Goldman Sachs - The True Banking Culture

Goldman Sachs – Strong Fundamentals Continue Business Tenet

Goldman Sachs used to downplay or avoid consumer-oriented retail businesses like stock brokerage, credit cards and mutual funds. There are three main activities that it engages in – Investment banking (chasing M&A deals), trading and principal investments (market making and proprietary positions) and a segment it once avoided, asset management (offers investment products).

Nonetheless, like most of its peers, Goldman Sachs cannot escape a weak business environment and will be affected in some ways or another. But what really surprises me is the shrewdness mentality in Goldman Sachs money making activities as well as just how smart Goldman Sachs is.

Let me just introduce some facts and figures.

1. Aug. 5 (Bloomberg) -- Goldman Sachs Group Inc. made more than $100 million in trading revenue on a record 46 separate days during the second quarter, or 71 percent of the time, breaking the previous high of 34 days in the prior three months.

2. Goldman didn’t believe its own hype during the crisis. Other banks invested heavily in the same toxic waste they were selling to the public at large. Goldman shorted them just before their value crashed. It was perfectly legal.

3. It took the $12 billion payment from the Fed for its AIG exposure even though it was protected on 100% of its position. It repaid Uncle Sam's $10 billion fast so it can offer its employees record compensation this year. It was a “thanks but no thanks TARP”.

What I have shown above is just some of the mind-blowing records that Goldman Sachs has made. While trading records are awesome, it makes one wonder how they ever achieve such astonishing results. Trading revenue was really amazing when I look at past figures for 2007 and 2006 – 31 billion and 25 billion respectively. There are two inferences that can be drawn from point 2 and 3. They are risk control and risk seeking respectively. I wonder how many other banks did the same thing as Goldman Sachs during the subprime crisis. As much as the implications of subprime and housing bubble are being discussed over and over again before it actually happens, not many banks out there have taken strong actions and considered the most adverse market conditions that may happen.

Though, Goldman Sachs does lose quite a significant amount of money in subprime mortgages, their ferocious short selling strategies minimize the loss. Are they the market leader for banks? I believe the numbers tell. JP Morgan may achieve the no.1 awards in many areas, but Goldman Sachs is a earnings machine.

Point 3 is really funny in my opinion. It sums up the brilliance of Goldman Sachs. Of course, they don’t take the $12 billion payment from the Fed and do nothing about it. I wonder how much more money do they actually make with this payment.

But all these can only happen and work if Goldman Sachs has the talent which is the durable competitive advantage of Goldman Sachs. If there is something for you to draw away from this articles – Goldman Sachs has a true banking culture.

Durable Competitive Advantage – Banking Culture

Goldman is also known for its insularity. Roy C. Smith, a professor of finance at the Stern School of Business at New York University and a former Goldman executive, noted that relatively few employees defect to rivals. Basically, it is hard to convince an employee that switching job to another rival firm is not a step down. It really takes a lot to retain talent, especially in the banking industry. The business can’t work without talents. You don’t have smart bankers to chase M&A deals, no whizz kid out there to conjure rocket science financial models to program trade, and certainly no talented support staffs that are willing to take a back seat and run the whole show.

Risk management is something that GS is actually famous for.

The risk control officers are treated as equal in authority to the risk takers. There is now a comprehensive effort to bolster what GS calls the "federation"--the empowering of the firm's support staff, those less glamorous individuals once called back-office types. That description is banned under the new culture. Recruitment, training and compensation are conceived to create a band of brothers and sisters honored for their contribution as much as some whiz kid trader or M&A banker. I believe most companies do claim that they do treat their operations department equally. But I can only see it at Goldman Sachs. I see it in the annual reports. In fact, they emphasize about their risk management culture. Operations department is under-recognized in many places even in my school club. But it is only at Goldman Sachs, where things are different. I really wish to go in there and see how the culture is like. What a fat wish!

Moving Forward

One should never dwell in past heroics. While it is great to make an impact in the past, it is important to keep it sustainable. I stumble upon the market share history from the annual report and I find it interesting.

1. During the Asian crisis at the end of the last decade, we made several significant investments in consumer and real estate assets.

2. After the dislocation that followed Long Term Capital Management’s problems in 1998, we increased our fixed income market share.

3. Following the telecom and technology bubble, we built up our private equity and mezzanine investments.

4. After the failure of Enron when capital was scarce in the power sector, we invested in power plants, resulting in recurring trading revenues as well as gains from restructuring power contracts.

5. In each instance, Goldman Sachs was able to identify opportunities during times of market dislocation. In this same vein, we have proven our ability to adapt our own structure, time and again, to meet rapidly shifting market conditions.

Nonetheless, this really exemplifies the talents at Goldman Sachs and how Goldman Sachs has always been able to position itself after a crisis while its peers struggle to restructure. Though this shows a lot about Goldman Sachs, I have to scrutinize more to look into the future of Goldman Sachs. I see it in one of their fastest growing businesses – proprietary asset management. As mentioned earlier, it was a segment that they once avoided. But right now, they see the future of it.

In my opinion, I do not believe in the recovery story. I can’t see how the U.S or the world economy is going to pick up just yet. This certainly has some implications on the investment banking segment for Goldman Sachs. M&A activities may be sluggish. Trading activities can still be strong given a possible period of volatility in the future (more about this in later posts). The next earnings driver will then be its asset management. This is also where I see the talented analyst of Goldman Sachs coming into play. I feel this is the reason why they are going into this consumer related business. They will be able to make full use of their formidable reputation.

To sum it up, Goldman Sachs is not just a bank. It is a bank with a true banking culture. I really wonder how long is Warren Buffett and Jon Paulson going to hold their Goldman Sachs shares.

Jin