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Clipping Nickels the Goldman Sachs Way

Happy Birthday, Sweetheart!

There is this widely-held belief that the financial elites are really important to our economy, which leads to the conviction that they are truly marvelous creatures. That’s just nonsense. This post describes several recent disclosures to throw in the face of any diehards you might meet. But stories, no matter how disturbing, can always be discounted by the true believers.

Let’s look closer at one of these firms. Goldman Sachs wants everyone to believe it is the home of the great brains. So, what is it exactly that they do with those great brains? Let’s look at the tape. The 10-K and the 8-K tell all. Oh, wait. We’ll need the results for December, 2008, because those aren’t in either of these statutory filings. They’re in this press release. No, really.

GS has three main business segments: investment banking, trading and principal investments, and asset management and securities services. Investment banking includes these services: mergers and acquisitions advisory services, financial restructuring advisory services, and equity and debt underwriting. Net revenues in this segment in the 1st Quarter were $823 million, 30% lower than the first quarter of 2008, and 20% lower than the fourth quarter of 2008. Perhaps there is some dying off of those large complex transactions.

Asset Management includes two different categories. One is the general brokerage services, and the other is fund management. Here’s a description of the second category from the 10-K:

We offer a broad array of investment strategies, advice and planning. We provide asset management services and offer investment products (primarily through separately managed accounts and commingled vehicles, such as mutual funds and private investment funds) across all major asset classes: money markets, fixed income, equities and alternative investments (including hedge funds, private equity, real estate, currencies, commodities and asset allocation strategies).

Net revenues were down in this segment, too. So, where did those 1st quarter profits come from? All of it came from the Trading and Principal Investment segment. Here is the description, also from the 10-K:

Trading and Principal Investments facilitates client transactions with a diverse group of corporations, financial institutions, investment funds, governments and individuals and takes proprietary positions through market making in, trading of and investing in fixed income and equity products, currencies, commodities and derivatives on these products. . . . In connection with our merchant banking and other investing activities, we make principal investments directly and through funds that we raise and manage.

Principal investments lost $1.4bn in the first quarter (on top of $1.03bn in December, 2008, and about $3.1bn in fiscal 2008, not counting their Chinese bank). Real estate and other corporate lost $1.3bn. Fortunately, trading activities for the benefit of GS produced gains of $8.5bn or so in the first quarter. Here’s the description:

Fixed Income, Currency and Commodities (FICC) and Equities are large and diversified operations through which we engage in a variety of client-driven and proprietary trading and investing activities.

In our client-driven businesses, FICC and Equities strive to deliver high-quality service by offering broad market-making and market knowledge to our clients on a global basis. In addition, we use our expertise to take positions in markets, by committing capital and taking risk, to facilitate client transactions and to provide liquidity. Our willingness to make markets, commit capital and take risk in a broad range of fixed income, currency, commodity and equity products and their derivatives is crucial to our client relationships and to support our underwriting business by providing secondary market liquidity.

In other words, GS trades capital around like monkeys, and justifies it by claiming it provides liquidity. That really takes great brain power. It’s like a continuous game of Tetris with other people’s money, only because you are so integrated into the game, you know where the pieces are long before they fall. Then, you take half the winnings and put it in your pocket. Of course, they do leave some tiny part for the people who put up the money. GS paid dividends of $642mn in fiscal 2008. That compares to $10.9bn in compensation and benefits. Did anyone get their money’s worth from any incidental improvement in liquidity?

The next time someone, like the President or Larry Summers, tries to tell you that Goldman Sachs is providing a service necessary to the economy, ask what they did that was so important. The only seriously profitable part of GS has nothing to offer the nation that we couldn’t get from any random poker table in Las Vegas.

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