Goldman Sachs Group Inc. and JPMorgan Chase & Co., two of the biggest traders of over-the-counter derivatives, are exploiting their growing clout in that market to secure cheap funding in addition to billions in revenue from the business.

Both New York-based banks are demanding unequal arrangements with hedge-fund firms, forcing them to post more cash collateral to offset risks on trades while putting up less on their own wagers. At the end of December this imbalance furnished Goldman Sachs with $110 billion, according to a filing. That’s money it can reinvest in higher-yielding assets.
“If you’re seen as a major player and you have a product that people can’t get elsewhere, you have the negotiating power,” said Richard Lindsey, a former director of market regulation at the U.S. Securities and Exchange Commission who ran the prime brokerage unit at Bear Stearns Cos. from 1999 to 2006. “Goldman and a handful of other banks are the places where people can get over-the-counter products.”
The collapse of American International Group Inc. in 2008 was hastened by the insurer’s inability to meet $20 billion in collateral demands after its credit-default swaps lost value and its credit rating was lowered, Treasury Secretary Timothy F. Geithner, president of the Federal Reserve Bank of New York at the time of the bailout, testified on Jan. 27. Goldman Sachs was among AIG’s biggest counterparties.
Goldman Sachs Chief Financial Officer David Viniar has said that his firm’s stringent collateral agreements would have helped protect the firm against a default by AIG. Instead, a $182.3 billion taxpayer bailout of AIG ensured that Goldman Sachs and others were repaid in full.
Over the last three years, Goldman Sachs has extracted more collateral from counterparties in the $605 trillion over-the- counter derivatives markets, according to filings with the SEC.
The firm led by Chief Executive Officer Lloyd C. Blankfein collected cash collateral that represented 57 percent of outstanding over-the-counter derivatives assets as of December 2009, while it posted just 16 percent on liabilities, the firm said in a filing this month. That gap has widened from rates of 45 percent versus 18 percent in 2008 and 32 percent versus 19 percent in 2007, company filings show.
“That’s classic collateral arbitrage,” said Brad Hintz, an analyst at Sanford C. Bernstein & Co. in New York who previously worked as treasurer at Morgan Stanley and chief financial officer at Lehman Brothers Holdings Inc. “You always want to enter into something where you’re getting more collateral in than what you’re putting out.”
The banks get to use the cash collateral, said Robert Claassen, a Palo Alto, California-based partner in the corporate and capital markets practice at law firm Paul, Hastings, Janofsky & Walker LLP.
“They do have to pay interest on it, usually at the Fed funds rate, but that’s a low rate,” Claassen said.
Goldman Sachs’s $110 billion net collateral balance in December was almost three times the amount it had attracted from depositors at its regulated bank subsidiaries. The collateral could earn the bank an annual return of $439 million, assuming it’s financed at the current Fed funds effective rate of 0.15 percent and that half is reinvested at the same rate and half in two-year Treasury notes yielding 0.948 percent.
“We manage our collateral arrangements as part of our overall risk-management discipline and not as a driver of profits,” said Michael DuVally, a spokesman for Goldman Sachs. He said that Bloomberg’s estimates of the firm’s potential returns on collateral were “flawed” and declined to provide further explanation.
(Source: Bloomberg)