But detractors were quick to point out that the quarterly results would have been substantially weaker had the $1 billion loss from December 2008 been included (Goldman’s year-end moved to a calendar-year basis when it became a bank holding company).
Any profits are to be welcomed when the economy is contracting at an unprecedented rate. So we should not be too churlish about the fact that the US bank made most of its profits through trading and principal investments, offsetting a decline in fees generated from investment banking activities. Some 70% of earnings came from fixed income, currencies and commodities – twice as much as is normally the case.
Banks like to portray the way they make money as being highly sophisticated but traditional spread banking is the primary driver of their profitability. The principle of borrowing short and lending long is as old as the hills, and first-quarter market conditions of declining interest rates, steep yield curves and a large amount of supply were the banking equivalent of a killing zone for making easy money – if you knew what you were doing.
Over many years, Goldman’s traders have made it clear that they do.
New-issue supply brings more opportunity for profits than simply the fee generated from origination. Closely associated with rising new-issue volumes are the substantial blocks of risk shifting through the secondary markets as a consequence of hedging and repositioning by underwriters and investors.
Once their books are up by a million or 20, traders are more prepared to take strong views on the market, and Goldman’s certainly did that. The firm’s average daily interest rate value at risk increased $43 million to $240 million.
It’s little wonder, then, that Goldman is so keen to escape the interfering clutches of the government and repay Tarp capital. If it continues to throw the balance sheet around to such effect there should be a bumper bonus round this December.
But Goldman’s traders and shareholders might be advised to pause and think about who deserves the credit for making these profits. Nothing can disguise the fact that without that government capital Goldman would have been shunned as a counterparty and quite possibly would have gone the same way as Lehman Brothers.
Furthermore, the government has provided a subsidy on funding that is a crucial component of Goldman’s margins. Goldman has used the TLGP (temporary liquidity guarantee programme) to raise nearly $19 billion of debt at a marginal spread over dollar Libor (at present 1.1%). Its first unguaranteed foray in January (a $2 billion 10-year issue) was a success – but the huge order book was a function of the 7.5% coupon. Even its subsequent unguaranteed follow-on trade, a $2 billion bond executed late April – and sold after Goldman had unofficially passed the government’s stress test – pays 6% for five years.
Just because Goldman has technically become a bank does not mean it is one. Its deposit base is like no other bank’s. It is wholly reliant on the US government or Federal Reserve for cost-efficient financing – either directly or indirectly.
Obtaining cheap financing provided by the state and then using that funding in the financial equivalent of a casino – even if you are a master player of the tables – is not a sustainable business model.
Maybe the US authorities will allow Goldman to repay the Tarp money and maybe they won’t. But either way until Goldman and the other financial institutions can raise funds in their own names and completely eschew government aid, they will and should remain subject to close public scrutiny and limits on remuneration.
