The Bullish Case for Goldman Sachs

Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Editor's Note: The original version stated Goldman Sachs acquired Morgan Stanley, we meant Merrill Lynch. This version has been corrected.

The investment banking industry is still going through some very painful adjustments, and there seems to be no end at sight for the industry wide downsizing.  The latest news in that direction comes from Morgan Stanley (NYSE: MS) which announced last week that it will be cutting 1,600 jobs from its global workforce. But sooner or later things will turn for the better, and Goldman Sachs (NYSE: GS) will most likely be the clearest beneficiary from the turnaround.

The Rise and Fall of Investment Banking

Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers, and Bear Stearns used to rule the investment banking business. These powerful banks used and abused leverage, traded all kind of securities and obscure derivatives, managed internal hedge funds and made big fat fees on  client advisory and IPOs among other activities. They were at the top of the financial world, and looked like unstoppable money making machines run by the most brilliant and ambitious minds in the business world.

As it turned out, these minds were certainly very ambitious, but not as brilliant as most people assumed. They were basically making a lot of money by assuming too much risk, and when the credit crisis showed its ugly face, it became apparent that these banks were not going to survive on their own. Even worse, they threatened to collapse the world economy on their way down. Something needed to be done and, for better or for worse, a solution was found.

While Lehman Brothers ended in bankruptcy, Bear Sterns was bought by JP Morgan (NYSE: JPM) with a big help from the Federal Reserve, and Merrill Lynch was acquired by Bank of America (NYSE: BAC). Both JP Morgan and particularly more Bank of America had their share of troubles because of the toxic assets included in these deals, so even at fire sale prices these acquisitions had questionable results.

Goldman and Morgan Stanley found a different solution, they became bank holding companies, and this gave them access to cheap funding from the Federal Reserve. They also received TARP money and raised additional funds from outside investors. At the end of the day, Goldman and Morgan Stanley remained as the last standing pure investment banks, although JP Morgan still has a sizable investment banking business.

The Last Bad Guy Standing

Goldman Sachs may not be the only investment bank, but it´s certainly one of the biggest players in a consolidating industry. Perhaps more important, it seems to be the only company aggressive enough to capture market share and increase profitability in the middle term. While JP Morgan is cutting its risks back and recovering from the London Whale scandal, Morgan Stanly is definitely on a retreat, aggressively reducing its workforce and cutting exposure to big business areas like bond trading.

Goldman is firing employees too; it cut 700 jobs during the first nine months of 2012 as part of a plan to reduce annual expenses by $1.9 billion. But the bank is the only one which seems willing to take more risks in the quest for growth opportunities and higher profitability.

In spite of the fact that  Goldman´s CEO Lloyd Blankfein went public saying that the bank is no longer involved in proprietary trading – trading with the bank´s money as opposed it doing it in behalf clients – Bloomberg recently uncovered the existence of a secretive group called Multi-Strategy Investing - or MSI- which is dedicated to, well, proprietary trading.

This has raised a lot of criticism, but the existence of this sort of internal hedge fund is apparently not against regulations. MSI reportedly holds its positions for more than 60 days, which makes it compliant under the Volker Rule. Besides, MSI has assets under management of $1 billion, which is fairly low for a bank with almost a trillion dollars in assets. Even if the MSI group is enormously profitable - or un-profitable - it will hardly move the needle at Goldman.

But the existence of MSI shows that Goldman´s culture is still intact, and this has important implications when it comes to investment returns over the coming years. While others are mostly focused on reducing costs and adapting to a stricter regulatory environment, Goldman is doing so while still looking for ways to increase earnings.

Due to its more aggressive attitude, the company will likely outgrow the competition over the next years, and the investment banking business still has a lot of upside room in the long term post crisis recovery. Goldman and its peers will never go back to the sky high returns obtained during the credit bubble, but that doesn´t mean that they can´t grow and deliver healthy profitability while using moderate levels of leverage and overall risk.

Bottom Line

Investment banks are still trying to adapt to the post crisis environment, but the worse is probably over in terms of balance sheet cleaning and business restructuring. One company stands to benefit the most from the long term recovery in the industry, and that´s no other than Goldman Sachs.


acardenal has no position in any stocks mentioned. The Motley Fool recommends Goldman Sachs Group. The Motley Fool owns shares of Bank of America and JPMorgan Chase & Co.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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