It’s earnings season for the big banks and investors are looking for good news to confirm that the U.S. economy is still in the boom phase. So far, Goldman Sachs (GS, Financial) has delivered with quite the sanguine report, besting Wall Street estimates that have, so far, driven shares 6% higher. Bank of America (BAC, Financial) followed up with a very impressive record earnings report, and Morgan Stanley (MS, Financial) is next. As far as bank health is concerned, we are clearly nowhere near a 2007-08 scenario.
Now glancing at the surface earnings statements to confirm a certain view of the economy is one thing, but it’s much more instructive to go a bit deeper into the numbers in order to see why. If we take a dive into Goldman Sachs' balance sheet and its components, for example, we can see the hard evidence that we are not anywhere near a 2008 scenario, despite housing prices arguably starting to cool a bit. In fact, even if housing fell substantially, we would still be far from a banking crisis caused by mortgage defaults.Â
If we look back at the balance sheet for Goldman Sachs in 2007, mortgage and other asset-backed loans and securities totaled $54 billion, accounting for just under 12% of total assets. In 2006, at the peak of the housing bubble, the ratio was slightly higher at 12.25%. But then, of course, the subprime crisis came and wiped out mortgage-backed securities until the Federal Reserve stepped in and bought as much as it could in a firesale. Goldman’s balance sheet was radically altered, with mortgage-backed securities accounting for only $22.4 billion, an absolute fall of $31.7 billion, and the ratio of these securities to total assets plummeted to only 6.6%. The housing crisis precipitated the decline in global equities, causing that portion of its balance sheet to collapse as well, which just exacerbated Goldman’s fall that year.
But here’s the interesting part. The only two portions of Goldman’s balance sheet not to fall in 2008 were U.S. government, fedral agency and sovereign obligations, which remained steady, and derivative contracts, which grew and, in many cases, constituted hedges against the fall in equities.
Now, if we fast-forward to the present, the situation has completely changed. Total assets on Goldman’s balance sheet as of the end of 2017 were about $269 billion. Out of that total, loans and securities backed by real estate total $15.4 billion, or only 5.7%, an even lower percentage than in the immediate aftermath of the housing bust.
Clearly, Goldman Sachs is not terribly exposed to a downturn in the housing market this time. The investment bank is not making the same mistake again. So where is the danger then? The answer is the sovereign bond market, primarlily U.S. Treasuries, but non-U.S. sovereign bonds are also a significant part of Goldman’s balance sheet. In total, the bank holds $110.4 billion in sovereign bonds, comprising an astonishing 41.1% of total assets on its balance sheet. This is more than double the ratio in 2006, which was 20.3%.
Point being, taking Goldman as generally representative of big bank balance sheets, there will probably be no banking crisis precipitated by any fall in the housing market this time around. That’s the good news. The bad news is that, judging by exposure ratios, a fall in the sovereign bond market globally could end up causing something even worse than what we saw 10 years ago.
Disclosure: No positions.
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