goldman sachs financial crisis

8/17/2019 goldman sachs financial crisis

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AMITY GLOBAL BUSINESS SCHOOL, HYDERABAD

REPORT

On

“BANK CRISIS OF GOLDMAN SACHS”

Prepared By Fa!"#$y G"%de

MINHAAL REEMA&''( Dr) SRI HARI KRISHNA


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BANKING CRISIS OF GOLDMAN SACHS

Banking crisis is a situation of financial distress and where the banking system is having

negative net worth. Banks are susceptible to a range of risks. These include credit risk (loans

and others assets turn bad and ceasing to perform), liquidity risk (withdrawals exceed the

available funds), and interest rate risk (rising interest rates reduce the value of bonds held by

the bank, and force the bank to pay relatively more on its deposits than it receives on its

loans).

Bank crisis occur because of the following two reasons

De$er%*ra$%*n %n a++e$ a#"e+ can occur, for example, due to a collapse in real estate

prices or from an increased number of bankruptcies in the nonfinancial sector. !r, if a

government stops paying its obligations, this can trigger a sharp decline in value of

bonds held by banks in their portfolios. "hen asset values decrease substantially, a bank can end up with liabilities that are bigger than its assets (meaning it becomes

insolvent.)

Ban- R"n # bank occurs when many people try to withdraw their deposits at the

same time. #s much of the capital in a bank is tied up in investments, the bank$s

liquidity will sometimes fail to meet the consumer demand. This can quickly induce

panic in the public, driving up withdrawals as everyone tries to get their money back

from a system that they are increasingly sceptical of. This leads to a bank panic which

can result in a systemic banking crisis, which simply means that all of the free capital

in the banking system is withdrawn.

S$*!- Mar-e$ P*+%$%e Feed.a!- L**p+ !ne particularly interesting cause of

banking disasters is a similar positive feedback loop effect in the stock markets, which

was a much more dynamic factor in more recent banking crises (i.e. %&&'%&& sub

prime mortgage disaster). There is a profound truth to this, creating an interdependent

and potentially selffulfilling investment thought process. This can create dramatic

rises and falls (bubbles and crashes), which in turn can throw banks with poorly

designed leverage into huge losses.

Re/"#a$*ry Fa%#"re !ne of the simplest ways in which bank crises can occur is a

lack of governmental oversight. #s noted above, banks often leverage themselves to

capture gains despite extremely high risks (such as overdependence on derivatives).

C*n$a/%*n *ue to globali+ation and international interdependence, the failure of one

economy can create something of a domino effect. n %&&-, when the ./. economy

collapses, the reduced buying power and economic output from that economy

dramatically damaged all economies dependent upon it (which includes most of the

world). This is called contagion.

https://www.boundless.com/economics/definition/sub-primehttps://www.boundless.com/economics/definition/sub-primehttps://www.boundless.com/economics/definition/leveragehttps://www.boundless.com/economics/definition/globalizationhttps://www.boundless.com/economics/definition/economic-outputhttps://www.boundless.com/economics/definition/economic-outputhttps://www.boundless.com/economics/definition/outputhttps://www.boundless.com/economics/definition/leveragehttps://www.boundless.com/economics/definition/globalizationhttps://www.boundless.com/economics/definition/economic-outputhttps://www.boundless.com/economics/definition/outputhttps://www.boundless.com/economics/definition/sub-primehttps://www.boundless.com/economics/definition/sub-prime


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# (systemic) banking crisis occurs when many banks in a country are in serious solvency or

liquidity problems at the same time0either because there are all hit by the same outside

shock or because failure in one bank or a group of banks spreads to other banks in the system.

1ore specifically, a systemic banking crisis is a situation when a country2s corporate and

financial sectors experience a large number of defaults and financial institutions and

corporations face great difficulties repaying contracts on time. #s a result, nonperforming

loans increase sharply and all or most of the aggregate banking system capital is exhausted.

GOLDMAN SACHS

G*#d0an Sa!1+, founded in 3-4, promotes itself as a 5leading global investment banking,

securities and investment management firm that provides a wide range of services

worldwide.6 7oldman /achs has become 5the most profitable securities firm in "all /treethistory.6 n %&33, 7oldman /achs reported 8%-,-33,&&&,&&& in net revenues.

ROLE IN THE CRISIS

Dere/"#a$%*n *2 Ine+$0en$ Ban-+

nder pressure from 7oldman /achs in particular, in %&&9 the /ecurities and :xchange

;ommission removed the 3% to 3 debt to net capital ratio it had previously imposed.7oldman

/achs, Bear /tearns, 1errill ? in its subprime

business over the previous year. @rom %&&3 to %&&', 7oldman /achs sold 83A> billion of bonds backed by risky mortgages. The bank was also the largest creditor of ew ;entury,

which was the second biggest subprime lender in the / until it went bankrupt in %&&'.

ow the firm2s reputation is on the line, as it fights a fraud suit brought by the ./. /ecurities

and :xchange ;ommission (/:;) over a single deal in %&&', the sale of a complex 5synthetic

collaterali+ed debt obligation6 called #bacus %&&'#;3. The deal lost investors 83 billion but

produced 83 billion in profits for 7oldman2s collaborator, !regonbased =aulson C

;ompany, a hedge fund betting the housing bubble would collapse. "hile 7oldman says it

did nothing illegal or unethical, the /:; says the firm withheld 5material information6 from

the investors 0 specifically, the hedge fund2s role in selecting underlying securities. The

/:; charges that 7oldman illegally withheld material information when it did not tell the


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#bacus buyers that mortgage bonds underlying the ;*! had been selected with the help of

=aulson C ;ompany, one of the world2s largest hedge funds. =aulson wanted to bet that the

housing and mortgage markets would collapse. To do that, =aulson needed a ;*! based on

mortgage bonds likely to fall in value when homeowners stopped making their payments.

=aulson was not included in the /:; complaint and has not been accused of any wrongdoing.

# synthetic ;*! transaction requires two parties taking opposite views. The 5long6 party

profits if the underlying securities rise in valueD the 5short6 party profits if they fall. :ach side

places a bet and, in effect, the loser2s losses become the winner2s gains.

n its #pril 34 complaint, the /:; alleged that 7oldman misstated and omitted key facts

regarding a synthetic collaterali+ed debt obligation (;*!) it marketed that hinged on the

performance of subprime residential mortgagebacked securities. 7oldman failed to disclose

to investors vital information about the ;*!, known as #B#;/ %&&'#;3, particularly the

role that hedge fund =aulson C ;o. nc. played in the portfolio selection process and the factthat =aulson had taken a short position against the ;*!.

SOLUTION TO THE CRISIS

7oldman /achs said it agreed to a 8>.3 billion civil settlement to resolve federal and state

probes into its handling of mortgagebacked securities before the %&&- financial crisis.

The ew Eorkbased bank would pay a 8%.A billion civil monetary penalty, make 8-'>

million in cash payments and provide 83.- billion in consumer relief, such as mortgage

principal forgiveness for underwater homeowners and distressed borrowers, and support for

debt restructuring.

The bank, which is scheduled to report fourthquarter earnings on "ednesday, said that the

settlement would reduce earnings in that period by approximately 83.> billion on an aftertax

basis. This will allow %&34 earnings to be free from the penalties.

7oldman had already provisioned for the expenses, having set aside 8%.93 billion for legal

expenses in %&3>.

The settlement would be the latest multibilliondollar deal resulting from a Foint statefederaltask force trying to hold banks accountable for allegedly misleading investors when selling

mortgagebacked securities.

=revious deals, however, were much larger. Bank of #merica paid 834.4 billion in a similar

settlement with the task force in %&39, and G=1organ ;hase handed over 83A billion in %&3A.

7oldman had previously paid 8A billion to the @ederal Housing @inance #gency. "all /treet

banks have paid a total of more than 89& billion in settlements to resolve claims connected

with faulty securities related to the financial crisis.

The final terms of the 7oldman deal, however, are still being negotiated.

http://www.sec.gov/litigation/complaints/2010/comp21489.pdfhttp://www.sec.gov/litigation/complaints/2010/comp21489.pdfhttp://www.sec.gov/litigation/complaints/2010/comp21489.pdf


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