Commentary | Economic Growth

Behind Goldman Sachs’ second quarter profit

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This week, Wall Street superpower Goldman Sachs announced second quarter net profits of $3.44 billion, far exceeding expectations. Earnings per share also rose, to $4.93 from $4.58 a year ago. This is a promising sign that the battered financial industry is on the mend, but it should be noted that Goldman didn’t do it alone. In fact, at least some of these profits were made possible by guarantees, low-cost loans and other assistance from the federal government.

Goldman did pay off its $10 billion in TARP loans last month, along with a one-time preferred dividend of about $426 million. The firm was able to do this by raising $8.9 billion in equity, debt and asset sales.

But the financial giant continues to benefit from several government programs aimed at loosening up credit markets.

First, $13 billion of the government’s bailout of AIG went straight to Goldman, a 100% payoff of bets the firm had placed with the insurer. While industry insiders say that this was done to ensure that legally-binding contracts were upheld, others, including former New York AG Eliot Spitzer, argue that this was simply “a way to hide an enormous second round of cash to the same group that had received TARP money already.” This $13 billion was delivered despite Goldman’s continued insistence that it did not need government funding.

Goldman also benefited from artificially inexpensive debt thanks to the FDIC’s Temporary Liquidity Guarantee Program (TLGP). This program put a federal guarantee behind bonds issued by Goldman and other banks, including Bank of America and JP Morgan Chase, making them far more attractive to investors. For example, when Goldman sold $5 billion of 3.5 year bonds in November, it was able to attract buyers while offering a yield only 200 basis points higher than ultra-safe Treasuries with similar maturities. Altogether, Goldman issued $28 billion in debt using this program between November and April.

Mark Zandi, chief economist at Moody’s Economy.com, called this bond-guarantee program an infinite subsidy whose value could not be calculated.

Finally, it should be noted that Goldman Sachs and other major financial players are benefiting from a Federal Reserve program that allows them to borrow funds overnight for close to zero percent. Designed to catalyze economic activity and keep interest rates low for businesses and consumers, the program has also boosted bank profits by widening the spread between the cost of their incoming and outgoing capital.

Altogether, this government support essentially enabled Goldman to return to its traditional model of business: accepting risk in order to magnify profits. Specifically, Goldman boosted its “value-at-risk” — the estimated value of its trading activities on a given day under a worst-case scenario — to $245 million this past quarter from $182 million in the same quarter last year.

Shrewd business decisions by Goldman traders (along with a reduced field of competitors) were undoubtedly responsible for a good share of the profits being crowed about by the firm this week. Notably, the firm cashed in on profit margins for commodity and foreign exchange trading that, according to the Financial Times, now stand “between two and eight times higher than before the height of the financial crisis.”

Indeed, the profits announced this week by Goldman Sachs are an encouraging sign that the financial markets are starting to return to normal. But they are by no means evidence of a full-fledged economic recovery. In fact, without the support of the aforementioned government programs, Goldman’s profits would have been incalculably lower.


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