Goldman Sachs: Fundamentals of the Fall

Jun.30.11 | About: Goldman Sachs (GS)

It has become apparent that Goldman Sachs (NYSE:GS) is losing its grip as the dominant bank on Wall Street. Just two years after solidifying itself at the top, by managing to profit mightily shorting mortgage-backed securities, Goldman's stock is falling. In recent trading days, the price of GS stock has hit one year lows of $128.30. The stock achieved its 52-week highs in mid January, reaching $175.34 and has declined roughly 35% since! So what is causing investors to pull their money? The weakness is a combination of the firm's legal troubles, new trading restrictions brought on by the Volcker Rule and the comparative weakness of its CEO, Lloyd Blankfein, among others.

Goldman is known to have extremely motivated employees who are willing to crush the competition. Unfortunately, the employees are also known to break the rules from time to time in order to win. Some of the more famous infractions include inside information being passed to Ivan Boesky and more recently Rajat Gupta passed investment information on to Raj Rajaratnam. There are other legal issues sprouting like weeds from Goldman as well. While it may not have been illegal, betting against mortgage-backed CDOs the firm sold to its customers will certainly not attract equity from anyone in the near future. Goldman has claimed they only hedged against the vehicles and that is why they made such a huge profit in 2008. The products are referred to under the name Abacus and were sold to clients from 2004-2008, while Goldman traders took long-term speculative positions against them, which they called "hedges." However, isn't the definition of "hedging" to take an adverse position from the investment in order to offset risk as closely as possible? So if a company were to hedge for its customer's interests, the objective should've been simply to not lose. GS was able to make billions in profit off the trade it took against products it developed and sold to clients, that is why it is a trade not a hedge. But then again, Goldman Sachs is a trading firm by nature.

Goldman makes most of its money through trading. While a huge percentage of this comes from market making, a large chunk can be attributed to proprietary trading. The Volcker Rule, which has been a major part of the financial reform, aims to reduce lending institutions' ability to take speculative trades solely for the company's benefit. This in turn will dent profit potential for banks such as Goldman in the long run.

Above I mentioned that Goldman's CEO, Lloyd Blankfein, is comparatively weak. I realize only a genius could helm Goldman Sachs, especially during one of the worst financial crises in history. However, compare Blankfein's performance with Jamie Dimon's of JP Morgan Chase (NYSE:JPM). Blankfein cannot control his troops, as evidenced by the insider trader allegations and products being sold that were known to be harmful to buyers. Blankfein and Goldman's public image is deceitful, greedy and unethical. Now turn your attention to Jamie Dimon. Newspapers have referred to him as the Lion of the Wall Street, certainly no negative connotations there. JPM has been raking in profits hand over fist, without selling allegedly unethical products to its clients; Dimon's troops are rarely in legal trouble. And as for Dimon himself? Just weeks ago he basically attacked Ben Bernanke with a surprise interrogation at the end of a press conference. The result? Dimon was applauded by the media, go figure. The point of this is to show that when fundamentally valuing a company, the management is a large piece of the pie. Goldman's Blankfein, while very intelligent, is performing weak. The sole responsibility of a CEO of a public company is to create and grow investor wealth, he is not accomplishing either of those (it seems he is encouraging the opposite).

All in all Goldman Sachs will most likely keep falling and underperforming the financial sector, based on broad fundamental weakness and public perception.

Disclosure: I have no positions in any stocks mentioned and no plans to initiate any positions within the next 72 hours.