Goldman Sachs, once Wall Street’s highest flier, has been grounded, and it does not bode well for the rest of the financial industry or the New York City economy that depends on it.
The bank, both envied and loathed for its ability to churn out huge profits year after year, reported a quarterly loss on Tuesday — its first since the financial crisis and only its second since going public in 1999.
The misstep by the financial leader speaks to what could be a more lasting shift on Wall Street, which has been steadily retrenching over the last 12 months. While protesters a few blocks away were denouncing greed and “too big to fail” banks, the institutions themselves were coming to grips with the current diminished reality.
Banks, required by regulators to discontinue high-profit businesses like proprietary trading, reduce borrowings and hold more capital, may no longer be able to produce the supercharged earnings that were common before the financial crisis.
Although Wall Street has not changed in some significant ways — top executives are still receiving huge pay packages and its lobbyists continue to have sway in Washington — the industry is facing forces of change unlike anything since the Great Depression. Trading operations are muted. Risk-taking is tempered. And boring businesses are back in vogue.
“These firms are going back to the traditional investment banking model of the 1980s and early 1990s,” said Tom Marsico of the mutual fund firm Marsico Capital Management, once a large owner of financial stocks who shed investments in Goldman and other banks this year.
Wall Street is feeling the pinch. Last week, JPMorgan Chasereported that earnings dropped by 4 percent in the latest period. Both Bank of America and Citigroup booked banner profits. But much of those results were attributed to one-time accounting gains, rather than improved fundamentals.
Goldman , which has been known for its prowess in trading, has found itself buffeted by the choppy markets and economic turmoil. While the firm posted decent results in equity trading and investment management, it lost nearly $3 billion on its investments in stocks and bonds, more than offsetting the pockets of strength.
New York, the nation’s financial hub, is bracing for the fallout. Wall Street, which accounts for 14 percent of the state’s tax revenue, is expected to lay off an additional 10,000 employees in the area by 2012, bringing total layoffs since 2008 to 32,000, according to a recent report by the New York State Comptroller. Each of those job losses could translate into nearly two additional positions eliminated in other industries, the comptroller estimated.
Investors have been anticipating the weakness for months. Since the beginning of the year, shares of financial companies have plummeted. While shares of Goldman jumped 5.5 percent on Tuesday, reflecting investor expectations and favorable developments in Europe, it was still down almost 40 percent for the year. Bank of America, which rose more than 10 percent the same day, stands at $6 a share, compared with $14 at the start of 2011.
The erosion of Wall Street’s earning power is reflected in a closely watched barometer known as return on equity. It measures the amount of money that a company delivers on each share, an important indicator for investors.
In the last nine months, Goldman’s return on equity fell to 3.7 percent on an annualized basis, down from 10.3 percent in 2010. Five years ago, it was 32.8 percent. Morgan Stanley , which is set to report earnings on Wednesday, posted return on equity of 8.5 percent last year, versus 23.5 percent in 2006.
Wall Street has proved resilient in the past. After the crisis — and the disappearance of Bear Stearns and Lehman Brothers — sweeping changes were predicted for the industry. A year later, the firms appeared to bounce back, reporting big profit gains and lavishing large bonuses on executives.
Whether the current weakness is short lived or the new normal will depend in part on how successful the industry’s lobbying efforts in Washington. The banks already have gotten regulators to ease off some of the new restrictions.
Still, the industry’s recent moves reflect more muted prospects.
To improve their profitability, banks have three main options: increase revenues, cut expenses and reduce the shareholder base. But the first method is not working at a time when earnings have been crimped by regulatory uncertainty and economic woes.
Goldman reported a loss of $428 million during the third quarter, compared with a $1.74 billion profit a year ago. The firm was punished by its holdings in stocks and bonds, losing $1.05 billion on its holdings in Industrial and Commercial Bank of China, a strategic investment the firm made in 2006. I.C.B.C. stock fell about 35 percent in the quarter, a paper loss that flowed through to Goldman’s results.
Citigroup posted profit of $3.8 billion in the latest quarter, up from $2.2 billion in 2010. But 85 percent of its earnings came from one-time gains, like reversing the reserves set aside to cover bad loans.
So the industry must rely on other means to improve returns in the current environment.
Cost-cutting has been a major focus across Wall Street. This summer, Goldman said that it would wring out $1.2 billion in costs from its operations by mid-2012, including eliminating about 1,000 jobs. Bank of America announced it would lay off 30,000 employees, as part of a wide-ranging plan to save $5 billion in annual costs by the end of 2013.
Goldman has also made share buybacks a priority, capitalizing on the weakness in the stock. In the third quarter, the firm bought back 18.1 million shares at a cost of $2.2 billion, one of the largest quarterly share reductions in its history.
In shrinking its shareholder base, Goldman does not have to produce the same level of earnings to maintain its returns or even increase them. But the situation reflects the broader problems facing the industry, said Roger Freeman, an analyst with Barclays Capital: “At least for now this is not a growth business.”