Goldman Sachs’ 4th quarter earnings call on 16 January was unusual, and not just because of the new management team that was present. What was notable was that the new CEO, David Solomon, devoted time to issuing an apology from Goldman to the Malaysian people.
The 1MDB fraud scandal, in which Goldman bankers paid bribes to secure Malaysian bond deals whose proceeds were stolen by corrupt officials, has become a major burden on the firm. One Goldman partner behind the scheme, Tim Leissner, has already pleaded guilty to fraud. Another, former co-head of Asian investment banking Andrea Vella, is currently a focus of investigations.
Malaysia’s government immediately dismissed Solomon’s apology; instead it wants $7.5 billion in compensation. Goldman is fighting that claim; the explanation that accompanied the apology sought to portray the bank itself as a victim of Leissner’s fraud.
Shareholders know better – the bank’s compliance failures are likely to cost it billions, whether directly to Malaysia or in US government fines (the bank is also facing class action lawsuits from investors). So how painful could this get?
Risky Finance has taken Malaysia’s $7.5 billion claim and used it as a hypothetical figure in its database of bank operational risk losses since 2008. We have no idea if and when such a claim would be paid. Just for the purpose of comparison, let’s assume that the money will have to be paid in the second quarter of 2019.
Our first chart shows the history of bank losses attributable to poor controls and fraud since 2008. The losses include the major post-crisis mortgage settlements, rogue trading losses, Libor and FX rigging fines and penalties for money laundering and consumer mis-selling. When expressed as a percentage of common equity tier one capital, we can see that a $7.5 billion Goldman settlement would amount to more than 10.3 % of today’s capital.
As a single payment that looks big, but there have been plenty of payments in the past ten years that would outrank it. To get a better idea of the scale, we’ve created a cumulative ranking of all the losses incurred by the banks since 2008. With the potential $7.5 billion 1MDB payment included, Goldman ranks in sixth place, just behind Credit Suisse and ahead of UBS.
It’s a dubious honour for the UK that the top three banks are all British, but this is a result of the multi-year payment protection insurance redress that the banks paid. Deutsche Bank is currently in fourth place, but is likely to go higher if fined for its role helping Danske Bank’s Estonian money laundering operation.
And remember that our $7.5 billion estimate for Goldman is just a baseline. Given the egregious nature of the 1MDB case, the Department of Justice might take an exemplary approach in punishing the bank. If you look at the firm’s fixed income, currencies and commodities unit you can understand why.
This was the unit that hatched the Greek swaps in 2001. It created the Abacus CDOs in 2006-7. It sold derivatives to Libya. Finally, it got to 1MDB. These aren’t a series of one-offs, but a way of doing business that no-one except a regulator appears to be capable of stopping.
Goldman’s involvement in outright criminality gives them the opening to do that. The template here might be BNP Paribas, which paid the Justice Dept an $8.9 billion fine in 2015 for breaking US economic sanctions.
A big settlement is definitely coming. The lesson is that Goldman is likely in the not-too-distant future to enter the club of permanently tainted banks, defined as those whose total operational risk losses over the past decade exceed 25 per cent of capital.
Banks in this club get change forced upon them. If their experience is anything to go by, Goldman may end up having to raise capital or sell part of its business, such as the FICC unit, in order to rebuild its reputation. David Solomon might learn that ‘sorry’ is never enough.