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Goldman Prop: A Veritable (Physical) Gold Mine... As Suspected

Tyler Durden's picture




 

Over a year ago we attempted to deconstruct Goldman's prop trading activity using scraps of data from the tax returns of the Goldman Sachs Foundation. The reason we did that, is that up until today, the firm had never disclosed the non-client aspect of its trading, instead dumping all related revenues and profits in the umbrella "Trading and Principal Investments." That is no longer the case, as starting today the firm will break down its client facing and prop ("Investing and Lending") revenue and profit streams. The reason for our long-term fascination with Goldman prop trading, which is nothing less than a glorified hedge fund, and has no client flow focus whatsoever (presuambly), is that we had always claimed it accounts for a substantial portion of the firm's if not top, then certainly bottom line. After all it was Lucan van Praag who told us directly, that prop trading contributions to Goldman were really de minimis, a response which we took extremely skeptically as the margins associated with a modest revenue amount may well be huge and thus result in a substantial pre tax net income benefit to the firm. Today Goldman also published an 8-K that did a pro forma breakdown of its earnings. To our great surprise, we were correct in assuming that Goldman prop has been the dynamo behind the firm's profitability in 2010.

As a reminder, here is how our exchange with Goldman proceeded back in late 2009:

4)      “Does the firm's FICC revenue line have absolutely no prop trading embedded within it? Goldman made $20 billion in FICC year to date: is none of this $20 billion due to capital at risk, or is it all due to wide bid//ask spreads? ”

We’ve said publicly that prop trading represents approximately 10% of this year’s reported net revenue.  Some of that revenue is reflected in the FICC line.

We generate the vast majority of our revenue in FICC by facilitating trading activity for our clients and nearly all our revenues in FICC are “due to capital at risk” (your phrase).  In periods  when capital withdraws from the market, bid-offer spreads tend to widen and we benefit to the extent that we are willing to commit capital and do so successfully. These activities necessarily involve risk taking.

Here are the facts: below we present the breakdown, per Goldman, of its now 4 key divisions, with the "Investing and Lending" group singled out.

Two things should be immediately obvious:

1) while revenues for the prop group were indeed not material compared to the other groups in the company, its pre tax net income margin was astounding, and seems to gravitate around 50%. Compare this to the Flow group, whose margins fluctuate with order flow and market conditions anywhere between 43% and 16% in the past three quarters. Additionally, margins for the other two traditional groups: Investment Banking and Investment Management are so low, that the contribution from these groups to the bottom line combined is less than Prop alone!

2) The net income contribution from Prop to Goldman is massive: in Q1 it was 20.4% of total, in Q2 it was a whopping 41.2% and in Q3 it was 29.6%. Does Mr. van Praag still contend that Prop is a minimum contributor to Goldman's net income? In fact, YTD Prop has accounted for 27.2% of all pre tax earnings, and the group with the most stable top line and margin. Does anyone see now why Goldman was so modest in disclosing the details behind Prop?

Of course, what this means is that Goldman will never end prop trading as such. It will merely rebrand it as it has now done to "Investing and Lending." And with Volcket now out of the picture, and all the crappy prop traders fired with the excuse that Goldman was ending its prop business, the firm can continue to generate massive top line revenue and bottom line profits in a group which is basically Prop trading in sheep's clothing. Which is as we had always expected.

The only good thing to come out of this, is that Goldman will now be forced to break down its VaR for both the Flow and the Prop groups. And we can't wait to see just what the risk differential that the glorified and backstopped hedge fund takes, when it is trading on behalf of clients and on behalf of itself, knowing full well that it can never possibly blow up courtesy of the Bernanke Put.

We are also looking forward to JP Morgan disclosing precisely the same detail, and we also hope that Jamie Dimon can find the time to disclose the alleged massive losses the firm has suffered in its commodity prop trading division in the past two quarters courtesy of the XY-sigma move in precious metals which the Fed's favorite bank was unfortunately not axed all that well in...

 

 

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Tue, 01/11/2011 - 16:01 | 867876 knukles
knukles's picture

Where's Van Praag?  Somebody wanna talk to him.

Tue, 01/11/2011 - 16:04 | 867885 dracos_ghost
dracos_ghost's picture

+1.

And gee, let's give them discount window access and PPT responsibilities too.

 


Wed, 01/12/2011 - 08:47 | 869558 boooyaaaah
boooyaaaah's picture

And they need to keep the ability to naked short -- shorting stocks without borrowing -----

And front running getting in front of trades

And the to big to fail perception --- retail traders by investing in GS can be part of the wink wink new economy. And the retail dummies that don't invest in GS still have to pay for the GS bail outs through taxes and new money creation.

All this with the help of favored Hedge Funds,Who conceal their positions

And GS through the Prop window can short products they sell to the public . MBS

Keep up the good work Tyler

Tue, 01/11/2011 - 16:06 | 867889 faustian bargain
faustian bargain's picture

I was going to ask the exact same thing. I'm guessing he got a direct order from the chief executive squid himself, to cease fraternizing with the hoi-polloi.

Tue, 01/11/2011 - 16:05 | 867887 alexwest
alexwest's picture

@Where's Van Praag?
probably shitting his pants...

alx

Tue, 01/11/2011 - 16:07 | 867891 thepigman
thepigman's picture

The whole equity market is the prop

trading desks plus the hedgies.

C'mon in...

Tue, 01/11/2011 - 16:09 | 867896 thepigman
thepigman's picture

Oh...and the Wanker

Tue, 01/11/2011 - 16:12 | 867898 thepigman
thepigman's picture

Even so it's running only 80% of

2009 volume and dropping. Word

gets around.

Tue, 01/11/2011 - 16:13 | 867901 gwar5
gwar5's picture

Anagram: Machos Glands = Goldman Sachs

Tue, 01/11/2011 - 16:17 | 867916 Seasmoke
Seasmoke's picture

WOW 41% in Q2.....thats unbelievable.....something is just not right at Goldman

Tue, 01/11/2011 - 16:19 | 867918 plocequ1
plocequ1's picture

The market is up. Its all right.

Tue, 01/11/2011 - 16:24 | 867929 JW n FL
JW n FL's picture

I am crying laughing!!! I swear to God!!!! CRYING LAUGHING!!!!!

Tue, 01/11/2011 - 16:24 | 867930 Stu
Tue, 01/11/2011 - 16:27 | 867942 Common_Cents22
Common_Cents22's picture

 

human traders are becoming props themselves, being replaced by HFT computers.

Tue, 01/11/2011 - 16:27 | 867943 JW n FL
JW n FL's picture

Incase the SEC cant follow a link all of the lies should be here on one page... no porn here so no worries of the page being read by anyone from the SEC... but just in case.. Sorry in advance to all the purists for the double post!

********************************************************************************

Dear Mr. Durden:

We read your comments about prop trading with interest.  I’ve addressed some of the points you raised, as well as the questions you directed to David Viniar and me.  The fact that I haven’t necessarily addressed all your points shouldn’t be construed as tacit acceptance of any of them.

1)      “Considering that Goldman must disclose a trading VaR, or value at risk on a quarterly basis, which over the past year has averaged over $200 million, one can back into actual prop capital and revenue”

Our VaR is primarily driven by client-related activity rather than proprietary activity.  Using VaR to “back into actual prop capital and revenue” would produce a meaningless result.

2)      “A month ago Zero Hedge presented a unique glance into Goldman’s prop trading activities courtesy of the 2008 tax filing of the Goldman Sachs Foundation”

Your premise wrong. There are tax and legal restrictions which prohibit the firm from trading on the Foundation’s behalf.

3)      “Goldman disclosed that it had $352.2 billion in fair value of principal trading instruments at September 30, 2009. How much of this is considered allocated to prop if this is in fact a distinct strategy from principal?”

The $352.2bn is the fair value of our trading assets, the vast majority of which consist of trading inventory we use to make markets for our clients.

4)      “Does the firm's FICC revenue line have absolutely no prop trading embedded within it? Goldman made $20 billion in FICC year to date: is none of this $20 billion due to capital at risk, or is it all due to wide bid//ask spreads? ”

We’ve said publicly that prop trading represents approximately 10% of this year’s reported net revenue.  Some of that revenue is reflected in the FICC line.

We generate the vast majority of our revenue in FICC by facilitating trading activity for our clients and nearly all our revenues in FICC are “due to capital at risk” (your phrase).  In periods  when capital withdraws from the market, bid-offer spreads tend to widen and we benefit to the extent that we are willing to commit capital and do so successfully. These activities necessarily involve risk taking.

Over the last 5 years, prop investing activities have represented about 12% of firmwide net revenues

5)      “What was the pro rata allocation to Goldman Sachs Foundation as a percentage of capital per each trading ticket in 2008? Does GSF have a dedicated trading silo within Goldman?”

As I said above, as required by law, the Goldman Sachs Foundation is managed separately. There are no “trading silos” dedicated to the Foundation’s activities

6)      “Why did the Goldman Sachs Foundation not participate in Goldman's prop CDS trades?”

See above. 

7)      “How much did Goldman's prop operations lose in 2008 trading Russell 1000 futures?”

The amount was de minimus.

8)      “How much did Goldman's prop operations lose trading all equity, credit and commodity products?”

Not disclosed

9)      “When will Goldman clearly and distinctly segregate on its income statement the prop trading profit and losses, if these are in fact unique from "principal" trading as defined, and attach an MD&A to all relevant disclosure?”

Our proprietary activity is small in the context of the firm’s overall revenues and risk exposures.

10)     “Goldman is insinuating is that the firm's prop trading really carries virtually no risk.”

We don’t think any trading activity is risk-free. Risk is risk, and our job is to make sure individual risks are appropriately sized.

11)     “How do you define market risk?”

We define it as the potential for change in the market value of our trading and investing positions.

12)      “Do you take fixed price positions?”

Please explain your question.

13)     “Are you exclusively a hedger or do you ‘optimize’ your assets?”

Please clarify what you mean.

14)     “Do you have a risk policy?”

Yes.  We think of risk management as being one of our core competencies and it remains integral to our success as a firm. 

Our management team is active in risk management discussions across the firm and open discussion on the subject are encouraged.  By the way, we think fair value accounting is a critically important aspect of risk management.  Another important tenet of our approach to risk management is the independence of control functions from the business units

We also use a variety of approaches to monitor risk.  In addition to VaR, we use multiple stressed-based methodologies, including jump-to-default analyses, to quantify tail risks. 

16) “How do you monitor trading/hedging limits?”

Virtually all of our equity and fixed Income businesses receive VaR based risk-limits, aged inventory limits and balance sheet limits. The limits are reviewed by senior management and Risk Committee on a regular basis.

17)  “Mr. David Viniar, who recently said that the firm doesn't benefit from any implicit government guarantee. Goldman, as presented here, benefits directly from $21 billion in FDIC (taxpayer)-insured bond issues. How does Mr. Viniar reconcile this particular fact with his spurious claim?”

We don’t believe that we have any form of guarantee, implicit or otherwise, from anyone and we certainly don’t manage our business as though we do.

We issued debt under the FDIC’s Temporary Loan Guarantee Program and, like every other bank that issued debt under the program, paid the FDIC a significant amount of money upfront for the guarantee. We also pay interest to the investors who bought the notes. We stopped issuing debt under the program in March. The notes are not callable.

In the context of the firm’s approximately $900 billion balance sheet and hundreds of billions of dollars of funding, we don’t think any informed investor would believe that FDIC insurance on a small portion of our funding represented a “guarantee” of the firm.

Regards / Lucas van Praag

Tue, 01/11/2011 - 17:44 | 868253 IQ 145
IQ 145's picture

 Put some tranny porn on the page too; maybe we can get the SEC employees to read it.

Tue, 01/11/2011 - 16:33 | 867973 Hondo
Hondo's picture

Yet the Fed lets this organization be classified as a bank with "full" access to the discount window.......it is completely insane and corrupt....but what should you expect from a corrupt organization as the FED anyway?

Tue, 01/11/2011 - 16:35 | 867978 buzzsaw99
buzzsaw99's picture

These activities necessarily involve risk taking...

 

My ass it does. They won two hundred days in a row last year. Some luck.

Tue, 01/11/2011 - 16:43 | 868014 b_thunder
b_thunder's picture

GS "Investing and Lending" should be renamed "Frontrunning and Usury" group

 

 

Tue, 01/11/2011 - 17:08 | 868104 topcallingtroll
topcallingtroll's picture

They are doing god's work. HFT is not frontrunning per GS. They would say it is more like taking candy from a baby or actually taking one lick from each of thousands of babies' lolipops and hoping each individual baby doesnt notice. That's gods work for ya!

Tue, 01/11/2011 - 17:51 | 868266 Cdad
Cdad's picture

Jamie Dimon of JP Morgan on the Blow Horn [CNBC]...not his usual cool self.  He is using the interview to pitch to America, speaking right to us through the camera [very punk ass move].  If you ask me, this is not going well at all.  Perhaps, upcoming disclosure is not a pretty thing.

His thoughts on the European debt crisis were literally juvenile.  Hyperventilating on the issue of future JPM banks in China.  F'n China?  Did he just use the standby China excuse? 

This guy...he needs to move along, out of the banking business and off to spend more time with his family.

Capital will not form with banks where clear evidence of systemic criminal behavior is present.  As such, our mortgage markets cannot clear while these guys defend their off balance sheet and illegal mortgages, blitzing the system with fraudclosure rushes.

This does not even speak to the silver and copper commodity desk issues.

He is closing with the plainly obvious..."business needs to succeed in order for the country to succeed."  Duh.  What a gas bag.

 

This bank is a clear sell.

Tue, 01/11/2011 - 18:24 | 868404 Cdad
Cdad's picture

WTF?  On Fast Money, M. Lee just said that Jamie Dimon did not say the things I just told you he said, but rather "he meant to say that he was raising the dividend in the 2nd quarter."

Now that is interesting because Jamie Dimon said no such thing during his interview.

This is a clear attempt over at the Blow Horn to make a headline that literally does not exist.  Fascinating...the propaganda.  Tyler...this is a very interesting instance of broadcast stock manipulation.

ATTN Comcast...more value destruction, each and every minute these guys are allowed to broadcast.

Tue, 01/11/2011 - 18:55 | 868474 steelhead23
steelhead23's picture

On another blog, familiar to many here, the poor, poverty-stricken folks at the opposite end of the socio-economic ladder from the likes of Lloyd Blankfein and the rest of the Vampire Squid's minions, are termed leechf***s, because they cost the country more than they produce.  Help me out folks, if the poor are leeches, exactly what term is applicable to a rich company that parasitizes the financial markets and thereby sucks down, not just tax dollars, but nibbles a bit on everyone's VaR.

Thank you Tyler for continuing the focus on the true enemies of the American People.  I see no evidence whatsoever that the populace understands who it is that is sucking their blood.

Wed, 01/12/2011 - 03:32 | 869452 dcb
dcb's picture

a guy at the squid telling lies, tell me it aint so Joe

Wed, 01/12/2011 - 10:09 | 869675 Spigot
Spigot's picture

dcb, we've gotta have another one of our little talks...

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