Goldman Sachs voor winst in voor- én tegenspoed

[Cees Binkhorst]

REPLY TO: D66 at nic.surfnet.nl

Om nogmaals de vrijdag af te sluiten en het week-end te beginnen ;)

Goldman Sachs heeft (als enige?) dispensatie gekregen van de Market Risk
Rule. Dit houdt in dat GS de risico's niet volgens het boekje hoeft te
waarderen, maar eigen schattingen mag maken. Dus heeft nu wél 100 miljard
steunkapitaal, maar mag zelf bepalen hoeveel haar kapitaalsbehoefte is.
Ze is bovendien een dochter van Group Inc., die voorziet in haar behoefte
aan risicokapitaal, én dus minder geld beschikbaar hoeft te maken.

Daarnaast voorziet GS, met nog zo'n 400 (van de 20.000) andere traders, in
(onrechtmatige?) winsten door haar computers zo dicht op die van de
beursen te zetten, dat ze pakweg 30 milliseconden eerder de aan- en
verkoopsignalen van alle andere traders langs ziet komen. Hierdoor maakt
ze met aangepaste aanbiedingen per jaar miljarden extra winst.

Groet / Cees

http://www.motherjones.com/print/25735
How You Finance Goldman Sachs’ Profits
By Nomi Prins | Tue July 28, 2009 12:28 PM PST

This is perhaps the most important thing I learned over my years working
on Wall Street, including as a managing director at Goldman Sachs: Numbers
lie. In a normal time, the fact that the numbers generated by the nation's
biggest banks can't be trusted might not matter very much to the rest of
us. But since the record bank profits we're now hearing about are
essentially created by massive federal funding, perhaps it behooves us to
dig beneath their data. On July 27, 10 congressmen, led by Rep. Alan
Grayson (D-Fla.), did just that, writing a letter to Federal Reserve
Chairman Ben Bernanke questioning the Fed's role in Goldman's rapid return
to the top of Wall Street.

To understand this particular giveaway, look back to September 21, 2008.
It was a frenzied night for Goldman Sachs and the only other remaining
major investment bank, Morgan Stanley. Their three main competitors were
gone. Bear Stearns had been taken over by JPMorgan Chase in March, 2008,
Lehman Brothers had just declared bankruptcy due to lack of capital, and
Bank of America had been pushed to acquire Merrill Lynch because the firm
didn't have enough cash to survive on its own. Anxious to avoid a similar
fate, hat in hand, they came to the Fed for access to desperately needed
capital. All they had to do was become bank holding companies to get it.
So, without so much as clearing the standard five-day antitrust waiting
period for such a change, the Fed granted their wish.

Bank holding companies (which all the biggest financial firms now are)
come under the regulatory purview of the Fed, the Office of the
Comptroller of the Currency, and the FDIC. The capital they keep in
reserve in case of emergency (like, say, toxic assets hemorrhaging on
their books, or credit derivatives trades not being paid) is supposed to
be greater than investment banks'. That's the trade-off. You get access to
federal assistance, you pony up more capital, and you take less risk.

Goldman didn't like the last part. It makes most of its money speculating,
or trading. So it asked the Fed to be exempt from what's called the Market
Risk Rules that bank holding companies adhere to when computing their
risk.

Keep in mind that by virtue of becoming a bank holding company, Goldman
received a total of $63.6 billion in federal subsidies (that we know
about—probably more if the Fed were ever forced to disclose its $7.6
trillion of borrower details). There was the $10 billion it got from TARP
(which it repaid), the $12.9 billion it grabbed from AIG's spoils—even
though Goldman had stated beforehand that it was protected from losses
incurred by AIG's free fall, and if that were the case, would not have
needed that money, let alone deserved it. Then, there's the $29.7 billion
it's used so far out of the $35 billion it has available, backed by the
FDIC's Temporary Liquidity Guarantee Program, and finally, there's the $11
billion available under the Fed's Commercial Paper Funding Facility.

Tactically, after bagging this bounty, Goldman asked the Fed, its new
regulator, if it could use its old risk model to determine capital
reserves. It wanted to use the model that its old investment bank
regulator, the SEC, was fine with, called VaR, or value at risk. VaR
pretty much allows banks to plug in their own parameters, and based on
these, calculate how much risk they have, and thus how much capital they
need to hold against it. VaR was the same lax SEC-approved risk model that
investment banks such as Bear Stearns and Lehman Brothers used, with the
aforementioned results.

On February 5, 2009, the Fed granted Goldman's request. This meant that
not only was Goldman getting big federal subsidies, but also that it could
keep betting big without saving aside as much capital as the other banks.
Using VaR gave Goldman more leeway to, well, accentuate the positive. Yes,
Goldman is a more risk-prone firm now than it was before it got to play
with our money.

Which brings us back to these recent quarterly earnings. Goldman posted
record profits of $3.4 billion on revenues of $13.76 billion. More than 78
precent of those revenues came from its most risky division, the one that
requires the most capital to operate, Trading and Principal Investments.
Of those, the Fixed Income, Currency and Commodities (FICC) area within
that division brought in a record $6.8 billion in revenues. That's the
division, by the way, that I worked in and that Lloyd Blankfein managed on
his way up the Goldman totem pole. (It's also the division that would
stand to gain the most if Waxman's cap-and-trade bill passes.)

Since Goldman is trading big with our money, why not also use it to pay
big bonuses? It's not like there are any strings attached. For the first
half of 2009, Goldman set aside $11.4 billion for compensation—34 percent
more than for the first half of 2008, keeping them on target for a record
bonus year—even though they still owe the federal government $53.6
billion, a sum more than four times that bonus amount.

But capital is still key. Capital is the lifeblood that pumps through a
financial organization. You can't trade without it. As of June 26, 2009,
Goldman's total capital was $254 billion, but that included $191 billion
in unsecured long-term borrowing (meaning money it had borrowed without
putting up any collateral for it). On November 28, 2008 (4Q 2008), it had
only $168 billion in unsecured long-term borrowing. Thus, its long-term
unsecured debt jumped 14 percent. Though Goldman doesn't disclose exactly
where all this debt comes from, given the $23 billion jump, we can only
wonder whether some of it has come from government subsidies or the Fed's
secret facilities.

Not only that, by virtue of how it's set up, most of Goldman's unsecured
funding comes in through its parent company, Group Inc. (Think the top
point of an umbrella with each spoke being a subsidiary.) This parent
parcels that money out to Goldman's subsidiaries, some of which are
regulated, some of which aren't. This means that even though Goldman is
supposed to be regulated by the Fed and other agencies, it has unregulated
elements receiving unsecured funding—just like before the crisis, but with
more of our money involved.

As for JPMorgan Chase, its profit of $2.7 billion was up 36 percent for
the second quarter of 2009 vs. the same quarter last year, but a lot of
that also came from trading revenues, meaning its speculative endeavors
are driving its profits. Over on the consumer side, the firm had to set
aside nearly $30 billion in reserve for credit-related losses. Riding on
its trading laurels, when its consumer business is still in deterioration
mode, is not a recipe for stability, no matter how much cheering JPMorgan
Chase's results got from Wall Street. Betting is betting.

Let's pause for some reflection: The bank "stars" made most of their money
on speculation, got nearly $124 billion in government guarantees and
subsidies between them over the past year and a half, yet saw continued
losses in the credit products most affected by consumer credit problems.
Both are setting aside top-dollar bonuses. JPMorgan Chase CEO Jamie Dimon
mentioned that he's concerned about attracting talent, a translation for
wanting to pay investment bankers big bucks—because, after all, they
suffered so terribly last year, and he needs to stay competitive with his
friends at Goldman. This doesn't add up to a really healthy scenario. It's
more like bad déjà vu.

As a recent New York Times article (and many other publications in
different words) said, "For the most part, the worst of the financial
crisis seems to be over." Sure, the crisis may appear to be over because
the major banks of Wall Street are speculating well with government
subsidies. But that's a dangerous conclusion. It doesn't mean that finance
firms could thrive without the artificial, public-funded assistance. And
it certainly doesn't mean that consumers are any better off than they were
before the crisis emerged. It's just that they didn't get the same
generous subsidies.

http://zerohedge.blogspot.com/2009/07/goldmans-4-billion-high-frequency.html
Goldman's $4 Billion High Frequency Trading Wildcard
A recent story in Advanced Trading goes after some of the minutae of High
Frequency Trading and provides a glimpse of the total value that HFT may
provide to behemoth PT powerhouses such as Goldman Sachs. The article
presents a very valuable perspective on just why HFT is so critical these
days, especially when cash traders go for 6 hour Starbucks breaks between
10 am and 3:30 pm: "high frequency trading firms, which represent
approximately 2% of the 20,000 or so trading firms operating in the US
markets today, account for 73% of all US equity trading volume. These
companies include proprietary trading desks for a small number of major
investment banks, less than 100 of the most sophisticated hedge funds and
hundreds of the most secretive prop shops, all of which operate with one
thing in mind—capture profit opportunities by being smarter and faster
than the closest competition." And as the market keeps going up day in and
day out, regardless of the deteriorating economic conditions, it is just
these HFT's that determine the overall market direction, usually without
fundamental or technical reason. And based on a few lines of code, retail
investors get suckered into a rising market that has nothing to do with
green shoots or some Chinese firms buying a few hundred extra Intel
servers: HFTs are merely perpetuating the same ponzi market mythology last
seen in the Madoff case, but on a massively larger scale. When it all
blows up, the question is whether the SEC will go after the perpetrators
of this pyramid with the same zeal that it pursued Madoff himself. We
think not.

The reason for this, as the AT article points out, is that HFT has become
the biggest cash cow for Wall Street: "The incredible capabilities offered
by technology have given meteoric rise to a relatively few high frequency
proprietary trading firms that now wield far greater influence on the
markets today than most people recognize." How big of a cash cow:

    "Proprietary trading takes in a number of unique strategies, including
market making, arbitrage (ETFs, futures, options), pairs trading and
others based on the linked trading of more than one asset class, e.g.,
futures index and cash equities. In fact, TABB Group estimates that
annual aggregate profits of low latency arbitrage strategies exceed
$21 billion, spread out among the few hundred firms that deploy them."

The $21 billion estimate is smack in the middle of the FIXProtocol
estimated $15-$25 billion in revenue that HFT generates. So let's do a
back of the envelope calculation: Goldman controls roughly 50-60% of
principal program trading on the NYSE, which in turn accounts for 30% of
all global program trading. Throw in Goldman's domination of dark pool
trading through Sigma X, and one can come up to quite a sizable number -
It would not be a stretch to conclude that, through various conduits,
Goldman is directly responsible for over 20% of global HFT trading. 20% of
$21 billion is over $4 billion a year. As margins on HFT are sky high (it
doesn't cost all that much to tweak a few hundred lines of code - and if
Sergey Aleynikov is any indication, $400,000/year for VPs in the program
is peanuts for a firm like Goldman), this $4 billion likely drops to the
bottom line almost dollar for dollar. Let's recall that Goldman's Q2
earnings were $3.44 billion. Does this mean that HFT/PT accounts for
roughly 25% of earnings for the firm that is a hedge fund in all but FDIC
backing? Zero Hedge would in fact take the over, especially in this
environment where M&A fees are a distant memory. We leave this question
open, but even if we are off, it would not be by order of magnitude, and
would explain why Goldman has thrown the kitchen sink into dominating such
NYSE programs as the SLP, and is expending so much energy to dominate dark
pools as well.

Going back to the AT article, which provides some additional critical
observations, especially with regard to the Aleynikov arrest and his
ludicrous $750,000 bail which surpasses that of indicted Ponzier Sir Allen
Stanford:

    First, strategies that optimize the value of high frequency
algorithmic trading are highly dependent on ultra-low latency. The
right decisions are based on flowing information into your algorithm
microseconds sooner than your competitors. To realize any real benefit
from implementing these strategies, a trading firm must have a
real-time, colocated, high-frequency trading platform—one where data
is collected, and orders are created and routed to execution venues in
sub-millisecond times.

    Next, since many of these strategies require transacting in more than
one asset class and across multiple exchanges often located hundreds
of miles apart, i.e., NY to Chicago, that infrastructure will often
require roundtrip long haul connectivity between the data centers.
[TD:Any real estate professionals out there who can determine just how
easy it is to set up a colocated station within millisecond distance
of the NYSE, and whether or not Goldman has any rights of first
refusal on this real estate optionality? Nothing like a little
derivative monopoly to keep potential SLP vendors at bay]

    Lastly and most importantly, this code has a limited shelf life, whose
competitive advantage is diluted with each second it is outstanding.
While a prop desk's high level trading strategy may be consistent over
time, the micro-level strategies are constantly altered—growing stale
after a few days if not sooner—for two important reasons. Firstly,
because high frequency trading depends on ridiculously precise
interaction of markets and mathematical correlations between
securities, traders need to regularly adjust code—sometimes slightly,
sometimes more—to reflect the subtle changes in the dynamic market.
The speed and volatility of today's markets is such that the
relationships forming the core of our algorithm strategies often
change within seconds of our ability to implement the very strategies
that exploit them. Secondly, competitive intelligence is so good
across all rival trading firms that each is exposed to the increasing
susceptibility of their strategies being reverse engineered, turning
their most profitable ideas into their most risky. As a result, any
firm acquiring the "stolen" code would gain benefit from it for no
more than a few days before that firm would need to adjust the code to
the dynamic conditions. Since these changes build on themselves, in a
matter of weeks that code would look quite different from that which
was originally "stolen."

And the conclusion:

    There's no doubt that Goldman Sachs, or any other proprietary trading
firm, could indeed lose tens of millions of dollars from its
proprietary trading if their strategies are stolen—and that is very
serious. The competitors that obtain access to these trading secrets
could (and would) use it to front run or trade against it, ruining
even the most well-planned tactics. This news story contains many very
important sub-plots: trading espionage, the necessity for a trading
firm to have sophisticated security systems built around its
technology, the requirements for risk management, and even the
potential for proprietary trading software to be targeted on a wider
scale for terrorist activity; but more than anything else it
highlights the critical role played by high frequency prop trading in
this new market.

This is indeed, a conclusion that Zero Hedge has been pounding the table
on for months. It is imperative that Wall Street firms shed much more
light into this astronomically profitable yet highly misunderstood and
under the radar concept. In the absence of more information, the
likelihood that Wall Street firms who dominate order flow and have
material unfair advantages over virtually everyone else, should be
isolated from trading up to the point where they provide sufficient
information to make the market a fair and equal playing field for all
investors. Until that moment, investing, trading and speculating is doomed
to have the same outcome for the majority of market participants as
playing roulette with 35 instances of 00, a much lower fun coefficient and
no ability to be comped for your room in light of significant trading
losses.

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