Money and Power
Page 4
Senator Levin then directed Sparks toward a series of internal Goldman e-mails about the importance of selling off the Timberwolf securities into the market. He wanted to know from Sparks how Goldman could do that after Montag had made his observation about Timberwolf. Sparks started to explain about how the price of the security drives demand and even a security sold at a discount can attract buyers. But Senator Levin was not much interested. “If you can’t give a clear answer to that one, Mr. Sparks, I don’t think we’re going to get too many clear answers from you,” Senator Levin concluded.
When Viniar, Goldman’s CFO, testified later in the day, Senator Levin asked him about Montag’s e-mail, too. “Do you think that Goldman Sachs ought to be selling that to customers—and when you were on the short side betting against it?” he asked. “I think it’s a very clear conflict of interest, and I think we’ve got to deal with it …” Before Viniar could answer, Senator Levin interjected: “And when you heard that your employees in these e-mails, in looking at these deals said, ‘God, what a shitty deal. God, what a piece of crap.’ When you hear your own employees and read about those in e-mails, do you feel anything?”
For the first—and perhaps only—time during the hearing, Viniar’s answer strayed from the script. “I think that’s very unfortunate to have on e-mail …,” he said. “I don’t think that’s quite right.”
“How about feeling that way?” Senator Levin shot back.
“I think it’s very unfortunate for anyone to have said that in any form,” Viniar replied, backtracking.
“How about to believe that and sell that?” Senator Levin asked.
“I think that’s unfortunate as well,” Viniar said.
“No, that’s what you should have started with,” Senator Levin replied.
“You are correct,” Viniar said.
When Blankfein finally appeared, after cooling his heels for most of the day, Senator Levin asked him about Montag’s e-mail, too. “What do you think about selling securities which your own people think are crap?” he asked Blankfein. “Does that bother you?” Blankfein seemed a bit confused and wondered if perhaps Montag’s comment was hypothetical. When Senator Levin assured him the e-mail was real, and that Montag had written “this is a ‘shitty’ deal, this is crap,” Blankfein seemed off-balance. He tilted his balding head to one side and squinted his eyes, something he has been doing since he was a youth—but which left many people thinking he was being evasive. “The investors that we are dealing with on the long side or on the short side know what they want to acquire,” he responded, and then added, “There are people who are making rational decisions today to buy securities for pennies on the dollar, because they think [they] will go up. And the sellers of those securities are happy to get the pennies, because they think they’ll go down.”
Blankfein’s perfectly rational response about the way markets work—where for every buyer there must be a seller and vice versa at various prices up and down the spectrum—had little or no impact on Senator Levin’s growing anger with Goldman and Blankfein. “I happen to be one that believes in a free market,” Levin said near the end of the long day. “But, if it’s going to be truly free, it cannot be designed for just a few people to reap enormous benefits, while passing the risks on to the rest of us. It must be free of deception. It’s got to be free of conflicts of interest. It needs a cop on the beat and it’s got to get back on Wall Street.” Shortly after the hearing, along with Senator Jeff Merkley (D-Oregon), Senator Levin introduced an amendment to the huge financial reform bill that would prevent Wall Street firms from engaging “in any transaction that would involve or result in any material conflict of interest with respect to any investor” in an asset-backed security, such as a CDO. A version of the amendment was included in the Dodd-Frank Act President Obama signed on July 21, 2010.
The senators raised a good question. How could Goldman keep on selling increasingly dicey mortgage-related securities, even though sophisticated investors wanted them, at the same time the firm itself had pretty much become convinced—and was betting—the mortgage market would collapse? And, frankly, why did synthetic CDOs exist at all, given how rife with conflicts of interest they seemed to be? Are these kinds of securities too clever by half? For that matter, how could Goldman get comfortable, in January 2011, with offering its wealthy clients as much as $1.5 billion in illiquid stock of the privately held social-networking company Facebook—valued for the purpose at $50 billion—while at the same time telling them it might sell, or hedge, at any time its own $375 million stake and without telling them that its own private-equity fund manager, Richard A. Friedman, had rejected the potential investment as too risky for the fund’s investors?
In a way that he was unable to articulate at the Senate hearing, in his spiffy but simple new office overlooking New York Harbor, Blankfein mounted a spirited defense of synthetic securities. He gave the example of an investor, with a portfolio of mortgage securities heavily weighted toward a certain year or a certain region of the country, looking to diversify the portfolio or the risk his portfolio contained. “It’s just like any other derivative,” he said. “If there are willing risk takers on both sides, you could diversify your portfolio with a ‘synthetic’—which is just another word for a ‘derivative’—on those securities. We could run the analysis and could take away or add to some of your exposure to this state or region, this vintage, this credit. We could be on one side of the transaction, which is what we do as a market maker—a client would ask us to do that—or source the risk from someone else or some combination. We might source some, not all, of that risk, or we might substitute it by trying to replicate a physical portfolio. That, to me, serves a purpose just like any other derivative helps sculpt a portfolio in order to give an institution the exposure or lack thereof they desire.” He is not blind, though, to the risks such complexity creates. “There could be trade-offs,” he continued. “If the securities and the risks created are too hard to analyze or too illiquid or too this or too that, you can well decide that those type of transactions shouldn’t be done. But that’s a very different calculation from saying derivatives serve no social purpose.”
But Senator Levin remained unimpressed by Blankfein’s argument. He believed that once Goldman made the decision to short the market in December 2006, the firm should have stopped selling mortgage-related securities, such as ABACUS or Timberwolf or other mortgage-backed securities, and let its clients know it was increasingly worried. “As a lawyer”—like Blankfein, Senator Levin is a graduate of Harvard Law School—“who’s trained that you’ve got a client and that your duty is owed to that client—and I know there’s various degrees of duty, and I understand that—but the duty here clearly was violated, to me, in the most fundamental sense,” he said in an interview. “And that’s what got me so really, really disturbed at that hearing was when they didn’t get it. They did not understand how wrong it is to package stuff, which they’re trying to get rid of, which they internally described as ‘crap’ or ‘junk’ or worse, [and sell] that to a customer. And then bet heavily against it. And make a lot of money by betting against it. They don’t get it. To me, the underlying injury is the conflict itself—is selling something that you then go out and bet against. But adding insult to the injury is when you are selling something, which you internally believe is junk that you want to get rid of, and describe it as such to yourself, knowing that … you’re aware of it. The underlying injury, to me, is the conflict whether or not it’s described that way.”
In his opening remarks, Blankfein told Senator Levin’s committee that April 16—the day the SEC filed its lawsuit—“was one of the worst days in my professional life, as I know it was for every person at our firm.” He then continued, “We believe deeply in a culture that prizes teamwork, depends on honesty and rewards saying ‘no’ as much as saying ‘yes.’ We have been a client-centered firm for 140 years and if our clients believe that we don’t deserve their trust, we cannot survive.”
Blankfein, focused on the particulars and steeped in the Goldman worldview, was convinced the firm was unfairly vilified. His failure to see the larger picture, his inability to understand the outrage at Goldman’s huge profits in the face of widespread economic misery have much to do with the insularity of Wall Street, and especially Goldman’s view of itself as the elite among the elite—smarter, and better, than anyone else. Indeed the story of Goldman’s success and long history underscore one of the great political truths: the scandal is not what’s illegal, it’s what’s legal. And no firm, through many crises and decades, had developed more skill in walking that fine line. Goldman certainly succeeded because it consistently hired and promoted men (and an occasional woman) of intelligence and acumen and because it created an environment that rewarded them lavishly for their risk taking. But it also succeeded by creating an unparalleled nexus between the canyons of Wall Street and the halls of power—a nexus known as “Government Sachs.” That nexus was finally coming unglued as the world markets teetered on the edge of the financial abyss now known as the Great Recession.
CHAPTER 1
A FAMILY BUSINESS
What became Goldman Sachs opened its doors in 1869. Like many of his fellow European Jewish immigrants who later went on to become successful bankers, when Marcus Goldman first came to the United States in 1848 from a small village in central Germany, he became a clothing merchant. This was the way the Lazards started in New Orleans in 1848, and how the Lehmans started in Montgomery, Alabama, in 1844. There was no surprise in this, of course, since owning a store was considered an “appropriate” occupation for a Jewish immigrant, whereas the banking profession was reserved for the established—non-Jewish—elites.
Marcus Goldman first arrived from Burgpreppach, Germany, in New York City but, according to Stephen Birmingham, the author of Our Crowd, “he quickly set off for the area that, rightly or wrongly, young German Jewish immigrants had heard was the peddlers’ paradise, the coal hills of Pennsylvania.” He made the journey from Germany when he was twenty-seven years old. At first, Goldman was a peddler, with a horse-drawn cart. But by 1850, according to the U.S. Census data, Goldman was in Philadelphia, where he owned a clothing store on Market Street and rented a “comfortable house” on Green Street. By then, he had met and married Bertha Goldman (no relation), who had also emigrated from Bavaria in 1848 and settled in Philadelphia with her relatives. Bertha “had supported herself quite nicely,” according to Birmingham, “doing embroidery and fine needlework for Philadelphia society women.” The Goldmans were married when Bertha was nineteen. By 1860, Goldman had become a merchant, according to the census data, and had fathered five children, Rebecca, Julius, Rosa, Louisa, and Henry. He listed on the census the value of his real estate at $6,000 and the value of his personal estate at $2,000. The Goldmans also employed two servants.
In 1869 Marcus Goldman moved with his family to New York City. One of the main reasons for the move was that Bertha Goldman had had about as much of Philadelphia as she could stand and urged her husband to move them all north. They settled at 4 West Fourteenth Street. By this time, Goldman had decided to abandon the clothing business, as had a number of his Jewish peers, and decided to do what he could to get into the money business.
He started a sole proprietorship, at 30 Pine Street, focused on buying and selling IOUs from local businessmen. The idea was to help these small operations turn their accounts receivable into cash without having to make the arduous trip uptown to a bank. Goldman’s office was in the cellar of the building, next to a coal chute and, according to Birmingham, “in these dim quarters he installed a stool, a desk and wizened part-time bookkeeper (who worked afternoons for a funeral parlor).” The name on the door: “Marcus Goldman, Banker and Broker.”
Despite the humble office space, Goldman made sure he looked the part of an aristocrat. “In what was the standard banker’s uniform—tall silk hat and Prince Albert frock coat—Marcus Goldman started off each morning to visit his friends and acquaintances among the wholesale jewelers in Maiden Lane, and in the ‘Swamp,’ where the hide and leather merchants were located,” Birmingham wrote in Our Crowd. “Marcus carried his business in his hat. He knew a merchant’s chief need: cash. Since rates on loans from commercial banks were high, one means New York’s small merchants had of obtaining cash was to sell their promissory notes or commercial paper to men like Marcus at a discount.” In his telling, Birmingham likened the “commercial paper” of the day—unsecured short-term debts—to a postdated check that could only be cashed six months in the future. Based on prevailing interest rates and the “time value” of money concept—the idea that one dollar in hand today is worth more than one dollar in hand six months from now, because presumably you could invest the money in the interim and earn a return on it—investors such as Marcus Goldman would buy the IOU for cash at a discount today knowing that, all things being equal, over time he could get face value for the paper.
According to Birmingham, the commercial paper of these small businesses in lower Manhattan would be discounted at between 8 to 9 percent. Goldman bought the discounted notes in amounts ranging from $2,500 to $5,000 and then “tucked the valuable bits of paper inside the inner band of his hat for safekeeping.” Throughout his morning, as he bought more and more notes at a discount from these merchants, Goldman’s “hat sat higher and higher above his forehead.” In this way, Goldman could keep score against the likes of his fellow ambitious Jewish bankers: Solomon Loeb, the Lehmans, and the Seligmans. The higher the hat on the forehead in the morning, the more business being done. In the afternoon, Goldman would make his way uptown to visit the commercial banks—Commercial Bank on Chambers Street, the Importers’ and Traders’ Bank on Warren Street, or the National Park Bank on John Street—where he would see a “cashier, or perhaps the president,” according to Birmingham, “deferentially remove his hat, and they would begin to dicker” about what price the bankers would pay for the notes Goldman had in his hat. The difference between the buying and selling—not unlike what his descendants would do with mortgage-backed securities 140 years or so later—would be Marcus Goldman’s profits. Right away, according to Birmingham, Goldman was able to buy and sell some $5 million worth of this commercial paper a year. Assuming he could clear, say, five cents on every dollar, he may well have been making some $250,000 a year—a tidy sum indeed in 1869.
The Goldmans quickly improved their lifestyle. The family moved to a four-story brownstone at 649 Madison Avenue, some twenty-five feet wide and ninety feet tall. Bertha was able to afford one of the “sumptuous turnouts”—a carriage—“with liveried servants” to go about her morning errands and shopping sprees. Around this time, on a passport application, Marcus Goldman was described as five foot, three inches tall, with a gray beard, fair complexion, and an oval face. His forehead was described as “high.”
For some thirteen years, unlike his peers who had a number of partners in their businesses—mostly siblings or in-laws—Goldman took in no partners, and his personal wealth grew, as did the capital of his firm, which stood at $100,000 in 1880, all of it belonging to Marcus Goldman. But, in 1882, at age sixty, at which point he was buying and selling around $30 million of commercial paper per year, he decided the time had come to bring a partner into the firm. In typical fashion, Goldman chose to invite a family member—in this case, his son-in-law, Samuel Sachs, the husband of his youngest daughter, Louisa—into the business. Not only would a family member be easier to control and to trust, but also i
n an era of quasi-arranged marriages, the Goldmans had already decided that the Sachses, also immigrants who came to the United States in 1848, possessed the right stuff.
Samuel Sachs’s father, Joseph, was a poor tutor and the son of a saddle maker from outside Würzburg. As a teenager, the Baer family—the father of which was a wealthy goldsmith from Würzburg—asked Joseph Sachs to tutor their beautiful daughter, Sophia. Against the wishes of the Baers, of course, “in a fairy-tale way, the poor young tutor and the lovely young merchant princess fell in love,” according to Birmingham. They decided to elope and take the next schooner for America (although where they got the cash from is not clear; Birmingham suspects Sophia Baer “pocketed some of her father’s gold” on the way out of town).
The Sachses raised five children in Baltimore and Boston before moving, after the Civil War, to New York City, where Joseph—who had been both a teacher and a rabbi—opened a school for boys named the Sachs Collegiate Institute, in 1871, on West Fifty-ninth Street. Their oldest son, Julius, ran the Sachs school and went on to become a well-regarded educator. “Herr Docktor Sachs was a stern, Old World schoolmaster whose uniformed boys, in smart black suits and starched stand-up collars, were seldom spared the rod,” according to Birmingham. He emphasized discipline and classicism and spoke nine languages fluently, including Sanskrit. Sachs Collegiate Institute quickly became the school of choice for other aspiring Jewish immigrants with names such as Lehman, Cullman, Goldman, and Loeb. The idea was to get these boys—it was an all-boys school then—“ready for Harvard at the age of fifteen,” Birmingham wrote.
By arrangement, Julius Sachs married the Goldmans’ daughter, Rosa, a combination that worked out sufficiently well that the parents arranged for Louisa to marry Sam, who had already started his working life—as a bookkeeper—at the age of fifteen after his parents’ untimely death.