Letting Goldman Roll the Dice

On this morning’s conference call, David Viniar, Goldman Sachs’ (GS) chief financial officer, emphasized the bank’s valuable social role. His bank made markets and provided credit when other financial players were suffering.

But is Goldman really such an indispensible financial intermediary? One look at the firm’s revenue breakdown shows that it’s more casino than anything else, and some of the markets it makes still put the economy in danger.

With markets recovering and competitors falling away, Goldman’s trading and principal investment revenue through the first nine months of the year was nearly $24 billion, on pace to break the $30 billion record set in 2007.

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Goldman, in other words, generates most of its revenue trading its own money and earning vigorish on customer transactions. It’s a hybrid hedge fund and bookie, with an investment bank and asset management business thrown in for good measure.

With that in mind, one is left to wonder whether Goldman was really worth saving last year. What have taxpayers received for the $50 billion worth of cash and guarantees, for giving Goldman access to the Federal Reserve as its lender of last resort?

Saving Goldman was mostly about saving the derivatives market, which is so big and unstable that the death of one counterparty could mean the death of all. With big commercial banks like JPMorgan Chase <JPM.N> in deep, saving the derivatives business was as much about protecting depositors and maintaining the integrity of the payment system as it was derivatives themselves.

Many of us didn’t like it — we thought banks like Goldman should have been recapitalized the right way, by wiping out shareholders and forcing subordinated creditors to eat their share of losses. But that ship has sailed. We socialized the risk while privatizing the profit because we were told we had no other choice: The government had to guarantee the biggest banks’ liabilities because they were too unstable to survive bankruptcy or FDIC receivership.

If that’s true, why haven’t we seen any substantial reforms to reduce systemic risk? Congress is kicking around new resolution authority to help resolve failed systemically-important banks. But the goal should be reducing systemic risk to being with. Yet serious reform of the derivatives market — something that would reduce its size significantly — is nowhere on the radar.

Indeed, Goldman’s trading results suggest that market is coming back with a vengeance. It’s playing in very risky markets with a capital structure that remains vulnerable yet is guaranteed by taxpayers.

To Goldman’s credit, they’ve rebuilt their capital levels faster than anyone. Their leverage ratio has fallen from 35 to 16 in less than two years, despite pressure from equity analysts to juice returns by deploying “excess capital”.

But at $50 billion, the bank’s mark-to-myth, or level 3, assets remain as high as its tangible common equity, the cushion it has to absorb losses. And Lehman proved that conventional definitions of capital aren’t worth much when push comes to shove. On Sept. 1, 2008 the bank was “well-capitalized” according to regulatory measures, two weeks later it declared bankruptcy and was showing negative net worth in the tens of billions.

Derivatives have lead to systemic crises every 10 years or so — portfolio insurance in 1987, Long-Term Capital Management in 1998, the global financial crisis a year ago — yet cosmetic changes are all that is ever offered. The frequency and violence of such events prove that more is necessary to rein in these markets.

Wall Street and its protectors at the Fed and Treasury tell us the bailout was necessary to protect the financial system, to protect Main Street. That may be. But Main Street still owns much of the risk while Wall Street gets all of the profit.

Even as Goldman reported results that reflected in part the resurgence in derivatives, the House Financial Services Committee passed legislation that would increase derivatives regulation. But the bill is riddled with loopholes that Wall Street can easily exploit. A much tougher line is necessary.

Comments

[DonFurio]

Hey idiot, you should be an owner of GS instead of whining, it's been a great performer. I sold last week because of valuation and bought something else, but it has been one of my best performers within the last year or so. Maybe if you weren't such a loser and a wimp, you would have been buying all year (GS or any of the financials) instead have been calling for nationalization.

The US gov't made a big return on GS, I don't remember exactly but I think it was around 20%. That's pretty good for a "bailout".

GS does trade some of it's own money, but a lot of it is actually from/for clients and they collect a fee.

I now firmly believe that they should rename this site Seeking Whiners or Seeking Short because almost every article is about those two things.

Admit it, what you really wanted was "punishment". You thought you should teach GS and its shareholders a lesson. Well guess what, I got to punish the shorts instead. Hahahahahaha.

2009 Oct 15 05:01 PM

[MarketGuy]

DonFurio=GS executive (or Timmy G?)

2009 Oct 15 10:20 PM

[untrusting investor]

Author's points are well written and well presented. Would certainly agree with the overall concepts presented. Unfortunately, it is highly unlikely that any substantive changes will be made. The politican/lobbyist/cor... connection is just too profitable and corrupt to believe that any real changes will be made. It probably will literally take a citizen revolt to effect any real change.

2009 Oct 16 02:02 AM

[Sol Rosenberg]

Good for you. You gambled at the casino and won. It has to happen every once in a while to keep people coming back. Just make sure you do something with those dollars before they're worthless thanks to all of the money Ben is printing to bail out your welfare queen banks.

2009 Oct 16 02:12 AM