Northern Country

How globalization changes capitalism, the economy and politics

Goldman Sachs reports second quarter earnings

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Meredith Whitney, the star analyst on Wall Street who correctly predicted the massive asset problems faced by all major investment firms during the last several quarters, increased her price target on Goldman Sachs. It prompted some to speculate if she had eventually flipped on her bearish posture on financial institutions in general. 

I don’t know if she did but the results of Goldman’s second quarter, blowing past all expectations certainly didn’t make her job any easier. In the latest April to July quarter Goldman’s profit leaped 65 percent compared to the same period of last year.

It certainly makes one wonder what does Goldman have that others don’t. For one thing a Tier 1 ratio that is depending on how you look at it, whether its Basel I of II, at 13.8 or 16.1 percent respectively. In addition the amount of liquid assets averaged $171 billion during the quarter. That is certainly a nice capital cushion in case of a more adverse operating environment in the future.

The most staggering part of Goldman’s earnings release were the huge revenue gains of 93 percent to 10.8 billion within its equities and principal investment unit. Trading and risk taking really paid off and the firm greatly profited from much higher than usual volatility in the markets.

These ups and down in the market prompted Matt Taibbi, a business writer for the Rolling Stone magazine, to call Goldman the Great American Bubble Machine. Maybe after this earnings bonanza it becomes more clear why Taibbi felt compelled to make such an outrageous claim. Goldman promptly dismissed it as the usual conspiracy theory.

Taibbi’s accusation certainly helps to explain some of the investment firm’s wizardry, and his uncompromising look behind the firms machinations reveal a really sinister network of public and private interconnections (see also here). On a more straightforward note the mere fact that Uncle Sam changed financial accounting rules back in April might have laid the foundations for the biggest jump in quarterly earnings since its IPO. 

In April the Financial Accounting Standard Board (FASB) succumbed to financial industry lobbying and lowered its requirements for market-to-market accounting of low liquidity investments without a real market. This move saved US financial institutions tens of billions of dollars in write downs to their balance sheets, which threatened to become an endless open pit.

At that point FASB only leveled the playing field for US financial institutions with their European counterparts, which according to IASB existing rules were not required to strict market-to-market in the first place. These days though IASB has again put the screws on financial institutions by threatening to implement new pro-cyclical rules in market-to-market accounting.

Getting back to Goldman, there is no denying the fact that the firm has a strong desire for excessive risk taking but they obviously seem to be able to maximize shareholder value even in a time more adverse to such high flying objectives. Again, what does Goldman have that others don’t?

Maybe it has to do with a high stake in another firm. Together with  JPMorgan, Bank of America and Royal Bank of Scotland, Goldman is a major shareholder of Markit, a firm which supplies information to financial markets around the world concerning the pricing of credit derivatives. Many believe that these relatively new products are at the core of the financial meltdown.

The US Department of Justice is now requesting detailed information about the pricing of credit derivatives and has launched an investigation into the ways Markit supplies this information and whether the firms owners have unfair access to vital market-making data. 

Markit of course denies any wrong doing, and so is Goldman I am sure, but hopefully the investigation will not stop here or just end in talk.

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