Despite Bailouts, Business as Usual at Goldman

Jenny Anderson|The New York Times

Lloyd C. Blankfein has a story about the cataclysm that nearly brought down all of Wall Street. It goes something like this: One by one, lesser banks were swept away by the financial storm of 2008. And as the floodwaters rose, no one, not even Goldman Sachs, seemed safe.

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The question, in Mr. Blankfein’s eyes, was how high the water would rise. But Washington stepped in with all those bailouts before the surge reached Goldman .

The story, which was recounted by several friends and colleagues, represents a sobering private admission from Mr. Blankfein, Goldman’s chief executive.

Publicly, it is a different story. Now that Goldman is minting money again, the bank insists that it was never in any real danger. Mr. Blankfein, in an e-mail message this week, disputed his private account, saying Goldman’s survival was never in doubt. Other Goldman executives reject the notion that the bank was rescued at all.

“We did not have a near-death experience,” said Gary D. Cohn, Goldman’s president. The government saved the financial industry as a whole, but it did not save Goldman Sachs, he said.

Rarely has the view from inside a company been so at odds with the view outside it. Could Goldman Sachs have lived if all those other giant banks had failed? Could it alone survive financial Armageddon?

Goldman executives are dismissive, even defiant, when critics argue that the bank is playing a heads-we-win, tails-you-lose game with American taxpayers. And yet the questions keep coming. Last month the story of Goldman’s postcrisis success — and conspiracy theories surrounding it — leapt from the business pages to the cover of Rolling Stone.

The idea that nothing has changed for Goldman Sachs strikes many outsiders as absurd. In this era of mega-bailouts, Goldman is widely perceived, on Wall Street and in Washington, as too big and important to fail. If its bets pay off, Goldman profits and its employees get rich. If its bets go bad, ultimately taxpayers will have to pick up the bill.

“Many observers on the market believe that Goldman and others of its size now have a free insurance policy,” said Elizabeth Warren, the chairwoman of the Congressional oversight panel for the $700 billion bailout fund. “Whether they do or not is less important than the fact that many in the market believe they do. That means at some level Goldman is playing with the American taxpayers’ future.”

Is Goldman gambling at America’s expense? Of course not, Mr. Cohn said. Should it change its business strategy in the wake of the gravest financial crisis since the Depression? No. Is Goldman taking big risks to make big profits? Courting more outrage over Wall Street pay with its plans to pay lavish bonuses? Throwing its weight around in Washington?

No, no, no.

Goldman executives dispute suggestions that high-stakes market gambles are behind its big profits — $3.4 billion in the second quarter. And they are dumbfounded when people like Ms. Warren suggest companies like Goldman, which paid back its bailout money last month, now operate with an implicit taxpayer guarantee.

After so many wrenching changes on Wall Street and in the economy, it might come as a surprise that the post-bailout Goldman is virtually indistinguishable from the pre-bailout one.

The bank has strengthened its capital base and reduced its use of leverage — the borrowed money that turbo-charges profits on the way up and can prove devastating on the way down. But Goldman sees little reason to change the way it does business. In fact, its executives are surprised that anyone would suggest it should.

Even Goldman’s conversion to a traditional banking company at the height of the crisis — a step many predicted would clip Goldman’s gilded wings — has been deftly sidestepped.

It is, in other words, business as usual at Goldman — and what a business it is. Quarter after quarter, Wall Street executives scour Goldman’s results hoping to figure out how the bank makes so much money. Mr. Cohn and other executives, in recent interviews, sketched the broad outlines of an answer. Mr. Blankfein declined to be interviewed for this article.

During the second quarter, Goldman bet, correctly, that the financial markets would calm down. It wagered that market volatility would decline and that certain securities tied to the troubled home mortgage market would revive. Its securities underwriting business bounced back too.

A vast majority of profits came from trading on behalf of clients like big mutual funds, pension funds and endowments, rather than from staking Goldman’s own money in the markets, Mr. Cohn said. Proprietary trading now accounts for about 10 percent of profits, down from 20 percent in 2005. Goldman dominated institutional trades linked to changes in a closely watched stock market index, the Russell 2000, and is benefiting because old competitors like Bear Stearns and Lehman Brothers are no longer around.

“We don’t have to outsmart the market today,” said Mr. Cohn. “We just have to do what our clients want us to do.”

Disproportionate share of blame?

But unlike some of its rivals, Goldman is not shy about taking risks. The bank stood to lose as much as $245 million on any given day during the second quarter, based on a common measure known as value at risk, or VAR. That was up from $184 million in mid-2008. But VAR captures only about a fifth of Goldman’s market risks and excludes investments that are difficult to value.

“Our risk appetite continues to grow year on year, quarter on quarter, as our balance sheet and liquidity continue to grow,” Mr. Cohn said. He and other executives say Goldman carefully manages its risks, which, for the most part, it has.

Goldman’s latest quarterly disclosures to the Securities and Exchange Commission, filed on Wednesday, provide another glimpse into the bank’s activities. Aided by cheap credit, Goldman generated more than $100 million in daily revenue from trading on 46 separate days during the second quarter — a record.

Since late 2007, Goldman has reduced its exposure to illiquid investments, which can pose dangers because they are traded so infrequently, by 8 percent. Its total exposure to these so-called Level 3 assets still stood at $50.4 billion. While VAR is up, other risk measures were down, and the bank’s capital base has grown significantly. Lately, Goldman has been taking more risks in stocks, but fewer in fixed income, currency and commodities.

Some of Goldman’s recent practices are drawing scrutiny from government officials. In its filing Wednesday, Goldman said various government agencies had inquired about its compensation practices, as well as its role in the market for credit derivatives, which fueled the financial crisis.

But over all, the events of the past year have not changed the way Goldman views or manages the risks it takes, said David A. Viniar, Goldman’s chief financial officer.

“There are a few business units that are taking a little more risk. Most are taking less,” Mr. Viniar said.

Mr. Cohn, Goldman’s president, acknowledges his bank is systemically important, meaning that its failure would probably send financial shock waves around the world. But he said that the implications of this status were unclear and that Goldman had no government backing.

David A. Moss, a professor at Harvard Business School, disagrees. He says the painful lessons of the financial crisis show the federal government now stands behind all systemically important financial institutions.

“We’re in a situation where we’ve extended important guarantees, both explicit and implicit, to almost all major financial institutions, yet we don’t have the regulations in place to control the excessive risk-taking that could result,” said Mr. Moss, the author of “When All Else Fails: Government as the Ultimate Risk Manager.”

In any case, Goldman has certainly helped itself to government programs that were put in place to stabilize the financial industry. For instance, the bank has issued billions of dollars of bonds guaranteed by the Federal Deposit Insurance Corporation. Since March it has sold $3.4 billion worth without government backing.

And Goldman’s conversion to a bank holding company, executed at the height of the crisis, gives the bank access to money from the Federal Reserve. In exchange, Goldman had to increase its capital, reduce its leverage and accept Fed oversight.

Many analysts predicted that switch would force Goldman to rein in riskier businesses like proprietary trading and parts of its commodities operation. But Goldman has largely carried on as usual. It has received standard exemptions that give it two years to comply with federal regulations governing bank holding companies.

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“They are very happy to go back to a business model that year-in and year-out has made them untold wealth,” said John C. Coffee, a professor of securities law at Columbia University.

Mr. Cohn concedes that Goldman, along with other banks, bears some responsibility for the financial crisis. “There’s no performance angel in this,” he said. But he bristles at all the fingers being pointed at Goldman.

“Every bank has to accept a degree of responsibility, but it sometimes feels like we’re being disproportionately blamed,” he said.