Traders take over as Goldman banks $2.4bn quarterly profits

Nobody move. This is a hold-up. The traders are taking over the bank.

As Hank Paulson, chairman of Goldman Sachs, heads to Washington to be President Bush's new Treasury Secretary, he cedes control of the financial powerhouse to a new generation of executives forged from the company's testosterone-fuelled trading divisions.

Goldman's blow-out results yesterday underscored once again how profits from trading have come to dominate the group, leaving the more gentlemanly investment banking division - from whence Mr Paulson came - firmly in the shade.

Lloyd Blankfein, who will step up to the top job when Mr Paulson is confirmed in Washington, has risen through the trading side and his elevation has sparked a battle for the soul of the business. The appointment of a new president - or even co-presidents - to succeed Mr Blankfein is being closely watched and vigorously fought internally. Mr Paulson's final act may be to force Mr Blankfein to accept at least one deputy from the investment banking side.

The word on Wall Street is that Mr Blankfein is insisting on appointing his long-time friend, Gary Cohn, as his no 2. Both men come from Goldman's commodities-trading subsidiary J Aron, but Mr Paulson is said to be arguing that an investment banker should be appointed to add balance.

Yesterday's results showed that trading accounted for fully 68 per cent of Goldman's revenues in the past three months. Investment banking - the business of helping the corporate world with merger deals, takeovers and fundraising - was down at a record low 15 per cent. But supporters of Mr Paulson say that investment banking accounts for 85 per cent of the value of the Goldman Sachs brand. It is this work that is at the heart of the network of relationships which makes Goldman such a powerful force, they say.

Piffle, say the traders, who cite the trading side's continuous innovation, its restless quest for new and lucrative financial areas such as energy trading or complex private equity deals. The numbers should speak for themselves. Of the $10.1bn (£5.5bn) quarterly net revenue reported yesterday, $7bn came from the trading and principal investments. It most likely accounted for an even bigger proportion of Goldman's $2.4bn profit.

The tensions between the two sides appear to have grown in recent months. In the UK, the trading and investment side backed a string of hostile bids for companies including ITV, Mitchells & Butlers and BAA. Since BAA was also an investment banking client of Goldman, the airports operator went ballistic and other clients lost trust that Goldman could manage such obvious conflicts of interest. Mr Paulson stepped in to insist on the primacy of the investment banking relationships. History doesn't record his exact words to the UK executives he telephoned, but one of his friends said it boiled down to: "Use your heads, you assholes."

There have always been tensions. Trading and investment banking were held in an uneasy equilibrium in the run-up to Goldman's flotation when Jon Corzine, a lifelong trader, shared the chief executive's job with Mr Paulson. That arrangement collapsed along with Long-Term Capital Management, the over-leveraged hedge fund which nearly brought down the financial system in 1998. Goldman had a large exposure to LTCM, and it shelled out some $300m for the bail-out. Goldman's investment bankers were furious to discover the trading division had, in effect, blown the bonus pot for the year and, with an IPO looming in skittish markets, Mr Paulson manoeuvred and Mr Corzine was sacrificed to make sure the business put on a respectable investment banking face for its new investors.

In fact, the Goldman prospectus the following year said this: "While we plan to continue to grow our trading businesses, the financial market shocks of the past year underscored the importance of our strategy of emphasising growth in our investment banking, asset management and securities services businesses. Through a greater relative emphasis on these businesses, our goal is to gradually increase the stability of our earnings."

This is, of course, precisely the opposite of what has happened. Yet even now the company is still rather quaintly reporting the results of its investment banking division at the top of its press releases, above the outcome from its massive trading machine.

Goldman also resists the claim that it is "the world's biggest hedge fund". Its detractors point to the so-called "value-at-risk" calculation, the amount of money Goldman Sachs could lose in a given day if markets went against it. This has been $112m on average over the past three months, up 87 per cent on just a year ago. It is almost three times the $43m disclosed for 1998, the year LTCM last chastened the trading side.

But value at risk does not mainly reflect spotty, braces-wearing juniors betting the company's money from its proprietary trading desk, Goldman insists. It is accelerating because clients are more demanding, needing trades executed immediately, requiring Goldman to have shares, bonds, or other financial instruments on its own books in order to win business. As hedge funds have grown to dominate trading in the financial markets, Goldman - which has probably the best set of relationships with hedge fund managers of any of the financial services companies - has grown the trading side that acts for them.

The message delivered belligerently by Goldman's finance director, David Viniar, yesterday was that "we will not operate any different than we have always operated", despite the transition from Mr Paulson to Mr Blankfein.

It is a view supported by many "Goldmanologists". Brad Hintz, the financial services analyst at Sanford C Bernstein, said: "Goldman Sachs is an unusual place - a cult, if you want to characterise it that way, or a partnership, not a pure management structure with a king on top. Mr Blankfein is first among equals, and there are some senior executives who make and vet decision on a consensual basis. Whether they choose one, two or three presidents, it is these 'senior partners' that will continue to decide."

Yet Wall Street is watching the race for the president or co-president posts. Goldman's investment bankers fear that an all-out takeover of top positions by the traders could lead to a shift in the way the bonus pool is shared. Shareholders are nervous that the company will downplay the respected investment banking business in favour of a volatile trading business.

Mr Hintz says: "The question is, is the market willing to pay up for trading? The fact is that trading is an opaque business, and investors are uncomfortable giving it a high multiple. By growing the trading side, are you increasing the value of the business, or just increasing its earnings?"