by Robert Rubin
We had lost about $100 million. Today that wouldn’t mean much, but in that world at that time, it was very meaningful. And it wasn’t just the losses to date but also a question of what those losses portended for the future. You have no way of knowing when a downward spiral will end or if the next period will be even worse. The fixed-income division had contributed greatly to Goldman’s overall profitability. Suddenly, our biggest trading operation had gone sour, and we didn’t understand why or what the future might bring.
Steve and I went into the trading room and said, “Let’s all sit down and try to understand what we’re holding. If we have positions we shouldn’t have, let’s get rid of them.” Leaving aside the psychological factors that incline most traders to resist taking losses, what soon became clear was that they hadn’t fully anticipated the behavioral characteristics these securities could have when conditions changed substantially. Many of these bonds had embedded or implicit options. As a simple example, the firm was trading mortgage-backed securities that represented the loans people take out to finance homes. As interest rates declined, people refinanced 13 and 14 percent mortgages at 9 and 10 percent. That meant that our bonds didn’t rise in line with the fall in interest rates and in some cases were paid off early—creating a loss on a position that had been hedged with Treasury bonds. A similar problem affected corporate bonds. As interest rates declined, bond prices rose to a point where the corporate issuers might exercise call provisions—the right to pay off an outstanding bond, usually to refinance at lower rates. When a bond was at $80, the borrower’s right to redeem at $102 was often ignored. Then, when the bond market had a massive rally, the call provisions did begin to reduce the otherwise expected premium, while the short position rose and created a net loss. What happened to us represents a seeming tendency in human nature not to give appropriate weight to what might occur under remote, but potentially very damaging, circumstances.
Another lesson in these 1986 bond market losses—which I had learned through mistakes made in arbitrage years earlier—was to think not only about the odds of making a profit on each trade, but the limits on tolerance for loss in the event market conditions became much worse then expected. The issue wasn’t simply financial staying power. A trader and his firm had to know the outer limits of what they were willing to lose relative to their earnings and balance sheet. A related problem was liquidity. Traders tend to assume that their positions will always be salable at very close to the last market price. When markets are doing reasonably well, they say, “Well, if I don’t like something I’ve bought, I’ll just kick it back out.” But when conditions deteriorate severely, liquidity diminishes enormously. Traders often can’t sell bad positions except at enormous discounts, and sometimes not at all. Then they may be forced to sell good positions to raise money. Thus, during periods of great market duress, investments can react in unexpected ways. Securities that have no logical relationship may suddenly move in tandem while securities that do have a logical relationship may diverge. Unexpected losses can develop rapidly and be huge.
Dealing with the 1986 meltdown in fixed income probably helped reinforce the position Steve and I had acquired as heirs apparent, and in 1987, John Weinberg appointed us co–chief operating officers of Goldman Sachs. Even after we assumed our new positions, however, I remained co-head of trading and arbitrage and the Management Committee member responsible for J. Aron—albeit with many fewer day-to-day responsibilities in each of those areas. Steve, on the other hand, chose to relinquish his position as co-head of the investment banking division, although he remained very involved in it.
Beginning in early 1987, we became embroiled in a crisis which—painfully—prepared me to help manage several other high-profile crises in subsequent years. A partner of ours, along with two people from another firm, was arrested for insider trading in a highly controversial case. Based on our counsel’s investigations, we believed our partner was innocent, and we stood by him through the entire ordeal. All the original charges were dropped. No new charges were ever brought against the other two. Our partner ultimately pled guilty to a single count unrelated to the original charges. His counsel advised him that he shouldn’t be found guilty but that, with a wealthy defendant in a jury trial in a matter of this sort, there were no guarantees.
For almost two years, Steve and I were engaged with this case and the issues it created for the firm. In dealing with this problem, we learned a number of important lessons. First, in managing a crisis, it is crucial that you not allow it to interfere significantly with conducting your business. One way to minimize this risk is to designate a small team to deal with the crisis. Steve and I told everyone else at Goldman that we’d keep them posted, but that their responsibility was to remain focused on their work. Second, we learned the importance of getting out and seeing your clients during a crisis. Clients have a lot of questions and the firm has to answer them. Third, you have to communicate with your own people frequently, especially since the media is likely to emphasize the negative. Fourth, regarding the media, my own experience over many years, in a number of crisis situations in both the public and private sectors, has convinced me that you simply have to grit your teeth and live through the rough early coverage—you ordinarily can’t affect the initial firestorm. What you can do is be candid about whatever the situation may be, affirmative with respect to your commitment to address your problems—if that is relevant in the particular situation—and confident about the future. Over time, your answers should begin to get more attention and the coverage should become more balanced. Finally, in all of this, you need to resist the tendency to become a little paranoid, thinking that people are looking at you differently when, in most cases, they’re not. It’s important not to be oversensitive, and to treat everyone normally. With all of the potential for something to go wrong in any big company, no matter how well run, and with the attendant media and political firestorms that can erupt in short order, knowing how to cope with a crisis can quickly become critically important for any senior manager.
At the end of 1990, John Weinberg stepped down, and Steve and I were named co-chairmen. Following the Weinberg-Whitehead example, we didn’t try to divide up responsibilities or subject areas. We told everyone to assume that either of us could speak for both and that touching one base was sufficient. This worked because we shared the same fundamental views about the firm, trusted each other totally, kept in close touch, and were both analytically minded in our approach to problems. When this structure does work—and that is a rarity—the advantages are substantial: there are two senior partners to call on clients and two people who can work together on issues with no hierarchical baggage, and who can reinforce each other in discussions with the rest of the organization. Also, when difficulties arise, having a partner reduces the feeling of loneliness at the top.
Absolutely key to our partnership was that when we disagreed, neither of us had his ego invested in winning. Steve and I had a rule that the one who felt more strongly would prevail, or at least have the decision more toward his direction. If one of us felt 80–20 and the other 60–40, the 60–40 one would say, “I sort of disagree, but if you’re eighty–twenty we’ll do it your way—or someplace in between, but more your way than mine.” In the rare cases when we disagreed and both felt strongly, we worked it out. Another proviso was that we usually—although not always—deferred to the more risk-averse position.
On maintaining a meritocracy, protecting the culture of the firm, and focusing on our customers, we agreed. But within those parameters, our views sometimes differed. As an example, Steve strongly favored greater differentiation in partnership shares, based on meaningful distinctions in performance. I, on the other hand, thought the possible ill will of those not favored outweighed the benefit of favoring the best performers—except where the difference was truly major. Over the years, I had seen partners who earned millions of dollars a year become deeply unhappy over tiny distinctions in partnership shares. (Bob Strauss once
captured this dynamic when he said that a lawyer at his firm earning $90,000 a year—this was some time ago—and offered a $10,000 raise with the stipulation that a peer next door would get a $20,000 raise would prefer no raise at all to someone on his own level being paid even more.) Steve referred to my inclination to avoid conflict-provoking distinctions as “solving for maximum social harmony.” Because he felt more strongly than I did, we agreed to increase differentiation, although less than Steve would have done on his own.
My partnership with Steve was in some respects a forerunner of the relationship I had as Treasury Secretary with Larry Summers and Alan Greenspan. None of these people is a shrinking violet. But because of mutual respect, trust, and our analytic approach to issues, these relationships worked. Alan had somewhat different starting points on some issues, but through financial crises, G-7 meetings, currency interventions, and much else, we almost always analyzed our way through to agreement. Steve and I didn’t worry that someone might consider one of us weak because the other’s view had prevailed, nor did Larry, Alan, or I. The overriding drive in both relationships was to reach the best decision.
WHEN STEVE AND I first became co-chairmen, I found the difference between the senior position and what we had been doing far greater than I had expected. With John Weinberg as senior partner, the ultimate approval and responsibility were his, even if we had operating responsibility. Once Steve and I became senior partners, the ultimate responsibility was ours. Larry Summers said the same thing to me about becoming Treasury Secretary. When he was deputy secretary, he felt that the difference between his job and mine was small. After becoming Secretary, he realized that the difference was enormous.
In those days, Larry Tisch, the CEO of Loews Corporation and later of CBS, used to tell me, “Bob, you worry too much.” I’d say, “Larry, you don’t understand. There’s a lot to worry about.” One worrisome issue was Goldman’s lack of a permanent capital base. A firm like ours needed a lot of capital to support what had become a massive global trading operation, to withstand difficult times, and, later, to be competitive in investment banking with the commercial banks. As it was a private partnership, each new retiree could withdraw his share of the capital within a relatively brief period. In a public company, capital remains in the company, and a retiree simply sells his stock on the public market. If conditions were difficult and partners became nervous, Goldman could face a run on the bank. Building capital is thus far more difficult in a private firm. And finally, the partners were at risk not only for the money in the firm but for their entire net worth—a source of great concern in the Penn Central bankruptcy. For these same reasons—as well as the simple desire to cash out—all of our major competitors had already gone public or merged into larger concerns. Steve and I were convinced that the way to deal with these issues was to become a limited-liability corporation and sell stock to the public.
One argument against going public was the flexibility of being able to periodically adjust partnership percentages among the partners, to reflect performance and changes in seniority. Another was the mystique of being private—especially after all the other big Wall Street firms had gone public or merged. The initial public offering proposal presented in 1986 was rejected, largely because the younger partners wanted to preserve flexibility so their stakes could grow more easily. And that structure continued to work for more than a decade. Years after both of us had left, the inevitable eventually happened and Goldman finally did go public.
IN EARLY 1988, I met Governor Michael Dukakis a few times and was impressed with his intelligence. Although I shared the popular view that he was somewhat stiff as a candidate, I raised money and contributed a bit of advice to his campaign. At one point, Dukakis was way ahead of George Bush in the polls, and after his defeat many in the party felt bitterly toward him for the way he had handled his candidacy. Issues about his campaign aside, I still thought that expressing moderate Democratic views—or, for that matter, any sensible views that reflected the complexity of the underlying issues—in ways that resonated politically was extremely difficult. The political system’s bipartisan failure to address the growing deficit demonstrated the imperative need to figure out how to do so. The country remained in denial about serious social issues as well. Our public education system was deeply troubled, and life in the inner cities was getting worse. I wondered whether the country would muster the political will to address its problems. The alternative to facing up to these problems, as I discussed at a dinner Bob Strauss held for me in Washington after I became co-head of Goldman Sachs, was the risk of inexorable national decline.
I hadn’t decided among the Democrats who were considering running in 1992, but I was looking around. I hosted—along with David Sawyer, a well-known Democratic political consultant and Oscar-nominated documentary filmmaker who died at a young age—a series of small dinners at which roughly fifteen business and media people talked with candidates and potential candidates. Among others, we had Senators Tom Harkin (D-IA), Dale Bumpers (D-AR), Joe Biden (D-DE), and Bob Kerrey (D-NE). Bill Clinton was our guest at dinner in mid-1991 and was enormously impressive. I’ve been to many events where a candidate spends much of the time talking. For more than three hours, Clinton engaged in a real dialogue—a serious give-and-take—on the issues important to us. At the end of the dinner, I said to Lew Kaden, a New York lawyer and Columbia law professor deeply involved in Democratic politics, “This guy Clinton is amazing. It’s remarkable how well he understands this stuff.” But Clinton expressed uncertainty about running because of the effect a campaign might have on his family.
Almost a year later, in May 1992, when Clinton had not only decided to run but had pretty much locked up the nomination, he drew together a few so-called advisers in Little Rock to discuss economic issues. The group included several Wall Street investment bankers—Roger Altman and my fellow Goldman Sachs partners Ken Brody and Barrie Wigmore—as well as a centrist economist named Rob Shapiro and three friends of Clinton’s, Robert Reich, Ira Magaziner, and Derek Shearer, who had well-developed views on an active role for government. I had no illusions about our position as “advisers.” We were mainly surrogates intended to lend credibility to Clinton’s economic policies, which, in reality, were set inside the campaign organization. But at this meeting, Clinton took the extraordinary step of taking a day off from the campaign—with no media coverage—to assess his economic proposals and see whether positions developed under the pressure of the campaign made sense for governing. He wanted to stop running for a day in order to check his course.
Doing that showed remarkable seriousness of purpose for a candidate in the midst of a campaign. The group of us flew to Little Rock and spent a number of hours with the governor and Hillary, whom I had never met before. Our group had a range of opinions, but we agreed on the most important issues—the importance of deficit reduction, the need for greater investment in education and health care, and the benefits of trade liberalization. These remained the central components of Clinton’s economic strategy for his eight years in office. Within the context of that consensus, there were differences in emphasis. Ken Brody, Rob Shapiro, Roger Altman, and I emphasized reestablishing fiscal discipline more strongly. Reich, Ira Magaziner, and Derek Shearer tilted somewhat more toward investment in education and training.
Our group was asked to draft an economic statement that subsequently evolved into the economic section of the campaign platform, “Putting People First.” I suggested that Ken Brody, who shared my focus on deficit reduction, draft the document. But Gene Sperling, who had just joined the campaign and instantly became its economic engine, became the chief draftsman, with some input from the rest of us. I’d known Gene slightly from the Dukakis campaign, where he had played a more junior role. Gene was bright, knowledgeable about economics, extraordinarily productive, and highly adept at crafting a message. He was also slightly disheveled and almost impossible to get on the phone except in the middle of the night. When, or whether, he s
lept was a great mystery. But on a substantive, as opposed to a stylistic level, Gene was well ordered. He understood what an economic platform for a campaign should look like and how to meld economic policy, politics, and communication.
Gene would sometimes have the “outside advisers” talk to the press when Clinton discussed economic issues or announced a new proposal. And so I began learning how to engage with the media in a Washington context. Gene told me that it was crucial to get my points across in my response to questions—in effect, to be responsive but from my point of view. Throughout my years in Washington, I never lost my wariness of the media, developed from my earlier experience in crisis response at Goldman, but I did develop great respect for many of the people who covered us and tried to respond seriously to those who were serious with us. One of the ironies of my time in Washington is that by the time I left, I felt that some of the most knowledgeable and interesting people I had gotten to know there were journalists, while at the same time I continued to have reservations about the way the media as a whole functioned.
I spent election night in Little Rock, celebrating Clinton’s victory. A couple of weeks later, I was summoned back to meet with the President-elect. His mood was upbeat, and he jokingly said, “I’m the leader of the free world,” as I shook his hand. We talked for a couple of hours, hardly at all about economic policy, which I told Judy seemed rather peculiar. I wasn’t even quite sure what his purpose in seeing me had been. Later I realized that this had indeed been an interview and served a less obvious but important managerial purpose: Clinton was getting a sense of what I’d be like to work with and how I would work with others—a sensitivity about personalities and the interaction of administration members I would observe many times in the years ahead. I remember Clinton noting that despite being a senior partner at Goldman Sachs, I’d developed very comfortable working relationships with Gene and other younger people on the Little Rock campaign staff, such as Gene’s deputy Sylvia Mathews. In fact, I liked working with more junior people, who were often closer to the specifics of what was going on and had more time to speak with me. I thought—correctly—that I had much to learn from Gene and Sylvia about politics, campaigns, and much else.