Why Goldman Sachs is doing so well

Allister Heath
SO Meredith Whitney was right. The high-profile Wall Street analyst upgraded her advice to potential Goldman Sachs investors from &ldquo;neutral&rdquo; to a &ldquo;buy&rdquo; &ndash; and the investment bank, whose European operations are based in Fleet Street, responded with a hugely positive set of numbers.<br /><br />Net profit for the three months to June hit $3.4bn from net revenues of $13.7bn, up 46 per cent. The firm, which sometimes seems akin to a money-making cooperative for its staff, revealed that the average compensation bill for its 29,400 employees was $226,000 in the second quarter; on an annualised basis, Goldman could soon be paying out $1m per worker. Its shares are up 80 per cent since the start of the year, so shareholders&rsquo; are not complaining, even though they had to fork out $5.75bn to help recapitalise the firm and pay back the Tarp government loan.<br /><br />Perhaps the most important figures from the Goldman results were that its leverage was just 14.2 times shareholders&rsquo; equity, roughly half what it was in the first three months of 2008. This is a much more reasonable level of gearing. Assets were down 4 per cent to $890bn, which is good as it shows that the balance sheet is being cut back. The result was a blockbuster 23 per cent return on equity. I hate Value at Risk, a deeply defective measure of risk assessment which attempts to gauge what a firm could lose on its trading book in a bad day, but it is probably worth mentioning that Goldman&rsquo;s was $245m, up from $184m a year ago. That remains manageable; and the firm&rsquo;s 13.8 per cent Tier I capital ratio is also robust and increasing slightly. In the past, many banks cashed in by increasing their leverage and risk-taking &ndash; but there is absolutely no sign of this here.<br /><br />The biggest single reason for Goldman&rsquo;s stellar performance is the dramatic decline in the competition. Goldman&rsquo;s traders &ndash; the firm has become a giant trading house &ndash; and underwriters are cashing in on huge credit and other spreads, which are unsustainable. But the good news is that with the huge flood of government and corporate bonds set to hit the global economy over the next couple of years, there will be a lot of work for Goldman. The eventual return of M&amp;A should also help.<br /><br />Does Goldman deserve to be doing this well? At the risk of further bolstering egos at the firm, the short answer must be yes. It was forced to take a Tarp bail-out; it didn&rsquo;t ask for it. Had it been British, it would probably have entirely avoided taking state cash, as Barclays and HSBC were able to do. It was a beneficiary of AIG&rsquo;s bailout; but it insists its large exposures to the insurance group were fully hedged and collateralised and that it would have been fine even without government intervention.<br /><br />There can be no doubt that the firm gained indirectly from government intervention, but so did all banks &ndash; and yet Goldman is outperforming everybody else by a mile. Rather than moaning about its bonuses, which the facts above suggest have not come at the cost of jeopardising economy-wide financial stability, politicians would be better off focusing on how worse-run and riskier banks can change and become as robust as Goldman. It, after all, is facing an effective corporate tax rate of over 30 per cent in the first-half &ndash; while loss-making banks, of course, will pay nothing. Angry, demagogic politicians should bear that in mind.<br /><br />allister.heath@cityam.com