Former Goldman Sachs employee Greg Smith wrote an op-ed in yesterday’s New York Times that simmers with pathos. Smith describes the devolution of the culture at Goldman: Whereas in the past, the company worked in the interests of its clients, they are now seen merely as the source of transactional profit, to be manipulated for the benefit of the firm. His story emerges in the midst of a huge effort by Wall Street to eviscerate and delay the implementation of the Volcker Rule, which limits bank traders to running a client-service businesses by prohibiting trading for the bank’s own account.
Having spent 12 years at Goldman prior to 1997, I sympathize with Smith’s feelings of loss and betrayal. I left just at the beginning of the institution’s evolution into its current form and have observed the process with despair—not only for the organization but for the loss suffered by the nation. Some context might provide greater meaning to Mr. Smith’s story.
At its best, Wall Street serves an important function. Historically, it provided the wherewithal for growth in industries as varied as rail and information technology; by bankrolling productive growth of industries that provided jobs and products to sell around the world, it vastly increased the well-being of all Americans. In times of crisis, bankers worked to preserve economic stability. Sometimes, they were genuine altruists, accepting the moral responsibilities that go along with their positions of wealth and power. More often, they were simply pursuing their own self-interest. Was J.P. Morgan a robber baron or the man who almost single-handedly saved the economy in the panic of 1907? The answer is both. But altruistic or not, bankers understood their enormous stake in the long-term vitality of the economy. Preserving the health of the economy was good for business this year and for decades to come. That was the contract between Main Street and Wall Street.
When I arrived at Goldman Sachs, John Weinberg headed the firm. It was a partnership of professionals then, not a publicly traded corporation, and the partners’ wealth was largely invested in the firm. I saw Weinberg, a Marine veteran of the Pacific campaigns, many mornings on the elevator with a muffin perched on a Styrofoam coffee cup, his briefcase in his other hand. He had just arrived at 85 Broad Street in his Ford (Ford was a longtime personal client). His appearance was closer to the guy behind the counter at the deli than the titan of Wall Street that he was. When he spoke, he was incisive and wise. His motto for Goldman Sachs (coined by his predecessor Gus Levy) was, “Be long-term greedy, not short-term greedy.”
He believed these words. The firm promulgated “Our Business Principles,” and the bankers bought into it. We included these in every presentation and were convinced that clients and potential clients would be persuaded of the firm’s trustworthiness given its fine principles. Like the Marines of Weinberg’s youth, we were convinced that we were the best of the best. But, wisely, the company’s culture was structured to tamp down arrogance and hubris. Peer reviews became a ritual in which working with a team and serving clients well were key metrics of success. The firm installed co-heads of many groups, demanding that the two cooperate. (Younger bankers predictably referred to them as “cone heads.”) The practice included the heads of the firm. Weinberg, in fact, initially served as co-head with John Whitehead, who retired just after I arrived.
Goldman Sachs was almost a cult. I worshipped it and was by no means unique. We all wanted to make a profit, and, inevitably, the ever-present temptation of greed led to a fair number of scandals and investigations. But principle was generally the trump card. Weinberg forbade participation in hostile takeovers, an immensely lucrative business. When the market crashed in 1987, he refused to take advantage of an “out” in an underwriting for the government of Great Britain, knowing that it cost the partners $100 million, and his loss was by far the largest. He blocked every suggestion to take the firm public. It was impossible to know whether his motives were based on principle or on the knowledge that the accumulated goodwill would return profits beyond imagination. For Weinberg, they were inseparable.
The parade of Goldman leadership after Weinberg’s departure in 1990 is truly remarkable: Bob Rubin and Steve Friedman, as co-heads; Jon Corzine; Hank Paulson; and Lloyd Blankfein. As the leadership evolved from the greatest generation to the baby boomers, the underpinnings of the culture decayed. “Our Business Principles” were always featured in the annual report and handed out to new recruits. But everyone could see that the firm’s view of its clients was changing. They became a source of transactions, the success of which was measured by the payday, not the enhancement of a long-term relationship. Professional retreats became dominated by speeches about how Goldman had to change to survive. For some of us, the time to move on had arrived, and it was a deeply emotional process.
Trading was always part of Goldman (and all of Wall Street), the counterpoint to investment banking. Investment bankers advise clients on capital raising and mergers and acquisitions. These activities are collaborative and essentially serve the client’s interest. As a result, long-term relationships and service to the client are essential to success in investment banking. In contrast, traders each have a book of long and short positions. Trader successes and failures are far more individual and immediate. The goal is not to help a client but to strike a favorable deal with a counterparty. Through the years, there were legendary struggles between bankers and traders for leadership of Wall Street firms. For the most part, however, the bankers ran the firms.
The world shifted. Trading exploded, largely fueled by information technology. It seemed that every number on earth could be divided by every other number, all in real time. Everything could be priced, and, once priced, could be traded. Markets were deregulated and carved into pieces, each representing a trading opportunity. The Wall Street firms, and Goldman in particular, with their enormous capital resources, could dominate more and more of the price points in the American economy, extracting value from the producers and consumers. Software programs could be written to access electronic trading platforms so that the enormous force of the trading houses could be brought to bear without the inefficiency of human intervention. It seemed that a business model relying on dispassionate exploitation of immediate opportunity had been perfected.
The golden rule kicked in—“He who has the gold makes the rules.” The predominance of trading profits reversed the balance of influence in favor of the traders. Clients were no longer just clients; instead, they were counterparties to be dealt with at arm’s length. In the end, the traders achieved Nirvana—using asset pools, they were able to synthesize their own clients as sources of securities to trade. The business of trading, focused on short-term profits, became dominant at Goldman Sachs, and every firm on Wall Street tried to emulate it.
Lloyd Blankfein’s rise at Goldman Sachs parallels this process. He started as a metals trader at J. Aaron, which was acquired by Goldman during the Weinberg years. A brilliant trader, he completed the conversion of Goldman Sachs that is described by Greg Smith. In a dramatic Senate hearing just before the Dodd-Frank Act was passed, Blankfine was questioned relentlessly by Senator Carl Levin about the conflicts of interest in the Goldman business model. He seemed genuinely perplexed that his responses weren’t persuasive. It is probably true that he believes his people did the right thing. After all, he is a trader, not a banker. He is constitutionally committed to the transaction.
Traders, like Blankfein, have a code of ethics. They always stand by their word when a deal is struck. It is just that they are unconcerned about long-term relationships. What troubles Greg Smith is the disingenuous lip service to Goldman’s commitment to clients. It is too bad that he had to learn the truth so harshly.
The American economy has lost something in all of this. Wall Street’s capital-markets business serves us best when it is aligned with the long-term growth of the economy. We need more Weinbergs (and maybe even more J.P. Morgans) and fewer trade bots.
This Wall Street metamorphosis was a response to the new environment and will persist until outside forces intervene. Recalling the value of Wall Street’s historic interest in long-term economic growth is not just an exercise in nostalgia for a lost era. Advanced trading practices constitute a relentlessly efficient means to deploy capital in great quantity instantaneously. If the premises behind trading strategies are flawed, however, the consequences are magnified. It is relatively easy to hire quantitative geniuses to construct algorithms and measure conditions with great precision. The decision of what to measure and the prudent use of the results is another matter. Short-term mentality is a problem. When things go wrong, and they will, this mentality assures that the damage is immediate and devastating.
The only rational choice for the economy as a whole is to curb trading practices and to align the interests of Wall Street and the public. Bankers would be wise to see that this realignment is ultimately in their interest, even if it adversely impacts immediate profits. They may be able to deploy sufficient lobbying resources to blunt and delay the financial reform effort. But a viable contract with the American people in which they support the long-term health of the economy is the only way to preserve their business for decades to come.
A word of advice: Be long-term greedy, not short-term greedy.