Yesterday Lloyd Blankfein, the CEO of Goldman Sachs, warned that there is too much complacency about low interest rates on the part of investors who continue to buy up corporate bonds despite record low yields.
'Someone is buying that debt', Blankfein said at The New York Times' Dealbook conference, 'What's going to happen when growth picks up and interest rates rise ? There's going to be a reversal and people will have losses'.
Someone is not only buying that debt. Someone is selling it to them. And one of those someones works at Goldman. Is this a problem ?
Blankfein certainly doesn't think there is a problem. In the same breadth that he warned of losses from investing in debt, he said that Goldman is telling all of its corporate clients to borrow as much as they can for as long as they can.
This is an important and profitable business for Goldman. Last quarter it made $466m from debt underwriting, triple what it made in the same quarter the year before. Goldman Sachs is the seventh biggest underwriter of corporate debt this year, according to Bloomberg's league tables.
Do you think that Goldman's bond sales team talks like Blankfein when they are wrangling investors to buy the latest bond issuance from Goldman's corporate clients? Of course not. Instead, they talk about the quality of the borrower, the yield being slightly higher than other comparables, and opportunities. Sure the paperwork has fine print about risk-factors, interest rates, market environments, yadda, yadda. But they aren't going to play the tape of their boss warning about investor complacency on those sales calls.
To put it more starkly, Goldman Sachs is actively selling bonds to investors that its Chief Executive Officer has publicly proclaimed to be likely loss-makers.
One response to this conflict is that this is just what Goldman does. It acts as an intermediary between the corporations that want to issue debt and the institutional investors that want to buy debt. An investment bank shouldn't have to be paternalistic here, thwarting the desires of sophisticated investors to buy bonds.
But that's exactly the kind of argument Goldman tried to make about its ill-fated Abacus deal. The investors who purchased the Abacus securities were highly-sophisticated investors in mortgage bonds. Goldman was simply an intermediary between the investors who wanted to be on the short side of the trade and the long side of the trade. That logic cost Goldman over a half-billion in SEC penalties and probably just as much in legal and other related costs.
If Goldman knows that buying corporate debt at current prices is a bad idea, should it just stop facilitating this mistake ? The problem with this view is that it implies that in the current environment, all the big Wall Street firms should stop underwriting corporate debt. Do we want a policy that induces an enormous credit crunch? Wouldn't this just make the job of the Federal Reserve all the more difficult?
And yet. What if Wall Street had behaved a bit more paternalistically in 2006 and 2007 ? What if it hadn't agreed to set loose upon the world so many structured credit vehicles linked to mortgages ? The result would have been an earlier pricking of the housing bubble-and far smaller losses. Will we one day wish we had encouraged more restraint by the debt underwriters?
And, slightly differently, will Goldman itself someday wish that it hadn't been quite so persuasive in urging all those corporate clients to issue quite so many bonds ?
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