Goldman Sachs's miracle profits
By
Associate Editor
David Stevenson Jul 24, 2009
Print this article
Investment bank Goldman Sachs seems to have shrugged off the credit crunch, announcing record profits and billions in bonuses. How did it do it? David Stevenson reports.
Why is Goldman Sachs back in the news?
"The money machine that is Goldman Sachs is humming again," says Andrew Bary in Barron's. Goldman has just reported second-quarter net revenues of $3.44bn, up 65% year-on-year and its strongest showing ever. The firm has also managed to repay $10bn of government loans received as part of a US government bail-out programme. The board has also set aside $6.65bn for pay and bonuses.
"As if the credit crunch had never happened, the Goldmanites are on course this year for average pay, bonus and benefit packages of an eye-watering $770,000 – or £475,000 – per head," says Alistair Osborne in The Daily Telegraph. "That's almost twice what President Obama earns."
How does Goldman do it?
Founded in 1869, Goldman Sachs has long had a reputation as one of the world's top investment banks, with a finger in almost every financial pie. It buys and sells stocks, bonds, currencies and commodities, and underwrites securities – for a fee – issued by other firms that are raising capital. It also acts as adviser to its corporate clients on mergers and acquisition (M&A) deals, and to governments on issuing sovereign debt securities, again taking a cut of each offering it handles.
It's been helped by a highly favourable financial wind. Since the banking deregulation of the Ronald Reagan era, the US economy has been 'financialised' – financial instruments that slice, dice and repackage risk have soared in importance compared to actually making things. The sector called 'securities, commodity contracts and investments' has grown especially fast, from only 0.3% of GDP in the late 1970s to 1.7% of GDP in 2007 – a near sixfold increase. Goldman has been at the centre of this growth.
So what sets it apart from rivals?
"Many experts believe Goldman's success is rooted in its savvy, high-octane trading style," says Stevenson Jacobs at Timesleader.com. Others are more cynical.
As Nobel prize-winning economist Paul Krugman notes, "other banks invested heavily in the same toxic waste it [Goldman] was selling to the public. Goldman made a lot of money selling securities backed by sub-prime mortgages – then made a lot more money by selling mortgage-backed securities 'short' [in other words, it got rid of them] just before their value crashed. All of this was perfectly legal, but the net effect was Goldman making profits by playing the rest of us for suckers."
And "Goldman's high-risk business model hasn't changed from what it was before the implosion of Wall Street", says former US Labor Secretary Robert Reich. The firm is "still wagering its capital and fuelling giant bets with lots of borrowed money".
But whose money is it?
The US taxpayers'. Goldman's performance is "not free-market earnings but an almost pure state subsidy", says journalist Matt Taibbi on his blog. Taibbi described the bank in a Rolling Stone piece as "a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money". Harsh perhaps, but it's hard to believe that Goldman would be celebrating record profits today without last year's mega-amounts of aid from the US government.
Does Goldman ever get it wrong?
Oh yes. Goldman did some very large credit insurance deals with the giant insurer AIG. But these would have been worthless had AIG gone bust. Instead, it was bailed out to the tune of $80bn.
"Exactly how big would Goldman's profits have been this year if they had to fill a $13bn or even $20bn hole from AIG's collapse?" asks Taibbi. And "you can bet Goldman has taken full advantage" of a galaxy of bail-out programmes organised by the US Federal Reserve to dump "worthless crap assets acquired over the past ten years when the banks were playing roulette".
Should we be worried?
"Goldman Sachs's resurgence should send shivers down the backs of every hard-working American who has lost jobs or a large chunk of retirement savings in this economic debacle," says Reich. Most of its major competitors are out of action or under the strict control of the Treasury and the Fed, so it has the market mostly to itself.
And "unfortunately, what Goldman does is bad for America", says Krugman. Huge bonuses show that "financial industry high-fliers are still operating under a system of 'heads they win, tails other people lose', with every incentive to steer investors into risks they don't understand".
Is the financial system on the mend?
By rescuing the financial system without reforming it, Washington has "set the stage for an even bigger financial disaster a few years down the road", says Krugman. Taxpayers are still on the hook if things go wrong, and bankers have every incentive to take big risks.
In the 1930s, when there was a similar expansion of the financial safety net, much tighter regulation was introduced. This time, new rules are still on the drawing board, "and the finance lobby is already fighting against even the most basic protections for consumers".
And there's danger here for president Barack Obama, says Michael Scherer in Time – one worker in six is unemployed and dole queues are growing. Obama may have "flashed anger and frustration at America's financial titans but so far he's resisted bonus-curb calls. This leaves the White House vulnerable."
Published in
Stock markets
| More
articles
by
David Stevenson
FREE - MoneyWeek's daily investment email
Our free daily email, Money Morning, is an informative and enjoyable analysis of what's going on in the markets. Written by our Editor, John Stepek, and guest contributors.
Sign up FREE to Money Morning here.
