33,823% of Goldman Sachs assets - legally hidden

Goldman Sachs held derivatives that totaled 25,284 percent of assets in 2008 and 33,823 percent as of June 2009 (source: FDIC SDI database). Why do these big numbers matter? They represent a form of dept that is invisible to the public, being held off balance sheet. Colin Henderson on the Bankwatch Blog seems has a real knack for turning information like this, which many of us would avoid, into something digestible, even if it leaves a sour taste on the way. This time around he has taken the FDIC SDI database and a Levy Economoics paper titled The Global Financial Crisis and the Shift to Shadow Banking and made it into a scary appetizer blog post.

What does this mean to those of us interested in technology and process? It suggests that for all the efforts by the regulators to enforce accurate accounting practices and liquidity of banks, the rules and regs from Sarbanes-Oxley, Gramm Leach Bliley, the SEC, FDIC etc, are virtually meaningless. As banks continue to show that they are following the letter of the law, with best practices processes and controls, preventing fraud and avoiding dubious money-laundering transactions, it seems that they are carefully hiding from their own systems a huge potential for financial ruin. According to Colin:

Incidentally when trying to understand derivatives, simply assume off balance sheet debt. There is all kind of rationale as to why that off balance sheet debt is not dollar for dollar, but the important point is that no-one argues that derivatives are worth zero. There is an intrinsic liability that frankly few bankers can explain to you, so you must begin with the face value of the liability, and banks are guilty until proven innocent on that one.

As an accountant, the notion of off balance sheet debt is a contradiction in terms. Is it a liability? If yes, it should be on the balance sheet.

So it would appear that the 33,823% was not actually actually worth that percentage in dollars of the assets of Golman Sachs. But unless each derivative is worth a penny on every face value of a dollar, its still one enormous amount of risk that is not open to investor scrutiny.

As an overhaul of bank regulation is considered more closely, and the experts wonder at whether Basel-II rules, ensuring banks hold enough liquid capital to cover their exposure, actually should, could or may help in the future, it seems that there is one big accounting lie going on. While the banks are allowed to hide liabilities, what hope is there that the processes and technology we put in place to ensure all the other fairly inconsequential transactions (I'm being facetious, yes I have heard of Barings and BCCI) don't lead to financial ruin. This is not something that is going away, as Bank of America and Citi now own more derivative exposure than in 2007, according to the FDIC numbers.

Technology, monitoring and process controls are only as good as the rules we put into them, and if those rules are explicitly told to ignore certain things, that seems to leave a very unappetizing can of worms.

A post from the Improving It blog

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