Risk Management saved Goldman Sachs

Goldman Sachs had used proper risk management tools and good business sense to good use to avoid the financial crisis suffered by most of wall street such as Bear Stearns, Merrill Lynch and Lehman Brothers. According the the NY times article, managers at Goldman used risk management tools such as the VaR and the L&P to make the proper decisions to get rid of or hedge against mortgage-backed securities, thus saving them from the current financial crisis.

VaR is a Value at Risk model, developed by statistitions at JPMorgan and it is by far the most commonly used model to evaluate the boundaries of risk over a short duration in a normal market. VaR became so popular beacuase it could be used as a risk measure in any class of asset and it also takes into account many variables such as diversification, leverage and volatility. Since the big financial meltdown, Wall street started asking questions about the reliability of the VaR model and the fact that it did not take into account what would happen in the event of a financial meltdown. Several prominent risk managers stated that the VaR model is a useless measure and that it creates a false sense of security for the companies.

Goldman Sachs, however, used more than just the VaR model to evaluate the risk in their portfolio. CFO of Goldman Sachs, David Vinair says that they check their Profit and Loss (P&L) model on a daily basis to make sure that it is consistent with their risk models. In December 2006, Goldman's mortgage business had lost money for ten straight days and all the top managers sat down for a meeting with their risk managers as they looked over all their trading positions in the firm. During the meeting they looked over their VaR numbers and other risk management models and made the final decision to get rid of most of their mortgage-backed securities and hedged the rest of them.

Some argue that firms should have payed closer attention to their risk models and then maybe the meltdown could have been avoided and others argue again that it is the fault of models such as the VaR model that gave firms the false security and that these models were responsible for the entire meltdown. I feel that firms should not soley rely on one risk model, but have a few in place so that managers can be informed and ultimately make the correct decision as is in the case of Goldman Sachs.