In a wide-ranging interview with The Wall Street Journal, Goldman Sachs President Gary Cohn delivers a friendly explanation of high finance for dummies, a jovial insider’s glimpse into how things are on Wall Street. Cohn handily dismisses ways that bank boards could more tightly manage firms like Goldman, and reassures everyone on its risk-free position vis-a-vis AIG. Goldman, unlike many of its peers, seems only at risk of making money. It’s a noteworthy performance: Cohn seems completely oblivious to the subtext of his remarks: Taxpayers have forked over $18 billion to a well-run firm that is about as healthy as it can be under the current circumstances.
Leverage, Cohn asserts, is “probably the single most misunderstood concept in the world.” To prove that most bank boards (and regulators, no doubt) don’t understand the many nuances of borrowing money to fund investments, Cohn offers “to sort of orchestrate” an example for anyone watching the WSJ forum “The Future of Finance Initiative”.
Supposed you have two companies, Maestro Cohn says, both with $100 million in equity. Company A buys $1 billion in US Treasurys — you know, the safe-haven investment that the Chinese have been stuffing themselves with, but now complain are leaving them hungry. So Company A has leveraged the company tenfold. Company B buys $500 million in illiquid European debt. Its leverage is a mere fivefold. Now Cohn asks, which company is in greater peril: The one that can sell its portfolio in 10 seconds or the one that “can’t liquidate under any circumstances”?
Or allow me to put it another way, which company endangers a society more: A firm that borrows enough money to make hedge fund managers nervous — but puts it into triple-A rated investments; or a firm that borrows almost as much as hedge fund managers but puts the cash into illiquid investments that no one understands?
Okay. That was a trick question. The investments in each case are one-in-the-same: the newly re-christened “legacy” mortgage securities!! Either way, taxpayers are stuck with the bill from here to eternity.
Nonetheless, Cohn’s point is well taken: Never use a single measure like leverage as a “broad brush” to measure risk. But it’s hard to swallow that a bank board wouldn’t understand the various shades of leverage. Does he think hand-picked advisors to major companies wouldn’t understand if a bank is borrowing money to buy junk? Oops. On that point, he may be right: The rating agencies didn’t know either. And what if the bank uses short-term borrowings to buy long-term positions? How could they possibly understand the perils of that mismatch in funding? I know, that’s so 1990s, something only a savings and loan would do. Or maybe not. Look, former Goldman Sachs chairman Robert Rubin didn’t understand what Citibank was doing when he served as a senior advisor there. How could anyone else get it ?
Next up: AIG and CDS, a complicated topic but apparently not as difficult as the concept of leverage. The WSJ wonders if the government rushed in to save AIG by way of saving Goldman Sachs. Cohn tries not to get exasperated. He’s heard that story as well: “I read the same newspapers that you read.”
Goldman was never at risk, he explains. Every single penny of its $2.5 billion in liabilities to AIG was hedged: Between collateral and CDS purchases (costing Goldman “well north of $100 million”), the firm was covered. In fact, Cohn says that depending on when the AIG positions were liquidated, Goldman could have made a profit.
So that makes us all dummies: First the government forces Goldman to take $10 billion in loans to ensure its health. Then it gets another $8.1 billion through the AIG back door to cover fully hedged positions. Maybe Cohn should explain to stressed out small business owners and families at risk of losing their homes how they can come out as well as Goldman Sachs. He could call it “Bailout for Dummies”. I bet it would be an overnight sensation. Reserve my copy now.
Image by .nele via Flickr