How Wall Street is making its billions

Wall Street banks have had profitable quarters. JPMorgan Chase reported $3.6 billion in profit (more than $1 billion per month). Goldman Sachs was only slightly behind, at $3.2 billion. These profits supposedly came from “trading.” I asked a friend who has worked in the money business how this was possible. “For someone to make money trading, there has to be someone on the other side of every trade who is losing money. Where does each bank find someone who can lose $1 billion every month?”

He explained that “carry trade” would be a more accurate description of what they’re doing. Because of the Collapse of 2008 financial reforms, the big investment banks are able to borrow money from the U.S. government at 0 percent interest. Then they can turn around and buy short-term bonds that pay 2 or 3 percent annual interest. Now they’re making 2 percent on whatever they borrowed. They can use leverage to increase this number, by pledging some of the bonds that they’ve already bought as collateral on additional bonds.

I asked if they were taking any risk in order to earn this return. “If interest rates went up to 20 percent, even though the bonds are short-term, the price of the bond could fall enough to make the trade a money-loser.” (Though since the banks are too big to fail, they would simply be bailed out with additional taxpayer funds.)

What kind of bonds are they buying? Are they investing the money in American business? “No, they are mostly buying Treasuries.” So the money is just being shuffled from one Federal bank account to another, with each Wall Street bank skimming off $1 billion per month for itself? “Pretty much.”

[A more old-fashioned way of making supranormal returns is insider trading, which was perfectly legal until the Crash of 1929 (history). The New York Times ran a story yesterday on Raj Rajaratnam, a hedge fund manager who invested heavily in inside information. Rolling Stone published "Wall Street's Naked Swindle" on October 14. The story is much more sensational and entertaining than anything from the Times. It covers a guy who spent $1.7 million on out-of-the-money put options on Bear Stearns on March 11, 2008. The options would become worthless on March 20, just 9 days later, unless Bear Stearns basically went bust. Bear Stearns collapsed the next day and the guy made a $270 million profit. He has never been identified by the SEC.]

42 Comments

  1. Anonymous

    October 17, 2009 @ 10:14 pm

    1

    Essentially, we all pay the Wall Street tax through inflation so that important people in suits can buy multi-million dollar apartments and dispossess people who work for a living. Makes total sense. This country was founded on rewarding those who can invent powerful lies to convince Congress that nonsensical investment vehicles have absurd monetary value.

    The rhetorical end result of all this is that the economy is irrigated with liquidity. However, in reality, the true result is that non-bankers all fall into penury debt slavery and die. The irony about that is, Wall Street is trying to collateralize life insurance policies. So, even as we non-bankers all become homeless and die, hedge fund managers can still legitimize their bonuses to Congress.

    Because oligarchs draw incorrect conclusions about human evolution from Dawkins, “The Selfish Gene”, misunderstand mythological self-determinism fables from Ayn Rand, and don’t grok that Adam Smith’s tales about the “Invisible Hand” were allegorical, we all must suffer. And, somehow we believe our angry powerhouse of a cleptocracy is the absolute zenith of human existence. Absolute fucking madness.

  2. Fan Zhang

    October 17, 2009 @ 11:25 pm

    2

    The billions of dollars of recent bank profits can be a little misleading. The figure would suggest that these billions of dollars of profits represent gains skimmed off of government loans, and put into the wallets of Wall Street fat cats.

    In reality, in return for the loan, the government acquired preferred shares in the banks it gave money to. When these banks report such high profits as they are now, and eventually return these profits through dividends, the US government get a share of these profits (and hence taxpayers do as well). Corporate profits don’t equal executive compensation.

    In your analogy to the carry trade then, the real cost of financing is not 0% due to the government liabilities the bank needed to take on to get the loan. Banks buy treasury bills not mainly as a way to make profit, but to avoid the losses (in forgone riskless interest) sustained by just holding reserves. In fact, the short term (1 year) t-bill rate as of today is only 0.36% (http://www.ustreas.gov/offices/domestic-finance/debt-management/interest-rate/yield.shtml).

  3. Roger Wenham

    October 18, 2009 @ 2:37 am

    3

    So the banks are being given money by the government, that they then lend back to the government, and we, the tax payer, pay interest on it.

    So those billions in profit are the American peoples tax dollars….

    Thats plain robbery ….

  4. Joost

    October 18, 2009 @ 6:39 am

    4

    “In reality, in return for the loan, the government acquired preferred shares in the banks it gave money to. ”

    No it didn’t. How many shares of Goldman Sachs does the US government have?

  5. Krabe

    October 18, 2009 @ 8:26 am

    5

    “big investment banks are able to borrow money from the U.S. government at 0 percent interest”

    What does this mean? Are they borrowing from FED? From who exactly they are borrowing this money, at 0 percent interest.

    Is this FED printing money, or is there some government entity that actually has real money to lend out?

  6. philg

    October 18, 2009 @ 1:48 pm

    6

    Krabe: All of the remaining sizable investment banks became “bank holding companies” in September 2008, which gave them access to borrowing facilities at the Fed. Currently the Fed will lend money to eligible banks at very close to 0%. They don’t need to print the money, but can create it electronically!

    I haven’t kept up with all of the other ways that banks can get money from the government, but it includes programs such as http://en.wikipedia.org/wiki/Term_Asset-Backed_Securities_Loan_Facility where a bank can sell something to the U.S. government at a much higher price than the private market is willing to pay.

  7. Thomas

    October 19, 2009 @ 6:56 pm

    7

    It’s worth pointing out again (as Simon Johnson has), that bank holding companies are explicitly not allowed to engage in some of the activities that Goldman et al have recently used to profit so heavily: http://baselinescenario.com/2009/10/03/a-short-question-for-senior-officials-of-the-new-york-fed/

  8. Mike

    October 19, 2009 @ 7:09 pm

    8

    Regarding the guy who made a fortune buying out-of-the-money puts on BSC… LOTS of speculators were buying out-of-the-money puts in the financials at the time. Stuff was imploding left and right. One bank would collapse, and the question was “who’s next”? Without inside information, it was possible to make 500%+ returns in one day on MER, WM, BSC, LEH if you got the timing right. I personally managed to do this on a couple of occasions, though my bets were hundreds, not millions of dollars.

  9. Sam

    October 19, 2009 @ 7:38 pm

    9

    Haha, this is completely and totally made up. But fun! I’m actually having trouble corroborating even a single aspect of the story.

    For this to work as described, Goldman alone would have to be borrowing half a trillion dollars from the government, right? ($512 bil * 2.5% / 4 quarters = $3.2 bil profit.) But the only ways I can think of for a bank to borrow money from the government in an open-ended way (i.e., not to fund the purchase of a particular type of asset) is at the Fed’s discount window or through the TAF, where the interest rates are 0.25% to 0.5%. Total lending to all banks through these programs is about $180 billion right now. And as an aside this has to be fully collateralized, so they can’t leverage the money.

    http://www.federalreserve.gov/releases/h41/Current/

    So they borrow this money, and invest it in short-term treasuries, except oops, the interest rate on short-term treasuries is still between 0% and 0.35%:

    http://www.bloomberg.com/markets/rates/index.html

    Maybe they’re buying long-term treasuries instead, but then the “no risk” story doesn’t work any more. And anyway, Goldman only has $355 billion in trading assets (total), so if their profits really are coming entirely from trading (which I don’t know), they’d have to be making returns 3.6 percentage points higher than their cost of funds.

    http://yahoo.brand.edgar-online.com/displayfilinginfo.aspx?FilingID=6729888-17001-24930&type=sect&dcn=0000950123-09-029919

    I don’t know how they’re doing that, but my guess is it’s because the financial system actually recovered after all the government intervention last spring; realized outcomes were much better than what was priced into markets a year ago. So probably banks are making money on all the complicated, illiquid assets they’re still holding.

    The deeper problem, though, is that Greenspun misunderstands what the point of the financial system is! He says that “for someone to make money trading, there has to be someone on the other side of every trade who is losing money,” but that isn’t the point at all. There has to be someone on the other side of every trade who is willing to pay you to take on risk. Financial firm profits come, on average, from taking on risk, whether it’s by selling insurance or by pooling short-term deposits into long-term loans. The carry trade is a perfect example: investors borrow money from a low-interest rate country and invest in a high-interest-rate country, taking on the risk of massive exchange rate readjustments like what happened in Iceland. It’s not free money, even if it seems like it is for a long time. (I just noticed that all this is attributed to a friend who “has worked in the money business,” which I guess explains how silly it is.)

  10. Sam

    October 19, 2009 @ 7:51 pm

    10

    By the way, I apologize for the tone of my post! I didn’t intend to be so dismissive, but I copied and pasted from an email I wrote to a friend who asked me about this. I agree that it’s important to respond critically when the government seems to be favoring big businesses in secretive ways.

  11. John Doe

    October 19, 2009 @ 9:43 pm

    11

    Philip, you might remember me as the person who defended the financial bailout related posts about one year ago. Yes, after a brief hiatus, I am back. A few points, and then my explanation to what I consider gross misunderstandings about finance:

    1) Banks are not making their profits from the carry trade–you will have to take this as a matter of faith for now, but as someone who works in a large bank, I can assure you that the entire investment banking model is certainly not an interest rate curve steepener/carry trade. This is laughable if you knew what I knew.

    2) Banks are making their money from market making trading/liquidity providing in financial assets. From direct experience, I am 100% sure this is the case.

    3) I am going to try and convince you that this trading is not a zero sum game, as opposed to your friend in the money management business that has the opinion (which I find deplorable): “For someone to make money trading, there has to be someone on the other side of every trade who is losing money. Where does each bank find someone who can lose $1 billion every month?”

    I call this the fallacy of the zero sum game, and you will see why in a second..

    Market making helps to facilitate the transfer of assets from one party to another. In an ideal world, the person who wants to sell an asset will find someone who wants to do the exact opposite transaction at the same exact time. In practice, this is not realistic so you have market makers (who stand willing to buy or sell an asset at certain prices, right now)

    I hate the zero sum fallacy that your friend proposes. It is simply not true. Trade, in fact, can be profitable for everyone because of differing opportunity costs (you don’t have to find someone to lose what you gain).

    Imagine Bill Gates sells 10% of his shares in Microsoft. He could be doing so because he realizes he could create/invest that money in a new veture (like the next Google, Youtube or Facebook) that could yield 200% annual returns on his capital. So he sells some of his shares to raise money, to someone who normally could only get a 4% yield in a savings account. And this person buys these MSFT shares that happen to return 10% that year.

    If you are a hopeless cynic, and believe that Bill Gates lost because the other person realized a return on his investment, you are missing the point. Yes, if you look at the individual trade, you will believe that Bill Gates lost on this “trade”. What you are missing is what he did after becuase he was able to do the trade–which is to build a new business that thrived at a rate well above 10%. So let’s tally it: investor who bought microsoft shares eared a 10% return instead of 4%, and Bill Gates was able to create a new venture with that capital that created jobs and earned an even higher return, for him and society.

    What people don’t realize is this: Zero sum is a matter of scope, and too often naive people will define the scope to be too narrow. If you look at an individual trade, yes, there is an up/down profit and loss. But you cannot do just that. You have to look at what people do after the trade, in fact, what they can do only because the trade happened in the first place. The essetial point: both sides can win!

    I am on a campaign against the zero sum mentality. It might surprise people, but we as people can create wealth out of nothing. The multiple trillions of dollars in equity value in the markets? Some people had to sell this, but it did not come at the expense of some people losing trillions of dollars. That is ridiculous. It is a pernicious way of thinking that belies the true beauty of markets, trade, and wealth creation.

    Trade (and Wall Street) can create wealth–it is not just a reallocation of wealth from one person to another. For anyone reading this, please, for the future of society, do not forget this essential point.

    P.S. I am stopping by HLS in a few weeks to visit a friend. As a former MIT CS major turned Wall St worker bee, I would be happy to share my perspective to contrast your friends in the money management industry. Shoot me an email if interested..

  12. Invig

    October 19, 2009 @ 11:13 pm

    12

    Sam,

    I’m sorry but your final point is crazy.

    ‘Risk’ is only one perspective to take on a financial transaction. Sure, it applies as a decision-making tool, and aggregation (collectivisation of risk) basis, but that does not remove the reality that it is all betting.

    Banks loan a small company money and price the risk into the interest rate charged.

    Fine.

    But what happens when the risk is skewed by the ‘too big to fail’ aspect of the banks? When banks can take excessive risks because

    a) the government will bail them out if it all comes falling down,
    b) the government has made special provision for them to be supplied money at a discounted risk as per a) and
    c) the staff get bonuses based upon taking personal advantage of this risk underpricing

    But, more importantly, the economic cake, while not static (as energy pours in, and is transformed to useful ‘work’ at a certain rate of efficiency) is nevertheless close to a zero-sum game over the short run. Enough for an approximation.

    AND Every dollar the banks make for not taking risks that generate productive investments, and is instead channeled towards God-knows ends, is a dollar spent on bolstering the network of already-powerful people who will use their wealth to actively prevent change to the system.

    So it is one dollar less for the real economy, and one dollar more for the corrupt.

    The gap is widening, Sam. What do your risk analogies say about that?

  13. Invig

    October 19, 2009 @ 11:23 pm

    13

    John Doe, re: zero-sum, see above.

    Wealth does not come out of nothing; it requires energy inputs to be transformed.

    Also, the small business (non-share) market is REALLY important as these are NEW networks.

    Established networks (large companies, governments) progressively become less and less efficient as they do not adapt and their personnel become corrupt or politicised (fragmented).

    So the economy is a dynamic machine made up of many, many networks all (essentially) growing/dying/beginning. It is the balance between renewal and stagnation that provides us with the level of efficiency of energy-to-work that underlies our standard of living and survival.

  14. George

    October 20, 2009 @ 12:00 am

    14

    @John Doe, However, an ineradicable amount of wealth is being created for the very few at the expanses of the rest of the society. What’s more, when those few screw up, they are allowed to screw up again, and again with more wealth to play with. This is plain out wrong specially when the process of how the few are making their wealth is so complicated that even someone with a collage education can’t make sense out of it all.

    I’m more than happy to play the game too, if it’s on a leveled playing field.

  15. philg

    October 20, 2009 @ 12:16 am

    15

    Wall Street Enthusiasts: I can see the merit in some of your arguments. However, I still think the Cave Man Economist perspective is valuable. Running dollars around in circles between Washington and New York City is not an activity that is going to result in long-term economic growth in the same way that Intel chips, GE jet engines, or Honda automobiles drive economic growth. Looking at how Wall Street is making money right now is valuable for understanding how some banks are putting out good numbers while the nuts-and-bolts U.S. economy is floundering.

  16. Why Wall Street is Making Its Millions | The New Paper Press

    October 20, 2009 @ 1:36 am

    16

    [...] has been a lot of talk on the blogosphere today about Philip Greenspun’s article How Wall Street is Making Its Billions, where Greenspun and a friend suppose that the financial groups Goldman Sachs and JPMorgan Chase, [...]

  17. Doug_in_PDX

    October 20, 2009 @ 2:00 am

    17

    So then, where is the cheap money for small business?

    If this were, in fact, “zero sum” with those profits being some healthy indicator of the flow of money, and not representative of some accumulation, would there not have to be lending to “check” the accumulation seen otherwise?

    I sure think so, and given how there is essentially NO material lending to small and mid-sized business right now, all I see is big players recouping their losses at our expense.

    At some point, when they have made “enough”, will we then see lending occur?

    If so, wouldn’t such lending be at considerably higher rates, implying that the risk remains on us, socialized through “insurance”, while they just keep that which they accumulated while not actually lending as they are supposed to do?

    Yeah, we are getting screwed.

  18. Lobby7Dude

    October 20, 2009 @ 2:18 am

    18

    Phil:

    You might do well to read some at Karl Denninger’s blog here:

    http://market-ticker.denninger.net/

    He has been ranting about the flagrant transfer of wealth from taxpayers to the banksters for quite a while.

  19. JP Morgan

    October 20, 2009 @ 3:20 am

    19

    What are you guys going to do about it? Nothing. So, drink your corn-syrup infused lattes, toxic food-like substances produced by agribusiness, vote Democrat/Replubican (pro neo-feudalist) and STFU, fatties.

    Very busy and important people have to manufacture more esoteric debt products to complete the financial coup d’etat and bring the total rape of the economy to fruition. In a few decades, a master race of a million or so bankers admiring each other’s Rolexes and Lamborghinis will inherit the earth. There’s no room for you whiners.

  20. john doe

    October 20, 2009 @ 8:18 am

    20

    You’re right when you say finance activities will not “result in long-term economic growth in the same way that Intel chips, GE jet engines, or Honda automobiles drive economic growth”.

    They certainly don’t drive economic growth in the same way and fashion. But both are critical. One is not better or more important than the other. Wall Street has never claimed to be in the manufacturing space…it knows it is a service industry, pure and simple. Ebay connects buyers and sellers of goods. Wall Street connects people who need capital with people who have capital. Regardless of what people might read in the press, this is actually a very important and highly non trivial service for the economy.

    And as for the “nuts and bolts” companies you mentioned… Who did GE turn to last fall when it needed to raise 15 billion dollars in capital? It turned to Wall Street. Without capital, no jet engines are made, no cars are built, no fabs are constructed to build chips. Again, both types of companies are important to each other–let’s not draw an arbitrary distinction between their relative worth.

    The reason a few wall street firms are doing reasonably well is a lot simpler than people think: less competition. This is not a phenomenon exclusive to finance. You see this with other companies too (Google reported record revenue last quarter, are they not part of the nuts and bolts economy either?)

    Fewer competitors due to mergers/bankruptcies have allowed the remaining firms to take up market share. While it is not ideal since market making spreads are wider, and as discussed earlier, this makes asset allocation more expensive, this has a plus side in the sense that larger profits attract competitors (just like everyone gunning for Google). This is indeed happening right now. These competitors will come in and reduce the spreads over time, but this will in turn be compensated for by the opportunity pie growing for everyone. Again, it is useful if people stop thinking about this in terms of zero sum.

  21. Actually, less than zero

    October 20, 2009 @ 8:59 am

    21

    Gosh, Phil, your blog has been educational on several subjects. Especially so on this topic that is dismal, indeed.

    I call the state of affairs put upon us by the Street (et al) near-zero. Only rhetoric could argue otherwise (as you so aptly stated).

    Actually, that whole financial thing right now is a negative game. Not unlike war, okay? Sure, many in the game are filling their pockets. They are in a type of bubble that only an effective mutual admiration society could sustain. What is happening on Main Street far outweighs, on the other side, those gains of the players, such as the golden sacks.

    Our problem? We let this happen. How to correct matters ought to be the focus. We need to determine the proper fix and apply it. How?

    Consider this. After 9/11, activity in aviation in the country ceased for a few days. We could actually take down parts of the so-called markets for a period and restart. In the old days, Sweden converted from left to right driving by shutting down the system.

    Yes, before the adjustment, there would be preparatory work. Is it possible given the current state of politics?

    The reality was most accurately depicted by anonymous in the first comment. In a nod to Orwell, it’s a class thing, people.

  22. Darius

    October 20, 2009 @ 9:06 am

    22

    …one more point here is that the money borrowed from the central bank is newly printed money. This newly printed money is subsequently lent to the government who has to pay 3% interest on it. In order to be able to pay this interest to the banks (so that they can make their “trading profits”) the government has to raise taxes from the people. This way such carry trade profits and bonuses paid from them come from taxes. So not only did the taxpayer had to bail the banks out but now he also has to pay the banks so that they can generate trading profits and pay bonuses.

  23. Horace

    October 20, 2009 @ 4:19 pm

    23

    This is why libertarianism and objectivism won’t work. They actually believe captalism rewards excellence and don’t take into account the financial gimmickry people have to submit themselves to to get investment capital. You’ll notice there was no such thing as a bank loan in Atlas Shrugged. Banks are never mentioned.

  24. SiliconValleyGeek

    October 20, 2009 @ 4:26 pm

    24

    For JohnDoe,

    Since you are much better informed of the inner workings of Wall Street than my congressman, perhaps you can answer a question:

    “What is the benefit for JPMC, WFC and BAC to delay disposition of non-performing residential properties?”

    For example, in Silicon Valley there are several distressed homeowners in my neighborhood. Let’s say they owe $800K, but the market is $600K. Homeowner has made no payment for 12 months, and for the last 9 months the home has been in short sale waiting for BAC to approve $600K purchase. Meanwhile, the owner, who was laid off, isn’t making payments, nor property taxes, nor maintenance, nor HOA, and the buyers are probably going to ask for a further discount as the market is still slipping, albeit slowly.

    What makes no rational sense to me, the neighbor, his agent, the buyer’s agent, the buyer’s lender or the HOA is that BAC doesn’t take the deal and unload the property ASAP rather than hold a lower valued rundown property. I asked the accounting guy at the office and he couldn’t figure it out, either.

    What’s the benefit for BAC? Somebody said they are holding the asset on their books as $900K and don’t have to mark it down to $600K market value. So, does someone think magic is going to happen and the value shoot up? At some point they have to take the loss, why wait?

  25. philg

    October 20, 2009 @ 4:46 pm

    25

    Horace: Capitalism has rewarded excellence. Look at Honda’s steady rise since its founding in 1948. Capitalism combined with some government regulation has given even greater rewards to subprime mortgage scammers. Lobbying the all-powerful government has provided even greater rewards (sticking with the auto theme, Honda’s market cap of $55 billion is roughly comparable to the taxpayer money that is being put into the UAW’s pension fund (after that fund, thanks to the poor judgement of Detroit automakers’ management, already absorbed 100 percent of the market value of GM and Chrysler and most of Ford’s value; see the first third of the book “While America Aged”).

    Honda is also a good reminder of the value of government central planning. The Japanese government tried hard in the 1960s to discourage Honda from entering the automobile business. The company is now the world’s 6th largest automaker.

    I don’t think we should conflate capitalism, a theoretical concept, with actual day to day economic systems in countries with governments that consume 30-50 percent of GDP. Regardless of the advertised economic system, a government will tend to reward its cronies.

    Would objectivism work? Probably not that well if, as you point out, Atlas Shrugged proposes a world without banks (very useful institutions for matching savers and businesses that need to invest in expansion). Would libertarianism work? There aren’t any truly libertarian countries, but the countries that spend comparatively small percentages of GDP on government seem to be doing well.

  26. John Doe

    October 20, 2009 @ 10:12 pm

    26

    SiliconValleyGeek:

    I understand your concern about these issues. I do not stick up for what BAC is doing with these home loans. You bring up a lot of legitimate reasons (not wanting to recognize the writedown of property on their books, at least not yet) but it is difficult for me to shed light on these issues, as my expertise is not in this area.

    In the end I was only defending the investment banking/trading side of this, which is not that related to direct, traditional mortgage lending. This is why I have not responded to a lot of posts asking why banks have not lent more to consumers or businesses…these areas are not the profit centers that have caused the ire that bloggers have expressed.

    Philip was referencing JPM and GS’s recent profits, which did well these quarters not because of lending to businesses or their mortgage loans, but because of their capital markets, trading and investment banking activities (read the 10Qs for more details if interested).

    We can debate the relative productive merits of manufacturing versus capital formation and investment banking, but what these posts did illustrate is how unproductive it is to rile up readers with not carefully researched conjecture about how these particular banks make money. The responses that followed where commentators were worked up about factually baseless accusations compelled me to act. Let us cite hard evidence before we make broad statements that will impact trusting readers.

    Manufacturing things is important. Connecting capital providers with capital users is important. But accusing banks of making money with methods that have no basis in evidence is certainly not productive.

  27. Drew

    October 20, 2009 @ 10:33 pm

    27

    >> The essetial point: both sides can win!

    Only if you purport that there will always be a higher-return investment available on the upside. This logically leads to a theory of “neverending returns” where someone or something is able to keep creating new businesses or investment vehicles that will return 100, 500, 1500, 15,000% on your initial investment.

    This is not what you’d call “reality-based”. It is, in fact, what’s already happened: haven’t we already magicked up new investments that “return” interest at increasingly ludicrous rates?

  28. JPGoldmanAIGRobbers

    October 20, 2009 @ 10:56 pm

    28

    Re: John Doe, Re: Google record profits

    uh, Google is actually laying OFF people. And no, they are NOT ‘nuts-and-bolts’ at all – they technically ‘make’ software (not hardware). Well, they DO build massive data centers, but most of that hardware comes from the far east (is not produced here – not even the Intel chips). So some short-term labor (all legal?) and some off-shore hardware – but no real sustained gain for the US economy. That ‘loaned’ capital went mostly offshore.

    To the Cave Man Economist out there – love that term, btw – ‘Nuts-and-Bolts’ means cars, planes, trains, and big industrial shit (like Oil drilling rigs and huge ocean-strength Windmills) that only the Scandinavians have the balls to build anymore.

    We build NOTHING here anymore (I worked in Aerospace for 25 years – big and small) – saw a lot of major cutbacks in those years. Business lost mostly to overseas suppliers and distributors.

    We understood W. Edwards Deming’s much too late and the US went with the MBA (Masters of Bullshit Administration) in the 80′s and 90′s and are now paying the price as a former industrialized country….imho…

  29. Rellag

    October 21, 2009 @ 1:34 am

    29

    John Doe,
    >>not carefully researched conjecture about how these particular banks make money

    Lets take a look at Goldman’s last SEC filing 10Q dated August 5, 2009 for the June 2009 quarter.

    Turn to page 77, Statistical Exhibit.

    Please note that Goldman’s aggregate interest rate for its $738b in financial liabilities (notes, repo agreements, etc.) was 0.78%, or $1.4b in absolute dollars.

    No single source of funds dominates this result, but US repo agreements, with either the Federal Reserve or other banks (not disclosed) were 14% of the total, with an interest rate of 0.41%

    Long term borrowings (> 12 month maturities), which are frequently tied to LIBOR, represented another 27% of the total liabilities, and bore interest at 1.2%

    So in the case of 41% of their funding, the [low] cost of funds seems very highly influenced by markets in which the Federal Reserve’s ZIRP and Quantitative Easing policies are most strongly felt.

    Also, the largest growth in funding since the crisis (November balance sheet date) has been in short term repos ($62b increase). There is insufficient disclosure to determine whether *all* of this is with the Federal Reserve as a counterparty, but surely you agree that repo rates, and the securities that can be repo’d, are strongly affected by FOMC operations.

    Goldman’s aggregate earned interest was 1.8% on $773mm, or $3.5b absolute. 83% of this, or $2.9b was from the line item “Trading assets”, which yielded 4.3% interest. Only $265mm of capital was allocated to this line item, but it dominates the overall result due to the high interest rate.

    To find out what’s in this item, flip back to page 24, Financial Assets at Fair Value as of June 2009. The subtotal “cash instruments…$265mm” is the relevant quantity. Here we find that the $265mm was composed principally of:

    * $92mm of U.S. Gov’t and Federal Agency obligations
    * $51mm of equities (which include preferred shares) and convertible debentures
    * $40mm in corporate debt and bridge loans

    I think the overall 4.3% interest rate on this class makes it reasonable to conclude the $92mm in gov’t and agency obligations are *not* treasury bills.

    Net Interest Income for the second quarter was therefore $3.5- $1.4 = $2.1b

    Goldman’s equity was $63b, so leverage on the interest-bearing assets alone (excluding non-interest bearing assets) was 12x.

    I therefore think it is fair to say that much of Goldman’s recurrent profitability to equity holders, stems from intermediation between the markets it can borrow in , and markets it lends to which includes the U.S. Gov’t, its agencies, and corporates, coupled with a high degree of leverage..

    In all, I find that the evidence supports Phil’s conjecture, and your comments have not been particularly relevant nor germane to the topic.

    Sorry.

  30. john doe

    October 21, 2009 @ 9:54 am

    30

    Sorry Rellag, but your analysis is at best misguided and at worst deceptive to readers.

    First of all, let’s not forget that at a first cut we could have all saved a lot of time and energy and just turned to page 2 of the 10Q. They break down exactly how much revenue is made in interest income vs investment banking activities. Turn your attention to the June 2009 column and it says 2 billion in interest income and 11.7 billion in banking, trading, and asset management revenue, for 13.7 billion total revenue in the quarter.

    So if what you are saying is that interest accounted for just 15% of their revenue, that is all fine and true (and again there should be no problem with this, given that even your analysis admits that half of trading assets yielding interest were corporates, converts, preferreds, etc. and given the yields on those securities in 2Q that is clearly what is driving interest income)

    But somehow I doubt that going around and telling people: “can you believe a bank made 15% of its revenue last quarter in interest income?” would rile them up the way they have been with this post.

    We have to be careful to not implicitly compare revenue with net income numbers. Let’s not forget that the 3 billion-ish numbers Philip was talking about were net income, while the 2 billion interest is revenue.

    So what is disturbing is that the average person reading your post sees 2 billion in interest and compares that to the 3 billion net income made in the last quarter (we won’t even go into the fact that you are analyzing second quarter numbers when Phiilip was discussing 3rd quarter results) and naturally assumes that they are only making money because of cheap short rate financing from the fed and then buying longer term govt securities, which is clearly not true.

    Let’s sum up: they made 2 billion in interest and they made about 12 billion in trading, banking, and asset management. So no, the assertion that the way wall street makes its billions is due to cheap short rate financing/lending back to the government does not hold water.

    At least we are moving beyond the “my friend told me” style of analysis and into actual numbers, but let’s not misconstrue these numbers.

  31. jorod

    October 21, 2009 @ 2:07 pm

    31

    Cheap money encourages speculation…..

  32. KB

    October 21, 2009 @ 3:01 pm

    32

    Some interesting comments here. Personally I think GS’s profits are coming a little from bonds but largely from trading and commercial banking. The feds policies have goosed the markets to create a “recovery” for the propped up financial economy, but have done nothing for the real economy, the one that involves real people. Institutional investors and the big players are still trading. GS has one of the largest dark pools and a whole host of trading platforms to support them, but with each trade, a transactional fee is taken. With movement in the markets, more trades are made, more profits flow to the market makers who facilitated the trades. As workers are being laid off (3,000 at Sun announced today), the financial institutions are taking the opportunities afforded them by the gov’t to make money by trading themselves, make money off of others trading, and make money off of the poor and middle class in banking fees and rapacious predatory lending schemes. We’re back to business as usual. The “jobless recovery” is no recovery to the bottom 95%.

  33. moby doug

    October 22, 2009 @ 3:30 am

    33

    Best protection for Wall Street thieves is all the mumbo jumbo “math” that hides the swindling, plus the gullibility of the citizen rubes. That’s how we could have a Magic 8 Ball like Greenspan providing cover for years, with his malarkey about how the market ‘would correct itself” and we didn’t need any of that nasty regulation stuff…..or transparency regarding derivatives….. No wonder the thieves on Wall Street called him a “genius.”

    It’s mindboggling to think that the Bush Administration handed hundreds of billions to the banks essentially “no strings,” just as Hank Paulson, former CEO of Goldman Sachs, demanded. That bailout money was the government’s, which to say the taxpayers’, point of leverage over the bankers/brokers who continue to loot the nation. They are still operating in black boxes, essentially free of regulation. And they will bring down the system again because they’re sure their Rubinista pals (Geithner, Summers) in the Obama Administration will always bail them out.

    The reason we went so long between the cataclysmic Wall Street collapses of 1929 and 1930 and the collapses of 1987, 2001, and 2008, is that the regulatory agencies had TEETH. They don’t any more, thanks to the Reagan Revolution. The nation is a freefire zone for swindlers rich enough to keep legislators and law-enforcers in their employ. It’s very difficult to reform this broken system (just as it’s nearly impossible to reform medical insurance) when so many Congressmen and Senators are owned by banks and insurance companies, and when the architects of the present financial disaster hold jobs such as Secretary of the Treasury and head of the President’s Council of Economic Advisers…..

  34. keefer

    October 22, 2009 @ 5:25 pm

    34

    I wrote an expose on the 2nd quarter profits here (mainly UK banks).
    http://www.fifthinternational.org/content/banks-profit-our-expense
    it’s a knock about polemic but identifies mainly trades, and profit from organising mergers and acquisitions
    a more indepth on the bank bails out is here
    http://www.workerspower.com/index.php?id=196,2077,0,0,1,0

  35. sometimesbullsometimesbear

    October 23, 2009 @ 11:25 am

    35

    John Doe agree that the zero sum game is not zero sum in the short term because it does bring in value for both buyer and seller; however, the game becomes a zero sum game at the end of the cycle. Yes, bubbles do float in the air higher and higher, but at some point they do burst and fall down. It is a cycle and the fella that is caught holding the ball at the end of the cycle is who carries home the crap! The wealth creation cannot go on and on forever.

    Another analogy to the above: Fine, trillions of dollars were lost in the subprime mess, but those trillions of dollars have gone into somebodys pockets isnt it? It hasnt just dissapeared in thin air!!!

  36. George

    October 23, 2009 @ 1:45 pm

  37. Patrick

    October 25, 2009 @ 10:06 pm

    37

    > Then they can turn around and buy short-term bonds that pay 2 or 3 percent annual
    > interest. Now they’re making 2 percent on whatever they borrowed…

    > I asked if they were taking any risk in order to earn this return. “If interest rates went
    > up to 20 percent, even though the bonds are short-term, the price of the bond could
    > fall enough to make the trade a money-loser.”

    Actually, there’s no risk at all in short term bonds. They can just hold them until maturity, get back ALL their principle, plus the interest. The risk of bond prices falling applies if and only if they are long term bonds.

    Also, Wall Street is borrowing from the Federal Reserve, not the US gov’t, and then lending to the gov’t. The Fed is a private bank cartel set up to protect the interests of the biggest banks in the US, but is partly regulated by the gov’t. That may sound like a rant, but it’s exactly true.

  38. Ashiz fan

    October 26, 2009 @ 12:49 am

    38

    Read the blog, ashizashiz.blogspot.com

    Dan Weintraub has many interesting points to make about the current financial situation in the USA.

    read also:

     thecomingdepression.blogspot.com

  39. Sceptic

    October 28, 2009 @ 3:53 am

    39

    Hi there,
    How can I verify that the story published at the Rolling Stones concerning the $1.7 million investment in Bear’s options is a valid story, and not just an urban legend?
    After all, I don’t see any problem for the regulator to locate the person who did that. All thing’s are being recorded somewhere, and the SEC has all means to look for such a transaction (someone said insider trading)?

  40. the actuary

    December 14, 2009 @ 11:43 am

    40

    Hi Philip,

    Regardless of what proportion of the banks money is made from the taxpayer under the current regulatory regime, what is more interesting is where the rest comes from.

    As a reasonable approximation, the financial services sector is a zero sum game – most financial activity is not dedicated to the socially useful activities of providing capital to other, non financial companies. So given that they are not generating significant quantities of wealth themselves, they must pay themselves from cash syphoned off from your savings, pensions and insurance contributions. It’s not a direct charge – that goes to your fund manager or financial advisor – but an opportunity cost, a return that you would have got on your investment were it not for banks trading on their own account, using information not available to you, to profit at your expense.

    So, let’s say everyone saves 10% of their income in a pension scheme (either directly or via their employer) Thus ~10% of annual GDP goes into some form of savings or investments. Now lets say 3% of GDP is accounted for (I’m not using the word generated, because nothing is generated except transactios) by pay, bonuses and profits of major financial firms taking slices of transactions made on behalf of your pension investment. There you go – for every $1000 you pay in, someone takes $300 out before you see any of the return. If your fund manager takes another 1.5% cut of your total fund every year, he will have taken a further $200 of every $1000 paid in over 40 years, leaving you only 50% of the total return from the money leant to the companies who manufacturer something we actually want, and halving your pension.

    Hence you are likely to retire into poverty.

  41. Melanie Stewart

    May 5, 2010 @ 1:19 pm

    41

    I developed conceptual maps as part of my MFA thesis. I am considering extending the body of work to include a map that compares the crash in the thirties to the current market.
    As my research is in its early stage, and finance is not my area of expertise, I would welcome a dialogue that includes all sides of the story.

  42. John Gills

    May 22, 2010 @ 4:14 pm

    42

    The rich and powerful have succeeded in suppressing the word plutarchy which describes what they have created in order to rule over everyone else.

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