Kevin Carmichael, Sinclair Stewart, The Globe and Mail
September 13, 2008
As the toxic cloud surrounding U.S. subprime mortgages continues to waft through the global financial system, banks and governments are seeking guidance from a battle-tested army: former Goldman Sachs executives. And with good reason. The current ‘Goldmanites’ have by and large steered their ship through the storm that still threatens other Wall Street giants. Kevin Carmichael in Ottawa and Sinclair Stewart in New York take a closer look at the investment bank with a six-decade tradition of public service and the reputation for an unparalleled command of risk
OTTAWA AND NEW YORK — Back in his investment banking days at Goldman Sachs Group Inc., Henry Paulson took just three weeks to orchestrate the 2005 takeover of Gillette Co. by Procter & Gamble for $57-billion (U.S.).
Last weekend, as U.S. Treasury Secretary, he engineered one of the biggest financial bailouts in history, putting up as much as $200-billion of taxpayers’ money to seize control of mortgage giants Fannie Mae and Freddie Mac. Now, he’s facing pressure to pull off a deal to save the cratering Lehman Brothers.
Mr. Paulson’s around-the-clock salvage missions to prop up pillars of the U.S. financial system are part of a worldwide scramble to contain the fallout from America’s catastrophic dalliance with subprime mortgages. As the U.S. teeters on the precipice of recession and global economies seek to claw their way out of the grip of the crisis, both the public and private sectors are increasingly turning to one source for help: Goldman.
While the Treasury Secretary is leading the charge, there are at least a dozen other former Goldman executives who are doing mop-up jobs around the world in government and the financial sector, including Bank of Canada Governor Mark Carney; John Thain, who was hired late last year to take over troubled Merrill Lynch & Co.; and Robert Steel, who was lured away from Mr. Paulson’s Treasury to resuscitate Wachovia Corp., the fourth-largest U.S. bank.
The plethora of former Goldman bankers in positions of influence right now isn’t going unnoticed, even by their fellow travellers in the corridors of power. “It comes up over casual discussion and over dinner that Goldman Sachs and its alumni seem to have substantial influence in many positions,” acknowledged Finance Minister Jim Flaherty.
The full measure of that influence has become more apparent in recent months, as governments and financial companies around the world scramble to contain the damage from a credit meltdown that many observers predict will result in losses approaching $1-trillion.
That raises an obvious question: Why is Goldman playing such an outsized role in the salvage efforts?
Observers will point to the firm’s near obsessive focus on recruiting, which has seeded its ranks with an enviable roster of talent, ripe for the poaching. They will highlight Goldman’s record of public service over the past six decades, and the succession of leaders who were encouraged to cap off their lucrative Wall Street careers with a stint in government. And of course, they will reference the company’s unparalleled command of risk: In an era where most of its blue-chip peers have been torched by lax lending standards and questionable bets – think Citigroup, Bear Stearns, UBS and Lehman, to name a few – Goldman has emerged with merely a few singes.
All of these factors go some way toward explaining the ascendancy of so many Goldman alumni amid the debris of the credit crisis. Yet the nature of the crisis has also played a role. Much of this disaster was manufactured on Wall Street, and it is here, at the epicentre of the U.S. financial system, that much of the punishment is being meted out. Given the complexity of the products underlying the collapse of the subprime mortgage market and the potential for a devastating domino effect if some of these major banks fail, it’s little surprise that officials in both the public and private sectors have looked to industry experts for help. And where better to turn than the investment bank that managed to sail through the downturn reasonably intact?
“There are lots of people around the table who have extensive experience in central banking and traditional banking,” explained Mr. Flaherty, speaking of his government peers. “There is significantly less experience in investment banking.”
Goldman’s involvement in public service goes back to Sidney Weinberg, a mail-room employee who scratched his way up the corporate ladder until taking the firm’s reins in 1930 – a position he would hold for almost 40 years. Mr. Weinberg, considered the father of the modern-day Goldman Sachs, opened a revolving door between the firm and Washington by serving the administrations of Franklin Roosevelt, Harry Truman and Dwight Eisenhower during the Second World War and the Korean War.
He was an enthusiastic vice-chairman of the war production board, and became known as the “Body Snatcher” for aggressively recruiting fellow executives to volunteer their time to the war effort.
“Mr. Weinberg really believed in it, and he taught that message explicitly,” said Charles Ellis, whose book The Partnership: The Making of Goldman Sachs will be published this fall.
Continuing the tradition
Mr. Paulson is the latest in a parade of senior Goldmanites, including Robert Rubin and Stephen Friedman, who dutifully followed Mr. Weinberg’s example.
He reluctantly left his post as Goldman’s CEO in May, 2006, to go to Washington for the final 2Ãƒâ€šÃ‚Â½ years of George W. Bush’s presidency, after being lobbied aggressively by Joshua Bolten, the president’s chief of staff. Mr. Bolten, incidentally, was executive director of legal affairs for Goldman’s European operations from 1994 to 1999.
Once in Washington, Mr. Paulson continued the Goldman tradition, summoning his former colleague, Mr. Steel, to be his deputy in charge of financial markets.
Mr. Paulson also drafted Neel Kashkari from Goldman’s San Francisco office as an adviser. When Mr. Steel unexpectedly departed for Wachovia this summer, Mr. Paulson turned to Ken Wilson, the head of Goldman Sachs’s financial services group, to advise him until the Bush presidency ends in January.
The same phenomenon is visible in other countries, as well. Indeed, there were three ex-Goldman executives at the table in April when the Group of Seven finance ministers and central bank governors turned their attention fully to the credit crisis at a meeting in Washington.
Along with Mr. Paulson, there was Mr. Carney, who had taken up his job as head of Canada’s central bank only a couple of months earlier, and Bank of Italy Governor Mario Draghi, who was a London-based partner at Goldman from 2002 to 2005. Mr. Draghi also leads the influential Financial Services Forum of central bankers and regulators, which spent six months preparing the report that became the basis of the G7′s demands for more transparency by banks and other regulatory changes.
But Mr. Weinberg’s legacy of public service is only part of the story. Many large banks, which suffered crippling (and self-inflicted) blows from the mortgage debacle, are mining the Goldman alumni network to help reverse their fortunes. Unlike Mr. Paulson, whose salary now is a relative pittance, the Goldmanites choosing to stay on Wall Street stand to make hundreds of millions of dollars in the biggest clean-up job since the Great Depression.
Merrill Lynch tapped Mr. Thain, who once ran Goldman’s mortgage desk, to right a ship left listing by former chief executive Stan O’Neal, who presided over an $8.4-billion loss related to bonds backed by home loans and other assets. Mr. Thain, who was running the New York Stock Exchange at the time of his hiring, began his latest job by poaching several of his former Goldman colleagues and empowering the risk management division – a core strength of the Goldman operation.
At Wachovia, Mr. Steel’s debut earned raves from analysts as he chopped the bank’s dividend and wrote off billions in ill-advised loans within his first month on the job. Mr. Steel also looked to his old firm for advice on what to do with his bank’s $122-billion of adjustable-rate mortgages, many of which are in danger of default because the loans are worth more than the homes they bought.
Managing the risk
It’s easy to see the attraction to the Goldman men.
Goldman scrutinizes risk from every angle, often in raucous meetings involving traders and the most senior executives. Goldman’s risk management officers are often drawn from the ranks of the traders, and they are paid a salary to match. In addition, bankers say risk management is given a prominent voice not merely in downturns, but in good times as well – something that was clearly not the case at many other large investment banks.
“We are a little better,” Lloyd Blankfein, Goldman’s 11th chief executive, said in an article published by Fortune magazine in March. “I will fight you if you say we’re just like everyone else. But I think it’s only a little better. It’s not as much as recent events would suggest.”
This appears an overly modest assessment. Last year, as many of its competitors began to falter, Goldman made a savvy bet that the housing market would fall. The firm’s traders borrowed massive amounts of securities linked to mortgages, correctly guessing they could settle the trade at lower rates as prices tumbled. The strategy paid off handsomely, and helped Goldman produce a record profit of $11.6-billion last year.
“Goldman Sachs is like General Electric, they train good managers,” said Peter Morici, a business professor at the University of Maryland. “It’s just always been that way.”
Inevitably, when observers attempt to describe what distinguishes Goldman, they use the word “culture.” That can include risk, or tradition, or even the centrality of recruiting.
Mr. Ellis, the author of the forthcoming book on Goldman, says the company’s talent roster is the result of a methodical, rigorous hiring process.
The vetting of recruits can involve more than a dozen interviews with executives from all facets of the company. If one disapproves, you likely are out.
Then there are the questions themselves. Recruiters have been known to toss out all kinds of curveballs, including this one: “If your favourite baseball team is in the World Series, what betting strategy would you have to deploy at even odds to be up a net $100 if your team wins and down a net $100 if your team loses?” (Hint: the World Series can last four, five, six or seven games and it helps to know something about option price theory.)
Prima donnas not welcome
The idea is to find people who will excel as part of at team. The star system is sternly discouraged at Goldman. Prima donnas hoard resources for their own trading or business strategies, and that can distract from the ultimate mission: the firm’s long-term profits. This tends to encourage hiring from the ranks of the military and college sports, “people who are used to hierarchies,” said one former Goldman banker, who spoke on condition of anonymity. “They’re not necessarily the smartest, but they know how to harness the resources most effectively.”
Mr. Paulson, for example, was a standout football player at Dartmouth College and Mr. Carney was a backup goalie on Harvard University’s varsity hockey team. Mr. Wilson served in the Vietnam War.
“Teams perform better than stars, is their motto,” says Roy Smith, a professor of finance at New York University and a partner at Goldman Sachs from 1966 to 1987.
Mr. Ellis, meanwhile, describes the culture at Goldman Sachs as “almost … tribal, in a positive sense.”
Of course, this cloistered culture, populated as it is by power and wealth, has roused its share of suspicion among outsiders, who view the firm as a kind of secret society - just do a Google search on “Goldman Sachs and conspiracy.”
Current and former Goldmanites dismiss the notion that the spread of former executives to positions of influence is a Machiavellian plot to further enrich the company. There are no secret handshakes, they insist; no covert collaboration to extend the firm’s reach.
Certainly, few of them need the money. One of the reasons Goldman partners have been able to migrate to public service is the sheer amount of wealth they have accumulated by a relatively young age.
Mr. Paulson, for example, made $38.8-million in 2005, his last full year at Goldman, and amassed a personal fortune that is estimated to be worth well in excess of $500-million.
Mr. Blankfein, the current chief executive, made $68.7-million in 2007, a record for a Wall Street chief executive. Goldman’s total compensation was $20.2-billion last year, almost enough to buy the Bank of Montreal at its current stock price. That works out to approximately $661,490 for each of the firm’s 30,522 employees.
“By the time these people are in their late 40s or so, they may feel they want to do something else,” Prof. Smith said. “They are very well off financially and free to do whatever they want.”
Giving a little back
Goldman employees, however, say the firm places considerable emphasis on giving some of it back. The company itself donated more than $100-million to charitable endeavours in 2007. It also grants workers one day a year for volunteer work. Almost 21,000 Goldman Sachs employees and family members did so last year.
“They do more giving philanthropically, more anonymously, than any other firm,” says Mr. Ellis, who has worked with Goldman Sachs for decades as founder of Greenwich Associates. “It’s stunning when you compare Morgan Stanley, Merrill Lynch, Credit Suisse – go down the list. It’s very much stronger at Goldman Sachs than anywhere else.”
Not everyone is so enamoured of the Goldman mystique.
Brad Setser, a former economist at the U.S. Treasury under Mr. Rubin and now a fellow at the Council on Foreign Relations in New York, accepts that both Mr. Rubin and Mr. Paulson have the right background to fix a disruption in financial markets. But he’s skeptical that a Treasury Secretary with a different background would have performed any worse.
“Goldman doesn’t have a monopoly on smart people,” Mr. Setser says.
Still, Mr. Paulson’s efforts to combat the crisis bear the distinct imprimatur of a deal maker.
The bailout of Fannie Mae and Freddie Mac was remarkable because it broke with the free-market ideology that guided the Bush administration’s economic policy before Mr. Paulson’s arrival.
Mr. Bush spent most of his presidency trying to limit the government’s exposure to Fannie and Freddie, the largest sources for U.S. home financing. Now, as a result of Mr. Paulson’s influence, he will leave the White House as the president who stopped just short of nationalizing the institutions.
It’s not the result Mr. Paulson sought. His goal was to stabilize the housing market, which couldn’t be done, most observers say, without a Fannie and Freddie in sound enough shape to purchase and resell mortgages. As incremental steps to restore confidence in the companies failed, Mr. Paulson set aside his beliefs in order to get a deal.
Mr. Paulson – along with Mr. Steel – was also among the group who advised Federal Reserve Board chairman Ben Bernanke to take on the risk associated with Morgan Stanley’s purchase of investment bank Bear Stearns, avoiding the complete collapse of one of the U.S.’s most storied financial institutions. His actions are being criticized by some academics and politicians for using taxpayers’ money to save private interests from mistakes for which they deserve to be punished – the moral hazard argument.
Mr. Paulson ignored the criticism and trusted his instincts and knowledge of financial markets. Mr. Paulson is intimate with the way Wall Street works and continues to tap “a long list of informants” to get reports directly from the front lines, Prof. Smith says. “I know a couple of bond traders who told me they had been called by Paulson on the phone to say, ‘What do you think about this market?’ ” he says. “That’s not something these other guys would have done.”
It will take years to understand the full impact of the solutions wrought by Mr. Paulson, Mr. Draghi, Mr. Carney and others.
In Mr. Paulson’s case, the decisions he takes this weekend regarding Lehman will go a long way to determining his legacy. His efforts as a firefighter have generally drawn praise, especially since he’s managed to find a solution acceptable to both Democrats and Republicans.
Still, he hasn’t been able to shake the criticism that he’s been too kind to his old friends on Wall Street, raising the risk of moral hazard to a new level. A decision to remain an adviser this weekend, rather than a financial backer, would silence some of those critics. “If you are a practical investment banker turned into a public official, you intervene to prevent the thing from getting a whole lot worse,” Prof. Smith said. “It’s better to act first in the time of a crisis than it is to not.”
U.S. Treasury Secretary
The Goldman years: Started in the Chicago office in 1974, beginning a steady rise that ended with him being named chief executive officer when the firm went public in 1999.
BANK OF CANADA GOVERNOR
The Goldman years: Worked as an investment banker in London, Tokyo, New York and Toronto for 13 years before joining the Bank of Canada’s policy-setting committee as a deputy governor in August, 2003
Bank of Italy Governor
The Goldman years: Served as a London-based partner and vice-chairman of Goldman Sachs International from 2002 to 2005.
Merrill Lynch chief executive officer
The Goldman years: Joined the firm after graduating from Harvard, ran the mortgage desk from 1985 to 1990, ran the European banking operations in the early 1990s before being tapped as chief financial officer in 1994. He left the firm in January, 2004, as president and chief operating officer.
Wachovia chief executive officer
The Goldman years: Joined Mr. Paulson in Goldman Sachs’ Chicago office in 1976. He was moved to London in 1986, where he founded the firm’s equity capital markets group for Europe. He moved to New York in 1994, and led the equities division from 1998 to 2001. He retired as a vice-chairman in 2004.
Citigroup’s executive committee chairman and former U.S. Treasury secretary
The Goldman years: Joined the risk arbitrage division in 1966, where he made his name in the still nascent field. He became a partner in 1971 and served as co-chairman from 1990 to 1992.
Goldman Sachs managing director and former president of the Federal Reserve Bank of New York
The Goldman years: Became managing director in 1996 and joined the risk committee.
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