Wednesday, April 15, 2009

Why Won’t Goldman Just Come Clean?

Phew ... a whirlwind of Goldman Sachs analysis in the wake of their, ahem, blockbuster earnings report. And Goldman’s share sale got pushed out the door pretty fast; it kind of reminded me of the salesman at the used-car lot: “So what do you say ... ah, that’s just a spot of rust ... the horn does work, it’s just a little finicky ... listen I haven’t got all day, you want it or not?”

Will Goldman’s new investors wake up with buyer’s remorse? The company still hasn’t done a good job explaining what’s going on with its first-quarter earnings. Here’s a short list of things worth asking Goldman, point blank:

1. Where does that $12.9 billion you got from AIG show up in your results (when taxpayers bailed out AIG, the insurer turned around and handed out billions to counterparties on derivative trades)? After all, you had a lousy fourth quarter, a lousy December, and then out of the blue you report a spectacular first quarter, even as the jobless rate climbs and housing deteriorates further and commercial real estate takes a tumble.

Chief Financial Officer David Viniar claims AIG funds didn’t juice the bank’s income during the latest reporting period.
Viniar said profit resulting from payments from ailing insurer American International Group Inc (AIG.N) "rounded to zero" in the first quarter.
Great, that’s settled. Or is it? Notice no one asked, “How would your earnings have been affected if you hadn’t received any payments from AIG?” or “Would you have suffered losses if not for the AIG payments?” Viniar claims Goldman unwound the bulk of its AIG positions by the end of 2008. So where did the $12.9 billion go?

(Note: to be fair, Goldman claims to be hedged on its exposure to AIG, so even if the insurer goes belly up, Goldman is covered. Whether the bank is perfectly and reliably hedged is impossible to know. It's likely that Goldman doesn't want to test this either, especially if it can get the U.S. government to back up AIG instead: that's the safest option of all.)

2. How much of your profit was related to the colossal unwinding of trades by AIG’s financial products division early in the year? See this excellent blog post at Zero Hedge for what looks like a scandal (warning, it’s pretty technical).

What happened, in a nutshell: AIG knew it was going to have to crawl back to the government for more bailout funds anyway. So, before doing so, it made a whole bunch of favorable trades with its counterparties (the major banks), allowing them to pocket big profits. Here’s the Zero Hedge analogy:
In simple terms think of it as an auto dealer, which knows that U.S. taxpayers will provide for an infinite amount of money to fund its ongoing sales of horrendous vehicles (think Pontiac Azteks): the company decides to sell all the cars currently in contract, to lessors at far below the amortized market value, thereby generating huge profits for these lessors, as these turn around and sell the cars at a major profit, funded exclusively by U.S. taxpayers.
Was Goldman in any way involved in these trades? If so, how, and how much did this activity boost profits?

3. How do you reconcile these two statements about your earnings? (bold mine; FICC stands for the fixed income, currency and commodities division, which had a blow-out quarter, with $6.56 billion in net revenue):
“The revenues in FICC were very, very broad based” across the variety of commodities, rates, currencies and credit businesses, Viniar told a conference call, adding that Goldman “clearly had the benefit of higher spreads, less competition."
And this:
David Trone, a Fox-Pitt Kelton analyst, said Goldman benefited from a “windfall” in fixed income, currencies and commodities results that is “unlikely to repeat.” He rates Goldman “in line.”
Hmm. Viniar implies that nothing in Goldman’s FICC results was exceptional at all: the revenue was “broad based” (a good way to deflect further questioning -- if you say, “the revenue gains were mainly concentrated in the credit business,” some smartass might ask, “What part of the credit business?”). Also if Goldman had the benefit of higher spreads, we should be able to expect that to continue for a while right?

But Trone (though not being specific either) hints that Goldman essentially got a one-time gift from somewhere. In that case, we should treat a large part of the FICC results as a one-time gain? Yes or no?

4. Why don’t you help us understand the odd results in the FICC division, if there’s really no story there? Here’s all that’s provided in the earnings report to explain what fueled FICC:
These results reflected strong performance in interest rate products, commodities and credit products, as FICC operated in a generally favorable environment characterized by client-driven activity, particularly in more liquid products, and high levels of volatility.
After that line Goldman proceeds to tell us everything that went wrong for FICC in the quarter: illiquid assets declining, revenue in currency lower, some $800 million lost on commercial mortgage loans and securities, corporate debt and private equity investments bleeding red ink.

So what went right? Commodities is cited as one winner, but it seems relatively small. So that leaves “interest rate” and “credit” products (including default swaps). Nebulous huh? This just seems like bad disclosure. Shouldn’t companies be required to be more specific when summarizing the main force behind two-thirds of their net revenue?

And what’s a “generally favorable environment characterized by client-driven activity, particularly in more liquid products” refer to anyway? Sounds like Elaine on Seinfeld when she says, "Blah, blah, blah, blah."

Whatever happened with Goldman’s earnings, the disclosure stunk. And that’s wrong because: 1. Goldman has chosen to be a public company, and certainly enjoys being able to play with other people’s money because of that. 2. As a public company, it has a duty to honestly report its earnings and the nature of those earnings to investors. 3. Its FICC division had a HUGE quarter and there’s virtually no evidence why.

Investors deserve to know if this resulted from a “one-time” windfall and where that windfall was. That’s transparency -- and unfortunately, it’s in short supply during this crisis.