The money-making machine of Goldman Sachs

Despite the world still being in the grips of a global recession, mostly to do with incompetent banking, US investment bank Goldman Sachs made a record quarterly profit in April-June this year of US$3.44 billion.

It also announced last week it is on track to hit a record year-end bonus payout pool of US$23 billion – an average of $630,000 per employee.

While other banks are still devaluing assets and their balance sheets from the flow-on effects of the sub-prime mortgage crisis, Goldmans is steaming ahead as the shining light for an insecure industry.

In fact, the financial crisis was a dream come true for the global bank. With investors and clients wondering where to turn amidst the chaos, it has presented the perfect opportunity for them to grab business off other banks.

And it’s not only business they’ll be looking to grab. Talented bankers will see them as the number one place to be because of the high earning potential and the status. Goldmans was already highly regarded and sought after by potential employees, but now their pulling power is undeniable.

So why is Goldman Sachs in such a dominant position? Mostly it was brilliant management and trading before, during and after the global financial crisis of 2008. Plus a network of powerful graduates who have gone on to higher places.

Goldmans did not have significant exposure to collateralised debt obligations (CDOs) – the assets backed by mortgages given to people who couldn’t afford them – unlike most of the other major investment banks.

Therefore, when the subprime mortgage crisis hit home, competitors such as UBS and Merrill Lynch went into emergency mode, Bear Stearns and Lehman Brothers died, and Citigroup sold a third of itself to the government.

Since then, markets have increased over 50 percent, and the volatile ups and downs have been heavenly for skilled traders.

When the US government offered financial assistance to all banks in October last year, Goldmans took it almost out of a sense of obligation.

They claimed they didn’t need it and were the first to pay it back with interest in June this year. However, there is no doubt that they benefited from the $10 billion in aid and from the government guaranteeing debt.

Now without the government aid, they are free to return to business as usual – at least until the rules get changed.

This is another area of Goldman’s strength – political ties. A large number of their graduates, or alumni, have gone on to be politicians in Washington, or members of the US and New York Federal Reserves. The Federal Reserves are the central banks who control the US economy.

It literally pays to know people in these places in an industry where information and money reign supreme.

Henry Paulson, a former CEO, was Treasury Secretary during the 2008 crisis. He let Bear Stearns and Lehman Brothers die (both major competitors of Goldmans) but bailed out AIG, who owed Goldmans the most money – $12.9 billion.

Stephen Friedman, a former director and current shareholder of Goldmans, was Chairman of the New York Federal Reserve (the bank’s supervisor and regulator) until he was forced to step down due to a conflict of interest.

In fact, a lot of their behaviour could be considered unethical by the man on the street. But perhaps the man on the street should look in the mirror when he wants someone to blame.

It was the American public who voted in the Bush administration. Twice. And it was the Bush administration who loosened the rules governing Wall Street banks allowing them to behave recklessly with greed as the overwhelming measure. Goldmans, along with the other banks, were merely playing within the rules.

However, it was Goldmans who self-regulated while the others partied on into the morning without a care for the hangover. And now they are charging along with a clear head and a healthy balance sheet.

The ‘Oracle’ himself, Warren Buffet, bought a $10 billion stake in the bank last year when the storm had reached fever pitch – a huge vote of confidence for the bank’s reputation in an uncertain time.

Buffet, the world’s greatest investor and wealthiest man (or second depending on where his friend Bill Gates is at), had been vocal about his desire to invest in Goldmans, once the share price was more reasonable, because he liked the company’s culture, and above all, its management team.

Goldman Sachs is certainly no angel. It is the epitome of rich world capitalism and to many that is wrong – particularly now.

Nevertheless, it has played within the rules, no matter how ridiculous they were (and that they probably helped to make them), and it has played extremely well. It saw the dangers others didn’t and is now sitting pretty on top of the banking world.

Changes must be made to the banking industry in the US – changes that will reduce Goldman’s profitability. That is President Obama’s job and the public’s job to make sure he does it.

But in the meantime, whatever your outlook on the world, one must stand back and admire the finely tuned money-making machine that is Goldman Sachs.

By The Casual Truth

Photo/BusinessWeek – Goldman Sachs Headquarters at 85 Broad Street, New York