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Goldman Relents, but Not Chase

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By: Richard Beales and Dwight Cass | July 21, 2009

Goldman Sachs  knows when to fold its hand. The bank announced on Wednesday that it would pay $1.1 billion to buy back warrants that it issued to the Treasury last October, at the height of the crisis — a figure that represents a full price.

Goldman originally offered about $650 million, but said it accepted the Treasury’s price rather than haggle. Jamie Dimon, chief executive of JPMorgan Chase, is taking a less acquiescent tack. But then, JPMorgan isn’t under quite the same politically charged spotlight as Goldman, led by Lloyd C. Blankfein.

Goldman turned in robust second-quarter earnings on the back of government support for financial firms and markets. The bank is on track to pay giant year-end bonuses. Its success has brought renewed criticism — on the heels of recently aired conspiracy theories and a charge, in Rolling Stone, that the firm is like a “vampire squid,” sucking up money wherever it can find it. Mr. Blankfein has already sounded humble notes. Avoiding horse-trading over the warrant buyback is another move that may help soothe political and popular indignation.

Goldman even said that, when the interest it paid before repaying the Treasury’s $10 billion of actual investment under the Troubled Asset Relief Program is combined with the warrant payment, taxpayers earned an annualized 23 percent return on their investment — conveniently the same as its return on equity in its blowout second quarter.

The amount paid by Goldman for the warrants was shy of a theoretical option value, but a discount for the illiquidity of the unusual 10-year instruments is legitimate. Pluris Valuation Advisors reckons Goldman paid something close to a fair market price.

The figure was also 17 percent above the most recent best estimate of the warrants’ value, produced by the Congressional Oversight Panel. Mr. Dimon, by contrast, recently refused to buy his bank’s warrants back at Treasury’s valuation, instead proposing — as was his right — that the warrants be auctioned.

JPMorgan has arguably weathered the crisis better than any of its rivals, barring Goldman. Mr. Dimon may be right that the Treasury is overvaluing JPMorgan’s warrants — but Mr. Blankfein’s move could still make him appear churlish by comparison. Mr. Dimon, though, knows that Goldman, with its record accruals for employee pay and its influential alumni network, is first in line for any backlash, justified or not. For now at least, he can afford to be less eager than Mr. Blankfein to roll over.

More Scrutiny Ahead

President Obama is clearly not out to make friends on Wall Street. His plan to regulate the $590 trillion market for unlisted, or over-the-counter, derivatives calls for more scrutiny of big dealers like JPMorgan and Goldman Sachs. But more potentially damaging for these firms is its call for most O.T.C. derivatives to be traded on exchanges.

The administration will introduce legislation next week to bring derivatives dealers — even currently unregulated or lightly regulated entities, like precrisis A.I.G. Financial Products — under stronger regulatory authority. Obama’s plan would require uniform reporting, capital and margin requirements for all firms that trade in these instruments, which include credit-default swaps, equity derivatives and long-established products like interest rate swaps.

This makes a lot of sense, and is a better approach than trying to scrutinize fast-changing individual products. After all, stricter capital and margin standards might have headed off the debacles at A.I.G. Financial Products and the monoline insurance companies, which sold credit derivatives without adequate capital to back them up.

Dealers won’t like the new standards and scrutiny, but in private bankers acknowledge they knew it was coming. Most are still adamantly opposed to the idea that all standardized contracts be traded on exchanges. Originally, the administration only called for these instruments to be cleared through central clearing houses, rather than bilaterally, to spread the pain if a big dealer like Lehman or A.I.G. were to fail in the future. The industry acquiesced.

But bankers fear that forcing most derivatives to be traded on exchanges would provide a degree of price transparency that will gut their often outsized profits.

They could be right. And their loss might be great news for their clients — and for exchange operators like the Chicago Mercantile Exchange and IntercontinentalExchange, which are likely to get the business. But the plan has to survive Wall Street’s promised lobbying blitz first.