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Goldman Profits Double, but How Does It Make Its Money?

In a 2010 two-part Making Sen$e report, the first of which you can watch above, Paul Solman explored how Goldman Sachs makes its money. In the second segment, which you can watch below, Paul looked more closely at Goldman’s use of taxpayer money.

Goldman Sachs’ second-quarter profits doubled this year compared to last, they announced Tuesday. Beating expectations of a $2.82-per-share haul, Goldman pulled in $3.70 a share in 2013’s second quarter compared to $1.78 a share in the second quarter of 2012. Net income rose from $962 million to $1.93 billion.

This graph from Quartz shows that this year’s net income is still far below its peak after the financial crisis.

“The firm’s performance was solid, especially in the context of mixed economic sentiment during the quarter,” Goldman chairman and chief executive Lloyd C. Blankfein said in a statement.

As Bloomberg notes, throughout the first half of 2013, Goldman Sachs has devoted proportionately less of its revenue to staff compensation than over the same period last year, and in the second quarter, they eliminated 300 positions.

But just how did Goldman increase their profits so dramatically? The bank reaped major returns from investing its own money. As Reuters reports, “The biggest source of growth was the investing and lending division, where revenue surged to $1.42 billion from $203 million a year earlier. JMP Securities analyst David Trone had expected the segment to produce revenue of $850 million.”

With Goldman’s investing and trading segment producing nearly seven times the profit this quarter as the same period last year, we decided to revisit our two-part Making Sen$e report from 2010 on how Goldman Sachs makes its money. After watching the two segments, consider this defense of Goldman that we received from a viewer.

But first, here’s an excerpt of a conversation from our first segment between Paul Solman and Nomi Prins, a former Goldman Sachs trading strategist, about how Goldman posts such extraordinary profits:

Paul Solman: But consider how they’re making those bucks, says Nomi Prins, on inside knowledge that comes in, as when she was there, with every trade a client asks Goldman to make.

Nomi Prins: And just by evidence from the profits that they make and where they make them and what divisions they make them in, they’re not sitting on that knowledge. They have to be — they are trading on that knowledge.

Paul Solman: So, they know somebody is going to buy a commodity or a currency, so they either buy that commodity or currency first or a commodity and currency very much like it?

Nomi Prins: Any information that you get, particularly if it’s going to move the markets a lot, is — is — is going to filter into the trading positions you take.

But, we asked in 2010, isn’t that front-running, trading ahead of your clients to profit from the price changes that will come from the clients’ trades, but for your own firm’s benefit? And isn’t that, strictly speaking, illegal? Paul put the question to David Stockman, director of the Office of Management and Budget under Ronald Reagan and no stranger to the Making Sen$e Business Desk, as you can read here and here.

David Stockman: The long and ancient secret of Wall Street is they have always been front-running their clients. In other words, when you’re in the customer trading business, and then you’re in the proprietary business, which trade are you making first? I don’t know. And, if it’s in milliseconds, how’s anybody going to figure it out?

So, I don’t know if you ought to get all exercised on that or not, but the fact they make all this money in proprietary trading is clearly part and parcel of being a massive player, dealer, in the markets for both customer trades and house trades.

Last week, we dove deeper into the milliseconds’ advantage trading firms enjoy with high-frequency trading.

After Goldman reported the most profitable year in Wall Street history in 2010, we wanted to investigate claims that taxpayer money — funneled through the Troubled Asset Relief Program (TARP) — was supporting most of its trades. Check out that report below.

In his second report, Paul Solman looked more closely at the role taxpayer money plays in Goldman’s profits. You can read the full transcript here.

And in other Goldman-related news, the Securities and Exchange Commission began Monday its civil fraud case against former Goldman Sachs trader Fabrice Tourre, “whose emails about the mortgage crisis became a symbol of Wall Street hubris,” the New York Times wrote. Read Susanne Craig’s and Ben Protess’ fascinating profile of Tourre and his globe-trotting here.

This entry is cross-posted on the Making Sen$e page, where correspondent Paul Solman answers your economic and business questions

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