How Goldman Made Bank in 2009

Goldman SachsLast year was a good one for financial titan Goldman Sachs (GS). Despite the downtrodden economy, Goldman managed to log a stellar performance, which will yield a record bonus payout of $23 billion to its workers. We certainly helped CEO Lloyd Blankfein and his minions with $52 billion in low-cost government financing.Sharp Decline In Most Businesses

%%DynaPub-Enhancement class="enhancement contentType-HTML Content fragmentId-1 payloadId-61603 alignment-right size-small"%% And let's not forget that Goldman was a huge beneficiary of ailing insurer American International Group's (AIG) bailout. When the Federal Reserve agreed to pay AIG's counterparties in full, Goldman pocketed a $12.9 billion check -- 100 cents on the dollar -- for its credit default swaps. But a perusal of Goldman's financial statements also reveals that it made big bucks in 2009 by trading commodities, currencies, bonds and stocks.

Without its trading business, Goldman would have had a miserable 2009. According to its November 2009 quarterly statement filed with the SEC, Goldman suffered a sharp decline in most parts of its business during the first three quarters of last year. Specifically, its investment banking revenues fell 22% to $3.2 billion and its asset management business declined 22% to $2.9 billion.

Other factors contributed to Goldman's record 2009. Its so-called trading and principal investments unit, which trades stocks, bonds, commodities, and derivatives for clients and its own account, spiked 89% to $23.8 billion and the money it made on lending rose 65% to $5.6 billion.

And the rise in Goldman's trading revenues translated into an even higher 112% boost in its pretax income. This despite a 29% increase in its operating expenses to $23.1 billion. Most of that increase in expenses was a result of a 47% increase in Goldman's compensation expense to $16.7 billion.

Trading Revenue Spike Mystery

Just how did Goldman make all that money trading? The short answer is, it's a mystery. What Goldman says in its quarterly report fails to provide insight: For example, in the first nine months of 2009 Goldman says it had "particularly strong performances in credit products, mortgages and interest rate products."

But Goldman fails to disclose specific reasons why it was able to generate this strong performance. All it discloses is that the improvement was due to "strong client-driven activity, particularly in more liquid products. In addition, during our second and third quarters of 2009, asset values generally improved and corporate credit spreads tightened." And Goldman boasts of "strong net revenues in derivatives."

This "disclosure" leaves investors scratching their heads trying to understand what Goldman actually did to nearly double its trading revenues. Perhaps it would help if it could provide a few examples of particularly profitable trades from "liquid products" -- whatever that means. Investors could also benefit from specifics on how improvements in asset values and tighter credit spreads boosted its trading revenue.

All in all, Goldman still operates its business with enormous risks -- including $46.3 billion that it has to repay in 2010 and 2011 to lenders and bondholders and a total of $277.8 billion it owes over the next several years -- that dwarf its $53 billion tangible equity base. Among these big risks are $66.2 billion in so-called Level 3 assets -- which have no observable market value and $130 billion in derivative contracts.

Goldman's Risky Balance Sheet

But the biggest risk on Goldman's balance sheet could come from the alphabet soup of off-balance sheet entities -- the kind that wiped out Enron -- which Goldman calls strange names like securitization entities (SEs) and variable interest entities (VIEs). These creatures are made up of slices of commercial and residential mortgages and total $82 billion for the SEs and $68 billion for the VIEs. It is a mystery how much losses from these entities will cost Goldman.

Does this mean that investors should expect Goldman to have a worse 2010? There is no way to know since its trading business is a black box. But one thing we can be sure of is that the U.S. will not let Goldman fail.

And thanks to all the taxpayer funded bailouts Goldman will soon pay its people an average of $782,313 -- about 13 times 2009's roughly $60,000 median U.S. family income.

Peter Cohan owns AIG shares.
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