The aim behind this article is to
investigate the factors of success of Goldman Sachs since the financial crisis
compared to its peers and to examine the existence of a standard best model or
strategy for investment banking practices to survive any future financial
crisis.
The financial crisis of 2008 also
called the global financial crisis is considered as the most dangerous and the worst
since the great depression in 1930. The real estate booming in the United
States which known as the housing bubble in 2004 made the government follow a
wrong policy that encourages the housing ownership by providing easy access to
loans without an adequate measure of default risk or capital holding from
banks. The financial crisis began in 2006 when the US subprime mortgage market
started to show increasing rates of defaults. By the end of 2007, this market
showed higher than normal rates of defaults which caused a decrease in housing
prices
Collateralized mortgage obligations
(CMO) which are a type of collateralized debt obligations (CDO) made the crisis
spread from the mortgage market to other sectors in the economy having a
disastrous effect especially on financial institutions that were trading the
mortgage-backed securities in an unregulated way by the federal government. As
the rates of defaults on mortgage loans increased the value of these securities
decreased which lead the financial institutions such as investment banks that
were trading them to lose confidence of their investors. This had a huge impact
in the stock market prices. This problem was more amplified by another
financial product which is credit default swaps (CDS); an insurance contract on
CMO for protection against default. This way all players in the investment
banking sector were linked to each other by this liability. When investors saw
decrease in their holding in CMO they started liquidating which made these
assets frozen because of lack of buyers. This liquidity problem led to
insolvency after private lending froze many credit markets. Companies couldn’t
get access to financing. Banks started to raise their LIBOR and the financial system that was
supposed to be built on trust started to fall down from the US spreading
worldwide following the domino effect. The rule of “too big to fail” wasn’t
valid anymore after the bankruptcy of one of the largest investment bank Lehman
Brothers in September 2008.
Collapse threatened almost every
financial institution worldwide which required the bail out of banks and these
institutions from national government. This was the case of Goldman Sachs that
was bailed out by Warren Buffet who bought its shares at massively discounted
prices. The US government allowed Lehman brothers to go bankruptcy whereas
Goldman Sachs was bailed out among others. Once the storm of the crisis has
gone, Goldman Sachs started to perform well on a rapid pace compared to its
peers and became the trademark for investment banking success.
According to a report published by
the permanent subcommittee on investigations in United states (Wall Street and
the financial crisis: Anatomy of a Financial Collapse, 2011) Goldman Sachs took
advantage from the failure of the mortgage market and engaged in troubling and
abusive practices that created concerns of many conflict of interest. The
report states that GS used structured financial instruments such as ABX, CDS,
and CDO to take a proprietary net short position against the subprime mortgage
market. When Goldman Sachs Reached its peak of $13.9 billion, its net short
investments resulted in a record gains for the structured financial Products in
2007 which amounted to $3.7 billion. After deducting other mortgage losses,
Goldman Sachs gained overall net revenue of $1.1 billion from its mortgage
department. The company engaged in securitization practices that amplified risk
in the market by selling low quality with high risk mortgage products to
investors worldwide.
The shift in Goldman’s culture and
practices is due to mainly two reasons. First, after the bank moved away from
its partnership status in favor of a stock exchange listing in 1999, it focused
on a more short-term, profit-centered approach.
Second, its 1990s decision to grow in size to avoid is being
overshadowed by the likes of JP Morgan. That resulted in a lot of deals which
raised conflicts of interest. For example, the firm gave advice to both the
buyer and the target firm when dealing with private equity. However, Goldman
Sachs is now committed to prioritize customer service and behave ethically in a
way to maximize shareholder returns and not only its returns. In the process of
rebranding, Goldman Sachs is focusing more on its corporate social
responsibility, ethics standards and quality of its employees.
According to a report published by
Accenture (focus for success: high performing investment bank, 2012), Goldman
Sachs success as a leading investment bank comes from its strategy of scaling
its financial products rather than focusing on a narrow segment. Furthermore,
Goldman Sachs can expand more by scaling and entering the Chinese market.
Goldman Sachs has a comparative advantage to bring its powerful competitive
assets to the Chinese marketplace in the form of its capital, expertise,
talent, and reputation (Erin P. Flanagin, Alex Fogel, George H. Hines, Jason M.
Kephart, 2006).
The
global financial crisis in 2008 had a huge impact on the global economy
worldwide which made governments and federal banks to rethink about regulations
and policies about banking practices in order to avoid the occurrence of this
crisis once again.
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