Thursday, October 20, 2011

Morgan Stanley's & Goldman Sachs' Quarterly Earnings

The past few days have seen some really fast dancing by Morgan Stanley's executives, and some financial sector pundits, concerning the firm's just-released quarterly operating results.

Some financial news networks were calling the firm's results stellar. It took a few more objective observers on both Bloomberg and CNBC to note how much so-called profit was due to the decline in value of the firm's debt.

A relatively new wrinkle, the thinking goes that when a firm's debt declines in value, it could retire it at a discount, which can then be booked as profit. In Morgan Stanley's case, concerns over its viability this past quarter sent insurance on its debt skyward, and its debt values plunging.

So the upshot is an unexpectedly large profit. Go figure.

Stripping that out, the real operating results aren't so pretty. In fact, the Wall Street Journal published an article on Tuesday detailing the ugly consequences of the firm's attempts to insulate itself from positions relating to MBIA. The crippled bond insurer's condition caused gyrations in the value for its debt, and insurance thereon, which, despite their best efforts, confounded Morgan Stanley's fixed income and derivatives strategists, causing a not insignificant loss.

Meanwhile, Goldman Sachs actually booked a quarterly loss. The Journal contrasted the firm's healthy old core business with its money-losing proprietary activities.

For both Morgan Stanley and Goldman, it's finally dawning on investors and analysts that these firms, despite their rush to secure bank charters in 2008, aren't truly commercial banks. They still market-fund short term, which is what led them to near-collapse three years ago, when Lehman's real collapse froze debt markets.

Looking at the three price charts in this post for Morgan Stanley, Goldman and the S&P500 Index for, first, 5 years, then 2, then 1 year, it's clear how investors have adapted their perspectives on these two firms.

Going into and coming out of the 2008 crisis, Goldman handily outperformed Morgan Stanley. But from early 2009, the two have essentially shared the same fate. The 1-year chart makes this crystal clear. Both are down 40% while the S&P has managed to stay roughly flat for the past 12 months. Morgan exhibits more volatility than its better-regarded peer, but they end up in the same place.

With the crisis now three years past, and the prospect of serious implementation of the Volcker Rule impending, investors and analysts are finally getting through their heads that the proprietary trading/investing profits of these two firms are largely history. Meanwhile, their continuing reliance on short term funding at a time when a Euro financial crisis of significant size is unfolding poses other significant risks.

Thus, both have been hammered over the past year, especially the past six months.

So much for what used to be the wildly-profitable component of the US financial services sector. The large commercial banks are either mired in post-mortgage-fiasco litigation and foreclosure problems, or wrestling with consumers who are deleveraging and repairing their own balance sheets.

Not much good news anywhere, Tom Brown and Dick Bove, who make a living out of touting this sector, notwithstanding.

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