Is it any surprise that Wall Street went a bit off the deep end with the (admittedly barmy, but that’s a separate issue) Blanche Lincoln proposal to spin off derivatives desks? Derivatives, which are now deeply integrated in how dealer banks devise customer transactions and how they manage their own risks, are a large proportion of total transaction activity. And to illustrate how important they are in total, Liz Rappaport of the Wall Street Journal (hat tip Rolfe Winkler) reports that Goldman just told the Financial Crisis Inquiry Commission that derivatives transactions provided 25% to 35% of its revenues in the last two years.
If you excluded the retail businesses of other major financial firms, I doubt the percent of total business attributable to derivatives would differ much from Goldman’s level. Derivatives (ranging from not-terribly-lucrative “plain vanilla” interest rate and foreign exchange swaps to highly profitable customized trades of various sorts) are now a bread and butter business of all the major firms.
But the fact that this revelation rises to the level of a news story points up another issue: the opaque, impenetrable accounting of the major dealers. At best, investors understand only aspects of their operations, putting them in the position of blind men trying to sus out an elephant (which might instead be a camel…..).
From the Wall Street Journal:
Goldman Sachs Group Inc. told the Financial Crisis Inquiry Commission that 25% to 35% of its revenue comes from derivatives-based businesses, according to a person familiar with the situation…
A memo sent to the panel Thursday night by the New York company included an analysis of derivatives-based revenue at Goldman from 2006 through 2009, said the person familiar with the matter. Based on the percentages provided by Goldman, such businesses generated $11.3 billion to $15.9 billion of the company’s $45.17 billion in net revenue for 2009….
Goldman’s analysis reflects all derivatives products, ranging from credit to equity to interest rates, traded on and off exchanges, said the person familiar with the situation.
Goldman said it doesn’t conduct its businesses in a way that delineates revenue from derivatives transactions or other types of trading….
For example, Goldman cited credit-trading desks that are separated by industry group, adding that traders are indifferent to whether they are selling clients a bond or a credit derivative. As a result, separating the revenue among the two product lines is useless, Goldman told the FCIC. The firm also said its technology systems firm-wide don’t single out derivatives transactions.
The analysis was based on a “best guess” of the main type of trading on each Goldman trading desk at the firm, said the person familiar with the matter. The numbers vary widely, with the company’s fixed-income unit getting much more of its revenue from derivatives than investment banking, where no revenue is tied to derivatives.
Yves here. Goldman’s inability to produce a tidy derivatives number is not “not credible.” I’ve always marveled at how a perennial aspect of McKinsey’s business is that financial firms are set up (typically because it reflects organizational structures) to do a good job of reporting revenues and profits by customer or by product, and be pretty incapable of providing the other view. McKinsey therefore inevitably finds good cause for believing that the understanding the missing perspective would add value, and gets to throw bodies at rejiggering the numbers.