Essay: Financial Risk Management, A Case of Goldman Sachs Bank during the Financial Crisis

Essay: Financial Risk Management, A Case of Goldman Sachs Bank during the Financial Crisis

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Goldman Sachs was one of the major investment banks (later became a bank) in US that went bankrupt but was bailed out during the financial crisis of 2008 over alleged malpractices involving shorting its subprime mortgage backed securities. Kunt, Evanoff and Kaufman (2011) define financial crisis/ distress as ‘an event in which substantial losses at financial institutions and/or the failure of these institutions cause,  or threaten to cause, serious dislocations to the real economy, measured in terms of output foregone.’ Financial malpractices at Goldman Sachs bank saw its profits decline due significant losses being realized from large subprime write downs which were followed by mortgage crisis meaning beneficiaries were unable to pay. The short selling of subprime mortgage securities to Lehman Brothers is blamed to have worsened the financial crisis to the detriment of both institutions. As a result, the bank approached the federal government for a bailout under the troubled asset relief programmed (TARP). Since the loan came with high interest rates and short repayment period, the banks financial condition worsened and become highly geared.  In summary, Goldman Sachs financial crisis can be classified as threefold, that is, financial malpractices among traders and top executives in trading mortgage securities (operational risk), mortgage industry crisis/ risks and high financial leverage.

Risk management theories that can be used to explain the crisis an offer insights into possible solutions are discussed hereunder. Weinberg (2007) noted that the bank relied on incomes from trading to maintain its profit growth which was risky. Ther.............