So a few days ago, I finished reading William Cohan's new book about Goldman Sachs. It's called "Money and Power: How Goldman Sachs Came to Rule the World", and I think it's definitely worth a read. I guess for background's sake, I read Cohan's book about Bear Stearns ("House of Cards") a couple of years ago, and I didn't like it at all. This one is much, much better. More balanced, less muddled, and more informative. Cohan is an editor at Fortune magazine and used to work for Lazard and JPMorgan, so he understands finance and is capable of discussing it in an informed way. On the other hand, I think the further away he's gotten from working within the industry, the more capable he's become of looking at it objectively. In "House of Cards", he essentially ignores astonishing risk taking by the Bear brass and pins the mortgage bubble on the Community Reinvestment Act of 1977 and policies promoting housing... from the beginning of the Clinton Administration. That view is typical of Wall Street insiders who refuse to acknowledge faults of their own, but has little basis in reality. In this book, Cohan takes a more holistic view, and it makes for much more credible reading.
I think, when it comes to Goldman, most people take one of two positions. The two are someone at odds with one another, and each has a small kernel of truth to it, but on the whole, both are wildly misleading. One is the position Goldman itself takes: that it is the best, the smartest, and the most ethical firm on Wall Street. Alone among the big banks, Goldman has a set of fourteen "Business Principles" that make it clear that they think they're special (#1: "Our clients' interests always come first"). Like all the big banks, they do a pretty miserable job of following those principles. At heart, Goldman does a lot of the same things every other bank does; it's true that they're the best on Wall Street at a lot of those things (managing risk in particular), and that they probably have, on balance, the smartest people. But I don't think there's anything, positive or negative, that Goldman does or doesn't do, that sets it apart from the rest of Wall Street, aside from carefully crafting its image.
The other position is the one thrown out by Matt Taibbi at Rolling Stone, that Goldman Sachs is essentially Satan, Inc. Taibbi has written at least two articles arguing that Goldman, in essence, collapsed the global economy, profited from it, and then took a fat bailout from the government on top of that. That view is even more bunk. The short story is that, in essence, while the economy was collapsing around Goldman, they made big bets and profited off that collapse. But think through that position, and you realize how absurd it is. Along among the big banks (there were some hedge funds and the like that were also short housing, but all of the big deposit-taking banks and the four other stand-alone investment banks were net long), they saw the housing bubble coming and hedged their exposure. Taibbi wants you to believe that, because the rest of Wall Street was absurdly long housing, and Goldman saw the bubble coming, it was somehow unethical for them to make a bet the other way. People like Taibbi liken that to realizing your car is a lemon and then selling it on. Which is an absurd analogy. All the information that Goldman had about housing was widely available to every other firm. They just weren't as good at interpreting the information as Goldman was. So, essentially, Taibbi and those who agree with him want you to think that, back in 2006, when the market as a whole was convinced that housing was a great investment, Goldman somehow shouldn't have taken an opposing position because... we found out a couple of years later that the market was massively overvalued. I'm unpersuaded.
Now that doesn't mean that Goldman is the world's most ethical firm. Some of their most famous declarations are straight-up untrue. One is their famous declaration that they don't represent clients in hostile takeover bids. There are enough cases Cohan points out of Goldman doing just that that it's clear that their claim is baloney. Not to say that there's anything illegal about it, but hostile bids for public companies are a fairly controversial practice, so if Goldman was going to claim that it's "better" than other Wall Street firms, it better actually live up to its claim. Another is putting their clients first. This one is a bit tricky. Goldman's clients, for the most part, are sophisticated investors, hedge funds, and other banks. If a deal goes bad because Goldman has a different opinion from a client's, and the client knows Goldman is short the deal, then there's no reason to punish them. Similarly, if two clients come to them, and one wants to be short housing while the other wants to be long, there's no reason Goldman shouldn't be able to structure the deal for the clients. By definition, one party's going to make money, and the other is going to lose money. But where Goldman crossed the line was that it probably misrepresented what was going on to some clients. Take the infamous ABACUS deal. John Paulson (the now-famous) hedge fund manager came to Goldman and said he wanted to go short housing. Goldman found a company to choose the portfolio, and found another client willing to take the long end of the deal. Of course, famously, Paulson made billions on his bet, while the party on the other end (a German bank) lost just as much. Where Goldman probably crossed the line was in failing to tell the German bank that Paulson was going to be both short the deal and had indicated which CDOs he wanted to short. And, whereas Goldman wrote that the securities were "sourced from the Street" (Wall Street), in reality they all came from Goldman's balance sheet. Their explanation was 1) that the German bank was sophisticated enough to do its own analysis of the securities it was buying (certainly true) and 2) that Goldman itself was part of the Street (disingenuous as all hell). But, even if their clients on the long end were sophisticated, Goldman still has a duty to disclose all material information about the deal to them, and they almost certainly failed to do that. Would doing so have led the German bank to exit the deal? Who knows. But it certainly would have made Goldman look better in hindsight. And would have lent some credence to their claim that their clients come first.
The most troubling part about their practices, though, is their seeming willingness to let business lines with inherent tension mix, and it's something Cohan harps on. Any securities firm has three major practice areas-- the size of those varies by firm, but more or less all of them do some form of merger/acquisition advisory, securities underwriting (underwriting debt offerings and IPOs), and broker/dealer activities (creating structured securities for clients, or trading for their own accounts; the last part is theoretically being scaled back by the Volcker Rule from the Dodd-Frank Act, but, given how hard it is to determine whether the firm is buying up securities to have them in inventory for clients, or to express an opinion about their future value). There are plenty of more specific business lines, but they all fall into one of these general categories. The problem is, trading relies on information, and the advisory and underwriting businesses have plenty of information that is material and not public. If a big company comes to Goldman and tells them that they want to purchase another company, Goldman's trading desk can make a killing if they find out about it and buy up the target company's stock (acquirers pay a premium to acquire a publicly traded company). The conflicts on the underwriting side are similar (the underwriter needs material non-public information to prepare the equity/bond issue). So what's Goldman's response? In essence, it's "Trust us, we're honest". They claim that the "Chinese walls" between their departments keep information from the investment banking floors from trickling down to the trading floor. This story might be believable if, in reality, Wall Street didn't have such a history of their "Chinese walls" working more like sieves. At the height of the tech bubble, much of Wall Street (Goldman included, though they were far from the biggest perpetrator) had to pay hefty fines because their research departments (people writing public outlooks on companies they were supposed to be researching) came under pressure from the investment banking department to issue positive outlooks for their clients, since doing so would allow those companies to be acquired or to go public, which in turn would mean the banks' advisory/underwriting departments would pocket a fee. Once Eliot Spitzer (then New York's attorney general) got word of this, the banks ended up having to pay fines, but the story nevertheless doesn't exactly inspire confidence in the Chinese walls put up in places like Goldman. Now, I suppose the last question on this count is what sets Goldman's conflict there apart from any other firm's. The honest answer is twofold. First, Goldman, up to the crisis, had the biggest portion of revenues coming out of their trading division of all the major banks (including trading houses like Bear Stearns). So they stood to benefit more than banks with smaller trading departments from placing directional bets on that kind of material information. Second, I don't honestly know enough about the other banks to know the full extent of what they do, but if I had to guess, they probably do the same thing.
In sum, though, I think Cohan's book did a good job laying out the history and the facts, and provided a balanced view of Goldman. It's certainly not Taibbi's terrible "Vampire Squid". Nor is it the client-focused beacon of Wall Street it claims to be. It's a Wall Street firm like any other-- filled with conflicts, occasionally toeing the line between the acceptable and the inappropriate, and notable mostly for its unparalleled success at making money.
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