Goldman Sachs announced much higher than expected profits today.
What does that mean? It’s like expecting your child to get a C+ on an exam, but her getting an A+ instead, and with a gold star!
But in a period in our economy where the Dow is still down 45% year to date, how did Goldman manage to rub two pennies together and make a quarter?
And does this mean that the banking crisis is over and TARP (gasp!) worked?
Goldman reported on at least three lines of business:
1. Investment banking
2. Trading and Principal Investments
3. Asset Mgmt and Securities Services
Investment banking revenue was down 30%–no surprise as few companies would’ve chosen to go public or even try to raise capital in the stock market last quarter because they wouldn’t have found many stock buyers.
Asset Management and Securities Services revenue were also down by 29%. Once again, even the wealthy last quarter were holding onto their money and not investing as much as usual, lowering the commission and fee production for the firm.
Also, fewer opportunities to create structured products and derivative instruments likely presented themselves (check out Three Little Securities Pt 3 to understand securitization).
This leaves #2: Trading and Principal Investments, where Goldman’s revenues were up 40% last quarter.
Specifically, they profited from their Fixed Income, Currency and Commodities businesses which apparently offset their losses in Real Estate and investments in other businesses.
Regarding Fixed Income profits–they may have bought distress, low-valued junk bonds where even a small increase in value would net a big profit if enough money is invested. Also, making money off the spread of loaning money from depositors is possible.
For Commodities–certain commodities did perform well recently, including coffee (and no surprise there…I drink several cups a day and my coffee beans are getting pricier!).
And regarding currency investing–you can make a great deal of money if enough money is invested.
Perhaps Goldman benefited from being well-capitalized and as a result able to rub two pennies together to make more pennies in their trading business. But was any of that money TARP money? If so, was that a permissible use of TARP money? Perhaps, since trading is classified as part of Goldman’s business model.
Nevertheless as banks announce their earnings, I can’t help but question if these banks would’ve been profitable without accounting rule changes and stimulus money (which, as it was pitched by the government, was intended to stimulate lending and not necessarily profitability).
As an investor, I want to know if they are truly able to make money via a sustainable business model.
Despite Goldman and Wells Fargo’s positive earnings news, this does not mean that the crisis is over. Both firms are well-managed and well-connected. They are also in niche businesses compared to the larger, more diversified Bank of America and Citigroup.
If the latter two report good earnings, perhaps we can breathe a little easier that the overall banking industry may be stabilizing. But I still want the transparency of understanding how they do business and where their profits came from before I completely exhale.