False Profits?

Suddenly, everything is coming up rosy for Goldman Sachs. After converting to a "bank holding company" last year and receiving $10 billion dollars in TARP assistance from the federal government, Goldman, formerly known as the nation's largest "investment bank," has shocked observers by posting a "profit." The company also sponsored a stock offering in order to raise funds to repay its debt to the government and to free itself from TARP.

Bye Bye December
Financial market analysts have approached Goldman's purported profits with skepticism. First, Goldman's earnings report excludes the entire month of December 2008. Floyd Norris, financial reporter for the New York Times, explains that Goldman converted to "calendar year," rather than quarterly reporting after it elected to become a bank holding company. Consequently:

Goldman’s 2008 fiscal year ended Nov. 30. This year the company is switching to a calendar year. The leaves December as an orphan month, one that will be largely ignored. In Goldman’s earnings statement, and in most of the news reports, the quarter ended March 31 is compared to the quarter last year that ended in February.

The orphan month featured — surprise — lots of write-offs. The pretax loss was $1.3 billion, and the after-tax loss was $780 million.

In response to Norris' arguments, Goldman says that banking law requires the change in its reporting schedule. This change, however, does not undo the reality that under the old schedule, Goldman may not have earned a profit. According to Norris, Goldman has declined to disclose whether it would have earned a profit under its traditional reporting schedule.

The Goldman-AIG Connection
Another area of skepticism concerns the controversial $12.9 billion payment Goldman received from AIG -- the troubled insurance company that has received over $100 billion in TARP assistance. AIG "insured" Goldman's investments in risky mortgage-related assets. Even though the market has effectively deemed these assets "toxic" (i.e., worthless), Goldman recovered much more than the market value of its investment after AIG used TARP assistance to cover Goldman's risk.

Had AIG entered into bankruptcy like other banks and, presumably, as the automobile industry will soon do, it is unclear whether (and probably unlikely that) Goldman would have received far more than market value for the unsecured insurance policies. Accordingly, the bailout of AIG represented a major financial gain for Goldman.

After stating that the public's interest in Goldman's relationship with AIG has "mystified" him, Goldman CFO David Viniar dismissed speculation that Goldman's receipt of controversial payments from AIG allowed the company to realize a quarterly profit. Viniar said that most of the transfers from AIG occurred last year, and that the transfers from January to March 2009 "rounded to zero."

Viniar also stated that December 2008 transfers from AIG were "insignificant," but he does not provide any numbers. As Norris argues, however, Goldman has doctored its reporting by excluding December from its quarterly numbers altogether. Norris also questions whether Goldman's December losses would have been even larger absent the AIG transfers.

Goldman's "Fuzzy Math" Excludes $28 Billion In Government-Secured Loans
Goldman has only announced a plan to pay back $10 billion in federal loans that it received by participating in TARP. Goldman, however, borrowed an additional $28 billion on the open market, but the government acted as a guarantor on those loans. According to Norris, Goldman has no concrete plans to repay those loans, but the federal guarantee undoubtedly conferred value to Goldman.

Goldman's Competitors Are No Longer Around
The Bush administration decided to save AIG, which has undoubtedly benefited Goldman. Bush officials, however, refused to bail out Lehman Brothers -- which was Goldman's biggest competitor. Many of Goldman's other competitors (e.g., Morgan Stanley) were folded into other companies in distress sales.

Goldman's recent "profits" likely result in part from the elimination of other leading financial institutions as serious sources of competition. Because many former and current Goldman staff participated in the government's decision to bail out AIG and allow Lehman Bros. to collapse, AIG's survival and payment of billions of dollars to AIG has provoked a substantial amount of scrutiny and controversy.

Is the "Market" Skeptical Too?
How has the market reacted to Goldman's "good" news? Today, just one day after Goldman announced its profits and generated 1/2 of the money needed to repay its debt to the government, the company's stock fell 12 percent.