Felix Salmon

We knew that Goldman Sachs had been very successful shorting the mortgage market;

we also knew that Goldman’s asset-management arm was very unsucccessful

this summer playing the stock market. And we’re also used, by now, to Goldman

setting new records for investment-bank profitability.

So the fact that Goldman Sachs earned

$3.22 billion between September and November is incredibly impressive but

also somehow unsurprising. The bit which jumped out at me was the way in which

equity trading revenues soared by 22% in the quarter, to $2.59 billion, even

as global stock-market prices and volumes were more or less flat. While the

Goldman Sachs special sauce is hard to export, it seems to be as potent and

pervasive as ever within the confines of 85 Broad Street. Just look at how they’re

doing in M&A, which helped drive financial-advisory revenues to $1.97

billion for the quarter:

Goldman, the No. 1 adviser in worldwide announced mergers and acquisitions

for the seventh consecutive year, arranged $417.9 billion of takeovers completed

during the fourth quarter, more than double a year earlier, according to data

compiled by Bloomberg.

In a way, it’s easy to understand how the likes of Ben Stein will look at these

kind of numbers with suspicion. How is it possible that Goldman can mint money

while everybody else – including Goldman’s clients – is taking a

bath? Surely there must be something nefarious going on!

But of course these numbers also prove that the last thing Goldman wants or

needs is an economic slowdown – there’s no way that Goldman is going to

arrange $400 billion of takeovers per quarter if the US economy slips into a

recession. Note that essentially $0 of that $3.22 billion came from economic

research. If you do want to look for dodgy dealings, I really don’t

think that Goldman’s economists are going to be a particularly fruitful place

to start your search.

In Kate

Kelly’s narrative of Goldman Sachs’s mortgage-trading gains, thrice

the traders want to keep their bearish bets but are forced to unwind their positions

by higher-ups. What fascinates me is the way in which value-at-risk, a very

quick-and-dirty risk measure, seems to have been of paramount importance within

the highly sophisticated investment bank:

Like other Wall Street firms, Goldman weighs its financial risk by calculating

its average daily "value at risk," or VaR. It’s meant to be a measure

of how much money the firm could lose under adverse market conditions. Because

the ABX had become so volatile, the VaR connected to the trades was soaring…

Goldman’s top executives understood the group’s strategy, say people with

knowledge of the matter, but were uncompromising about the VaR. They demanded

that risk be cut by as much as 50%, these people say…

"This is the wrong price" to close out the positions, Mr. Birnbaum

snapped at a colleague assigned to help reduce risk, slamming down his phone

receiver, these people say. He was overruled…

By late July, the Bear Stearns funds had collapsed and rumors were circulating

of multibillion-dollar CDO losses at Merrill. Goldman was raking in profits.

But once again, concern was growing about VaR, the all-important measure of

risk. At one point in July, senior executives called another meeting to demand

the mortgage traders pull back, according to people familiar with the matter…

Around Labor Day, Mr. Birnbaum was asked to ratchet back one of his short

positions by $250 million, according to Hayman Capital managing partner Kyle

Bass, a client who had similar positions at the time. Mr. Bass says he made

$100 million by relieving Goldman of that particular short bet. "It appeared

to me that [the traders] constantly fought a VaR battle with the firm once

the market started to break," says Mr. Bass.

Back in October, I asked

what the pont of VaR was. Here are some of the responsees I got: "it doesn’t

accurately gage value at risk". "I presume that MS, like other investment

banks, has other, more sophisticated, risk controls." "In being so

quick and taking only historical and very little information into consideration,

it is pretty poor." "VaR’s right now are of especially little

use." "It is pretty useful for giving a gross snapshot of risk taken

to the guys in the boardroom, or at the SEC or in Basel…That’s about it."

"VaR seems at best mislabeled, and at worst completely useless for managing

risk." "It is not the end-all metric, many think it has fatal flaws."

Yet according to Kelly, this rather crappy measure is so important that on

at least three separate occasions the mortgage-trading desk was forced to unwind

its highly-profitable positions just in order to reduce its VaR. Weird.

Even a stopped clock is right twice a day, or something. Somehow – more

by luck than judgment, I’m sure – I managed to call this one pretty well.

December

11:

If Citi can carve off some large chunks of its SIVs, it might be able to

reduce the rump vehicles to something digestible – at which point Citi’s

brand-new CEO can take them onto the bank’s balance sheet as part of his fresh

new strategy or somesuch. But there’s still a fair amount of pruning to go

before that happens: I don’t think Citi can really afford to take anything

like $66 billion of SIV assets onto its balance sheet right now.

December

13:

Citigroup Inc., badly bruised by mounting losses, is bailing out seven affiliated

investment entities, bringing $49 billion in assets onto its balance sheet

and further denting its capital base.

The bank said it would provide emergency support to the entities, known as

structured investment vehicles, if it can’t find buyers for their short-term

notes…

Yesterday’s move underscores how quickly Vikram Pandit, who was named Citigroup’s

chief executive Tuesday, is moving to tackle the myriad problems facing the

bank.

So Citi’s managed to further prune its SIVs from $66 billion to $49 billion

in the past few days, and is presumably actively seeking to cut them even more

if it can, maybe by dint of taking advantage of the underwhelming MLEC.

How’s Citi going to pay for this? Well, that’s the call I made yesterday –

by

cutting its dividend, of course. But what are the chances of me being right

twice in two days?

There’s an art to the write-down. On the one hand, you don’t want to scare

people by writing down too much money unnecessarily. But on the other hand,

you want to be conservative, and you certainly don’t want to have to

take any subsequent write-downs because the first tranche wasn’t aggressive

enough. (Just ask Chuck Prince.) So I was heartened to see today that Lehman

Brothers seems to be getting it right: its fourth-quarter

profits included "$320 million of gains from the sale of leveraged

loans that were previously written down".

That’s the way it should be done: take a big-but-not-too-big writedown, and

then turn a profit during the following quarter when you sell those assets for

more than you wrote them down to. Let’s hope other banks will prove able to

pull off the same trick.