Going Off the Goldman Standard
David Brooks meet Michael Lewis.
Seriously, though, I think both Brooks and Lewis are wrong about the shape of things to come. Goldman’s role, from the origins of the firm, has been to be the smartest guys in the room. They were the scrappy Jewish firm that, when it couldn’t get into the club, started its own. They have been the leaders in financial innovation for more than one economic cycle. But I rather doubt that “promote innovation” is going to be the rallying cry of our financial system going forward.
Who are the new titans?
JPMorgan Chase (market cap: $141 billion), the result of combining the largest and most boring domestic banking empire with the whitest-shoe firm on Wall Street; and Bank of America (market cap: $156 billion), another boring banking colossus, the result of combining West Coast old money with New South new money, to which we will now add Mother Merrill, queen of old-time brokerage. Each of these firms is 50% greater in value than Citigroup (the firm that tried to become the financial supermarket of the future) and roughly three times the market value of Goldman Sachs. Neither has been notable as an engine of financial innovation.
If there’s a new establishment a-borning, it’s not going to be composed of the smartest guys in the room, but the old-fashioned bankers who are worried about being fleeced by the smartest guys in the room.
Seriously: if you were a regulator in 2004-2005, the best way to identify likely problems would simply be to look at which areas are making too much money on Wall Street. Any profit center showing extraordinary growth, extraordinary margins, and/or an extraordinary Sharpe ratio in its returns was likely to be a place where risk-management was not adequately capturing the tails of the risk distribution. The more evidence that risk management had looked at everything and nothing could be found, the more worrisome that should be for regulators.
Now, to be fair, the big losses were not incurred by Goldman Sachs – that’s why Goldman is still standing. They were incurred by people who were imitating the super-smart guys, but weren’t smart enough to get off the train before it crashed. But even so, let’s say the regulators actually use this rule of thumb going forward: when someone’s making too much money doing something new, our job is to figure out how to stop them. Who rules in that world? Goldman Sachs? Really?
I don’t follow it that closely, but wasn’t Goldman’s Global Alpha fund down 40% in 2007? And most of that in a week of deleveraging against beta-‘neutral’ positions being unwound by other big hedge funds?
I do like Lewis’ description of the best poker player being said all the dumb money has been taken off the table, and then a drunken USA walks into the casino looking for some action. However, like you, I think we’ll see a much different deal going forward – Atlanta as the future of finance?
— rortybomb · Sep 24, 07:38 PM · #
Noah, thanks. your posts have been extremely helpful during this crisis.
To show my appreciation, I was wondering if you could answer a question that’s been buzzing around in my mind. To set it up, you probably need to read this excerpt from the paper Complexity Theory and Network Centric Warfare:
Obviously, the “spark” in the forest fire model is some kind of energy event that pushes a space in the grid over the combustion threshold. My question is tripartite.
1. what was the “sparking event” for the current financial crisis? — (most analyses focus on the production of kindling, e.g., overleveraging, sub-prime mortgages, risk-ignorance, greed, dirty Republican mantras like “everyone should be a homeowner”, etc.)
2. is there, and can you think of, a definition that encapsulates all possible sparking events? — (similar in generality to “an energy event that pushes a space in the grid over the combustion threshold.”)
3. if so, can you think of a way to tune this parameter from “on top”?
hope this makes sense. thanks.
— JA · Sep 24, 07:47 PM · #