Tuesday, January 22, 2008

Goldman wins this time...the next?

Here is an interesting Michael Lewis article from Bloomberg:


You could expect firms to have variable exposure to sub-prime mortgages (and their eventual collapse). Goldman, however, (as far as we can tell right now) seems to be a bit of an outlier. Some banks did better than others but I don't know of any that actually made a pile out of this whole thing. Lewis presents evidence that two individuals were given large power to offset the rest of the firm's positions (basically as Lewis says, calling everyone else in the firm an idiot). It turns out this time they were right. The position must have been massive, and probably massively risky if they were able to overwhelm losses in other parts of the bank and produce substantial profits. This reminds me a bit of Long Term Capital. Really smart, maybe arrogant guys, given a ton of freedom to take on hugely risky positions. Will Goldman have an even bigger blowup in the future?

Who knows, maybe its a stupid question since its based on speculative evidence and they surely will have a big loss sometime in the future given their business of relatively high risk (lots of proprietary investments), but the loss may not be caused by risk management structure.

One final thought. I don't think arguing that this could be interpreted as a hedging strategy works, unless they wildly miscalculated the hedge. You could argue that from a risk management standpoint, it might be a good idea to go market neutral when an area looks especially uncertain or irrational. But this position seems to have made a bunch of money. Not a hedge at all but an outright call. (Although it was probably a sophisticated set of trades in order to isolate the specific risk they were looking for.)

No comments: