One of the staples of the financial crisis has been a critique of investment banks for being over-leveraged and under-capitalised. But in the analyst reaction to today’s earnings announcement from Goldman, we can see that its executives are under tremendous pressure from the investing public to lever up.
Goldman revealed that even though it has been increasing the risk it takes in day to day trading, it has dramatically increased the amount of idle capital it is sitting on. This is nothing new for Goldman. For years it famously had a “box” at Bank of New York where it held something like a hundred million in Treasuries that just sat around waiting for a day when Goldman might find itself in a liquidity crunch.
What is new is that Goldman’s box, which we assume is probably still with BoNY, has even more cash and Treasuries than ever before.
And the analysts hate that. On the earnings call, analyst after analyst asked Goldman why it wasn’t doing more with its capital. Why aren’t they putting it to work in the markets? In their view, Goldman is just not being efficient enough when it came to deploying its capital to make a return for its investors.
In short, we witnessed first hand the investor demand for risk and leverage.
Goldman’s answer to all these questions was so consistent you could tell David Viniar had it written down in his notes. It amounted to three points:
- Market Risk. The world is still a dangerous place, so Goldman wants to have a lot of liquidity stored away in case the credit pipeline dries up again.
- Regulatory Risk. Regulators may increase capital requirements or change the way a firm’s capital levels are calculated. It’s a good idea to have a bunch of extra cash on hand to hedge the regulatory risk.
- Unwilling Sellers. The values just aren’t there. Banks may whine about illiquid assets, but the problem is that they are still hanging onto distressed debt at levels that make it too risky for Goldman to buy it. It’s the equivalent of Nantucket homeowners refusing to sell at anything below the prices they paid at the boom. Goldman, like our own Henry Blodget, would like to own a cottage in Nantucket but not at these prices.
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