Goldman Sachs 2007 Annual Report Download - page 78

Management’s Discussion and Analysis
Excess Liquidity
Our most important liquidity policy is to pre-fund what we
estimate will be our likely cash needs during a liquidity crisis
and hold such excess liquidity in the form of unencumbered,
highly liquid securities that may be sold or pledged to provide
same-day liquidity. This “Global Core Excess” liquidity is
intended to allow us to meet immediate obligations without
needing to sell other assets or depend on additional funding
from credit-sensitive markets. We believe that this pool of
excess liquidity provides us with a resilient source of funds and
gives us significant flexibility in managing through a difficult
funding environment. Our Global Core Excess reflects the
following principles:
■ 
The first days or weeks of a liquidity crisis are the most
critical to a company’s survival.
■
Focus must be maintained on all potential cash and collateral
outflows, not just disruptions to financing flows. Goldman
Sachs’ businesses are diverse, and its cash needs are driven by
many factors, including market movements, collateral
requirements and client commitments, all of which can
change dramatically in a difficult funding environment.
■
During a liquidity crisis, credit-sensitive funding, including
unsecured debt and some types of secured financing
agreements, may be unavailable and the terms or availability
of other types of secured financing may change.
■
As a result of our policy to pre-fund liquidity that we estimate
may be needed in a crisis, we hold more unencumbered
securities and have larger unsecured debt balances than our
businesses would otherwise require. We believe that our
liquidity is stronger with greater balances of highly liquid
unencumbered securities, even though it increases our
unsecured liabilities.
The size of our Global Core Excess is based on an internal
liquidity model together with a qualitative assessment of the
condition of the financial markets and of Goldman Sachs. Our
liquidity model identifies and estimates cash and collateral
outflows over a short-term horizon in a liquidity crisis, including,
but not limited to:
■ upcoming maturities of unsecured debt and letters of credit;
■
potential buybacks of a portion of our outstanding negotiable
unsecured debt;
■ adverse changes in the terms or availability of secured funding;
■ 
derivatives and other margin and collateral outflows, including
those due to market moves;
Derivative transactions may also involve legal risks including
the risk that they are not authorized or appropriate for a counter-
party, that documentation has not been properly executed or
that executed agreements may not be enforceable against the
counterparty. We attempt to minimize these risks by obtaining
advice of counsel on the enforceability of agreements as well
as on the authority of a counterparty to effect the derivative
transaction. In addition, certain derivative transactions
(e.g., credit derivative contracts) involve the risk that we
may have difficulty obtaining, or be unable to obtain, the
underlying security or obligation in order to satisfy any physical
settlement requirement.
Liquidity and Funding Risk
Liquidity is of critical importance to companies in the financial
services sector. Most failures of financial institutions have
occurred in large part due to insufficient liquidity resulting
from adverse circumstances. Accordingly, Goldman Sachs has
in place a comprehensive set of liquidity and funding policies
that are intended to maintain significant flexibility to address
both Goldman Sachs-specific and broader industry or market
liquidity events. Our principal objective is to be able to fund
Goldman Sachs and to enable our core businesses to continue
to generate revenues, even under adverse circumstances.
Management has implemented a number of policies according
to the following liquidity risk management framework:
■ EXCESS LIQUIDITY.
We maintain substantial excess liquidity
to meet a broad range of potential cash outflows in a stressed
environment including financing obligations.
■
ASSET-LIABILITY MANAGEMENT. We seek to maintain funding
sources that are sufficiently long-term in order to withstand
a prolonged or severe liquidity-stressed environment without
having to rely on asset sales.
■ CONSERVATIVE LIABILITY STRUCTURE. We access funding
across a diverse range of markets, products and counter-
parties, emphasize less credit-sensitive sources of funding and
conservatively manage the distribution of funding across our
entity structure.
■ CRISIS PLANNING. We base our liquidity and funding
management on stress-scenario planning and maintain a crisis
plan detailing our response to a liquidity-threatening event.
76 Goldman Sachs 2007 Annual Report