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Goldman Sachs Lack of Love Puts Profit at Risk: David Reilly
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Commentary by David Reilly
July 22 (Bloomberg) -- Weathering the aftermath of the financial crisis may prove tougher for Goldman Sachs Group Inc. than surviving the storm.
Long the Wall Street firm everyone loves to hate, Goldman saw the brickbats rain down last week after it posted blowout second-quarter results and set aside a record amount for compensation. Even the arch-conservative Wall Street Journal editorial page joined the attacks.
Usually, Goldman takes a sticks-and-stones approach to such vitriol, even if being labeled a great vampire squid wrapped around the face of humanity by Rolling Stone magazine is new. This time, though, names may hurt the bank and its share price.
Goldman is at the center of the debate over regulation of too-big-to-fail institutions that benefited from what was estimated this week to be a $23.7 trillion bailout of the financial system. Even President Barack Obama singled out the firm when talking of the need for change on Wall Street.
Now, there are some companies, like Goldman Sachs, that have paid the money back and that means that we dont have the same kind of levers on them that we might have, Obama said during an interview on PBS earlier this week. And thats why I think its important to pass this broader financial regulatory reform package.
The danger for Goldman is that it becomes a focal point for populist bailout ire, leading the government to take a tougher stance on regulation. Treating too-big-to-fail institutions as financial utilities, for example, would curtail Goldmans ability to generate returns on equity in excess of 20 percent.
Clear Picture
So until the policy picture becomes clearer, its tough to justify talk of a return to valuations for Goldmans stock greater than two times book value, or its net worth. After gaining more than 15 percent in the past 10 trading days, Goldmans stock is now priced at about 1.5 times second-quarter book value.
Goldman will have to work hard to see that its wings dont get clipped, especially after posting second-quarter net income of $3.4 billion and setting aside $11.4 billion in the first half of 2009 for compensation and benefits.
For starters, most folks arent quite sure how Goldman manages to make prodigious amounts of money. That leads to a feeling the firm must either be taking huge risks, or unduly benefiting from its extensive government connections.
Goldman hasnt done a good job dispelling such notions and it sometimes makes matters worse. The firm has failed to adequately explain its trading relationship with American International Group Inc. and give a clear sense of whether and how it benefited from the massive bailout of the insurance giant.
Bubble Times
The firms 23 percent return on equity in the second quarter also struck some investors as more reminiscent of bubbly times. An old rule of thumb is that the higher a financial firms return on equity, the bigger the risk taken to make its money.
On top of that, much of Goldmans systemic risk stems from its big role in derivatives markets. With outstanding derivatives contracts with a notional value of $48 trillion, Goldman trails only JPMorgan Chase & Co. with $81.1 trillion and Bank of America Corp. with $77 trillion in contracts, according to Office of the Comptroller of the Currency.
Yet Goldmans total credit exposure from derivatives contracts is more than 10 times its capital, or the buffer available to absorb losses, according to the OCC. That compares with just 3.2 times for JPMorgan and 1.7 times for Bank of America.
Trimming Risks
For its part, Goldman says it has trimmed the risks it takes while shrinking its balance sheet. Over the past year the firm has halved the amount of borrowed funds, or leverage, it uses.
Goldman has also built up the amount of liquidity, or short-term funding, to record levels, while bolstering its cushion against loss. The firms Tier 1 ratio, a measure of regulatory capital, stood at 13.8 percent at the end of the second quarter, compared with 9.7 percent at JPMorgan.
The world is still a tough place, Goldman Chief Financial Officer David Viniarsaid on the firms earnings call last week. Were going to be conservative.
And in all the Goldman bashing, one thing gets lost: it was the only major investment banking firm that avoided self- inflicted wounds during the crisis.
Bear Stearns Cos., Lehman Brothers Holdings Inc. and Merrill Lynch & Co. all to some degree had a hand in their own demise, while Morgan Stanley tripped itself up on a botched trading strategy.
Avoiding Landmines
Goldman didnt step on one of its own landmines and insulated itself early on from the worst of the slump in housing and financial markets.
True, Goldman and Morgan are only alive today because the government propped up the financial system. The same is likely true, though, for others like JPMorgan and especially Citigroup Inc.
Not to mention that the bailouts were meant to keep financial institutions afloat so they could eventually make money. So Goldman did what the government wanted.
The problem is that what the government gives, it may also take away. And in a new era of frugality, the risk is real that policy decisions will be driven by headlines about huge Goldman profits and bonuses.
If thats the case, Goldman may find its image crisis turning into a profit problem.
(David Reilly is a Bloomberg News columnist. The opinions expressed are his own.)
To contact the writer of this column: David Reilly at [email protected]
Last Updated: July 21, 2009 21:00 EDT
http://www.bloomberg.com/apps/news?pid=20601039&sid=aa9m6duHps5k
Goldman Sachs Lack of Love Puts Profit at Risk: David Reilly
Share | Email | Print | A A A
Commentary by David Reilly
July 22 (Bloomberg) -- Weathering the aftermath of the financial crisis may prove tougher for Goldman Sachs Group Inc. than surviving the storm.
Long the Wall Street firm everyone loves to hate, Goldman saw the brickbats rain down last week after it posted blowout second-quarter results and set aside a record amount for compensation. Even the arch-conservative Wall Street Journal editorial page joined the attacks.
Usually, Goldman takes a sticks-and-stones approach to such vitriol, even if being labeled a great vampire squid wrapped around the face of humanity by Rolling Stone magazine is new. This time, though, names may hurt the bank and its share price.
Goldman is at the center of the debate over regulation of too-big-to-fail institutions that benefited from what was estimated this week to be a $23.7 trillion bailout of the financial system. Even President Barack Obama singled out the firm when talking of the need for change on Wall Street.
Now, there are some companies, like Goldman Sachs, that have paid the money back and that means that we dont have the same kind of levers on them that we might have, Obama said during an interview on PBS earlier this week. And thats why I think its important to pass this broader financial regulatory reform package.
The danger for Goldman is that it becomes a focal point for populist bailout ire, leading the government to take a tougher stance on regulation. Treating too-big-to-fail institutions as financial utilities, for example, would curtail Goldmans ability to generate returns on equity in excess of 20 percent.
Clear Picture
So until the policy picture becomes clearer, its tough to justify talk of a return to valuations for Goldmans stock greater than two times book value, or its net worth. After gaining more than 15 percent in the past 10 trading days, Goldmans stock is now priced at about 1.5 times second-quarter book value.
Goldman will have to work hard to see that its wings dont get clipped, especially after posting second-quarter net income of $3.4 billion and setting aside $11.4 billion in the first half of 2009 for compensation and benefits.
For starters, most folks arent quite sure how Goldman manages to make prodigious amounts of money. That leads to a feeling the firm must either be taking huge risks, or unduly benefiting from its extensive government connections.
Goldman hasnt done a good job dispelling such notions and it sometimes makes matters worse. The firm has failed to adequately explain its trading relationship with American International Group Inc. and give a clear sense of whether and how it benefited from the massive bailout of the insurance giant.
Bubble Times
The firms 23 percent return on equity in the second quarter also struck some investors as more reminiscent of bubbly times. An old rule of thumb is that the higher a financial firms return on equity, the bigger the risk taken to make its money.
On top of that, much of Goldmans systemic risk stems from its big role in derivatives markets. With outstanding derivatives contracts with a notional value of $48 trillion, Goldman trails only JPMorgan Chase & Co. with $81.1 trillion and Bank of America Corp. with $77 trillion in contracts, according to Office of the Comptroller of the Currency.
Yet Goldmans total credit exposure from derivatives contracts is more than 10 times its capital, or the buffer available to absorb losses, according to the OCC. That compares with just 3.2 times for JPMorgan and 1.7 times for Bank of America.
Trimming Risks
For its part, Goldman says it has trimmed the risks it takes while shrinking its balance sheet. Over the past year the firm has halved the amount of borrowed funds, or leverage, it uses.
Goldman has also built up the amount of liquidity, or short-term funding, to record levels, while bolstering its cushion against loss. The firms Tier 1 ratio, a measure of regulatory capital, stood at 13.8 percent at the end of the second quarter, compared with 9.7 percent at JPMorgan.
The world is still a tough place, Goldman Chief Financial Officer David Viniarsaid on the firms earnings call last week. Were going to be conservative.
And in all the Goldman bashing, one thing gets lost: it was the only major investment banking firm that avoided self- inflicted wounds during the crisis.
Bear Stearns Cos., Lehman Brothers Holdings Inc. and Merrill Lynch & Co. all to some degree had a hand in their own demise, while Morgan Stanley tripped itself up on a botched trading strategy.
Avoiding Landmines
Goldman didnt step on one of its own landmines and insulated itself early on from the worst of the slump in housing and financial markets.
True, Goldman and Morgan are only alive today because the government propped up the financial system. The same is likely true, though, for others like JPMorgan and especially Citigroup Inc.
Not to mention that the bailouts were meant to keep financial institutions afloat so they could eventually make money. So Goldman did what the government wanted.
The problem is that what the government gives, it may also take away. And in a new era of frugality, the risk is real that policy decisions will be driven by headlines about huge Goldman profits and bonuses.
If thats the case, Goldman may find its image crisis turning into a profit problem.
(David Reilly is a Bloomberg News columnist. The opinions expressed are his own.)
To contact the writer of this column: David Reilly at [email protected]
Last Updated: July 21, 2009 21:00 EDT
them. The looting will not stop until we stop them.
mmunists.
