Goldman's Profits: Gambling with Taxpayer Money?

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Larry Downing / Reuters

Lloyd Blankfein, CEO of Goldman Sachs

Is Goldman Sachs gambling with government funds? During the first quarter, the investment bank greatly increased the amount of trading risk it takes in the market. Should those wagers go sour, Goldman could lose heavily, and so could taxpayers.

So far, the firm's bets are paying off. On Monday, Goldman said that it had made nearly $2 billion in the first three months of this year alone. But some analysts say Goldman, which received $10 billion from the government through the Troubled Asset Relief Program, is generating most of those profits by making risky bets on interest rates and other fluctuations in the financial markets with money it has received from the government. Goldman says it would like to pay back its TARP loans as soon as possible, and on Tuesday the company raised $5 billion in a stock offering that the executives said would help Goldman do so. But Goldman's huge trading profits, at a time when it and other banks are pulling back lending, raises new concerns about whether Goldman and other financial firms are improperly profiting from taxpayer assistance. (Read "Is the Economy Starting to Recover? Or Just Less Bad?")

"Goldman reached this trading climax with the help of TARP funding," says analyst David Hendler, who follows Goldman and other financial firms for CreditSights. In a report to clients, Hendler wrote that subsidized funding from the government has "manufactured" these outsized gains for Goldman. "Goldman's results were unbalanced and . . . . due to extremely high risk taking."

Goldman said that much of its increased trading was to execute client orders, and not trades the bank was making solely on its own. During a conference call with analysts and investors, Goldman CFO David Viniar said that most of Goldman's trading profits came from such liquid investments as Treasury bonds and not in the trickier markets for subprime mortgage bonds or credit default swaps, which can be harder to buy and sell. Goldman said it made very little money from CDS contracts it settled with AIG, but declined to comment exactly how its trading profits were generated. A Goldman spokesman said, "By putting the capital on our balance sheet to work we are helping the market to function, which benefits the market and the economy." The spokesman said Goldman is comfortable with its risk profile.

There are no strict limits as to how banks are supposed to use the government assistance they receive. Lawmakers, who passed the $700 billion financial relief fund in October, originally pressured banks to use government money to make loans. But as the banks' conditions deteriorated and the economy worsened, those demands have faded. AIG, Merrill Lynch and other Wall Street firms have come under fire for paying out rich bonuses to executives despite receiving billions in government assistance. In response, lawmakers have tightened executive compensation rules for banks that have received TARP funds. While Goldman's profits are sure to raise eyebrows, it is not clear that it did anything wrong.

But what is clear is that Goldman is taking significant trading risks, opening the firm up to the possibility of big losses at a time when regulators and lawmakers are trying to reduce the dangers of the nation's financial system, not increase them. At the end of the first quarter, Goldman's measure of value-at-risk, which tracks how much the financial firm could lose in one day, rose to $240 million. That was up over $80 from just over a year ago, and it is 10 times the risk the firm used to take on a daily basis at the beginning of the decade. And that may even be understating the amount of risk Goldman is really taking on. Hendler says Goldman computes its VAR by looking at what the firm could lose in relatively normal market conditions. Factor in today's wild market swings and Hendler figures that based on Goldman's recent exposure, the firm could lose as much as $340 million on a really bad day.

Indeed, trading has always been a big portion of Goldman's business. But it has become even more so. The firm generated nearly half of its revenue, or $5.7 million, from trading in the first three months of this year. That's up from about 35% on average over the past four years. It has yet to be seen whether other firms have upped their trading bets as well. Goldman was the first of the major financial firms to report earnings in the first quarter. Citigroup and J.P. Morgan have said that they, like Goldman, made money in the first two months of the year. So it is likely those firm have increased the amount of risk they are taking as well. If so, the ramping up of trading at Goldman and others underscores how much these firms have evolved in the past decade and how difficult it may be for regulators to reign in the firms' risk to the economy.

"If a firm wants to speculate on interest rates that's fine. There is nothing that prevents them from using TARP that way," says Dean Baker, who is the co-founder of the Washington, D.C. liberal-leaning think tank the Center for Economic and Policy Research. "But I am not sure that helps the economy, and if they were to get that wrong the firm and taxpayers would be much worse off."

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