Goldman's New Level of Risk

Is Goldman Sachs taking on more risk in a turbulent time?

There are signs in its latest quarterly filing that it is.

Goldman says its total of illiquid, difficult-to-value assets under the accounting category of level three increased 39 percent in the first quarter from the fourth, to $96.4 billion. The ratio of the firm's level three assets to total assets rose to 8 percent, after it had been at 6 percent the two previous quarters.

The concept of the level three accounting classification has been a much-debate warning flag for investors who have feared that Wall Street firms were obscuring potential write-downs on risky complex assets by categorizing them through valuations done by the firms themselves.

Accounting standards require firms to mark based on actual market data. For assets that are difficult to value, however, there are three levels to show their fair value requiring varying degrees of outside market data. For level three, there is nothing comparable trading on any market.

As Jesse Eisinger wrote in Conde Nast Portfolio: "To value these assets, the banks have sophisticated internal models, which they point out are carefully pored over by their auditors. But it's sort of like finding the asset's value by sticking your finger in the wind."

The increase in level three reflected largely the reclassifying of loans and securities backed by commercial real estate and leveraged loans and other bank debt.

"Just because an asset is defined as level three doesn't mean we're uncomfortable with the value of the asset,'' Lucas van Praag, a Goldman Sachs spokesman, told Bloomberg News. "It also doesn't provide any insight into the relative risk of the underlying asset.''

Goldman also showed a pickup in trading volatility in the first quarter, according to the filing. Goldman had trading gains of $100 million or more on 28 days, and trading losses of at least $100 million on 17 days.

That means that for half the quarter, Goldman had huge swings in trading profits and losses. In comparison, Morgan Stanley had eight big loss days and 20 big win days for the quarter.

Goldman has had a quite a ride in recent years, but that doesn't mean it can't be bumpy times.

Jeffrey Cane