Goldman Sachs Cash Flow, Earings, Solvency?

NOTE: I received the post below via email from Dave. He originally published this on www.LeMetropoleCafe.com on February 22, 2009

Dave From Denver - More on Goldman Sachs' massive negative cash flow - I wanted to follow up on the financial information on Goldman Sachs that was presented in Midas last week. The negative operating cash flow numbers were so staggering that I wanted to see what was going on for myself. Goldman went public in early May 1999, so I tallied up the numbers from 1999 thru the first three quarters of 2008, the most up to date financials filed by GS. To summarize what was reported last week (my numbers will be slightly different because I shifted the time period slightly). From 1999 - 3rd qtr 2008, Goldman reported at total of $48.4 billion in net income. During this period, Goldman reported a total of $238 billion of negative cash flow from operations and investing (mostly operations) which was funded by $246.5 billion in cash from financing, primarily bank debt and bonds.

I also wanted to look at the quality of Goldman's earnings. From 2002 thru Q3 2008, net interest earned represented anywhere from 35.1% to 113% of total net income (77% of net income during 2008 so far has been this "carry trade"). That means that not only has Goldman's operations sucked up $238 billion in cash over the last 10 years, the quality of its earnings has been largely dependent on being able to earn more interest on its investments than it pays to finance those investments. I thought Goldman Sachs was an investment bank that made money from selling stocks and bonds, advising on mergers and acquistions and other traditional securities firm activities. But based on the nature of their earnings, Goldman looks more like an savings and loan bank, hoping to make more on its investments (interest income) than it has to pay out in the cost of its liabilities (interest expense).

If you step back and think about what Goldman is doing conceptually, the operations of the firm look somewhat like a Ponzi scheme. As you follow the pattern of cash flow use and the financing required to fund their operations, it looks like they require more and more financing just to tread water. For example, in 2007, GS had $1.1 trillion in assets and generated $11.4 billion in net income (GAAP accrual income, not cash on cash economic income). This is a 1% return on assets. Do the large shareholders of GS really want to pay out massive compensation to the top management of GS for delivering a whopping 1% return on assets? I can do better and take less risk investing in 1 yr. bank CD's. I'm not quite sure why anyone would want to own this stock. I may buy some long term out of the money puts on GS on Monday.

What I find even more interesting to contemplate is that, based on looking at Goldman's uses and sources of cash, if the market for funding Goldman's balance sheet were to slow down, there is a high degree of probability that Goldman would become insolvent. Remember, Goldman's ability to service its debt and rollover its short term financing is highly dependent on the quality of those assets. If the music stops on Goldman's source of financing, and Goldman has no ability to generate cash from its portfolio of rapidly deteriorating assets, Goldman collapses. This would explain why the Fed/Treasury is working so hard to squeeze money from the

Government/taxpayer to keep these banks alive. Let's not forget that the Fed is quickly swapping bad assets from these investment banks for Treasuries held by the Fed and taxpayer gurarantees. For now, this is keeping firms like Goldman alive...

Then, a comment from one of GATA's finest:

But what I find most amusing is the statement made by CEO Llyod Blankfein the other day, under oath in front of Congress, that he didn't really need the $10 billion in TARP that Paulson gave GS in October and that he wanted to pay it back. Well Lloyd, where is that $10 billion? If you didn't need it, why don't you pay it back today? The answer to why you can't pay it back is no hidden secret - the answer is that Goldman can't pay it back because they need every dime they can get ahold of just to keep their operations going. The truth will always be found if you follow the money. My hat is off to the Midas contributor who originally looked into this quite revealing topic. My guess at to why Jon Winkelreid, who I remember as a rapidly rising star in fixed income corporate finance when I worked there for 2 years in the late 1980's, unexpectedly left Goldman last week despite being a candidate to run the firm is that he is wisely trying to distance himself legally from being associated with a collapsing Ponzi scheme. ***