slight of hand, so its balance sheet is an honest reflection of its exposure.
"We have dramatically reduced our leverage and as a mark-to-market firm--we aggressively mark our assets to market--our leverage ratio is a true reflection of risk," said van Praag.
Nevertheless, as Wall Street follows Goldman, overall systemic risk is ramped up. Meanwhile, Congress is debating whether to give the Fed authority to regulate systemic risk throughout the economy. The congressional letter puts the Fed on the spot, demanding that it explain why it's allowing Goldman to use taxpayer dollars to increase systemic risk.
"The only difference between Goldman Sachs today and Goldman Sachs last year is that today, the company is officially gambling with government money. This is the very definition of 'heads we win, tails the taxpayers lose,'" reads the letter.
Read the full letter:
Dear Chairman Bernanke:
In the fall, Goldman Sachs secured access to government funding by converting from an investment bank into an ordinary bank. Despite this shift, the CFO of the company, David Viniar, said last week that the company is continuing to operate as if it were still a high-risk investment bank: "Our model really never changed," he noted in a quote to Bloomberg. "We've said very consistently that our business model remained the same."
This statement seems accurate. Earlier this year, the Federal Reserve granted a temporary exemption to Goldman Sachs from standard bank holding company Market Risk Rules, allowing the company to continue operating as if it were an investment bank. The company and its employees have taken full advantage of its new government subsidies, and the retained ability to bet big. In its most recent quarter, Goldman Sachs earned high profits of $2.7 billion on revenues of $13.76 billion, with 78 percent of this revenue derived from high-risk trading and principal investments. It paid out much of this revenue in compensation, setting aside a record $772,858 for each employee at an annualized rate. The company's own measurement of risk, its Value-at-Risk model, recently showed potential trading losses at $245 million a day, up from $184 million last May.
Despite its exemption from bank holding company regulations, Goldman Sachs has access to taxpayer subsidies, including FDIC-backed bonds, TARP money (since repaid), counterparty payments funneled through AIG, and an implicit backstop from the taxpayer that allowed a public equity offering in a queasy market. The only difference between Goldman Sachs today and Goldman Sachs last year is that today, the company is officially gambling with government money. This is the very definition of "heads we win, tails the taxpayers lose."
It is worth noting that there sometimes might be good reasons to grant temporary regulatory exemptions, considering that companies cannot instantly change their business model. Still, given Goldman Sachs's last quarter results and public statements that it is not changing its business model, we are worried that the company is using its regulatory freedom to evade capital requirements and take outsized risks with taxpayers on the hook for losses.
With this in mind, our questions are as follows:
1) In the letter granting a regulatory exemption to Goldman Sachs, you stated that the SEC-approved VaR models it is now using are sufficiently conservative for the transition period to bank holding company. Please justify this statement.
2) If Goldman Sachs were required to adhere to standard Market Risk Rules imposed by the Federal Reserve on ordinary bank holding companies, how would its capital requirements differ from the current regulatory regime?
3) What is the difference in exposure to the taxpayer between these two regulatory regimes?
4) What is the difference in total risk to the portfolio between these two regulatory regimes?
5) Goldman Sachs stated that "As of June 26, 2009, total capital was $254.05 billion, consisting of $62.81 billion in total shareholders' equity (common shareholders' equity of $55.86 billion and preferred stock of $6.96 billion) and $191.24 billion in unsecured long-term borrowings." As a percentage of capital, that's a lot of long-term unsecured debt. Is any of this coming from the Government? In this last quarter, how much capital has Goldman Sachs received from the Federal Reserve and other government facilities such as FDIC-guaranteed debt, either directly or indirectly?
6) Many risk-management experts, most notably best-selling author Nassim Taleb, note that VaR models can dramatically understate risk. What is your overall view of Taleb's argument, and of the utility of Value-at-Risk models as regulatory tools?
As we work through legislative conversations regarding systemic risk, these questions are taking on increased significance. We appreciate your time and the efforts you are making to explain the actions of the Federal Reserve to Congress, and to taxpayers.
Alan Grayson (D-Fla.)
Brad Miller (D-N.C.)
Dan Lipinski (D-Ill.)
Elijah Cummings (D-Md.)
Ron Paul (R-Texas)
Tom Perriello (D-Va.)
Maxine Waters (D-Calif.)
Jackie Speier (D-Calif.)
Maurice Hinchey (D-N.Y.)
Walter Jones (R-N.C.)