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DAVID WEIDNER'S WRITING ON THE WALL
Goldman is getting the best of the credit crisis
Commentary: Opponents have been vanquished and bad bets wiped away
By David Weidner, MarketWatch
Last update: 12:01 a.m. EDT Oct. 2, 2008
NEW YORK (MarketWatch) -- Not often do you regard a company whose stock is about 50% off its 52-week high as a success story.
But a success is exactly what Goldman Sachs Group Inc. is shaping up to be at this stage of the credit crisis. If we were to begin the long journey back to stability today, Goldman would undoubtedly emerge even more powerful than before.
Did anyone expect another outcome?
A solo act
Commercial banks such as Citigroup Inc., Bank of America Corp. and J.P. Morgan Chase & Co. are obvious winners in the credit debacle. They've been able to buy battered banks at fire-sale prices. America is about to become a country with three national banks that have big broker/dealers as subsidiaries.
These new superbanks will be formidable, but there is a question of how much risk-taking they'll be willing to stomach. Logistics are an issue too. They're integrating firms that may have been priced like single-branch banks but, from an infrastructure standpoint, are giants of American finance.
Morgan Stanley, whose stock is 65% off its high, has shored itself up by selling a 20% stake to Tokyo's Mitsubishi UFJ, but will still need to add deposits, just like Goldman.
Only Goldman, by virtue of its investment from Warren Buffett and its ability to buy retail bank deposits, will be the last bulge-bracket investment bank unencumbered by commercial-bank ownership.
You don't have to be a conspiracy theorist to recognize that a series of decisions and events have transpired to put Goldman at the top of the heap. Well before the credit crisis, people worried about Goldman's influence in the markets. Several former executives of the investment bank have senior roles in government and at the New York Stock Exchange, and its analysts are among the most powerful in the space.
Let's limit the discussion to the start of the credit crisis in the summer of 2007. Just before the market turned, Goldman traders got a hunch and began shorting and hedging the mortgage securities that were eating away at rivals' revenue. Trading revenue soared 70% that quarter to $8.23 billion.
It was Goldman's last quarter in a series in which each new profit report exceeded expectations and prior results. Goldman's share price was in shouting distance of $300. It was also when grumblings about the investment bank's transparency became louder. That's important because Goldman continues to give few details about its "proprietary trading" business. What is it exactly? No one knows for sure.
What followed was notable for what didn't happen: write-downs. Goldman has admitted to less than $5 billion in write-downs, including the $1.1 billion when it reported earnings Sept. 16. That's on a balance sheet of $1 trillion.
In between those earnings announcements, Goldman lost its biggest competitor in prime brokerage, Bear Stearns Cos., on March 17. In September, it also lost the biggest competitor in debt underwriting, Lehman Brothers Holdings Inc., and a big rival in investment banking, Merrill Lynch & Co., in an emergency sale to a commercial bank.
Judging by the government's reaction, Morgan Stanley and Goldman should have been next -- either through a crisis sale like Merrill or a liquidation like Lehman. Investors sent their stocks reeling. Morgan Stanley quickly began talks with Wachovia Corp., while Goldman kept quiet.
During all of this, Goldman Chief Executive Lloyd Blankfein was in the middle of talks about the future of another crippled company, American International Group Inc., at the New York Federal Reserve. As Gretchen Morgenson reported in the New York Times last week, those talks resulted in an $85 billion bailout of AIG via a government loan, and, oh yeah, the deal may have saved Goldman $20 billion in losses due to its trading position with the insurer."
Goldman poured cold water on that claim saying in a statement it "had no material exposure to AIG.
"Our counterparty risk was offset by collateral and hedges, and that remains the case."
There have been other fortuitous decisions, too. For instance, the Securities and Exchange Commission's ban on short-selling was lifted for market-makers such as Goldman, and U.S. regulators may be willing to back Goldman's purchase of $50 billion in troubled assets from other banks, according to a Financial Times report.
It was the Buffett investment that was the master stroke. Announced on the same day that President Bush, Congress and presidential candidates worked on the first draft of Treasury Secretary Henry Paulson's bailout plan, everyone hailed the deal as a huge financial gain for Buffett and an expensive vote of confidence for Goldman.
If it were only that, the price was rich. But the investment earned Goldman permanent access to the Federal Reserve discount window, lowered its leverage to just over 18 times equity, brought it closer to its new bank-holding company structure, and, according to Fox-Pitt Kelton analyst David Trone, wasn't costly for Goldman.
"Goldman's raise will simply pad its equity capital cushion to appease the market's recent concern about its model," he wrote. It put "to rest doubts that a company could raise without fundamentally needing it."
Goldman, like its rivals, is on the prowl for deposits, but unlike its competitors, it will be the acquirer. Goldman emerges from this mess essentially the same institution. It has the same lack of transparency. It still manages hedge funds and private-equity businesses. It still has a thriving prime brokerage business.
As former Drexel Burnham Lambert CEO Fred Joseph said last week, investment banking is "not disappearing at all. [Banks] will act more like advisory firms and underwriters and lenders. They'll act a little bit more like banks, and less like hedge funds."
That doesn't mean those enterprises won't disappear. And Goldman will be one of the few left open for business.
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