Sunday, August 2, 2009

Goldman’s profits or Goldman profits?

I was somewhat shocked that the announcement of Goldman Sachs’s huge profits did not stir more controversy. Goldman posted a record $3.44bn in profits for the second quarter of 2009 and, as a typical professional services firm, has set aside an enormous amount to be distributed as bonuses to its employees in 2009 ($11.4bn). This means that the average bonus (i.e. total profits distributed by the number of employees, including assistants and folks in the mailroom) will amount to $770,000. Why would anyone be shocked? Good for the folks in the mailroom (hopefully, they have a mailroom at Goldman…) and the assistants.

But that is not the point. Two interesting New York Times articles (see reference below) break down the sources of Goldman’s profits and it turns out that the bank made most of its money on trading activities. It reminded me of a presentation I attended late May during which investment management legend André Perold (long-time professor at Harvard Business School) explained, comparing Goldman’s balance sheet and off-balance sheet numbers (trading numbers are captured off balance sheet), that it had essentially become a trading firm as trading totals dwarfed any of Goldman’s more traditional banking activities by a enormous order of magnitude.

One of the articles also said that Goldman had increased its risk exposure in the past few months, which means that they took some “winning” – but risky – positions, and while the risk that they took (that can be measured by the “value at risk” ratio, i.e. how much the firm could lose in one single day) was not as high as the one that was prevalent just before the meltdown, it was still significant and much higher than that of its competitors. In trading, that is how you win big: if you don’t play big, you won’t win big – but you can lose big too…

And that is the main problem I have with these ballooning profits – that they were rooted in high exposure to risk – AGAIN…

What have we learned from the meltdown? What has Goldman Sachs learned from the meltdown? What is the nature of their business? What is their mission? I’d be curious to know. Are they a bank? A trading firm? Why are they around to begin with? What value do they create for society?

I don’t want to fall into the simplistic and cynical view that large financial institutions know by now that they can engage in whatever risky practices because they are pretty sure that the government is going to bail them out, as long as they are big enough.

I don’t think that those firms are led by loose cannons. But it is hard, reading that piece of news, not to wonder how what was supposed to be a new post-meltdown world order is going to be different from what it was before the crisis.

Also, working with MBA students on their career choices, I am probably particularly sensitive to compensation questions and the extent to which compensation is the main driver behind the interest in Finance jobs of the current generation of MBA grads. Oh yes, I have heard everything: those jobs are intellectually challenging, I’ll be with like-minded people, I like the hectic work pace, etc. and all that is true and is arguably exciting for a 27-year old. But how can numbers like that $770k (again it is an average, thus the number will probably be higher for any post-MBA folks) not be a huge draw for those young folks, and how then can their perceptions of a fair compensation – or for that matter of their own worth – not be totally screwed up by such an incredibly high figure?

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