Goldman Sachs

Modern Midas

Bumper profits and a stellar reputation. Time to worry

“IT IS important to be a bit institutionally paranoid, especially when things are going well.” Thus Lloyd Blankfein, chief executive of Goldman Sachs at a conference in November. After the year Goldman has had, Mr Blankfein cannot be far off hearing imaginary voices.

On December 18th the investment bank unveiled full-year results that contrived to be both widely expected and astonishing. Earnings in the fourth quarter stood at $3.2 billion, a 2% rise on the same period in 2006. Even as most of its peers have been dragged down by subprime-related investments, Goldman's fixed-income business has boomed, thanks in part to a proprietary bet that the value of mortgage-backed securities would fall. The rest of its businesses are also steaming ahead. Its share price, as of December 18th, remained (just) up from the start of the year. Its status as Wall Street's employer of choice is gold-plated, not least because of a bonus-and-salary pool of $20 billion. “If Goldman Sachs comes calling, you have to consider it,” says one headhunter.

Mr Blankfein's neurotic impulses are well founded, however. Being at the summit of the banking industry is all very well, but the only way left is down. There are reasons, besides the impact of a slowing economy, to think that Goldman's triumphant 2007 contains the seeds of a less comfortable 2008.

The first is that success on this scale always reaps a harvest of envy (never mind that Mr Blankfein's handsome bonus will be dwarfed by the pay-off given to Stan O'Neal for leaving Merrill Lynch in incomparably worse shape). Rich, well-connected bankers have a limited call on sympathy at the best of times. Goldman's gamble that many of America's overstretched borrowers would default on their mortgages is unlikely to win it new friends. Signs of a backlash are visible: Christopher Dodd, a Democratic senator, has raised questions about the part played by Hank Paulson, who ran Goldman before becoming treasury secretary, in fuelling the subprime mess.

The second cause for concern surrounds Goldman's finely balanced (or horribly compromised: take your pick) business model. As well as acting as an adviser and financier to clients, Goldman makes lots of money from putting its own capital to work. Proprietary trading and investments accounted for two-thirds of the firm's revenues in 2007. The tensions inherent in this approach are neither new nor unique to Goldman, but they have become much more obvious now that its traders have made hay taking short positions against debt instruments of a type peddled to clients by other parts of the bank. Accusations that Goldman has been issuing deliberately bearish research in order to drive markets down and make even more money are fanciful. But some of its clients may become more questioning.

The third trapdoor concerns Goldman's risk appetite. You may think that serenely stable share price suggests Goldman is a safe haven; its low price-earnings ratio tells a different story. Between 2003 and 2006 Goldman's traders were losing money on many more days than other Wall Street firms (see chart). The bank's risk-sensitive culture is rightly lauded; its agility in times of trouble has been proven. But it is neither cautious nor transparent, qualities that investors are likely to prize in coming months. Mr Blankfein's antennae are right to twitch.

A weird day on Wall Street

This was a weird and wonderful day on Wall Street; one for the history books.

First, we learnt that David Rubenstein of Carlyle Group had bought a copy of the Magna Carta for $23.1m and plans to keep it on display at the National Archives in near his office in Washington. He did it, he told the Wall Street Journal, to "repay a debt I have to the country".

Talking of debt, Morgan Stanley then declared a $9.4bn write-down on mortgage securities, mostly run up by a single trading desk, which is quite a lot of money for a few people to lose. It said it was taking a $5bn capital infusion from China's sovereign wealth fund and John Mack, its chief executive, would give up his annual bonus as penance.

Finally, we had a conference call to match - and indeed surpass - for strangeness the one held by Bear Stearns in the summer at which Jimmy Cayne, its chief executive disappeared halfway through the call and Bear's stock fell sharply.

This time, the conference call was held by Sallie Mae, the giant mortgage securitisation group. It started amiably but Al Lord, its chief executive, then got into a tussle with analysts about how much information he was divulging. The call ended with Mr Lord saying testily to his head of investor relations head: "Let's get the (expletive deleted) out of here" and Sallie Mae's shares dropping 21 per cent.

You might have thought that staying on a call long enough to answer questions and remaining polite would not be too much to ask of a chief executive trying to retain confidence in his company. These are strange times indeed.

About John Gappe

I am the FT’s chief business commentator and this blog is about business, finance, media, technology and related matters. I live in New York so there is a bias towards US topics but I range more widely. Comments and criticism, which hopefully are at least as interesting as anything I write, are welcome.

Morgan Stanley writedown further saps confidence

Wall Street shares reversed early gains yesterday after a rating agency lowered its credit outlook on Ambac Financial and MBIA, two bond insurers, to "negative" raising fears of heightened turmoil in credit markets.

The successful conclusion of the Federal Reserve's first $20bn term loan auction was not enough to reassure investors after S&P also cut its credit rating on ACA Financial Guaranty, a smaller bond insurer, to junk.

Morgan Stanley added to the negative sentiment after it announced another $5.7bn in writedowns but the shares gained after it secured a capital injection from China.

The S&P 500 rose as much as 0.5 per cent after the Fed published details of the loan auction and but later fell 0.2 per cent to 1,452.02. The Nasdaq Composite was flat at 2,595.58 while the Dow Jones Industrial Average declined 0.3 per cent to 13,198.82

Financials pared early gains after S&P said "worsening expectations" for the performance of mortgage-backed securities meant it was lowering its outlook on MBIA and Ambac Financial 's AAA-rating to "negative" and was cutting ACA Financial Guaranty from A to CCC. MBIA fell fell 6.4 per cent to $25.93 while Ambac declined 6.3 per cent to $25.30. Both companies may now need to raise additional capital.

Shares in Morgan Stanley climbed as much as 6.8 percent after it said China Investment Corp, an investment vehicle controlled by the Chinese government, would inject $5bn to help shore up its balance sheet. The capital infusion provided an early boost to financial stocks as traders bet that other banks will look abroad for much-needed funding.

The company is the latest financial group to seek funding from foreign investment groups, following similar moves by Citigroup and UBS. CIC owns a stake in Blackstone Group, the publicly traded private equity group. "Meaningful investments into various financial entities suggest that the capital constraint dilemma may be finding some solutions, which could be part of the stabilisation process needed to calm down both debt and equity markets," Tobias Levkovitch, chief US equity strategist at Citi Investment Research, said.

Morgan fell to a $3.6bn loss in the fourth quarter after it took $9.4bn in mortgage-related writedowns, $5.7bn more than the company had advised in November. Full-year earnings were down 62 per cent to $3.44bn. The shares were up 3.3 per cent at $49.65 at midday.

Goldman Sachs, up 0.6 per cent at $202.63, reported stellar quarterly results on Tuesday but the bank warned that a difficult November period had clouded its outlook in the near-term. Bear Stearns , 1.3 per cent weaker at $91.43, reports its fourth-quarter results today.

Stocks had climbed in early trade after the Federal Reserve revealed details of its first term loan auction which provided $20bn in funds to help ease liquidity problems. Bids totalled $61.6bn for the $20bn in available financing, and funds were awarded at a 4.65 per cent interest rate, slightly below the 4.75 per cent rate available at the discount window.

"It seems that it did have a positive reaction initially. But now we can't really get any traction to the upside," Richard Sparks, senior equities analyst at Schaeffer's Investment Research, said.

Mr Levkovitch said recent central bank moves to help ease funding could be among the building blocks of a "substantive recovery".

In other earnings news Palm disappointed after it fell to a $9.6m secondquarter loss and revenues slid 11 per cent to $349.6m, slightly below expectations. The shares sank 8.8 per cent to $5.41 after Deutsche Bank cut its price target to $4.50.

Hovnanian Enterprises , the homebuilder, fell 8.8 per cent to $7.66 after it reported a wider than expected $469m loss with the company reporting a rise in buyers cancelling contracts.

Transport stocks also suffered a bad day after Union Pacific , the rail company, lowered its fourth-quarter guidance because of rising fuel costs. Its shares fell 4.8 per cent to $123.26. The drop hit Burlington Northern Santa Fe , down 2.5 per cent at $81.58.

Darden Restaurants , operator of the Olive Garden and Red Lobster chains, fell 19.2 per cent to $29.38 after its 2008 earnings guidance missed expectations.

Japan stocks up, banks gain on subprime fund snub

TOKYO, Dec 20 - Japanese stocks rose on Thursday after a six-day losing streak, with bank shares including Mitsubishi UFJ Financial Group (8306.T: Quote, Profile, Research) up on reports that they will refuse to contribute to a U.S.-led subprime rescue fund.

Still, amid high volatility in thin trade, coupled with lack of powerful market-moving factors, some participants said the market could go in either direction.

Takahiko Murai, general manager of equities at Nozomi Securities, said the market could move in a solid direction only if there were big surprises such as from the United States at this time of year, when many investors are already away.

"Today, too, it also depends on which way large-lot future orders come in the afternoon session."

As of 0101 GMT, the benchmark Nikkei average .N225 was up 0.3 percent at 15,081.96 and the broader TOPIX index gained 0.4 percent to 1,462.27.

Japan's three largest banks, Mitsubishi UFJ Financial, Mizuho Financial Group (8411.T: Quote, Profile, Research) and Sumitomo Mitsui Financial Group (8316.T: Quote, Profile, Research), rose sharply on talk they plan to reject a request to help finance a U.S.-led subprime rescue fund.

Financial sources said the three banks turned down the fund because of concerns over putting their capital at risk. [ID:nT102827]

MUFG climbed 2.9 percent to 1,061 yen and Mizuho rose 1.9 percent to 539,000. Sumitomo Mitsui rose 2.9 percent to 853,000.

But Nozomi's Murai said it was unlikely to be the end of the story. "I think there will be another round of requests," he said.

Steelmakers also climbed, with Nippon Steel Corp (5401.T: Quote, Profile, Research) up 2.4 percent at 632 yen and rival JFE Holdings Inc (5411.T: Quote, Profile, Research) gaining 2.3 percent to 5,360 yen.

Sumitomo Metal Industries Ltd (5405.T: Quote, Profile, Research) gained 2.2 percent to 459 yen and Kobe Steel Ltd (5406.T: Quote, Profile, Research) rose 1.2 percent to 344 yen.

Tokyo Star Bank Ltd (8384.T: Quote, Profile, Research) rose 2.3 percent to 350,000 yen but was below an expected bid price of 360,000.

Financial sources said Japanese private equity fund Advantage Partners has agreed to launch a roughly 250 billion yen ($2.2 billion) bid for Tokyo Star and will make an announcement as early as Thursday.

Advantage will offer about 360,000 yen per share, the sources said. That would be a 5 percent premium to Wednesday's close of 342,000 yen and roughly one-fifth above its level in early September when it was unclear if the deal would go through. [ID:nT184590] (Reporting by Taiga Uranaka, Editing by Michael Watson)