Those Lucrative Interest-Rate Hedges

Peter Eavis notes something quite astonishing today:

The interest rate on [Goldman's] long-term borrowings was a minuscule 0.92% in the third quarter, down from 3.53% in the third quarter of 2008. This $203 billion of debt is Goldman’s largest single funding source, so as its cost plunges, its bottom line benefits…

Goldman has been helped by its use of interest-rate derivatives. When issuing long-term fixed-rate debt, Goldman has for years entered swaps that effectively convert nearly all of that debt to floating-rate. Thus, as interest rates plummeted, so did one of Goldman’s main expenses.

To put these numbers into perspective, a savings of 2.43 percentage points in one quarter amounts to $1.2 billion in saved interest costs on $203 billion. That’s over 40% of its third-quarter earnings.

Even so, Goldman’s hedging gains by converting fixed-rate into floating-rate debt pale in relation to $3.6 billion that Wells Fargo made on much the same trade, hedging its mortgage-servicing rights. Clearly much if not most of the US banking sector made enormous profits in Q3 on interest-rate swaps — profits which are the very definition of unsustainable.

And there’s another question, too: if the likes of Wells Fargo (WFC) and Goldman Sachs (GS) are making billions on these swaps, who’s on the other side of the trade? Who lost billions of dollars by swapping floating into fixed? Call it the Summers trade, after Larry’s disastrous foray into the rates market when he was at Harvard. It didn’t work then, and it clearly isn’t working now, either.

Comments

[a fat panda:]

" And there’s another question, too: if the likes of Wells Fargo (WFC) and Goldman Sachs (GS) are making billions on these swaps, who’s on the other side of the trade? Who lost billions of dollars by swapping floating into fixed? "

You are kidding? It is the US taxpayer that is on the other side of the swap. GS borrows at the fed discount window, TAF, FDIC backed debt, etc.. for next to nothing. According to one article on this site, GS borrowed 28 billion from the Fed Discount Window.

This isn't the Summers trade. It is the Bernanke trade.

Nov 05 10:49 AM

[Steve J:]

The Fed window is not the US tax payer.

Nov 05 11:23 AM

[Robert Mart...:]

Felix,

As FatPanda noted above, the other side of Goldman's trade is the U.S. taxpayer. Goldman is profiting from our zero-interest rate policy with abandon.

Unfortunately, it is putting America further from financial solvency. You don't cure a drunk with another drink, and you don't cure a credit bubble with more debt. That's why the U.S. dollar is collapsing: America has debts it cannot pay and a currency it cannot support.

Investors need to be defensive: Gold and commodities are the best bet to preserve wealth.

Rob

Nov 05 11:42 AM

[a fat panda:]

The Fed Window is a printing press in the back-office of the Fed. If you consider inflation as a tax, and many do, the tax payers are on the hook for all of the dollars being printed. The fact that it will take 2 years for inflation to take hold only means that it is future tax payers that anchor this business rather than today's tax payers. I am not sure that there is much of a difference.


On Nov 05 11:23 AM Steve J wrote:

> The Fed window is not the US tax payer.

Nov 05 09:36 PM