GOLDMAN SACHS CFO: None of us have 'really' been stress-tested
One of the largest debates among investors lately has been over liquidity, specifically in the bond market.
The concern is that sellers could overwhelm buyers, sending prices tumbling. And the disastrous implications of such an event has drawn considerable attention from every corner of the financial world.
Some argue that it will be the cause of the next great crash, others say it's no big deal.
According to Goldman Sachs' CFO Harvey Schwartz, the real problem is that no one has any idea what will happen when it comes down to it.
"I think the biggest question for all us out there is we've never really been stress tested through a more volatile market environment," said Schwartz.
Sure, regulators have run the Wall Street's book through simulated stress tests. But that can't compare to the real thing.
"We don't really have a good way of assessing the collective impact of all the rules whether it's capital liquidity, derivatives, regional rules," Schwartz continued. "I think that's a very hard thing to assess and so collectively I think over a number of years we are all going to have to keep a very close watch on it."
Schwartz, speaking during a question and answer session at Bank of America Merrill Lynch's Banking & Financial Services Conference, brought up the issue after being asked about the effect of government regulation on liquidity.
As Schwartz's colleague Steve Strongin pointed out in August, one of the worries is that as government regulations have required banks to keep more liquidity on hand. This would mean they would have less flexibility to swoop in and buy bonds from distressed sellers in the event of a sudden crash similar to the Treasury flash crash in October 2014.
On the other hand, others have said that there would be no effect from the changes and the rancor is simply bristling from asset managers over increased oversight.
Schwartz said he falls somewhere in the middle of the two arguments.
He said that even without government regulation, the environment of near-zero-percent Fed funds interest rates, a booming fixed-income investing market, and ballooning numbers of asset managers would have had similar effects on liquidity.
"That in and of itself, absent regulatory reform, would certainly have an impact of marginal liquidity," said Schwartz. "Particularly if that one segment is so large, relative to which segment has gotten smaller, and this is the segment that actually provides the intraday liquidity."
Schwartz said, however, it's impossible to know the impact of regulation on the situation. So far in the relatively stable market environment the benefit of the regulation has been apparent, but the downside isn't yet known.
"I think that's a very hard thing to assess," he said. "So collectively, I think over a number of years we are all going to have to keep a very close watch on it. But it will really help over time, but that collective regulatory impact obviously has some benefits. It's a question of whether or not you can measure the cost."
The gist of Schwartz's answer is: yes it's a giant concern, but we have no idea what will happen.