Meltdown 101: How does Goldman Sachs do it?

[July 15, 2009]  NEW YORK (AP) -- Another financial quarter, another period of blowout profits for Goldman Sachs. With some of the other big banks still losing money, many may wonder: How does Goldman do it?

Gutsy trading and talented employees have helped. But Wall Street's largest remaining investment bank has also benefited from billions in taxpayer-funded bailouts, as well as a sharp drop in the number of competitors.

Even as the recession drags on, the 140-year-old firm is having a very, very good year. The latest evidence: Goldman on Tuesday reported second-quarter profits of $2.7 billion, off a stunning $13.8 billion in revenue. That's a 65 percent profit jump over the same quarter last year.

Other big banks like Morgan Stanley, Citigroup and Bank of America are set to report earnings in the coming days, but analysts predict they won't be as strong as Goldman's.

Here are some questions and answers about how the investment bank manages to thrive when the financial sector -- and the economy as a whole -- are struggling.

Q: What exactly does Goldman Sachs do?

A: Founded in 1869, Goldman started out trading short-term corporate debt. Today, it buys and sells securities and financial products including stocks, bonds, currencies and commodities like oil. It also underwrites securities offered by other firms, and advises on billion-dollar mergers and acquisition deals. In addition, the firm sells research and helps rich clients manage their investments.

Q: Doesn't it seem like Goldman always makes more money than other big Wall Street firms?

A: Goldman has long had a reputation as one of the world's top investment banks. It's known for stacking its ranks with the best and the brightest and rewarding them with huge paydays.

The strategy seems to have worked. The firm has had just a single money-losing quarter since going public in 1999, and its stock is up a whopping 77 percent this year. In contrast, the S&P 500 index -- a good measure of where the overall market stands -- is down 0.2 percent.

Q: But what does Goldman do that others don't?

A: Many experts believe Goldman's success is rooted in its savvy, high-octane trading style. The bank took in a record $6.8 billion in revenue from fixed income, currency and commodities trading during the second quarter. Other firms haven't been as aggressive with the type of trading they're willing to do, limiting their risk exposure but also their profit potential.

Goldman has also made a mint underwriting securities. As investor optimism has increased, companies have flooded back into financial markets, selling new shares of debt and stocks to raise badly needed capital. Goldman takes a cut of each share offering it handles.

Q: How has Goldman benefited from government bailouts?

A: Goldman took $10 billion at the height of the crisis last fall as part of the government's $700 billion bank rescue. Last month, it became one of the first banks to repay the money, freeing it from onerous restrictions on executive pay and hiring.

But the bank has benefited from other federal aid. It was among several U.S. and foreign banks that were paid a chunk of the $182.5 billion in federal aid used so far to rescue crippled insurer American International Group. The money went to cover banks' losses on complex mortgage investments, as well as for collateral needed for other transactions. Goldman's cut: $12.9 billion.

Goldman also took advantage of a Federal Deposit Insurance Corp. program that guarantees banks' newly issued debt. That backstop has allowed Goldman to raise capital at lower interest rates, increasing its rate of return on that money.

Q: Who are Goldman's competitors?

A: Due to the financial mess, there aren't many left. Of the five big stand-alone U.S. investment banks in business last year, one (Lehman Brothers) filed for bankruptcy and two (Bear Stearns and Merrill Lynch) sold themselves. That leaves Morgan Stanley as Goldman's main rival.

The dwindling number of competitors has helped Goldman lock in clients. And it has reduced the number of players piling into trades also being executed by Goldman, which can make the deals more lucrative for the bank.

Q: I'm just an ordinary investor with a 401(k). How does Goldman affect me?

A: Some believe Goldman has an outsized influence on the financial markets, a claim the firm itself denies. During oil's record-breaking run last summer, some market watchers blamed the spike in part on Goldman's prediction that prices would hit almost $150 a barrel.

Q: Aren't a lot of top government officials former Goldman executives?

A: Several of the bank's alumni have gone on to take top jobs in government. Among them: Henry Paulson, the last Treasury secretary under the Bush administration and a former Goldman CEO; Josh Bolten, chief of staff under President George W. Bush; Robert Rubin, another former Goldman co-chairman who served as Treasury Secretary under President Bill Clinton.

Q: How will the Obama administration's proposed financial reforms affect Goldman?

A: It's too early to tell, but many experts say the proposed rule changes won't dramatically change the way Wall Street firms do business.

Since converting to a bank holding company last year, Goldman is under tighter scrutiny from regulators. That has limited the amount of leverage Goldman can take on when betting on securities and other financial products. But, as Tuesday's stellar earnings show, the bank is still taking plenty of risks and, at least so far, reaping huge rewards.

[Associated Press; By STEVENSON JACOBS]

Copyright 2009 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.