The Bankwatch

Tracking the consumer evolution of financial services

Goldman Sachs derivative liability = 33,823% of assets

I have spoken at length here about the insidiousness of derivatives and Credit Default Swaps.  So this new statistical reference frankly awed me.  It is from a Levy paper on the recent shift over the last 50 years to a shadow banking system, that has largely replaced bank balance sheet lending with Money Managers.  As I read this paper, while I am also reading ‘This Time is Different – eight centuries of financial folly’, there is little to feel good about in the apparent economic rebound that the government keeps telling us about.

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The data on derivatives is impressive. JPMorgan Chase, for example, held derivatives worth 6,072 percent of its assets at the peak of the bubble in 2007. The other two giants, Citigroup and Bank of America, although still far behind Chase, had 2,022 percent and 2,486 percent respectively. Goldman Sachs, the other giant, had an astonishing amount of derivatives on its balance sheets: 25,284 percent of assets in 2008 and 33,823 percent as of June 2009. Citigroup and BOA now have more of this risk on their books than before the crisis (FDIC SDI database).

The part that awed me, is that BofA and Citi now have more derivative exposure than they did in 2007!  Huh!   What is Timothy Geithner being paid for?  I have to admit after TARP and the apparent hands on approach I like most assumed things were being fixed, but apparently not. 

This simply adds to the point that despite all the histrionics and efforts in Washington, nothing has been learned and the American Banking system is now at least at as much risk now as in 2007, pre crash.

Incidentally when trying to understand derivatives, simply assume off balance sheet debt.  There is all kind of rationale as to why that off balance sheet debt is not dollar for dollar, but the important point is that no-one argues that derivatives are worth zero.  There is an intrinsic liability that frankly few bankers can explain to you, so you must begin with the face value of the liability, and banks are guilty until proven innocent on that one.

As an accountant, the notion of off balance sheet debt is a contradiction in terms.  Is it a liability?  If yes, it should be on the balance sheet.

Written by Colin Henderson

March 11, 2010 at 16:12

Posted in Uncategorized

17 Responses

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  1. […] Goldman Sachs derivative liability = 33,823% of assets The Bankwatch (hat tip reader Steve L). Yo! […]

  2. Is Goldamn still expempt from the standard var calculation?

    Probably viewing this.

    The Ror

    March 15, 2010 at 08:36

  3. As an accountant, the notion of off balance sheet debt is a contradiction in terms. Is it a liability? If yes, it should be on the balance sheet.

    I’m not an accountant and not in finance, but I don’t see how anyone can argue against this.

    liberal

    March 15, 2010 at 11:12

  4. The notional value of the derivative is not necessarily reflective of the potential liability. A $1 billion dollar notional swap may be settled for less than $1 million. The notional amount of the derivative as a % of the total assets is truly a meaningless number.

    John

    March 15, 2010 at 13:51

  5. > The notional value of the derivative is not
    > necessarily reflective of the potential liability

    In a recent confab of known names of folks commenting on the Financial Meltdown, a fellow by the name of Frank Partnoy claimed that the notional value should be used to discuss the obligations of the issuing counterparty–

    Frank Partnoy on Off-Balance Sheet Transactions

    And remember, AIG’s counterparties were paid off by the US Federal Government at 100 cents on the dollar, so the idea that the notional value is useless is not borne out by practice, at least in the $180B AIG debacle.

    Moreover, if a $1B CDS can be “settled” for $1M, then why hasn’t that happened, making this world-wide trauma disappear. There are supposed to be $600+T (notional) in existence. Since most of this amount must be in “naked” CDSs, seems like settling 0 cents on the dollar would be another way to settle this mess in a real hurry.

    Wayne Martin

    March 15, 2010 at 14:33

  6. Thanks for all the comments. As an ex banker I get it that derivatives are something of a black art and in fact the amount that shows as an asset on the books of one FI could have a different amount as a corresponding liability on books of the other FI.

    All I know is that derivatives were enough to bring down AIG so there is something to the worry about them.

    Colin Henderson

    March 15, 2010 at 15:06

  7. […] Goldman Sachs derivative liability = 33,823% of assets The part that awed me, is that BofA and Citi now have more derivative exposure than they did in 2007! Huh! What is Timothy Geithner being paid for? I have to admit after TARP and the apparent hands on approach I like most assumed things were being fixed, but apparently not. […]

  8. Derivatives did not bring down AIG. It was leverage and falling home prices that brought them down.

    And the federal government did not pay AIG 100% of the notional value of the CDS investments. This is a common misconception, which is what happens when a journalists think they have a good understanding of credit default swaps written on collateralized debt obligations. They paid the fair market value for the CDS contracts at the time, which was the difference between the CDS price and the underlying assets, here CDOs. Those CDOs have actually risen in value, so this turned out to be a great deal for the Fed and AIG. Goldman was indifferent actually since they had collateral in hand from AIG at the time, which they would have kept had AIG went bankrupt.

    Requiring companies to post the notional value of derivatives contracts is absurd. Say I sell a CDS contract on the United States of America to Billy Bob, where Billy Bob agrees to pay me $50K a year, and I agree to pay Billy Bob $1 billion should the United States go bankrupt. Is that a $1 billion liability for me? Of course it’s not. The odds I will have to pay that out are very low, like 1%.

    A better argument could be made requiring the banks to disclose both the asset and the liability portion of derivative contracts. That obviously would have no effect on the value of the company per se, since the company is already reporting the net difference between the two (i.e., the fair value of the derivative). However, it would change the leverage ratio, and it would give a better idea of a firm’s risk, which could be important when the fit hits the shan.

    I think this article makes a good point in that more more stringent disclosure is definitely needed by the banks on derivative positions. However, it’s highly unlikely we will see Congress do this–actually, they recently passed legislation requiring less disclosure from financial firms.

    stevenstevo

    March 15, 2010 at 20:42

  9. That’s an interesting paper by the Levy institute. Capitalism is definitely not perfect. No one ever said our economy would exploit the virtues of human nature (progress) while remaining immune to human nature. People will always be greedy. But you can’t stop the bad without hindering the good. Tax us too much and we’ll go start our own country and throw your tea in the ocean.

    I think the question boils down almost to a philosophical or even a political one. If not capitalism, then what? Communism has obviously failed. And socialism is not so great either (see: Europe). We just got done with a 2-year recession and 10% of our country is unemployed, so capitalism has obviously failed.

    Seems like to me the only thing left to do is keeping moving right. Perhaps libertarianism?

    stevenstevo

    March 15, 2010 at 21:12

  10. hmmm Steven ..

    re: Requiring companies to post the notional value of derivatives contracts is absurd. Say I sell a CDS contract on the United States of America to Billy Bob, where Billy Bob agrees to pay me $50K a year, and I agree to pay Billy Bob $1 billion should the United States go bankrupt. Is that a $1 billion liability for me? Of course it’s not. The odds I will have to pay that out are very low, like 1%.

    I am not sure I buy that. As a banker and an accountant rule #1 is that if there is a potential liability of $ 1 bn then it must be reported. The issue of ‘odds of liability being required’ is not the issue. When a banker assesses a balance sheet, the contingent liability is a liability.

    We can debate the nature of reporting and whether its a direct liability as I believe or a reported liability within the financial statement comments but reported and recognised it must be.

    Colin Henderson

    March 15, 2010 at 23:30

  11. Yeah, that’s a good point. But there is an asset that offsets the liability. With a CDS contract, or let’s say a put option, the seller agrees to buy back an asset if it reaches a certain price. That definitely sounds like an obligation, but they get an asset in return. If I sell a put with strike $45, and the stock drops to $40, sure I have an obligation to pay the counterparty $45 to buy the stock from him/her, but I also end up with an asset worth $40, which I could then go sell in the market. So my loss is of course $5. In reality physical delivery often doesn’t take place–I would just pay up $5 instead of going through the trouble, but whatever.

    Right now that’s all companies have to report generally–the net difference. There’s a whole lot more to it than that actually, but for the sake of example.

    IMO,accounting rule #1 is that your balance sheet must balance. If I have to book a $45 liability, then what’s the other side of the transaction? And don’t say contra-equity account.

    It’s a tough call–just like with the legal field, stuff falls in the grey areas with accounting rules all the time. Problem is, while the media will abstain from pretending like they’re experts on antitrust legislation or intellectual property laws or whatever, they sure do act like they’ve got a 5-year PhD in economics. And another one in corporate finance. And throw one in more in accounting and organizational behavior while you’re at it.

    Actually, what do economists know? If they could just get better at predicting the future, then none of this would matter! Then we would know the true value of derivatives, and none of this would be an issue.

    stevenstevo

    March 16, 2010 at 07:02

  12. “I think the question boils down almost to a philosophical or even a political one. If not capitalism, then what? Communism has obviously failed. And socialism is not so great either (see: Europe). We just got done with a 2-year recession and 10% of our country is unemployed, so capitalism has obviously failed.

    Seems like to me the only thing left to do is keeping moving right. Perhaps libertarianism?”

    Life isn’t yin or yang; life is yin and yang. Europe, and the US, are “mixed” economies. (If the US were a purely capitalist economy, there would be no public schools, roads, parks, Social Security, MediCare, etc.)
    For my money, nothing is going to work for everybody without population control and limits on personal wealth. Capitalism’s dependence on ever-expanding markets and cheap labor and raw materials is unsustainable. The social justice of socialism, (and environmental equilibrium,) is unattainable without limits on population. (How can you cater a party without knowing how many guests there are?) Social justice is also impossible when wealth is concentrated among a few individuals, yet the entreprenurial/creative spirit of human nature is essential to human progress.
    Will we figure this all out before we kill ourselves? At the moment I’m doubtful. Tomorrow I might feel more optimistic.
    BTW, Libertarianism is a philosophy, not an economic system.

    Ralph Averill

    March 16, 2010 at 07:05

  13. […] See how the Big Banks are faring right now→ … then ask yourself: Do I want my money in their banks? ~~ Possibly related posts: […]

  14. […] the stunning headline on this post from The Bankwatch: The data on derivatives is impressive. JPMorgan Chase, for example, held derivatives worth 6,072 […]

  15. Stunning. Do you have any similar figures for UK banks?

    Jeremy

    March 17, 2010 at 11:10

  16. […] Citi and Bank of America have more liabilities than they did before the crash. And as the Bankwatch blog points out, those figures of 4,000% pale into insignificance when compared to Goldman Sachs’ 33,823%. […]

  17. […] “This simply adds to the point that despite all the histrionics and efforts in Washington, nothing has been learned and the American Banking system is now at least at as much risk now as in 2007, pre crash.“ http://thebankwatch.com/2010/03/11/goldman-sachs-derivative-liability-33823-of-assets/ […]


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