Goldman Sachs humbled

The Wall Street giant announced its first quarterly loss in a decade and its stock has plummeted by two-thirds this year. So, how did the mighty institution fall? Mathieu Robbins reports
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The Independent Online

Goldman Sachs, which yesterday announced its first quarterly loss since it listed a decade ago, is a hallowed name, be it on Wall Street or in the City. The venerable New York-based bank founded in 1869 still passes for one of the most innovative companies in the financial sector and is a coveted place to work for any ambitious financier.

The bank routinely comes top in league tables for prestigious M&A mandates, showing that it is also amongst the most trusted advisers to the world's corporate elite. And it has also developed a reputation as an innovative, meritocratic and results-driven trading institution. It was the first to trade commercial paper in the United States, and was amongst the creators of risk arbitrage and block trading in the 1940s and 1950s.

A year ago, its rivals were taking billion of dollars in write-downs due to the collapsing US housing market and its knock-on effect on mortgages and fixed-income securities. But the bank's proud staff – never known for their self-effacing modesty -- could brag that it had played the credit crunch to its gain when it emerged Goldman traders had made a $4bn profit from betting on the collapse of the US sub-prime mortgage industry. They called it right, of course, and helped the bank post record profits in 2007.

But Goldman's announced a $2.12bn loss for the three months through to November, compared with a net income of $3.2bn a year earlier, as revenues fell 52 per cent to $22bn. Its chief executive, Lloyd Blankfein, and six other top executives have given up their bonuses this year after the worst financial crisis since the Great Depression forced Goldman to convert to a bank-holding company and accept $10bn from the US government in October. The group cut 10 per cent of its staff last month. Its stock has plummeted by about two-thirds this year and its book value per share declined to $98.68 in the fourth quarter from $99.30 at the end of August.

Goldman's return on equity, measuring how well it invests earnings, dropped to 4.9 per cent for the year through to November from 32.7 per cent in 2007. And on the debt side, the ratings agency Moody's Investors Service yesterday lowered its long-term rating on Goldman's senior debt after it announced the loss, citing the "ongoing credit-market crisis" and a "persistent difficult operating environment". The agency also gave the bank a negative outlook.

So how did even such a mighty institution fall? Is even Goldman Sachs at the mercy of the markets?

To be fair, the bank's shares rose yesterday as the loss was less wide than expected, and Goldman also stands out among investment banks for posting a profit – albeit down 80 per cent on 2007 at $2.3bn – for its full fiscal year.

But this year – and in particular the three months since Lehman Brothers collapsed in September – has been so traumatic for the financial services sector that making a profit would have been a lot to expect of any bank, even Goldman. Let's look at three pillars of the business: advisory, asset management and trading. While Goldman continues to be near the top of the pack in mergers and acquisitions advisory, that market has fallen off a cliff as company chief executives look to hoard their cash rather than undertake expansive – and expensive – M&A deals. The IPO market has all but died as share prices are moving so fast it's impossible to set a price for a listing. And while there is little doubt these advisory businesses will recover over time, they are unlikely to resurface meaningfully to boost the banks earnings any time soon.

Its asset management unit fared little better. Asset management sales fell by a fifth compared with the fourth quarter of 2007, due to asset depreciation and the corresponding impact on the group's management fees. Stock indices have almost halved in value in the last year, and there have been few other asset classes that have done well enough to offset this tumble.

Then there is proprietary trading. Goldman has traded products ranging from shares to derivatives to oil and even electricity. The group has operated power stations, and created a commodities price index. But trading is fickle. While Goldman made money in that market, the pre-eminence of the activity rose at the bank, making up the lion's share of its revenue and profits last year. But the group's former strength has now become a weakness. Trading and other principal investments lost $4.4bn in revenue in the fourth quarter, compared with $6.9bn in sales they brought in a year ago. While Goldman is now becoming a bank holding company, meaning in theory that it will take less risks, it has yet to define exactly how it will go about cutting its risk profile. But the bank has, like its peers, shown itself to be mortal when left unregulated. The reason? Greed. Rather than be a stable bank, Goldman chased the big-profit trades and investments – and has now fallen foul of the risk inherent in chasing such big returns. So, all in all, for all its history and culture, Goldman Sachs is getting – and indeed deserves – little better than its rivals.

"This crisis has demonstrated that the business model of wholesale investment banks is not as resilient as it appeared," said Peter Nerby, a senior vice-president at Moody's, in the credit report on Goldman published yesterday.

Goldman has in recent years tried to boost growth by increasing investment in emerging markets. But as recent economic woes in China and Dubai show, the decoupling of such markets from the Western economies remains more of a theory than reality and investments in places such as Russia are unlikely to bring through any big benefits before the rest of the world recovers.

So, just like its peers, Goldman Sachs can't keep on defying the markets forever. Except, of course, unlike Bear Stearns, Lehman Brothers and Merrill Lynch, which made up three of the top five Wall Street banks a year ago, Goldman can say it is still here to tell the tale. As it was after 1929.

Goldman Sachs: 140 years of history

Goldman Sachs, which reported its first quarterly loss in more than a decade yesterday, is one of the great institutions of Wall Street. The bank was created in 1869 by Marcus Goldman.

In 1882, Goldman's son-in-law Samuel Sachs joined, prompting the name change to Goldman Sachs. The bank pioneered commercial paper for US entrepreneurs, before helping to establish the IPO market in the early 1900s. In 1928, it launched the Goldman Sachs Trading Corp, a closed-end fund which failed after the stock market crash of 1929, hurting the firm's reputation for several years. In the 1930s Goldman's focus shifted away from trading and towards investment banking.

The effort paid off and Goldman was lead adviser on Ford's IPO in 1956. In subsequent years, Goldman also started an investment research division and a municipal bond department – and became an early player in risk arbitrage. In 1986, the firm formed Goldman Sachs Asset Management and the same year underwrote the IPO of Microsoft and advised General Electric on its acquisition of RCA. Goldman also became the first US bank to rank in the top 10 of the M&A league tables in the UK that year.

During the 1980s, the firm became the first bank to distribute its investment research electronically and created the first public offering of original issue deep-discount bond. In the 1990s the bank expanded globally. It launched the Goldman Sachs Commodity Index and opened a Beijing office in 1994.

In 1999, Henry Paulson, now US Treasury Secretary, became head of the firm and Goldman IPO-ed that year. It announced record earnings in 2007, partly because, unlike rivals, it predicted the US sub-prime crisis that started the credit crunch.

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