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Inside Goldman's Money Machine

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Goldman Sachs (NYSE: GS  ) filed its quarterly report with the SEC on Wednesday, giving investors a peek at just how consistently profitable its trading activity was in the third quarter. The bank made over $100 million in daily profits on over half of the 65 trading days in the quarter, recording just a single daily loss. There's another number in the report that helps to explain this extraordinary profitability; unfortunately, it also highlights the massive distortions the "too big to fail" doctrine creates in our capital markets.

0% financing available for all qualified speculators (almost!)
The number I'm referring to is Goldman's long-term borrowing cost during the third quarter -- an absurdly low 0.92%. Goldman is an extreme, but, as the following table shows, the large investment banks are all benefiting from an enormous implicit subsidy from the federal government:

"Too-Big-to-Fail" Banks

Average Interest Rate, Long-Term Borrowings -- Q3 2009

Average Interest Rate, Long-Term Borrowings -- Q2 2009

Goldman Sachs (NYSE: GS  )



Morgan Stanley (NYSE: MS  )

Filing not yet available


Merrill Lynch (part of Bank of America (NYSE: BAC  ) )

Filing not yet available


JPMorgan Chase (NYSE: JPM  )



Highly Rated Corporates



Berkshire Hathaway Finance Corporation, (debt guaranteed by Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) )

Filing not yet available


Johnson & Johnson (NYSE: JNJ  )



*For the six-month period ended June 30, 2009.
** Weighted average interest rate for debt issued by Merrill Lynch and its subsidiaries at June 30, 2009.
*** As of June 30, 2009. This rate covers short- and long-term borrowings.Source: Company filings.

What could justify the disparity between the borrowing rates of investment banks against those of a staid conglomerate and a pharmaceuticals giant? Surely no-one will argue that the business and financial risk of Berkshire Hathaway (total debt to equity ratio: 33.9%) or Johnson & Johnson (NYSE: JNJ  ) (29.4%) is greater than that of Goldman Sachs. The only explanation I can see is the government backstop (something Goldman shareholders can't rely on, and they definitely haven't been properly compensated for the risk they have been running).

Don't let's leave taxpayers on the hook again
U.S. financial authorities must tackle the problem of "too-big-to-fail" head-on. I can't think of anyone in any position of responsibility that has even publicly entertained the idea of breaking up financial behemoths. In Europe, EU competition authorities are forcing Royal Bank of Scotland, Lloyds TSB and ING to break themselves up in exchange for state aid. If we can't find the will to address this rotten state of affairs, U.S. taxpayers will simply continue to subsidize excess investment bank profits.

U.S. Government policies are having other nefarious consequences. Read this because the dollar is doomed.

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Alex Dumortier, CFA, has no beneficial interest in any of the companies mentioned in this article. Berkshire Hathaway is a Motley Fool Stock Advisor and Motley Fool Inside Value recommendation. Johnson & Johnson is a Motley Fool Income Investor pick. The Fool owns shares of Berkshire Hathaway. Try any of our Foolish newsletters today, free for 30 days. Motley Fool has a disclosure policy.

Read/Post Comments (7) | Recommend This Article (9)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 06, 2009, at 3:49 PM, cmfhousel wrote:

    I think it's because interest-rate swaps allowed them to essentially convert their fixed-rate long-term debt into floating-rate debt, where the 0.9% rate is consistent with current short-term rates. Still, I agree, it's crazy to have a bank with borrowing costs that low.

  • Report this Comment On November 06, 2009, at 4:20 PM, davejh23 wrote:

    This favorable financing can't last forever, can it? At some point, their long-term borrowing costs are going to increase dramatically...and their profitability is going to fall off a cliff...unless there's flat-out corruption involved...

  • Report this Comment On November 06, 2009, at 6:06 PM, starbucks4ever wrote:

    "The bank made over $100 million in daily profits on over half of the 65 trading days in the quarter, recording just a single daily loss"

    This sentence says too much and too little. If it refers to the closed positions only, then Goldman's results are perfectly natural. In that case the "unrealized losses" column should reconcile the reported miracle with the probability theory. If, on the other hand, the numbers refer to the day-trading activity, then there is only one other trader who's been that successful: Bernie Madoff.

  • Report this Comment On November 06, 2009, at 6:12 PM, jkipling wrote:

    That right there is the crux of what's wrong with American monetary policy.

    It's simple math.

  • Report this Comment On November 07, 2009, at 9:17 AM, WilliamaA wrote:

    While there may be many reasons to criticize Goldman Sachs, their borrowing rate is not one of them. It simply reflects the fact that short term interest rates are very low.

    Goldman finances its short term trading portfolio in the same way that investment banks have done for decades -- by pledging the assets in the portfolio to obtain short term loans. J&J's borrowing rate is much higher because they are financing long term assets (property, plant and equipment, also drug patents) with longer term money. With a strongly upward-sloping yield curve, long term money costs more.

    There is no taxpayer subsidy here.

  • Report this Comment On November 07, 2009, at 9:32 AM, cmfhousel wrote:


    As Alex's article mentions, this *is* long-term debt we're talking about, not short-term borrowings.

    As to the comment "There is no taxpayer subsidy here," well yes, there is. Goldman issued tens of billions worth of long-term debt backed by the FDIC. J&J couldn't. That's a subsidy.

  • Report this Comment On November 08, 2009, at 7:16 AM, wuff3t wrote:

    No, no, it's okay - they're doing God's work, remember? You can't judge GS by the standards of mere mortals...

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