Welcome to Capital Account. Goldman Sachs gets outed in a scathing resignation letter on the New York Times op-ed page today from executive director and head of Goldman Sach’s US equity derivatives business in Europe, Greg Smith. In the letter, Greg Smith does not pull any punches. He says, in his letter, that the environment at Goldman Sachs is now “as toxic and destructive as I have ever seen it.” Greg claims that Goldman puts making money ahead of everything else, including ahead of its own clients who it regularly refers to as “muppets,” sometimes over internal email. He also says that “today, if you make enough money for the firm (and are not currently an ax murderer) you will be promoted into a position of influence.” An ax murderer?? It sounds like Greg Smith is describing a sociopath, not a 143-year old financial institution. But wait, it get’s better. Smith also lists a three-step method for becoming a leader at Goldman Sachs today. He says that one should: a) Execute on the firm’s “axes,” which is Goldman-speak for persuading your clients to invest in the stocks or other products that we are trying to get rid of because they are not seen as having a lot of potential profit. b) “Hunt Elephants.” In English: get your clients — some of whom are sophisticated, and some of whom aren’t — to trade whatever will bring the biggest profit to Goldman. Call me old-fashioned, but I don’t like selling my clients a product that is wrong for them. c) Find yourself sitting in a seat where your job is to trade any illiquid, opaque product with a three-letter acronym. The mention of illiquid and opaque products is most interesting because it is consistent with behavior we have seen from the TBTFs in the past with respect to derivatives, in that they prefer these illiquid markets as they can better manipulate the price of what they are selling, and thus generate huge fees.
But today is also important for another reason. The results of the Fed’s most recent stress test came out yesterday after the market closed, and the results weren’t pretty, at least not for 4 of the 19 banks tested, including Citi Group, which failed to pass the test. So how accurate or useful are these tests anyway? After all, we saw during the financial crisis of 2008 that the banks themselves were unsure of how much exposure they had. In addition, these stress tests do not treat the asset side of bank balance sheets the same as they do the liabilities side. The liability side is much more opaque, in part because of the issue of dynamic hedging, which requires constant trading activity in the event that markets begin to deleverage. It is very difficult to model out a deleveraging, like what we saw in 2008, because you have lots of market participants who each have risk models that they have to abide by and that requires dynamic hedging. That can become very difficult in an increasingly illiquid market full of large air pockets. These are all things that we discuss on the show today with Yves Smith, writer of the very popular economic blog, Naked Capitalism.
Lastly, we cover Roger Lowenstein latest article that will make the Atlantic’s cover story titled “Hero or Villain.” Speaking with Bernanke one-on-one, Lowenstein presents the central banker as a deeply conflicted, but unfathomably human character, and tries to demonstrate that Bernanke’s academic and personal contradictions have manifested in his approach to monetary policy. We will give you our take on the today’s segment of “loose change.”