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Goldman’s Easy Money Days Are Over

Posted by Larry Doyle on January 21, 2010 11:32 AM |

If I had a nickel for the number of people who have asked me how Goldman Sachs makes money, I would have a lot of nickels.

Goldman Sachs as a company is easily vilified. America always wants a villain when times are tough. Goldman makes the most money on Wall Street so they must be the ‘baddest’ guys. Well, generally speaking people are never as good nor as bad as they may seem. Look at Tiger Woods. He fooled America for a good long time. The fact is, Goldman Sachs mastered a business model which no other Wall Street enterprise fully embraced. I am certainly not a Goldman apologist and believe they very likely took advantage of situations that drove enormous profits. I highlighted the Goldman business model last July in writing, “How Does Goldman Sachs Operate?”: >>

With the repeal of Glass-Stegall, most investment banks looked to grow origination capabilities in order to compete with the large commercial banks. At the same time, most commercial banks looked to grow their investment banking and trading operations.

Goldman stood out by taking an entirely different tact. Goldman decided to utilize its capital and balance sheet less so for origination capabilities and much more for principal trading (that is, making bets and taking positions with its own capital). Effectively, Goldman decided to operate much more like a large multi-strategy hedge fund. Goldman took enormous risks both in their proprietary books but also in their trading activity with customers. Goldman made a concerted decision to dominate the markets in which they chose to play.

Today Goldman’s business model is under attack. America will hear from President Obama targeting the very core of Goldman’s business model, that is proprietary risk-taking on Wall Street. Surely that must be what is driving the overall market and Goldman Sachs’ stock lower. Well, yes and no.

While Obama is “proposing” (a long way from actual implementation) limits on bank proprietary risk, the simple reality is Goldman’s earnings are currently impacted by a drastically different dynamic. What is that? Earnings within Goldman’s FICC (fixed income, commodity, and currency) business declined significantly in the 4th quarter.

The WSJ attempts to put Goldman’s earnings in a positive light by utilizing the standard year-over-year comparison. Let’s zero in on the key component within Goldman’s earnings. From the article Goldman Profit Leaps as Firm Restrains Pay:

Fixed-income trading slowed after extraordinary profits in the previous three quarters. Revenue from fixed income, currency and commodities was $3.97 billion, down from the $5.99 billion in the third quarter.

Why did revenue in this division decline so much? Very simply, the toll Goldman collects (that is the spread between the bid and offer in the market) has narrowed tremendously. Previous wide spreads (in Wall Street parlance, wide enough for a Mack truck) represented very easy money. Those days are over, at least for now. The narrowing of the spread directly impacts Goldman’s bottom line and that of every other firm on Wall Street.


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  • Petricone456

    Not sure if you read that the Supreme Court just reversed a 63 year-old law that limited corporations and unions spending on advertisements to endorse political candidates. This could be interesting in light of what we’re hearing out of the Obama administration today. If Goldman could spend $50 million pumping its own agenda through political ads do you think there’s any chance Obama will get his full agenda passed into law? I admit its a bit scary for those on Wall Street given the public appetite to regulate the industry. In any sense, would be curious to hear your thoughts now that the Supreme Court just opened the door on corporate campaign spending. I enclosed the link to an article on the Supreme Court ruling below:

    • Larry Doyle

      I firmly believe we need term limits and serious campaign finance reform. The Canadian system of elections seems very appealing to me. A brief campaign period with a number of debates and televised appearances. Keep the money and stench out of it.

      I know that some of the campaign finance reform we have had merely led to the development of organizations such as and others (on both sides of the aisle) but this garbage needs to be severely regulated. Buying influence and that is at the core of this problem is not serving America’s interest.

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