If prudent investors can make only 0.5% on short-term assets, how does Goldman Sachs prosper?
Robert Rubin was a very powerful man. After 26 years and rising to the level of co-senior partner, he left Goldman Sachs in 1994 to become Treasury Secretary in the Clinton administration. His first major undertaking was during the Mexican bailout of 1995.
... Rubin drew criticism in Congress for using a Treasury Department account under his personal control to distribute $20 billion to bail out Mexican bonds, of which Goldman was a key holder.
For 1998, the first year for which we have public financial information on Goldman Sachs, their total revenue was $22 billion, and their net profit was $1.256 billion. It is highly probable that the $20 billion was extremely helpful to Goldman Sachs -- if not essential to its continuing existence.
And Robert Rubin had some very powerful friends.
In April 1998 Travelers Group announced an agreement to undertake the $76 billion merger between Travelers and Citicorp, and the merger was completed on October 8, 1998. The possibility remained that the merger would run into problems connected with federal law. Ever since the Glass-Steagall Act, banking and insurance businesses had been kept separate. Weill and Reed bet that Congress would soon pass legislation overturning those regulations ... . To speed up the process, they recruited ... to the Board of Directors...Robert Rubin (Secretary of Treasury during Democratic Clinton Administration) whom Weill was close to ... .
Here is a short history of Sandy Weill's march to riches. He began as a licensed broker at Bear Stearns. By 1962, he had formed his own firm, Carter, Berlind, Potoma and Weill. By 1979, it had completed fifteen acquisitions of other brokerage firms, which made Carter, Berlind the second-largest brokerage firm in the United States. It sold Shearson Loeb Rhoades to American Express. By 1992, he bought 27% of Travelers Insurance Company, the company he would later merge with Citicorp in 1998, while making billions of dollars for himself.
Billionaire Sanford Weill made 'Citigroup' into [one of] the most powerful financial institutions since the House of Morgan a century ago ... . Just days after the Clinton administration (including the Treasury Department) agrees to support the REPEAL [of the Glass-Steagall Act], Treasury Secretary Robert Ruin, the former co-chairman of a major Wall Street investment bank, Goldman Sachs, raises eyebrows by accepting a top job at Citigroup as Weill's chief lieutenant ... .
... November 12-1999, President Clinton stated, 'Glass-Steagall (FDR Banking Bill) is no longer appropriate for our economy. This was good for the industrial age. The (1999) Financial Modernization Bill is the key to rising paycheck and great security for ordinary Americans' ... .
What is this Goldman Sachs that issues forth such powerful people as Robert Rubin? What is its magic? Maybe we can find something out from their financial statements? If we look at the Goldman Sachs Group, Inc. and Subsidiaries Consolidated Statements of Earnings for December 2009, the company identifies itself as being in three businesses: Investment Banking, Trading and Principal Investments, and Asset Management and Securities Services. To get a better historic picture of these businesses, we have gone back to the beginning of Goldman Sachs' life as a publicly held company in 1998. From this data, we have calculated the following long-term growth rate of various financial variables taken from Value Line and Goldman Sachs' own financial statements:
We have just made our first major discovery. The Asset Management and Investment Banking Businesses have completely ordinary, if not mundane, growth rates. Goldman Sachs is clearly not knocking the lights out in its Asset Management and Investment Banking businesses. For all the rumors of their legendary accomplishments, they aren't getting them from these two businesses. So what propels them to their stratospheric heights?
Value Line data also identifies a category of business called Interest Income Revenue. And here, its long-term compounded growth rate is a paltry -0.68%.
For further clarification, we need to get Goldman Sachs' recent financial statement. And here are the last three years:
The first thing we note is the eye-popping volatility in the revenue categories and what looks like another business called Interest Income and Expense. Relating this to ourselves with our 0.5% earnings on our short-term assets, let's push these numbers around a little bit to see what they tell us.
In 2009, Interest Expenses were $6.500 billion. When subtracted from the $13.907 billion in Interest Income, we find Net Interest Income of $7.407 billion. The interest spread is 2.14 ($13.907 billion/$6.500 billion). This means that if they are making 0.5% on their interest-bearing assets like you and I do, their rate of interest expense would have to be (Are you ready for this?) 0.23% (0.5%/2.14). Who could borrow money at 0.23%? This is really amazing! And what amount of interest-bearing assets would Goldman Sachs have to own to earn $13.907 billion at 0.5%? The answer is $2,781,400,000,000. Could Goldman Sachs own $2.780 trillion of anything? Well, maybe they found some asset that earns more than the 0.5% interest that you and I earn on our money. Yes, they must be earning much more than our pathetic 0.5%. One of the accepted, quality benchmark assets is the 10 Year Treasury Note, which yielded 3.59% on 12/1/09. So how much of these would Goldman Sachs have to own at this 3.59% rate of interest to earn $13,907 billion in income? The answer is $387,000,000,000.
If this was the correct amount of interest-earning assets, to get a borrowing cost of $6,500,000, the implied rate must be 1.67% ($6.500/$387.000). Who would lend Goldman Sachs $387,000,000,000 at 1.67%?
This is getting very complicated. In 2008, Goldman Sachs had an interest spread of 1.136 versus 2009's 2.14, and in 2007, Goldman Sachs' interest spread was 1.095 versus 2009's 2.14. If Goldman Sachs had had an interest spread in 2009 of 1.136 instead of 2.14, their interest income would have been reduced to $7.384 billion, and net interest income would have been $884 million, and net revenue would have declined by $6.523 billion to $38.650 billion. To have achieved the same net income for the common shareholders of $12.192 billion, Goldman Sachs would have had to cut their compensation and benefits by $6.523 billion, reducing them to $9.620 billion -- a 40% reduction. Therefore, in 2009, their profits would have been destroyed except for the huge increase in interest margin.
What is going on here? In 2009, Goldman Sachs had a huge collapse in interest income from November 2008 and 2007. And yet, their interest spread surged to 2.14 from an average of 1.12 for the prior two years. And they almost doubled their net interest income after an almost 66% decline in interest income. They should just change their whole business model to getting that 2.14 interest spread on everything they do. They could just drop everything else. As a matter of fact, let's see what Goldman Sachs looks like if we strip out their other businesses, asset management, and brokerage and focus on the business that remains.
A Mysterious Business remains after the elimination of the Investment Banking and Asset Management and Security Services businesses. It looks like even a dangerous business. Over the years in question, there appears to be extreme volatility with respect to Trading and Principle Reserves and Interest Income and Interest Expense. Most importantly, its interest margin behavior is incomprehensible.
The Trading and Principal Investment business has no specifically identified costs. Usually, if you are trading something, it has a cost associated with revenue. This revenue dropped from a peak in 2007 of $29.714 billion to $8.095 billion in 2008. This is a collapse in sales in one year without having a catastrophic loss. Immediately thereafter, the sales returned to the norm. In 2009, the interest spread increased by to 2.14, while Interest Income and Interest Expense dropped dramatically. Nonetheless, the net Interest Income almost doubled.
And this business is sensitive to small changes. In 2007, the best year, if interest expense had increased just 10% and trading had decreased just 10%, total revenue would have decreased by $7.169 billion and profits would have been virtually wiped out. In 2008, a collapse in trading revenue resulted in the necessity of cutting employee compensation and benefits to $10.934 billion from $20.190 billion in 2007. This is about a 50% decrease, and the Mysterious Business still would have lost $4.789 billion. In 2009, the high increase in net interest income to $7.407 billion accounts for most of the net profits of $7.598 billion. This is all so unusual.
But to see just how dangerous a business the Mysterious Business is, you have to also consider the debt structure of the company and a series of financial ratios.
This is really a lousy company. It makes you wonder how it got this big and how it has survived the 2007-2010 financial meltdown.
Highlights, or should we say lowlights, of the Mysterious Business data are the following: Total debt is 11x Equity in 2009 and 12.7x Equity in 2008; Profits would have been $7.598 billion in 2009, a loss of $4.798 billion in 2008, and a profit of $5.187 billion in 2007. This produces cumulative profits of $7.987 billion, or an average profit of just $2.662 billion per year. The return on total debt in 2009 is just 1.89%, and the return on total capital is just 2.9% in the same year. Electric utilities do better than this with little volatility and a lot less debt. Yes, it definitely would be a lousy business.
Well, as a matter of fact, it did not survive this crisis. It was saved by the United States taxpayers who through the Federal Reserve breathed life into its corpse.
Lender of last resort indeed. The Federal Reserve pulled back the curtain yesterday on its emergency lending during the financial panic of 2008 and 2009 ... .
We learn, for example, that the cream of Wall Street received even more multibillion dollar assistance than previously advertised by either the banks or the Fed. Goldman Sachs used the Primary Dealer Credit Facility 85 times to the tune of nearly $600 billion. Even in Washington, that's still a lot of money. Morgan Stanley used the same overnight lending program 212 times from March 2008 to March 2009. This news makes it impossible to argue that either bank would have survived the storm without the Fed's cash.
The infusion of $600 billion would have basically covered the amount of Goldman Sachs' short-term liabilities of $651.958 billion in 2008 and $593.958 billion in 2009. Goldman Sachs apparently had to refinance all of its short-term liabilities.
Recall our earlier calculations, when we determined how many 10 Year Treasury Securities yielding 3.59% it would take to generate 2009's interest income of $13.907 billion? It was $387,000,000,0000. We also found out that to get 2009's interest cost of $6.500 billion, the lender would have to charge just 1.67%. Why don't we see what the respective interest income rate and interest expense would be for $600,000,000,000? The required rate of interest income is 2.3%. So if the interest spread is 2.14, the required interest rate expense is 1.08%. How fascinating! It looks like, or we infer that, somebody lent Goldman Sachs $600,000,000,000 of United States Treasury Securities at an approximate duration of five years. The 5 Year Note had a 2.3% rate of interest in December 2009.
If the company had 35,400 employees, the $600 billion would equate to $16,949,152 per employee. If the Federal Reserve would treat you to a personal no-recourse loan with the same terms and conditions as Goldman Sachs, you would have an income of $389,824 and an expense of $183,050. This would be a net income of $206,777 for just doing nothing -- how great!
Let me just say one thing about $600 billion. You could build a hundred $6-billion nuclear power plants in America for this amount of money. But our corrupt government wants to cripple our economy because some nuclear plant might emit toxic waste. So the EPA won't issue realistic permits to build them. This same government has no problem giving Goldman Sachs the same amount of money after it has generated enough toxic financial returns to destroy itself and the fools who lent them all this money. Thehard working U.S. taxpayer might end up repaying this $600 billion. And who would lend you money at 1.08% to buy anything?
But Goldman Sachs is not out of the woods yet. The whole effort of the Federal Reserve is to keep interest rates as low as possible for as long as possible to give all the lousy assets held by them and the American financial industry a chance to heal and increase in value. So you can continue to expect to make less than 0.5% on your cash assets for a long, long time.
If interest rates rise above 2.3% while they are holding these securities -- or worse yet, any securities of lower quality than U.S. Treasuries -- their value will drop below $600 billion, which means they could lose money on them if they sell or exchange them before the end of the five-year duration. And once again, their net worth could be eroded by a decline in the value of these assets. Any precipitous rise in interest rates could threaten the "life" of Goldman Sachs again. Not only would it threaten them, but a precipitous rise in interest rates would also threaten all other financial institutions who were turned into toxic waste generators by the removal of the Glass-Steagall Act in 1998.
... Robert Kutter (Stanford University) testified before Barney Frank's Committee on Banking and Financial Services in Oct. 2007. 'Since repeal of Glass-Steagall (FDR Banking Act) in 1999, after more than a decade of de facto inroads, super banks have been able to re-enact the same kinds of structural conflicts of interest that were endemic in the 1920s - tending to speculators, packaging and securitizing credits and then selling them off, wholesale or retail, and extracting fees at every step along the way. And, much of this paper is even more opaque to bank examiners than its counterparts were in the 1920s. Much of it isn't paper all, and the whole process is supercharged and automated formulas.'
The real crime of the matter is revealed by our discovery of exactly the nature of Goldman Sachs Mysterious Business. Quite simply, the Mysterious Business is the largest highly leveraged hedge fund in the world that is run exclusively for the benefit of the employees of Goldman Sachs. All risks are absorbed by the Federal Reserve System with the U.S. taxpayers standing by at all times as ultimate guarantors.
Except for this alliance, Goldman Sachs would have disappeared under the waves of the financial crisis whose destructive excesses could no longer be prevented by the Glass-Steagall Act. The process by which this happened is a disgrace at best.
Robert Rubin left the top of his career at Goldman Sachs in 1995 to become Treasury Secretary in the Clinton administration. He quickly, and controversially, disbursed $20 billion to support the bailout of Mexico's government bond market in which Goldman Sachs had extreme, if not life-threatening, risk. He then became the architect and engineer of the removal of the Glass-Steagall Act, with the principal immediate beneficiary being Sandy Weill, who would make billions by merging his Travelers Group into Citicorp. Not surprisingly, Robert Rubin would go to work almost immediately for Sandy Weill as a top executive for Citicorp.
When the dust finally cleared, it became obvious that the demise of Glass-Steagall allowed the risk-taking traders at Citicorp to jeopardize nearly $1 trillion worth of customer deposits, which is the main reason the feds had to spend so much bailing it out. With that, Bob Rubin's Wall Street career was over. He was forced to resign from the Citi board and the firm itself with his reputation in tatters, but not without earning more than $100 million.
To make $100 million in ten years, or $10 million a year, let's see how much money you would need to get from the Fed on the terms and conditions of Goldman Sachs' bailout. If the net interest income is 1.22 (0.0230 minus 0.0108), it would take an $819,672,130* loan for ten years. Good luck with your less than 0.5% earnings on your prudent savings.
Goldman Sachs and its spawn, Robert Rubin, prove conclusively and absolutely that the regulatory doctrine of "Too Big to Fail" is a catastrophic failure.
*corrected 1/3/11, with thanks to a reader for pointing out the error.