Goldman Sachs history shows resignation naivete
By Rob Cox
This column appears in the March 26 edition of Newsweek. The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
In a sententious harrumph, a midlevel Goldman Sachs banker stormed out of Wall Street’s leading investment bank last week by publishing a critique in the New York Times of his now former employer. Greg Smith accused Goldman Chief Executive Lloyd Blankfein and President Gary Cohn of fomenting a corporate culture where the pursuit of making money “sidelined” the interests of clients, whom Smith said were referred to as “muppets” by superiors. “Today, if you make enough money for the firm (and are not currently an ax murderer) you will be promoted into a position of influence,” he wrote.
Smith has been called brave for speaking out against the apparent wickedness of the bank that lavished him with a decade of bonuses. But there’s also a glaring naivete to his appraisal that is as short-sighted as the supposed decisions of Goldman’s masters to chase profits today over the interests of clients tomorrow. Money is and forever will be the lifeblood of global finance. The only changing dynamic is the degree to which other goals compete with this pursuit.
Goldman did not suddenly become greedy when Smith trotted in with his Stanford degree and table tennis trophy 12 years ago. For 143 years Goldman has tried to strike a balance between serving the needs of its customers and creating lucre for its partners. It has often failed. Goldman executives wincing at being the butt of late-night talk show jokes may be as historically myopic as Smith. In 1932, after the stunning collapse of Goldman Sachs Trading Corp, an investment fund that crippled the firm and singed its clients, vaudevillian comic Eddie Cantor made Goldman his regular whipping boy.
It took decades for Goldman to repair its reputation as a trustworthy broker under the leadership of consummate relationship banker Sidney Weinberg. But it wasn’t too long before the desire to mint money returned with a vengeance under Goldman partner Gus Levy in the 1950s and 1960s. Rather than simply dispensing advice to clients like Ford Motor, Levy pioneered the deployment of Goldman’s capital to generate returns in ways that set the firm, and indeed the whole financial industry, on its current trajectory.
Levy championed two businesses – block trading and risk arbitrage – which both essentially boiled down to Goldman taking risks in the stock market with its own money in the same way hedge funds do today. True, Goldman depended on the willingness of clients to trade with the firm, but its profits were primarily a function of an ability to get the better of them. “Something well bought is half sold,” Levy once remarked.
In 1969, empowered by these gold-spinners – and three years after hiring the future Treasury Secretary Robert Rubin as a trader – Levy displaced Weinberg to run Goldman. So the present-day Smith’s supposed revelation that money-making will get you everywhere at Goldman was already obvious more than four decades ago.
The activities Levy championed may sound quaint to derivative whiz-kids like Smith today, but they were the forerunners of the trading operations that have made Goldman the bulk of its 21st-century coin and led the firm to its current predicament. The really important tipping point came in 1999, when Goldman converted from a partnership.
Goldman’s annual report that year, which the letter-writing dissident Smith should certainly have perused before joining, showed the firm making about 20 percent of its $13.3 billion revenue from trading bonds, yen, dollars, and commodities like oil or gold, where Blankfein himself made his first fortune at Goldman. The white-shoe art of advising companies on deals and raising money raked in a third of revenue.
Then priorities at Goldman shifted, as they have done every few decades, but to a degree that was historically unprecedented. The demands of becoming a publicly traded company led to a diversification away from simply acting as an agent for customers, a relatively low-growth business. After all, shareholders want profit to increase fast – and so do all those employees now incentivized by the stock price.
At a 2005 internal meeting described by Charles Ellis in “The Partnership,” Blankfein told executives: “If we insist on anchoring our firm only to the pure agency service strategy of the past, we will surely, gradually at first but inevitably with acceleration, cease to be leaders and even lose our relevance.”
Within a few years, Goldman’s trading arm surged to a whopping 52 percent of the group’s $45.2 billion of revenue. By the numbers, Goldman has thrived. What the firm failed to calculate was the cost to its reputation of a success born less of helping customers than helping itself.