RUMOURS of a cash crunch and hidden losses on derivatives start flying. Markets turn jittery. Stocks fall and counterparties begin to pull in credit lines. One of the world’s largest financial firms is on the brink of collapse, threatening to plunge the world into yet another crisis.
In a boardroom high above New York the firm’s senior executives meet representatives of Goldman Sachs and ask for reassurance it will keep its credit lines open. Should the bankers stand by a client, even if it means putting Goldman Sachs at risk, or should they protect themselves, possibly precipitating a financial meltdown?
The film on the screen pauses. Lights in the room brighten and about 100 vice-presidents of Goldman Sachs’s London business blink into it, reaching for answers that will neither make them look stupid in front of their peers nor venal in the eyes of their superiors. A tentative hand rises: “Our first responsibility is to the firm,” says one.
“So the firm comes first despite our business principles [a promise always to put its clients’ interest first]?” asks the moderator, a Goldman Sachs veteran who heads one of its European businesses. Pressing the point he asks the group whether Goldman’s status as a systemically important financial institution ought to have any bearing on the decision. Do its obligations to help ensure financial stability trump all others?
The case study runs for several hours. It is preceded by an emotive documentary on the history of Goldman Sachs, filled with interviews of luminaries and former executives, each hammering home the virtues that supposedly make the firm distinctive — teamwork, personal accountability and the legendary exhortation by Gus Levy, a former leader of the firm, to be “long-term greedy”, by which he meant it should forgo short-term profits if they came at the expense of client relationships.
Critics of the firm, of which there are many, would doubtless guffaw at this theatre. Yet internal training sessions such as the one that The Economist recently attended (with the knowledge of the session’s moderator but without the knowledge of participants) do shed light on the efforts being made by the firm to burnish a badly tarnished reputation.
A firm that for years had shunned the limelight, and that prided itself on the sobriety and understatement of its senior executives, has become the object of ridicule and caricature since the crisis. When described by Rolling Stone magazine in 2009 as “a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money”, bosses shrugged off the insults as the product of jealousy and misunderstanding. Even now few executives say that Goldman should have done anything differently, other than giving customers more information. When asked about a $US550m settlement with the Securities and Exchange Commission in 2010 over claims that it misled investors in a subprime-mortgage product known as Abacus, Goldmanites still privately argue they did nothing wrong.
Wronged as it felt, the firm was nonetheless forced to re-examine itself when it became clear that the trust of its clients was being eroded. A survey of 200 of its most important clients that was released in early 2011 showed some of them thought Goldman Sachs placed its short-term interests above those of its clients, and that its involvement in proprietary trading, among other businesses, put it in conflict with its clients. That cut to the heart of its franchise. Without the confidence of clients “it won’t matter that we know how to make money,” says one executive. “People won’t want to deal with us.”
Squid pro quo
Goldman’s attempts to rehabilitate its reputation have consisted in part of changing its internal rules for dealing with clients. The new rules are best summed up as Goldman playing Nanny to its clients, instead of acting as an equal to its counterparties. Almost all clients bar the biggest and smartest have had limits placed on the sorts of transactions they can undertake. Municipalities, for instance, may not be allowed to buy or sell derivatives unless these are clearly matched by an underlying interest (a loan that needs hedging, say). Goldman is also being more open with clients, telling them exactly how much it will earn from transactions and what different roles it may be playing.
As important are its efforts to reprogram the firm’s culture. As well as the hours of training — the programme is being run across the firm, and the first sessions were led by Lloyd Blankfein, Goldman’s chief executive — internal incentives have been revamped. Pay and promotion are now tied more to whether employees work well in teams, for instance. There is less focus on rewarding staff for the revenue they generate.
These reforms may not be enough, however, without deeper structural changes aimed at reducing the number of conflicts, real or perceived, with which it constantly has to grapple. Steven Mandis, a Goldman veteran turned academic, argues in a remarkable new book, “What Happened to Goldman Sachs?”, that the firm’s culture has been drifting for years. Among the many examples he cites, the firm historically refused to advise bidders launching hostile takeovers because it felt that clients would trust it more as a result. In the late 1990s it reversed this policy, hoping to expand its share of the M&A market.
Another example was the expansion of its proprietary-trading business, in which the bank traded for its own profit. “Until the financial crisis these guys were our biggest competitors,” says the head of trading at a large hedge fund. “It wouldn’t be a stretch to say that Goldman Sachs was the biggest hedge fund in the world.”
It has since pulled back on pure prop trading, but Goldman’s investing heft remains formidable. Its principal-investments arm pulled in more revenues than its investment-banking unit in the first half of 2013. Instead of eliminating conflicts of interest, Goldman hopes to rely on greater disclosure and the wits of its people to defuse them. The firm’s introspection is real; and whatever clients’ misgivings, the bank heads the M&A league tables. But it remains committed to a business model that is designed to put it in difficult situations.