Goldman’s troubles will end when Blankfein goes
The following is a guest post by Christopher Whalen, senior vice president and managing director of Institutional Risk Analytics. You can also follow him on twitter. The opinions expressed are his own.
As Congress was approving financial reform legislation yesterday, Goldman Sachs agreed to pay $550 million to the SEC to settle a civil lawsuit that claimed Goldman had misled investors in a subprime mortgage product as the housing market began to collapse three years ago. The settlement marks the beginning of the end of Goldman’s public humiliation for its relatively small part in the subprime debacle, but the firm still has a great deal of work to do to satisfy the conditions of its settlement, repair its relationship with clients and mend its damaged public reputation.
I have had a “neutral” rating on the forward operating results of GS since Q1 of this year and will leave that rating in place for two reasons. First, the carry trade reflected in record net interest margins in the banking industry is going to slowly diminish at GS and many other banks. Unless the Fed allows interest rates to rise soon, all of the assets of banks and funds will gradually re-price to near-zero. When the media waxes euphoric over the “trading” results of firms like GS, they fail to realize that much of trading revenue comes from simple interest rate spreads over funding.
Second, despite the settlement, GS remains in the midst of a mini-crisis in terms of brand and reputation. As Felix Salmon noted in a post on blog post back in June, Goldman CEO Lloyd Blankfein and his lieutenants are playing customer relationship management in order to retain clients. While JPMorgan Chase is playing offense, looking outside the U.S. for growth, GS is still very much in a defensive posture. Indeed, JPM’s bankers have been aggressively trying to take business away from GS for months.
For GS, everything depends on how the firm manages the process of addressing the remaining financial and political risks that have erupted over the past year. Blankfein has done a reasonably good job in steering GS through the political minefield, but the firm still faces a lot of private litigation as well as the more daunting task of winning back the trust of the blue chip corporate clients. Part of the requirement is simply time, but I believe that GS will eventually need to replace Blankfein and other members of the GS management team to truly put this crisis behind them — but not for the reason most people might think.
Buy side investors don’t do business with GS or the other major sell side firms because they trust them; they do business with firms like GS because they believe that the firm has better access to information. The sad fact is that the trust that once made firms like GS and the old JP Morgan & Co special has long since been lost, leaving the marketplace that remains a hideous, barbaric place bereft of honor — and a source of infinite operational risk to all participants.
The reputation of GS as a firm for being smarter and better informed than the larger firms on Wall Street goes back many decades, to the turn of the last century when Wall Street was run by the white shoe securities firms in Boston, Philadelphia and New York. In those days, firms like GS had to be smarter than everyone else as a basic matter of survival. And in those days, GS protected and nurtured each client relationship because the trust that these clients put in the firm were considered to be a precious asset.
In order for GS to complete at least the superficial process of dealing with the ill-effects of the crisis, I believe that they need to select a new CEO and CFO to not only placate key corporate and buy side investors, but also to satisfy the concerns of the SEC and, more importantly, the Fed. Not nearly enough attention is paid to the fact that GS is now a bank holding company and is subject to prudential supervision by the Fed, the State of New York Banking Department and the FDIC.
The ideal replacement for Blankfein will be an investment banker, not a trader. Think about a younger version of John Thain. I suspect that the board of GS will continue to support Blankfein in public and will allow him to oversee the remainder of the cleanup effort. But after a decent interval has passed, I expect that Blankfein and other key members of the management team will step down.
This will not be a concession of wrong-doing, but simply a reaffirmation of the mechanistic rule of succession that has made GS such a great firm over the past 150 years if its existence — namely pushing senior partners and managers up and out to make room for the next generation of masters of the universe. Then the crisis at GS will truly be ended.