Why Does Goldman Sachs Need a Fed Exemption for VaR Calculations?

Lately the topic of Goldman's (GS) VaR has taken on significant prominence, not least because as Zero Hedge disclosed Tuesday, it hit a record high. The implications for this were large enough that even Bloomberg picked up on this story.

Many readers raised questions of how is it even remotely possible for the company to have a VaR in the low-mid $200 MM ballpark, yet to post a record number of $100MM+ trading days in Q1; Zero Hedge is willing to wager that the upcoming 10-Q release will demonstrate another record number of $100MM+ days in the just closed quarter as well. How is that possible?

The clue may come from a February 5 letter by the Federal Reserve to Goldman CAO Sarah Smith. The letter had come in response to GS requests for "temporary exemptions from the application of certain aspects of the Board's Market Risk Rules for state member banks and bank holding companies and the Board's general risk-based capital rules for bank holding companies." Basically through the end of 2009 Goldman is basically using non-traditional. SEC approved VaR models as can be seen here:

GSGI has requested that (1) through December 31, 2009, GSGI and Bank be permitted to use certain Value-at-Risk ("VaR") models approved by the SEC... to determine their capital requirements for specific risk under the Market Risk Rules; (2) through December 31, 2009, GSGI and Bank be permitted to use methods approved by the SEC to determine their capital requirements under the Market Risk Rules for those trading assets, including distressed debt and restricted stock investments that the SEC did not require to be included in the VaR-based models of GSGI and Bank; and (3) GSGI be allowed to use methods approved by the SEC to calculate risk-based capital requirements for its nonfinancial equity investments that are subject to the Board's Credit Risk Capital Rules.

The letter goes into detail explaining why a bank needs to follow a MRR VaR methodology. Yet what is not made clear is i) why does Goldman need almost a full year of alternative VaR calculation and MRR exemption and ii) what is the protocol for the SEC to enforce VaR compliance when Goldman's ultimate regulator is the Federal Reserve.

The exemption raises critical questions not only with regard to the validity of the company's indicate VaR, but also downstreaming capital requirement reports. Zero Hedge would be remiss to point out that a very close relationship between the most critical financial company in the world and the most discredited regulator (SEC) does not bode well for confidence in this critical risk indicator, which as many have pointed out, is clearly the main metric by which to measure not only the performance, but the risk capacity of the world's largest government-backstopped hedge fund.

Mr. Canaday, Mr. Van Praag - the floor is, again, yours. In your absence, Zero Hedge will, and encourages it readers to, contact Mr. Homer Hill at the Federal Reserve Bank Of New York to provide additional clarity on the matter.

GS VaR Request -

Comments

[Moon Kil Woong:]

SEC approved really means almost the same thing as unregulated. I totally agree that GS is still trying to engage in fiscal arbitrage and that the SEC should have no role in determining what a bank's VaR or capital requirements should be.

If GS is doing so swell shouldn't they cut back on the bonuses and keep more capital in house to eventually not be such a systemic risk if their bets go bad? They are still operating as a casino brokerage even though they have become a bank. They must choose, either get low interest government bank loans that they can turn around to make loads of cash off of or leverage themselves to the sky in order to make sick returns on equity. They should not have the luxury of both. They also shouldn't be allowed to gamble so fiercely simply because now that they are a bank, if they go under it is the taxpayers that have to pay the gambling debts.

"Oh," GS might say to that, "What's the difference? We always assumed we could force the taxpayer to bail us out even before we became a bank." Thus, now you understand the indemic root of the brokerages gambling mentality that doomed us all. It's all win win for these guys. Why should they bother having risk analysis at all? To them, that's the jobs of the worst regulators on the market. Apparently they feel it's the SEC. They could be right about that.

Jul 16 06:11 AM

[expat in China:]

Great Moon

Jul 16 07:08 AM

[CautiousInv...:]

They may or may not be playing regulatory arbitrage.

I am only somewhat familiar with these risk models, but their shortcomings have to do with reliance upon normal distribution of trading outcomes. More recently we have learned that there is skewness to the probability of outcomes........creating fat tails of risk.

I think the request is based upon the huge number of transactions and the volume of principal trading activity usings HFT platforms while acting as a SLP. I'm geussing.

To the extent this is true, perhaps the argument is that Goldman should not be providing supplemental liquidity as it exposes Goldman, who is certainly too big to fail, to too much risk. After the debacle we have lived through why license Goldman to assume additional risk so it can make more money while helping the NYSE as a liquidity provider?

Jul 16 08:30 AM

[morph366:]

Moon's comment is right on the mark.
When you're too big to fail the exact procedures and techniques used for risk management and VaR calculations are just a charade to make it look like they are being prudent

Jul 16 08:48 AM

[OldLimey:]

The notion that GS has to 'ask' the federal government before doing anything flies in the face of the last 12 months' experience.

Jul 16 09:42 AM

[dybydx:]

LOL. good pt.


On Jul 16 09:42 AM OldLimey wrote:

> The notion that GS has to 'ask' the federal government before doing
> anything flies in the face of the last 12 months' experience.

Jul 16 10:03 AM

[Wizler:]

I worked for a COO of an iBank that was the fall guy for pushing the VaR enevelope..off with his head....don't think we will see any GS heads roll?

Jul 16 11:19 AM

[RTF 360:]

www.cnn.com:80/2009/PO...

for Janet Tavakoli the woman who litteraly "wrote the book" on structured investment vehicles and OTC swaps to turn on Goldman Sachs is earth shattering news in the world of high finance.
Please read and share widely; she has busted these Banksters for what they are ; thieves and thugs.

Goldman Sachs does't have "earnings" they have booty & loot.

Jul 16 12:21 PM

[PainfullyAware:]

When you are the "Functional Arm Of The Presidents Working Group On Financial Markets" Special Favors are the rule of the day.

GS and JP Morgan - Profits Way Up; more than likely from the fees they are charging the G'ubmint to overwhelm the market momentum.

At least some are beginning to take notice of the Nefarious Actions.

Recognition Of Root Cause Is The First Step To Remedy.

Jul 16 01:29 PM

[coldcall:]

Moon's comment is bang on the money.

I find the whole thing depressing because this is not capitalism folks. The fact that these frigging banks caused a global crisis of biblical proportions, and now continue to milk the system and tax payer for every last penny ranks as perhaps the greatest human scandal ever.

Though i'm probably more shocked how the sheeples have accepted this status quo.

Jul 16 03:24 PM

[Ars Conject...:]

I don't want to pour cold water on the rampant conspiracy theorizing or the general lynch mob tone of the comments. Yet, even if what others have said is all true, nevertheless, just from a purely practical perspective, it could reasonably be expected to take a firm with Goldman's size and diversity one year to complete the IT infrastructure project necessary to rip out or modify their current VaR model (such as it is) and replace it with a new one (such as it will be).

Jul 19 04:06 PM