News, analysis and personal reflections on the markets & the financial sector

Saturday, December 15, 2007

Goldman Sachs makes $4bn profit on daring sub-prime bet

Goldman Sachs has bucked the trend on Wall Street after it emerged that the bank made a $4 billion (£2 billion) profit from betting on the collapse of America’s sub-prime mortgage industry while key rivals, such as Citigroup and Merrill Lynch, made multibillion-dollar losses on investments in high-risk home loans.

The gains were realised after Michael Swenson, 40, and Josh Birnbaum, 35, two members of Goldman Sachs’s so-called structured products trading group, persuaded their firm that the sub-prime mortgage market was heading for trouble. They believed that mortgage lending criteria had become so lax that a jump in defaults on high-risk home loans was inevitable and would drag down the value of the bonds that they backed.

It is understood that Mr Swenson and Mr Birnbaum had to argue there case fiercely with some colleagues who questioned their judgment. However, Dan Sparks, the head of the group’s mortgage department, backed them and Goldman Sachs decided to bet heavily against sub-prime loans. The three are expected to be awarded bonuses of between $5 million and $15 million each.

The profits will take Goldman Sachs to an expected $11 billion profit for the year, marking a record for the group, as competitors report significant earnings declines and even losses.

The gains from the mortgage derivative investments have more than offset a loss of between $1.5 billion and $2 billion that Goldman has suffered on its other home loan-related holdings, according to The Wall Street Journal.

Traders at Deutsche Bank and Morgan Stanley also bet against the sub-prime mortgage market this year, but in each case, their gains were essentially wiped out because their banks underestimated how far the markets would fall, The Wall Street Journal reported.

Meanwhile, Citigroup, UBS and Merrill Lynch are among the banks that have reported multibillion-dollar losses on investments in securities backed by sub-prime mortgages. In each case, the chief executive resigned after the losses came to light.

Goldman Sachs said this week that staff would share in an $18.8 billion bonus pool worth on average $600,000 for each of their near30,000 staff worldwide, compared with $16.5 billion last year.

Lloyd Blankfein, the chairman and chief executive of Goldman Sachs, is expected to record a 30 per cent increase in his pay to $70 million.

Goldman Sachs’s profits for the first nine months of this year were $8.4 billion, up a third on the same period last year, despite writing off about $1.7 billion of debt.

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