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FRED
06-21-07, 10:18 PM
http://www.itulip.com/images/MaginotRiskMgt.jpgGoldman's "ready." Are you?
June 21, 2007 (Eric Janszen - iTulip)

As the markets enter into another period of volatility, the financial press jumps onto the doom-wagon. But a plethora of articles intended to calm investors is also due. While the former keeps us glued to the screen, the latter is more in line with the interests of the financial products industry of which the financial press plays a vital role.

The leader of a string of articles we can safely expect to see over the coming weeks and months is "Goldman's Ready" by Robert Lenzner at Forbes. Lenzer's article is in the tradition of financial Alfred E. Newman (http://www.chriswylde.com/alfred_e_neuman.jpg) style What, Me Worry? articles published under similar circumstances, excerpts below. Our experience is that when anyone representing the financial products industry volunteers the advice not to panic–who asked?–the wisest policy may be to panic now and avoid the rush.

The following were originally compiled by InvesTech Research (http://www.investech.com/) before the tech stock bust.
"IN MANY WAYS this has been the most remarkably cheerful summer in recent financial history. The stock market speaks for itself. After the serious decline in May, prices of the leading securities have been marching steadily upward... This prosperity might be disquieting if it were accompanied by any of the symptoms of inflation." - Outlook & Independent, August 7, 1929

"Now, of course, the crucial weaknesses of such periods -- price inflation, heavy inventories, over-extension of commercial credit -- are totally absent. The security market seems to be suffering only an attack of stock indigestion... There is additional reassurance in the fact that, should business show any further signs of fatigue, the banking system is in a good position now to administer any needed credit tonic from its excellent Reserve supply." - Business Week, October 19, 1929 (One week before the crash)

"One of the most striking features of the present chapter in stock market history is the failure of the trading community to take serious alarm at portents which once threw Wall Street into a state of alarm... Traders who would formerly have taken the precaution of reducing their commitments just in case a reaction should set in, now feel confident that they can ride out any storm which may develop. But more particularly, the repeated demonstrations which the market has given of its ability to 'come back' with renewed strength after a sharp reaction has engendered a spirit of indifference to all the old-time warnings. As to whether this attitude may not sometime itself become a danger-signal, Wall Street is not agreed." - The New York Times, Sept. 1, 1929 (Two days before the final top)

"It may be well again to stress the all-important point that the Federal Reserve has it in its power to change interest rates downward any time it sees fit to do so and thus to stimulate business." - Financial World, April 10, 1929
Which brings us to the Goldman piece by Robert Lenzner. Imagine what iTulip's intrepid reporter Jane might say if she tagged along with Rob to get the story.
Goldman's Ready (http://www.forbes.com/2007/06/19/croesus-chronicles-goldman-oped-cz_rl_0619croesus.html)
June 19, 2007 (Robert Lenzner - Forbes)

Goldman Sachs is my alma mater and arguably the greatest investment bank in the world. So we stopped in the other day to inquire about how it intends to protect itself in a market meltdown, like the one on Oct. 19, 1987, or some unexpected global liquidity crisis.

Jane: "Hi, guys! Just 'dropping in' to see if Goldman's ready for a flu pandemic or nuclear war. Are we in the right office? Hey, what's for lunch?"

Its biggest risk is liquidity, since it has no consumer bank deposits like a commercial bank to finance its derivatives positions and its prime brokerage margin accounts to hedge funds, and to maintain a $970 billion balance sheet.

Goldman (nyse: GS - news - people ) has a finely tuned risk-control department run by Bob Berry, a bespectacled mathematician from Cambridge University, who has 18,000 computers at eight separate locations churning out daily reports on positions in every tradable security, commodity or currency. Constantly monitoring exposures, these daily reports set limits for exposures depending on market conditions. The reports are subdivided by trading desk and then again to individual traders.

Jane: "A bespectacled mathematician from Cambridge University. Good! We don't want Goldman's risk control department run by a woman who looks like Paris Hilton. The daily reports set limits for exposures depending on market conditions? Cool. Like automatic pilot on an airplane. Where's the 'black box'? Ha, ha!"

Another special risk group looks at future disasters with, one hopes, small probabilities, like avian flu, a sharp oil spike or a nuclear bomb attack.

Jane: "The Armageddon Risk Management team. What a cool job!"

If all hell broke loose and Goldman's clients could not pay it a cent in compensation, the firm has sequestered its own Fort Knox, the so-called BONY box, more properly called the Global Core Excess Capital Account. The BONY box is named for the Bank of New York (nyse: BK - news - people ), where Goldman holds more than $50 billion in unencumbered government securities of the U.S., Germany, France and Japan--securities that could be instantly turned into hard cash.

Jane: "Geez. You guys got 18,000 computers spread around to avoid the risk of getting nuked or the IT department wiped out by bird flu? Fort Knox has gold in it, right? So the BONY box is, what, full of computers with hard drives containing $50 billion in yen, euros, and dollars attached to a network? Need to sell during a nuclear war? Sure hope the fiber is up and the FX markets are open!"

Goldman believes this free excess capital would suffice to pay off obligations for at least three months and maybe more, even if the firm did not get back a cent from its clients. Of course, what worries me is if the financial system is in such trauma that the Bank of New York can't transfer the securities out or liquidate them and pay off Goldman's liabilities. Maybe I've been seeing too many disaster movies lately.

Jane: "Fifty billion's only good for three months? I guess we'll have the pandemic or nuclear war mess cleared up by then."
This is an especially clever piece because the author poses as a doomer (http://www.itulip.com/forums/showthread.php?p=11355#post11355) then makes the point that only a nut case who's been watching too many disaster movies can worry Goldman isn't ready for anything.

Hey, we are sold!

We note Rob's curious use of the term "financial Maginot Line" to refer to the level of risk Goldman's defenses may not protect against, versus the level of risk Goldman believes they are protected against, but are not.
Goldman's 10-K filing with the U.S. Securities and Exchange Commission also includes an enticing promise of continued financial health. In addition to the $50 billion Global Core Excess Capital Account, it appears there's a significant amount of unencumbered securities that include high-grade money market, corporate bonds and marginable equities that if pledged or sold would provide the funds necessary to replace at least 110% of our unsecured obligation.

"Naturally, no one at the firm wanted to give me the number or spell out this financial Maginot Line. It seems some of these securities would have to be sold or transferred from subsidiaries around the globe to New York to pay off debt.
For those who don't recall the history behind the term, the Maginot Line is named after French minister of defence André Maginot. It was a massive and expensive complex of fortifications, including concrete walls, tank obstacles, machine gun posts, and other defences, which France constructed along its borders with Germany and with Italy to help prevent a repeat of France's WWI experience.
"The World War II German invasion plan of 1940 (Sichelschnitt) was designed to deal with the Line. A decoy force sat opposite the Line while a second Army Group cut through the Low Countries of Belgium and the Netherlands, as well as through the Ardennes Forest which lay north of the main French defences. Thus the Germans were able to avoid a direct assault on the Maginot Line. Attacking on May 10, German forces were well into France within five days and they continued to advance until May 24, when they stopped near Dunkirk.

"The term is sometimes used today to describe any comically ineffective protection."

Wikipedia - Maginot Line (http://en.wikipedia.org/wiki/Maginot_Line)
One final quote from Investech's series that echoes the unease that inspires the Goldman piece and others like it to follow as we head into Summer.

"As the Fall begins there is a tenseness in Wall Street. Its presence is undeniable. There is a general feeling that something is going to happen during the present season. Just what it will be, when it will happen or what will cause it is anybody's guess." - Business Week, Sept. 7, 1929 (Four days after the final top)

We're guessing that this time the "something" is a crash. The cause, the same as always: the overwhelming desire of investors to dump assets they know to be leveraged and overpriced–before the other guy does. With the usual trigger: someone starts selling.

iTulip Select: (http://www.itulip.com/forums/showthread.php?t=1032) The Investment Thesis for the Next Cycle™
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grapejelly
06-21-07, 11:36 PM
nice piece...and you made me laugh.

tree
06-23-07, 01:01 PM
Where are the usual comments? Are we afraid this is "it"?
On Friday, web sites of NYT and WaPo were curiously devoid of stories about market down more than 180 pts in response to Bear Stearns bail-out. WaPO ran an Associated Press story on it today, Saturday, buried in the business section; didn't want to dirty a staff reporter with it. NYT had "front-page" story on the site, but also on a low-readership Saturday. When and if the crash comes, these publications will be held responsible for having helped perpetuate the real estate bubble, and taken many ignorant consumers into lifelong bankruptcy. They'd better hope the pensions funds aren't taken down too and sent off to never-never land at the federal Pension Benefit Guaranty Corp. In the age of Web transparency, mainstream media are not pretty sites.

Ishmael
06-23-07, 01:09 PM
Ok, so you have $50 billion of unencumbered low interest earning securities and interest rates double. Puff, you now have $25 billion of mark to market securities which you could sell. Puff, even less if everyone is selling and no one is buying due to margin calls.

Goldman is forgetting one thing. These are marketable securities and not cash. They must be turned to cash but in a liquidity crisis everyone wants cash and not marketable securities. Please sir will you please take our marketable securities for ten cents on a dollar.

That is why it is called a credit crunch. It is magic, assets that were once good are now worth a lot less!

Jim Nickerson
06-23-07, 01:37 PM
Ok, so you have $50 billion of unencumbered low interest earning securities and interest rates double. Puff, you now have $25 billion of mark to market securities which you could sell. Puff, even less if everyone is selling and no one is buying due to margin calls.

Goldman is forgetting one thing. These are marketable securities and not cash. They must be turned to cash but in a liquidity crisis everyone wants cash and not marketable securities. Please sir will you please take our marketable securities for ten cents on a dollar.

That is why it is called a credit crunch. It is magic, assets that were once good are now worth a lot less!

Ishmael, I think you always are making some thoughtful comments based I guess on experience in accounting plus however else you have gained your "smarts." I enjoy your insights, but do you really think an outfit as large as GS is forgetting anything? If interest rates were to double, they wouldn't do that overnight, and GS wouldn't wait for rates to double before doing something to protect itself, would it?

Ed
06-23-07, 02:37 PM
“Although no one is forecasting a crash like that in 1929-30, ...”
WSJ 10/19/87, p. 1, col. 6, article by Metz and Garcia

“The stock market crashed yesterday.”
WSJ 10/20/87, p. 1, col. 6, article by Metz and Garcia et al., first sentence

jeffolie
06-23-07, 03:11 PM
I read in the Long Beach Press Telegraph that Bearn Stearns expects the 2 hedge funds to liquidate over the coming months gradually to avoid a fire sale of their assets.

One firm, Brookstreet did not have a white knight to loan it billions and had to go bellyup on Friday. If other shakey firm have to liquidate, then the fire sale of complex financial instrument will destroy Bear Stearns hope of a gradual sell off.

Ishmael
06-23-07, 05:13 PM
Jim:

Thanks for the complement. Oh, I was just having some fun there but when I first joined I asked EJ a similar thing. What could guys like Greenspan et al have been thinking to have taken us to this point.

In 2002 I started becoming very concerned when I saw debt swelling to keep things going. I had lived through the oil and gas boom and bust and knew what excess liquidity could bring.

How could little ole me with my state institution education (even though I have been the CFO for 4 public companies) see this when all of these Phd's from Harvard and Princeton and MBA's from Wharton and University of Chicago do not see it I wonder? So there is the answer of a question with a question.

I wake up most mornings and think I must be wrong but it seems to always point to the obvious -- Financial meltdown (I also hear a whispered question by a number of CEO's).

When things melted down in 29 I think Goldman just about went BK. I think it will be rough on them with this financial meltdown but they will probably survive it but the question is will they survive the aftermath. Will they survive the average American looking at how they have been swindled by the financial service industry which represents 28% of the S&P and basically controls Washington through being the number one contributors to both political parties or how they controlled the press through advertising. How the financial service industry got all of the controls taken off of them that were put on them after 1929 and then proceeded to do exactly the same thing. I tend to think not. Mellon the Secretary of Treasure in 1929 was hounded till the end of his days. Probably the same here.

For some reason I have this scene in my head and some one shouting Viva La France and a storming of Southern Connecticut when I look at the whole situation. Maybe this time there will be a statue on Wall Street with the words Never Again printed on it.

Ishmael
06-23-07, 05:24 PM
Then on the other hand I am going to France for a couple of weeks in September and all of the planning for the trip is just putting me in a revolution sort of mood.

I asked the question the other day, is Paris Hiltion our Marie Antoinette. I have been kind of obsessing on the French thing lately and our history. The French go into Vietnam and then we go into Vietnam. The French go into Algiers and get their butts handed to them we go into Iraq and get our butts handed to them. The French have John Law and we have our Greenspan. Just weird!

Like I said, I am just in a French mood today sitting and planning my trip!

Tet
06-23-07, 05:24 PM
For some reason I have this scene in my head and some one shouting Viva La France and a storming of Southern Connecticut when I look at the whole situation. Maybe this time there will be a statue on Wall Street with the words Never Again printed on it.
It's said that after the Mississippi Bubble the word Bank wasn't spoken for a hundred years in France. I think the Dot.com implossion was the worst of it, it's just a matter of time for those who were swindled figuring it out.

spunky
08-11-07, 06:28 PM
Then on the other hand I am going to France for a couple of weeks in September and all of the planning for the trip is just putting me in a revolution sort of mood.

I asked the question the other day, is Paris Hiltion our Marie Antoinette. I have been kind of obsessing on the French thing lately and our history. The French go into Vietnam and then we go into Vietnam. The French go into Algiers and get their butts handed to them we go into Iraq and get our butts handed to them. The French have John Law and we have our Greenspan. Just weird!

Like I said, I am just in a French mood today sitting and planning my trip!


Good for you. I enjoyed my time in southern France , but enjoyed Greece more. If I was going to the southern med I would bypass France and head right for Greece. Of course, France would of been more entertaining if I was'nt on an enlisted mans E-4 pay :D


Nothing like sitting at home here in rural southern Indiana watching pigs get slaughtered, drunk on homemade wine.

Minor slaughter as it is :(



peace out :rolleyes: