If, like me, you had the impression that the financial economy was in serious trouble, then you, like me, were probably surprised to learn that several banks have been reporting record profits, despite the apparent dire straights the financial economy is supposed to be in.
Reporting for Fortune, Colin Barr tells us:
Goldman Sachs reported a much stronger-than-expected first-quarter profit Monday, bouncing back from its worst quarter as a public company.
Goldman (GS, Fortune 500) also set plans to raise $5 billion through a sale of stock, saying it wants to become the first big bank to repay the federal loans extended during last fall’s financial sector meltdown.
In reporting its results a day earlier than expected, New York-based Goldman said it earned $1.81 billion, or $3.39 a share, for the quarter ended March 31. Analysts surveyed by Thomson Financial were looking for a profit of $1.64 a share.
How could Goldman earn such lofty profits?
The firm said the latest quarter’s gains were driven by big profits in its fixed income business, where revenue surged to $6.56 billion – 34% above the previous record.
“Given the difficult market conditions, we are pleased with this quarter’s performance,” said CEO Lloyd Blankfein in a statement.
In addition to the record fixed income revenue, which Goldman said was driven by “strong performance in interest rate products, commodities and credit products,” Goldman also posted $7.15 billion in trading and principal investment revenue.
But Goldman’s principal investments lost $1.41 billion during the quarter, reflecting losses on real estate and a stake in a Chinese bank.
Revenue in Goldman’s financial advisory and investment banking businesses declined by 21% and 30% from a year ago, as dealmaking declined, while revenue in its asset management business fell 29%, reflecting the plunge in stock prices over the past year.
Readers of Fortune will probably take Barr’s account as authoritative, fair, balanced, all the rest, but there are a few details that remain unclear and unreported in Barr’s account.
One: Goldman may have received two sets of insurance payment, one from the taxpayer. As Karl Denninger explains, it appears that Goldman bought credit-default swaps against the default of AIG, but also collected from its AIG insurance policies (after the government bailed AIG out). If correct, what this basically means is that Goldman was paid twice for its risky investments, once when AIG collapsed, then again, when the federal government bailed AIG out. It’s as if you had insured your car, had an accident, collected the insurance money, on the theory that you’d use that money to buy a replacement car, then the government gave you a free car for the hell of it. You would be reporting a good year too, if that happened. To what degree are Goldman’s profits the result of its receiving both taxpayer-subsidized first-order insurance payments and second-order insurance payments?
Two: Floyd Norris at the New York Times reports a more directly fraudulent possibility:
One way [for Goldman to show a profit in this economic climate] was to hide a lot of losses in not-so-plain sight.
Goldman’s 2008 fiscal year ended Nov. 30. This year the company is switching to a calendar year. The leaves December as an orphan month, one that will be largely ignored. In Goldman’s earnings statement, and in most of the news reports, the quarter ended March 31 is compared to the quarter last year that ended in February.
The orphan month featured — surprise — lots of write-offs. The pretax loss was $1.3 billion, and the after-tax loss was $780 million.
Would the firm have had a profit if it had stuck to its old calendar, and had to include December and exclude March?
According to this account, Goldman has used an accounting trick so that it doesn’t have to report its losses for the month of December–that is, Goldman will never have to report its losses from this “orphaned” month. These falsely positive numbers are subsequently driving its stock price up–since investors are apparently unwisely trusting Goldman’s numbers–which will then allow Goldman to buy its way out of TARP.
I suppose all of this alleged mendacity doesn’t bother me if the end result is that Goldman has used an accounting trick to swindle $5 billion from the investing public, though there are lots of pension plans and other effectively non-voluntary allocations of stock that would go into their coffers. Investors would be stupid to get anywhere near Goldman stock, in my view, until the accounting details behind its orphan month become clearer. Such fraudulent cooking of the books should also be illegal, of course, but that’s another story altogether.
But the idea that Goldman got insurance money from taxpayers — via the AIG bailout — to pay back losses it had already bought additional, second-order insurance to cover, then used the taxpayer subsidized profits and resulting stock price gains to pay back its part of the highly unpopular TARP program, all while having gotten basically $10 billion in direct subsidy, with no obligation to repay, from the very same taxpayer — well, that seems less lovely to me. Essentially Goldman is using the posted earnings of one indirect subsidy to pretend it repaid its debt to the taxpayer (since most people, say readers of the Fortune article, would think Goldman only received a subsidy via TARP), and compounding matters Goldman received its indirect subsidy on a risk it had already hedged against.
As Karl Denninger rightly suggests, we need to investigate what exactly has been going on behind the scenes at Goldman.
Here goes a Bloomberg article in which Goldman tries to explain its relationship with AIG:
But later in the same article, we get this:
So how much did Goldman get because of the AIG bailout, directly or indirectly? Whatever the answer, the implication seems to be that AIG insurance returns didn’t have an impact in this quarter, but that they did have an impact over previous quarters’ earnings, “from 2006 to now.”
Comment by Lee — April 15, 2009 @ 1:04 am
For another critical take on this article, check out Yves Smith at naked capitalism.
The comments section is particularly interesting. There seems to be some ambiguity in the claim, by Viniar, that the AIG relationship didn’t lead to any recorded gains this quarter. As one commentator suggests:
All of which brings me back to my original point: an investigation should be conducted into the nature of these controversial AIG payouts (not just to Goldman).
Comment by Lee — April 15, 2009 @ 1:15 am
Your post suggests that Goldman cashed in on credit default swaps that can only be cashed if AIG failed. But AIG didn’t fail. And I don’t believe Goldman collected on any such credit default swap. If you know for certain that Goldman did in fact collect in this way, can you show me the reference? As far as I can tell, Karl Denninger isn’t saying Goldman collected from a credit default swap. He quotes Vinier referring to swaps that “would have paid off in the event of an AIG bankruptcy” but AIG never went bankrupt. Denninger is saying Goldman MAY have collected on a “hedge” against a possible credit loss related to AIG.
Denninger’s point seems to be that if the “hedge” was paid with bailout money, then it is wrong for Goldman Sachs to receive it. But what about the fact that Goldman purchased the hedge and was therefore (I assume) legally entitled to it? The whole point of bailing out AIG was to make sure AIG could continue to function, which means making sure AIG can meet its financial obligations — and if one of those obligations is to pay off on a hedge Goldmann bought, then what’s wrong with AIG meeting its obligations?
Goldman didn’t buy this hedge because it wanted to screw taxpayers. It bought the hedge to protect itself against possible credit loss. We have no reason to criticize it for doing so — and we certainly have no reason to criticize Goldman for wanting AIG to honor that hedge.
In an effort to keep its obligations, AIG made payments to all sorts of entities with bailout money; should we now expect all of these recipients to give back the money? That’s an insane idea. The whole point of the bailout is to bring stability to the financial markets.
As for Goldman’s inflated balance sheet — do we have any sense of how significant these “inflations” are as a percentage of Goldman’s total reported profit?
Finally, what difference does any of this make? It seems to me we can draw two important conclusions from Goldman’s profits: (1) the bank seems to be in better shape than was once feared, and it’s not going to fail anytime soon, (2) if Goldman’s situation is similar to the situations at other banks such as Citigroup and Bank of America, that means bank nationalization won’t be necessary because the Geithner plan will be sufficient to recapitalize the banks.
Am I wrong to be drawing these conclusions wrong?
It seems to me that you and Denninger are making moral arguments about Goldman — that Goldman was morally wrong to get hedge money and TARP money, and that Goldman is wrong to be manipulating its figures to make its profits look bigger than they really are. These are interesting moral arguments, but I think it’s important to note that they have no bearing on the economic question of whether the Goldman news is a good sign for the economy.
Comment by Ian — April 15, 2009 @ 11:25 pm
I think you misunderstand Denninger’s point. To quote Denninger, “IT APPEARS GOLDMAN GOT PAID TWICE FOR THE SAME RISK AND THE SECOND PAYMENT CAME STRAIGHT OUT OF THE TAXPAYER’S HIDE.”
Emphasis on appears. Denninger bases his perfectly reasonable views on the March 2009 Goldman teleconference, which he quotes. I don’t know about you, but I care about how my tax dollars are used. I think the tea party nuts who protested around the country today are largely ridiculous, but to the degree that they gain any support from the general population, they do so because people are frustrated when they learn that their tax dollars are not being wisely spent. How my taxes are spent isn’t a matter of morality, but self-interest, though the two are not easily disentangled. Ergo, my suggestion: let’s find out via an investigation. As the popular Bay Area bumper sticker says: Bush deserves a fair trial. Goldman, too.
As for the “orphaned” month of December, whether this matters depends on whether Goldman’s profits were only possible because of accounting trickery. If so, then the idea that Goldman is on firm footing as a company is a bit of an optical illusion, soon to be punctured. Again, not a problem if Goldman only defrauding stupid investors, but a problem if we use Goldman’s profits to assure ourselves that the economy is a-ok.
Comment by Lee — April 15, 2009 @ 11:47 pm
I’d love for my tax dollars to be wisely spent. And if the AIG bailout money went towards improving the condition of Goldman Sachs, then that was money well spent. The entire reason for bailing out AIG is to prevent the devestating ripple effects that would result from AIG defaulting on its obligations to entities such as Goldman. AIG was SUPPOSED to use the bailout money to honor its obligations — that’s evidence that the AIG bailout is working. What do you think AIG is supposed to do with the money? Keep it in their vaults? Distribute it at baseball games?
It is precisely your sense of self-interest that should cause you to rejoice that AIG used bailout money to honor a financial obligation to Goldman. The whole problem with letting AIG fail is that it would weaken or destroy other institutions, such as Goldman.
As for the “fair trial,” that you’re talking about — there is zero evidence to suggest Goldman did anything that is actually illegal. Correct?
As for the “optical illusion” you’re talking about, I think it’s possible that Goldmna’s profits are somewhat inflated — but that doesn’t mean the bank isn’t on solid ground. Are you suggesting that Goldman is actually insolvent, a zombie bank, dead in the water? You say this illusion is “soon to be punctured.” Can you be more specific? How long shall we wait for news of Goldman’s collapse before we can safely assume that Goldman may actually be on solid ground?
Nobody is assuring thesmelves that the economy is “a-ok.” The economy is not “a-ok.” The economy is in serious trouble. But even given everything you’ve said, the news of Goldman’s profits is a good sign.
Comment by Ian — April 16, 2009 @ 12:07 am
If Goldman covered its losses via reinsurance, and it paid for the reinsurance protection it received, then it ought therefore to have been protected. If in addition to receiving its reinsurance, it received a free cash bonus of my tax money, sorry, but I’m not rejoicing. I want my tax dollars to be given to companies that are at genuine risk, and only when those companies are “too big to fail,” and I want a measure of control to come with my tax “investment.” I’m not a patsy or a sucker; I want a fair return on my investment.
As for the general suggestion, “given everything you’ve said, the news of Goldman’s profits is a good sign,” I don’t think we can be sure yet. If someone had said in 2006 — as people like Dean Baker did — that “there’s a housing bubble and it’s going to blow up in our face,” then you said, “When?” the only answer that person could have given would be, “When it does.”
Some analysts have suggested that Goldman’s profits are the result of risky investments. Here’s Reuters:
Comment by Lee — April 16, 2009 @ 2:39 am
Regarding the TARP funds, I don’t think the plan was to give the money only to banks that were at genuine risk. I think Geithner sort of forced all the big banks to take TARP money — because if only the worst-off banks took TARP money, depositors could just look and see which banks took TARP money and then withdraw their money from those banks, which would defeat the purpose of the TARP. Either way, the “free cash bonus of my tax money” WAS the reinsurance, wasn’t it? Besides the reinsurance, the only other tax money Goldman received was the TARP money, which it is giving back.
You could be right that Goldman is in far worse shape than these recent profit figures would suggest.
Comment by Ian — April 16, 2009 @ 6:55 am