How Goldman Profits From the Credit Crunch

How does Goldman Sachs do it? The bank has emerged almost unscathed from the credit crunch: last week it notched up $2bn in profit in one of the worst quarters in the history of banking. How different the picture is elsewhere. UBS has recorded losses of $37bn and parted company with its chairman Marcel Ospel and chief executive Peter Wuffli. Lehman, Citigroup and Merrill Lynch have all taken huge write downs and lost key executives who were forced to walk the plank by angry shareholders. Northern Rock and Bear Stearns had to be rescued by the authorities, but Goldman has prospered. Why?

For a start, the bank is extremely good at managing risk. Some have likened Goldman to a huge hedge fund because it is prepared to use its balance sheet to take positions in almost anything you care to mention: commodities, mortgages, currencies, equities, commercial property. Quite often the bank uses money stumped up by the people who work there, but it also raises funds from debt markets, clients, private investors and - more recently - from the US Federal Reserve, which is currently providing collateral for all the US banks because of the credit squeeze.

But unlike some European banks, where the activities of traders have gone more or less unnoticed by management (the same was true of Britain's Barings, which let Nick Leeson run amok), Goldmans affords prime position in its hierarchy to the chief financial officer and senior risk managers who monitor staff so closely that at any one time the bank can assess its worldwide risk and reward profile down to the last dollar.

That is crucial in an organization such as Goldman, which encourages staff to 'think outside the box' and to aggressively pursue money making opportunities wherever they might arise, but only after talking through their ideas with 'the team'.

The bank dislikes the idea of 'star players' and does all it can to prevent deal makers from becoming personalities. Flamboyant displays of wealth and ego are frowned upon, although Goldman bankers enjoy staggeringly large disposable incomes. Somehow the bank combines its penchant for rugged individualism with an over-arching duty of collective responsibility. Against that cultural backdrop, early in 2007 a small group of traders sought permission from management to take multi-billion dollar bets against the US mortgage market, months before the sub-prime crisis broke and in the face of evidence that suggested the credit boom had much further to run. It was a measure of Goldman's confidence in its own people and systems, as well as its ability to oversee risk, that executives gave the traders the green light, enabling the bank to profit from the slump. 'We are defensive risk managers, working to ensure that our franchise and reputation are protected,' says David Viniar, Goldman's chief financial officer.

Goldman has shown it is ready to exploit the damage that the credit crunch has inflicted on others: its latest figures show that it made over $600m from underwriting fees, money that it has earned from raising capital for financial institutions that have been brought low by credit losses. Goldman has moved to capture hedge fund business from Bear Stearns, which almost collapsed in April, and it has transferred its top deal makers from comfortable positions in London or New York to Asia and South America, where the markets are still booming.

But how long can Goldman retain its Midas touch reputation? The question has been asked countless times, but rarely has the financial environment appeared as bleak as it does today. Trading is volatile and positions can change in the blink of an eye, so even the best risk managers will be sorely tested.

No less worrying is the looming regulatory backlash against all investment banks that are being blamed for the reckless lending that led to the credit crunch in the first place.

Given its record, however, betting against Goldmans is a giant leap of faith that few are willing to take.