Of Windows and Orphans

The near-scandal of the day, it seems, is Goldman Sachs' use of an "orphan month" in reporting first quarter earnings. The firm's fiscal year ended with November of 2008, but Goldman switched to the calendar year cycle in 2009, part of the process of becoming a bank holding company (fellow traveler Morgan Stanley did the same thing). That left December hanging out there by its lonesome. That was rather convenient for first quarter earnings; the omission of what was quite possibly the firm's worst month ever allowed Goldman to report the $1.8 billion profit we all read about yesterday.

"Bush budgeting," declared Paul Krugman. "Chutzpah simply does not do it justice," said Barry Ritholtz. Felix notes that the lost December will probably be ignored for compensation purposes, and he's probably right, but is that an issue? Goldman is repaying TARP funds specifically so that it can avoid restrictions on compensation, and while we might expect shareholders to be peeved at this (or at the share dilution generated by yesterday's $5 billion offering), Goldman shares have erased most of yesterday's decline.

Markets may be thinking that the firm's freedom to compensate excessively will let it go talent hunting. In any case, it's a little difficult to cry deception when Goldman's 8-K includes its December numbers -- just not as part of any one quarter. If this is a secret, it's hidden in plain sight.

The real issue with Goldman isn't the orphan month or the TARP repaying gambit. It's that the bank is making a play at going it alone while still leaning heavily on US government guarantees, amidst a broader rescue strategy aimed at saving the system as a whole (rather than helping healthy banks while taking over the sick ones). So long as the government is committed to that approach (and the stress tests may signal that a change is coming), Goldman's actions are likely to undermine financial stability. Felix writes:

Like it or not, Goldman is a central part of the financial system, which means that it's a central part of any bailout strategy. It can't unilaterally say no to that, and I hope that it gets slapped down by Treasury as definitively as it was slapped down by the stock market yesterday.

If Treasury doesn't slap Goldman down, then the administration is either moving toward a dual-track approach (and potential receivership), or is more in thrall to the iconic firm than I'd care to believe.