Understanding Goldman Sachs

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A day after claiming the Big Man Above was on its side, Goldman Sachs (NYSE: GS) CEO Lloyd Blankfein gave another baffling defense of his firm's practices, telling a banking conference that over the years, "We pretty much stuck to our investment-banking knitting."

Like most defenses of the megabank culture, this would be a good argument ... if it were true. Alas, we'll refer to Goldman's recent quarterly results, which tell a slightly different story:      

Segment	Q3 2009 Revenue
Investment Banking	$899 million
Trading and Principal Investments	$10 billion
Asset Management	$1.4 billion

If you're wondering how investment banking -- proud contributor of 7% of revenue -- qualifies as Goldman's "knitting," while trading, where 81% of revenue is derived, doesn't get an honorable mention? Congratulations, you've cracked the code!

If you want to see what a bank that sticks to its investment banking knitting looks like, check out Goldman Sachs back in 1998:

Segment	1998 Revenue
Investment Banking	$3.4 billion
Trading and Principal Investments	$2.4 billion
Asset Management	$2.8 billion

Back then, 40% of revenue came from investment banking. How something can go from 40% of revenue to 7% of revenue and still qualify as sticking to your knitting is bewildering. Annualized out, investment banking revenue has stayed about flat over the past 11 years, while trading and principal investments revenue has gone up seventeen-fold. Think about that.

No one can blame Blankfein for wanting to come off as being a good ol' investment banking boy. Investment banking is the relatively riskless practice of advising mergers, taking firms public, and underwriting securities. Investment banking helps businesses grow and thrive. It promotes entrepreneurship. Investment banking doesn't make you too big to fail.

That's how banking used to work. Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) co-Chairman Charlie Munger commented on this earlier this year, saying, "Investment banking used to be a consulting business. It was extremely boring. The partners didn't make nearly the kind of money they do today. They were very conservative businesses."

Today? It's all about trading and risk taking, preferably while backstopped by taxpayers. That's where the money is.

We shouldn't just pick on Goldman Sachs here. Morgan Stanley (NYSE: MS), JPMorgan Chase (NYSE: JPM), Bank of America (NYSE: BAC), and Citigroup (NYSE: C) all rely on trading operations to either rake it in or cover up loan losses, too.

But we're heading into a fierce national debate over what to do about "too big to fail." No doubt, banks will be quick to tell you that everything's cool, and no changes are necessary.

Hogwash. The makeup of these banks needs to be called out as they are. And, by and large, they aren't even banks. They're trading conduits, backed by you and me: proud, hardworking American taxpayers, ensuring that few Goldmanites won't be subjected to the abject poverty of a life with less than a seven-figure income.