David Viniar's Anti-Regulator Message On The Goldman Sachs Earnings Call Is Much Subtler Than That Of Some People He Could Name

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Like I mentioned earlier, the David Viniar show this morning is a good time in its (relatively) quiet way. If, like me, you've drunk the GS we-understand-risk Kool-Aid, you'll particularly enjoy Viniar's take on capital requirements, which is - and I say this as a compliment - pretty cynical. Now, one thing that you might have in your arsenal of thoughts about bank capital is something along the lines of "capital requirements are a way of forcing bank managers to confront the risks of their positions and fund those positions in a loss-absorbing way to protect their creditors and the financial system more broadly." Your faith in that position should I think be a little shaken by some of the Viniar Q&A. For instance:

Roger A. Freeman - Barclays Capital: [H]ow are you charging the desks for capital at this point? Is it on a Basel I basis or Basel III or some combination?

David A. Viniar: ... As far as how we're charging the desks, that's a little bit of a complicated question. And we're working through that now, and it -- there's no one-size-fits-all yet. And we have to be careful. As you know, Basel III does not kick in for quite a while, and quite a bit of what we do is very short dated. And so we don't want to charge desks on a Basel III basis, have them turn down profitable opportunities that would be long gone from our balance sheet long before Basel III ever kicks in. So we're really taking into consideration the tenor of what we do and trying to figure out what capital regime we're going to be under. And it's still -- I would say, we're going through a transition process here.

On the one hand, totally unsurprising and unobjectionable. On the other hand note the pragmatism: if and when our regulators are going to charge us for capital under the (generally higher) Basel III rules, we will charge desks for capital based on those rules. If not, not. The rules are the rules and the transition to new rules will be made in accordance with the rules. Only. If you thought "well, Basel III will improve the health and safety of banks by steering them away from the riskiest worst scariest products" - guess what, Goldman disagrees. They'll manage capital to whatever regime is in place, as a matter of complying with regulation, but the capital rules appear to have no effect whatsoever on how they actually think about the risks of their assets, trades and businesses.

Are they wrong? Well, a while back I sort of baselessly speculated on rumors that Goldman was looking into abandoning mark-to-market for some of its loan book, pointing out that this sacrifice of principle could help it compete on relationship loans that help win other business. Viniar chatted about this very topic on the call with Howard Chen of Credit Suisse and it turns out there's another important element:

We're looking at the accounting treatment for just, what I would call, a portion of the relationship loan commitments. ... [T]he consideration is being driven by the more onerous capital treatment for the fact that the same assets held on mark-to-market versus a held-for-investment basis are different. I mean, it's much more onerous for mark-to-market. So that's what driving even our consideration. You should know, and I will use this word, we are still fanatical believers in mark-to-market. Substantially all of our assets today are mark-to-market. Our risk is managed on a mark-to-market basis. And whatever we conclude on, what I'll call, a very small portion of assets, just relationship lending, those statements will still be true. Substantially all of our assets will be mark-to-market, and we will manage all of our risk on a mark-to-market basis. So nothing will change there.

Remember, of course, that there's no difference at all in the economics of a "mark-to-market" versus "held-for-investment" relationship loan. In each case, you lend $100 up front and get a stream of payments with a present value of $95 or whatever. If you're mark-to-market like GS and MS, you mark that $5 loss up-front and are sad; if you're hold-to-maturity like most banks, you book the stream of payments as received and, if all goes well, never have any accounting loss. But that's just accounting. The cash flows that happen in the world are the same cash flows.

Goldman manages its balance sheet on a mark-to-market basis: that is, as much as possible, it takes the present value of all its expected cash flows and sees what happens to that value over time, booking gains as it goes up and losses as it goes down, without worrying about whether some of those cash flows are "held to maturity" or whatever. It's one way to live your life, probably a good one if you're a financial intermediary. Basel, on the other hand, has different capital requirements for loans that are "mark to market" versus "held for investment," which maybe has some historical justification in the kinds of entities that once mostly did the one versus the other, but has absolutely nothing whatsoever to do with the underlying characteristics of the assets or with the risks of holding them. And so Goldman will pick the approach that gets the best capital treatment - but that will have absolutely nothing to do with how it thinks about the risk of those assets.

I guess the lesson is, if you enforce bank capital requirements that are encrusted with senseless formalism, you'll get banks who treat those requirements as senseless formalities. Maybe that's fine. Maybe your view on capital requirements is "bankers can think they manage risks well but the only way to keep the system safe is to have blunt-force capital rules that provide some loss absorption when all their risk management goes pear-shaped." That's a perfectly fine view. But if your view is of the form "regulators should figure out the bad risks and get rid of them," then the occasional senselessness in the rules should give you pause - and you should get worried when it's obvious, as I think it is from the Goldman call, that the banks are thinking harder about risk than the regulators are.

The Goldman Sachs Group Management Discusses Q4 2011 Results - Earnings Call Transcript [Seeking Alpha]

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David Viniar's Work Here Is Done

Back in 2009, Goldman Sachs Chief Financial Officer David Viniar, whose face may not be as recognizable to you as that of Lloyd's but whose voice you've likely found just as if not more soothing each time you hear it during the firm's earnings calls, decided he was ready to move on after a three-plus decade long career with The Firm. Normally, that would have been just fine; people would have wished Viniar all the best as he happily waved good-bye to all his colleagues and friends from the gondola lift made of fluffy clouds and money that transports all Goldman Sachs executives to retirement. Unfortunately for DV, however, it was around the time that he started to think about leaving that Goldman hit some unfortunate rough patches that included "a civil fraud suit by the Securities and Exchange Commission over marketing of mortgage-related securities, a federal criminal probe on the same matter, and a civil suit brought by a hedge fund that bought a Goldman CDO." And while other higher-ups-- no names: Jon Winkelried-- would have thought nothing of abandoning Lloyd in his time of need or what kind of message it would have sent that a top official was calling it quits, David "Bones" Viniar is  a little more loyal than that. Lot more loyal in fact ("He's so loyal he's only going to do anything when the timing is appropriate," one person said at the time, adding that "David will do whatever the firm asks of him") and so he stayed. Stayed by Lloyd's side during his darkest hour. Stayed when the Goldman needed him most. And although some might have hoped he'd forget about wanting to leave; that he could be tricked into staying "just one more year" and another and another and another after that; that that good-bye he put on hold would stay on hold forever; that, if all else failed, Gary Cohn could put him in a sleeper hold with his legs...that good-bye has come. Goldman Sachs today announced that Harvey M. Schwartz, the global co-head of the Securities Division, will become Chief Financial Officer at the end of January 2013. After a distinguished 32 year career at the firm, including 12 years as the Chief Financial Officer, David Viniar has decided to retire and will join the Board of Directors as a non-independent director at that time. The firm expects to appoint additional independent directors to its board in the near term. David Viniar retiring as Goldman CFO [FT Alphaville] Related: David Viniar Stands By His Man