Last week a Goldman Sachs former employee Greg Smith wrote an op-ed for the New York Times explaining why he was resigning from Goldman Sachs. He alleged Goldman's culture had recently deteriorated and that Goldman's "toxic and destructive" culture isn't doing right by its clients.
The puzzling thing about his article is that he claims this is new behavior for Goldman. Neither Mr. Smith nor Goldman Sachs in its subsequent rebuttal talked about well-publicized congressional hearings or Goldman's record settlement of $550 million with the SEC in satisfaction of charges against it for one of its Abacus CDOs. For years I've written in books and articles about suspect practices in the origination and distribution of residential mortgage backed securities and other collateralized debt obligations. Goldman Sachs was one of many firms involved, and its Abacus CDO was one of many such deals that merit further investigation. (See "Goldman Sachs Spinning Gold," April 7, 2010.) But even that isn't new behavior, and I'll give more examples of problematic behavior in a moment.
Goldman Sachs's Non-Response
Goldman's Chairman and CEO Lloyd Blankfein and President Gary D. Cohn attempted damage control writing that Smith's missive doesn't "reflect our values, our culture, and how the vast majority of people at Goldman Sachs think about the firm and the work it does on behalf of clients."
Goldman didn't actually respond to Mr. Smith's allegations. I'm guessing Goldman's senior leaders, Lloyd Blankfein and Gary D. Cohn, didn't flunk statistics. After all, they keep telling us they're the best and brightest. Yet they offer an argument flawed by sample bias. They write the "vast majority of people at Goldman" -- people paid by them -- have a different view than Smith. To 'support" an argument with this type of biased data is the statistical equivalent of cheating at cards.
Et Tu, Bloomberg?
New York mayor Michael Bloomberg rose to Goldman's defense saying its Chairman and CEO Lloyd Blankfein was "trying to lead this firm at a time when God couldn't lead it without being criticized."
Michael Bloomberg's defense of Goldman was unfortunate in its choice of words. Blankfein came under fire in November 2009 for his quip in London's Sunday Times for saying he was doing "God's work." We all know how busy she is, so a more apt comparison (or contrast) might have been one involving another mere mortal.
What Do Customers Really Think?
I haven't done a valid survey of Goldman's clients, so I cannot tell you what they think. I can, however, speak for myself and cite a public article that suggests clients should think hard about their relationship with Goldman.
On the bright side, Warren Buffett, legendary investor and CEO of Berkshire Hathaway, seems to have gotten the kid glove treatment from Goldman, and he has lovely things to say about them. If you have billions of dollars of cash to put to work, connections with the White House and near daily good PR in the mainstream financial press, you may have a similar experience in your dealings with Goldman Sachs.
Buffett's experience is not universal. The following examples are a small sample and should not be taken to be the general opinion of Goldman's clients. But they are important examples, and I can personally attest to one of them. The first is public and the second is public information from one of my books, but for the first time, I identify Goldman Sachs as the "professionals" involved.
Jim Clark of Netscape Fame: "No More Goldman"
Mr. Smith worked in equity derivatives. I don't know what customers of that product think, but at least one customer of Goldman Sachs' equity division is happy to see the back of them.
In January 2011, Rich Teitelbaum of Bloomberg Markets reminded the financial world that Goldman Sachs Asset Management has an anemic track record. ("Blankfein Flunks Asset Management as Clark Vows No More Goldman.") Despite Goldman's public relations hype that it employs the "best and brightest," it trailed the average return of its peer group in every category. Perhaps the most gripping part of Teitelbaum's article was his report of customer Jim Clark's point of view:
Jim Clark of Netscape and Silicon Graphics fame was irritated that Goldman wanted to fee stuff its Facebook offering with a 4 percent placement fee, a half percent expense fee, and a snatch-back of 5 percent of investors' potential profits.
A few months earlier, Clark had invested in Facebook through another financial firm at a lower price, and the other firm wouldn't potentially gouge him with Goldman's 5 percent pleasure-of-your-company tax. "I don't think it's reasonable," Clark told Bloomberg. "It's just another way for [Goldman] to make money from their clients." The question remains whether Clark bought his stake at a reasonable price.
Goldman's Stacked Deck
The following incident took place in Goldman Sachs' London offices around a decade ago. To the best of my knowledge, only one of the individuals is still working for Goldman. At the time he was a managing director; he's now a New York-based partner. I used this event as an example of a pitfall for the unwary in my book Collateralized Debt Obligations & Structured Finance, John Wiley & Sons, 2003. I reiterated the incident in the expanded second edition, Structured Finance, 2008. When I wrote the book, I didn't identify Goldman as the firm, but I do it now to illustrate that Goldman's has a history of problematic behavior that has been below the radar screen. Goldman has a long history of, inadvertently or otherwise, trying to pull a fast one.
One well-known, well-respected, American investment bank asked me to consider protection from one of their "transformer" vehicles. They asked if the bank I worked for would intermediate a credit default swap transaction. Requests for intermediation are common. Many banks need an OECD bank counterparty for regulatory capital purposes. If the structure is right, the intermediation fee can allow the intermediary bank to earn a reasonable return on the minimal capital required, and all parties are satisfied.
The investment bank sent over their documentation. It was a paltry two-page document, whereas monolines will send a small booklet and make their lawyers available to discuss language details. When I looked at the document, I realized that the transaction was unsuitable. The following diagram shows the gist of the proposal, without embarrassing those who should be.
The investment bank assured me they would give me proper credit default swap documentation incorporating whatever language I wanted. If a credit event occurred, the bank would look to the SPE to make payment under the terms of the credit default swap, and I could design the terms.
The investment bank invited me to a meeting at their offices. Four tailored Armani suits or better appeared at the meeting. If life were a fashion war, the investment bankers would be winning. They were confident and took victory postures. They attempted to persuade me to do the transaction. I continued to decline. I could sense their building frustration. They couldn't understand why they weren't getting my agreement. After all, they were taller, they were louder, and they were in the majority.
So what was the problem?
I picked up a cookie -- the meeting didn't have to be a total loss -- and explained. I didn't want to play their shell game. The problem was that my counterparty for the credit default swap protection would have been the SPE, a shell corporation. The only asset of the SPE was an insurance contract. The SPE would only receive a credit default payment after the insurance company determined its actual recovery after taking the matter through bankruptcy proceedings. The SPE had no way of assuring timely payment under the terms of the credit default swap confirmation.
The transformer wasn't even worth the price of the child's toy of the same name for the purpose they were suggesting. Sure, the SPE would have ultimately got paid and the bank would ultimately have received payment, but that wasn't the point. The point was that the SPE did not have the resources to perform under the terms of its transaction with the bank. It could not pay on a timely basis, no matter how cleverly crafted the credit default swap confirmation. If a credit event occurred, the bank would have to fund the credit default payment to the ultimate protection buyer until the SPE finally received its payment from the insurance company. The investment bank only offered the usual credit default swap intermediation fee, but the bank had additional risk beyond the credit default swap agreement.
It's possible that the well-dressed guys weren't aware of this until I pointed it out. The implications of that are ugly enough. But if they were aware, the implications are even uglier.
So what do the rest of Goldman's clients think about the firm? That will be the crucial question for Chairman and CEO Lloyd Blankfein and President Gary Cohn. I can't answer that question for them, but I can guarantee them that they won't find the answer by asking the "people at Goldman."
1 - My new e-book, The New Robber Barons , is now available. You must own a Kindle or have installed the Kindle app for PC, Mac, or iPad to download it. You can find it at Amazon US here, at Amazon UK here, Amazon France here, at Amazon Germany here, at Amazon Italy here, or at Amazon Spain here.
2 - Unicredit, an Italian bank, is a large scale client that Goldman Sachs apparently recently alienated. According to the Financial Times, a couple of months ago, Goldman was ejected by Unicredit as an underwriter on a deal."despite vocal protestations. By the end of January, UniCredit had successfully raised its funds -- and Goldman Sachs had alienated another client." The reported reason for Unicredit's action was that Goldman tried to organize a rebellion when it didn't get the lead role as the deal's global coordinator, and it backfired on them. The Financial Times published this story on March 16, 2012.