Later On

A blog written for those whose interests more or less match mine.

How to earn money like Goldman Sachs

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Sharona Coutts writes at ProPublica:

Goldman Sachs has proved once again that it knows how to make money. Wednesday’s announcement of a record quarterly profit of $3.44 billion [1] ($) has spurred debate [2] over how the bank did it.

In addition to making money via its own trades, Goldman profits by advising clients about deals. Some of that advice has proved quite savvy.

As we reported last year [3], one of Goldman’s money-making strategies was to encourage some clients to bet on declines of the creditworthiness of a range of states — including California, New Jersey, New York and Florida. Goldman advised hedge funds to take the bets by buying credit default swaps, the insurance-like financial instruments that have been blamed for contributing to the financial meltdown last fall [4].

The strategy angered California Treasurer Bill Lockyer [3] because his state was paying Goldman millions to help market the same bonds that Goldman was advising other clients to bet against.

This week’s announcement of huge profits — and the likelihood of near-record bonuses [5] — at Goldman led us to wonder how much investors could have earned by following Goldman’s controversial advice.

Basically, if you had bought swaps against $10 million in California bonds in July 2008, it would have cost just under $80,000. Today, you could theoretically sell those swaps for $350,000 — making a 338 percent profit.

For bets on credit a downgrade of New York, the profit would have been 575 percent, according to data provided by Markit [6], which tracks credit default swaps.

Of course, there are lots of caveats buried in these numbers. Notably, the prices assume that someone would want to buy the swaps, and that they would have the cash to do so.

But fundamentally, it looks as if Goldman was right to advise clients that betting against states was a good way to make money. California didn’t like it because, as Lockyer’s spokesman said at the time [3], drumming up bets against California bonds could further undermine confidence in the state’s ability to repay its debts. That, in turn, could force the state to pay higher interest rates to borrow money, and cost taxpayers tens of millions at a time when the state is facing one of the worst budget crises in its history [7].

So who are the people who’ve promised to pay up if California, or other states, cities and municipal entities, default? There’s no way to know, because the swaps are still unregulated — though Congress is debating if and how to change that [8].

Continue reading.

Written by LeisureGuy

17 July 2009 at 8:06 am

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