Getting it right: how Goldman weathered subprime turmoil

Getting it right: how Goldman weathered subprime turmoil

New York: For more than three months, as turmoil in the credit market has swept wildly through Wall Street, one mighty investment bank after another has been brought to its knees, levelled by multibillion-dollar blows to their profits.

And then there is Goldman Sachs Group Inc.

Rarely on Wall Street, where money tends to travel in a thundering herd, has one firm gotten it so right when nearly all its peers were getting it so wrong. Three banking chief executives have already been forced to resign because of the debacle and the pay for nearly all the survivors is expected to be deeply cut.

But for Goldman’s chief executive, Lloyd Blankfein, this is turning out to be a very good year. He will surely earn more than the $54.3 million (Rs213 crore) he made last year. If he gets a 20% raise—in line with the growth of Goldman’s compensation pool—he will take home at least $65 million.

Many expect his pay, which is tied directly to the firm’s performance, to reach as high as $75 million. Goldman’s good fortune is not due simply to good luck. Late last year, with the markets roaring along, David Viniar, Goldman’s chief financial officer, called a “mortgage risk" meeting in his meticulous 30th floor office in the firm’s New York headquarters. At that point, Goldman’s mortgage desk was down somewhat but the notoriously nervous Viniar was worried about bigger problems. After reviewing the full portfolio, his message was clear: the bank should reduce its stockpile of mortgages and mortgage-related securities and buy expensive insurance as protection against further losses, a person briefed on the meeting said.

With its mix of swagger and contrary thinking, it was just the kind of bet that has long defined Goldman’s hard-nosed, go-it-alone, risk-taking style. Meanwhile, most of the firm’s competitors, with the exception of the smaller and more specialized Lehman Brothers, appeared to barrel headlong into the mortgage markets. They kept packaging and trading complex securities for high fees and more market share without hedging, or protecting themselves against the positions they were buying.

When the credit markets seized up in late July, Goldman was in the enviable if not quite believable position of having offloaded the toxic products that Merrill Lynch & Co. Inc., Citigroup Inc., UBS, Bear Stearns Cos. Inc. and Morgan Stanley, among others, had kept right on buying until it was too late.

“If you look at their profitability through a period of intense credit and mortgage market turmoil," said Guy Moszkowski, an analyst at Merrill Lynch who covers the investment banks, “you’d have to give them an A-plus."

This stark contrast in performance has been a struggle for competitors to swallow. The bank that seems to be in every corner, with a hand in so many deals and products and regions, made more money in the boom and—at least so far— managed to go right on making money in the bust.

Not surprisingly, Goldman’s stock has significantly outperformed its peers. At the end of last week it was up almost 13% for the year, compared with a drop of almost 14% for the XBD broker-dealer index.

Meanwhile, Merrill Lynch, Bear Stearns and Citigroup are each down almost 40%. Goldman’s secret sauce, say executives, analysts, historians and industry observers, is an odd mix of a high-octane business acumen, tempered with paranoia and institutionally encouraged—though not always observed—humility.

“There is no mystery, or secret handshake," said Stephen Friedman a former co-chairman and now a Goldman director. “We did a lot of work to build a culture here in the 1980s and now people are playing on the balls of their feet. We just have a damn good talent pool."

That pool has allowed Goldman to extend its reach across Wall Street and beyond. Just last week, John Thain, a former Goldman co-president accepted the job as chief executive of Merrill Lynch, while a fellow Goldman alumnus took Thain’s job running the New York Stock Exchange. Another fellow veteran trader, Daniel Och, took his $30 billion hedge fund public. Meanwhile, two Goldman managing directors acted as liaisons, helping bring Alex Rodriguez back to the New York Yankees baseball team, a classic Goldman deal that enhances the value of the firm’s 40% stake in the YES network—which it is trying to sell—while also pleasing Yankee fans. The symmetry was perfect: like the Yankees, Goldman, more than any other bank on Wall Street, is both hated and revered.

Robert Rubin, a former Goldman head, is the new chairman of Citigroup. In Washington, Henry Paulson Jr. another former chief, is the treasury secretary, having been recruited by Joshua Bolten, President George W. Bush’s chief of staff and a yet another former Goldman executive. Goldman alumni run the Canadian and Italian central banks. The World Bank president is yet another. Jon Corzine, after representing New Jersey in the Senate, has moved to the governor’s chair. And in academia, Robert Kaplan, a former vice-chairman, has just been picked to run, on an interim basis, Harvard’s $35 billion endowment.

Goldman, of course, has made its share of mistakes. It took among the most serious write-downs on loans that were made to private equity firms, totalling $1.5 billion. The firm runs one of the largest hedge fund operations in the world but its flagship funds—funds whose investors include marquee Goldman clients and employees of the firm—have had a two-year run of abysmal performance. Clients are expected to redeem billions of dollars of capital at the end of this year. Moszkowski estimates that investment and commercial banks in the US have taken $50 billion in write-downs related to mortgages with more coming; Blankfein said at a conference last week he expected to take none. In recent years, Goldman has established the largest private equity and real estate fund complexes in the world. That has led to natural tensions with private equity clients, who sometimes complain, but never in public, about Goldman’s insistence on often teaming up with them for a piece of the action.

“Goldman has done the best job of any firm in the US or world competing with their clients but doing business with them," said one client who asked not to be identified because he does business with the firm. “They’ve managed to get their clients to live with it."

Still, this profit approach rubs some Goldman veterans and clients the wrong way. They see the firm’s desire to advise, finance and invest—a so-called triple play—as antithetical to Goldman’s stated No. 1 business principle of putting clients first.

And there is little question that its success in trading, investment banking and servicing hedge funds—many of the traders come right from Goldman—allows the firm a unique bird’s eye view on trends and capital flows in the market.

Numerous Goldman investment bankers, former and current, voice the view that Blankfein’s approach—broadly defined as monetizing the investment banking business—creates a brand intended to feed Goldman’s profits rather than relationships. But this harking back to the firm’s golden days as a pure advisory firm does not find much sympathy at Goldman these days.

“I have little patience for these people who talk of the last days of Camelot," Friedman said. “Principal investing has been an important and useful business. If you want to be relevant you have to anticipate where the world is going."

Blankfein, at a recent conference, echoed that sentiment. “While the integration of our investment banking operations with our merchant bank was somewhat controversial at the time, we felt these businesses were mutually reinforcing," he said.

Money soothes a lot of concerns, of course, and Goldman had plenty of that to spread around. Through the third quarter, Goldman’s $16.9 billion compensation pool—the money it sets aside to pay its employees—was significantly bigger than the entire $14.3 billion market capitalization of Bear Stearns.

Goldman executives and analysts assign much of their success to smart people and a hierarchy where executives are encouraged to challenge each other. But the distinction that has become most readily apparent recently is the firm’s ability to manage its risks, a tricky task for any bank. Checks and balances have to be in place to turn off a business spigot even as it is still making a lot of people a lot of money. In a world where power gravitates to the rainmakers, that means only management can empower party crashers.