Risk-taking is back in style on Wall Street.
It’s making life hell for analysts who obsess over these numbers and what they mean for big banks’ bottom lines.
Wall Street can expect more risk-taking in trading this year. Take Morgan Stanley as an example. So-called value-at-risk in the fiscal first quarter was higher than average, said Chief Financial Officer
Value-at-risk, or VAR, a calculation banks report every quarter, became popular in the late 1990s after the implosion of hedge fund Long-Term Capital Management sent shock waves through the global markets. It is a statistic that illustrates how much a portfolio would be expected to lose in one day under normal market conditions, given a certain historical time frame for context and a probability.
Reported VAR can rise if a bank is taking bigger bets or if the markets are generally more volatile, or both. Since the markets lately have had relatively low volatility, “The conclusion is that there are good opportunities out there and they are placing bigger bets,” says Ron Papanek, a market strategist at RiskMetrics in New York.
Trouble is, as analysts say, there isn’t a standard way of reporting VAR, so it’s difficult to compare banks to each other and difficult to figure out what’s in the number to begin with. “You don’t know what they’re measuring, and they don’t tell you,” says Andrew Collins, an analyst at Piper Jaffray who covers
The measurement isn’t going to tell anyone about what would happen in a severe crisis (it’s supposed to model usual activity), and it doesn’t say much about the risk of trading positions in securities or other investments that can’t easily be sold off in one day.
Analysts complain that investment banks like Goldman Sachs, Morgan Stanley and Lehman operate largely as “black boxes,” emitting little information about trading positions that would help analysts understand the real risks they, and by extension their shareholders, face day in, day out.
This is why Goldman Sachs is constantly accused of being not much more than a giant casino, or hedge fund. Its value-at-risk rose to $92 million in the fiscal first quarter, with a substantial increase in equity risk exposure, commodities and currencies.
Papanek from RiskMetrics (a risk modeling firm that was spun off from JPMorgan in 1998), says that’s not an unreasonably high VAR. Goldman reported record profit of $2.4 billion for the quarter, or $800 million a month. Based on its 95% probability, Goldman stood to lose more than $92 million on one out of 20 trading days a month, or 5% of the time. The $92 million is also just 4% of the quarterly earnings. “That’s pretty good,” Papanek says.
But others don’t necessarily see it that way. “Goldman Sachs is ramping up its risk appetite to almost unchartered waters as it claims there were an abundance of profitable trading opportunities,” wrote CreditSights analyst David Hendler in a recent research note. “There is not enough disclosure by the company to justify these risk levels.”
Goldman could lose about $2.3 billion, or 39%, of its estimated 2006 earnings per share in a market-jolting event, based on the value-at-risk it reported for the first quarter, according to Hendler’s calculations ($1.8 billion or 29% of 2006 estimated earnings based on last year’s VAR number).
Lehman, meanwhile, would stand to lose about $500 million, or 15% of this year’s projected earnings in a crisis, or what Hendler calls a “five sigma, fat-tail event.” That is higher than the potential risks assumed by commercial banks like JPMorgan Chase (14%),
Morgan Stanley, for example, is seen having about 27% of 2006 earnings at risk in a big market blowup, Hendler says, possibly losing $1.5 billion.
Its reported value at risk in the first quarter rose to $84 million, with increases in commodities exposures, equities and foreign exchange.
Spokesmen for Goldman, Lehman, Citi, Bank of America and JPMorgan declined to comment.
Morgan’s more aggressive stance on trading risk might have something to do with the world views of its top managers.
“Not taking enough risk is the biggest risk of all,” says Cruz.
A spokesman for Morgan Stanley also declined to comment but pointed to Cruz’s comment: “The corner stone of our risk management strategy has always been that we are not going to take risk that will endanger the franchise … but I feel there was a lot of room and there is still a lot of room to take more market risk.”