Goldman Sachs 2007 Annual Report Download - page 44

Management’s Discussion and Analysis
LIQUIDITY RISK. Liquidity is essential to our businesses. Our
liquidity could be impaired by an inability to access secured
and/or unsecured debt markets, an inability to access funds
from our subsidiaries, an inability to sell assets or redeem our
investments, or unforeseen outflows of cash or collateral. This
situation may arise due to circumstances that we may be unable
to control, such as a general market disruption or an operational
problem that affects third parties or us, or even by the perception
among market participants that we are experiencing greater
liquidity risk. The financial instruments that we hold and the
contracts to which we are a party are increasingly complex, as we
employ structured products to benefit our clients and ourselves,
and these complex structured products often do not have readily
available markets to access in times of liquidity stress. Growth
of our proprietary investing activities may lead to situations
where the holdings from these activities represent a significant
portion of specific markets, which could restrict liquidity for
our positions. Further, our ability to sell assets may be impaired
if other market participants are seeking to sell similar assets at
the same time, as is likely to occur in a liquidity or other market
crisis. In addition, financial institutions with which we interact
may exercise set-off rights or the right to require additional
collateral, including in difficult market conditions, which could
further impair our access to liquidity.
Our credit ratings are important to our liquidity. A reduction
in our credit ratings could adversely affect our liquidity and
competitive position, increase our borrowing costs, limit
our access to the capital markets or trigger our obligations
under certain bilateral provisions in some of our trading and
collateralized financing contracts. Under these provisions,
counterparties could be permitted to terminate contracts with
Goldman Sachs or require us to post additional collateral.
Termination of our trading and collateralized financing
contracts could cause us to sustain losses and impair our
liquidity by requiring us to find other sources of financing or
to make significant cash payments or securities movements.
For a discussion of the potential impact on Goldman Sachs of
a reduction in our credit ratings, see “ — Liquidity and Funding
Risk — Credit Ratings” below.
■
Reductions in the level of the equity markets or increases in
interest rates tend to reduce the value of our clients’ portfolios,
which in turn may reduce the fees we earn for managing
assets. Increases in interest rates or attractive conditions in
other investments could cause our clients to transfer their
assets out of our funds or other products. Even in the absence
of uncertain or unfavorable economic or market conditions,
investment performance by our asset management business
below the performance of benchmarks or competitors could
result in a decline in assets under management and in the
incentive and management fees we receive and might make it
more difficult to attract new investors.
■
Concentration of risk increases the potential for significant
losses in our market-making, proprietary trading and investing,
block trading, merchant banking, underwriting and lending
businesses. This risk may increase to the extent we expand
our proprietary trading and investing businesses or commit
capital to facilitate customer-driven business.
■ An increase in market volatility increases our measured
risk, which might cause us to reduce our proprietary
positions or to reduce certain of our business activities. In
such circumstances, we may not be able to reduce our
positions or our exposure in a timely, cost-effective way or in
a manner sufficient to offset the increase in measured risk.
■ The volume of transactions that we execute for our clients
and as a specialist or market maker may decline, which would
reduce the revenues we receive from commissions and
spreads. In our specialist businesses, we are obligated by
stock exchange rules to maintain an orderly market, including
by purchasing shares in a declining market. This may result
in trading losses and an increased need for liquidity. Weakness
in global equity markets and the trading of securities in
multiple markets and on multiple exchanges could adversely
impact our trading businesses and impair the value of our
goodwill and identifiable intangible assets.
42 Goldman Sachs 2007 Annual Report