Page Six through Seven (the end)__The End of Wall Street As They Knew It
And as the world becomes deleveraged, money has been pouring out. In October 2011 alone, hedge funds saw $9 billion go out the door. The London-based Man Group, the largest publicly traded hedge fund in the world, saw its stock dive 25 percent over the course of one day in September, when it shocked the market by announcing that $2.6 billion had been redeemed by clients over a three-month span.
“We used to rely on the public making dumb investing decisions,” one well-known Manhattan hedge-fund manager told me. “but with the advent of the public leaving the market, it’s just hedge funds trading against hedge funds. At the end of the day, it’s a zero-sum game.” Based on these numbers—too many funds with fewer dollars chasing too few trades—many have predicted a hedge-fund shakeout, and it seems to have started. Over 1,000 funds have closed in the past year and a half.
In October, a thousand protesters stood outside John Paulson’s Upper East Side townhouse and offered the hedge-fund billionaire a mock $5 billion check, the amount he earned from his 2010 investments. Later that day, Paulson released a statement attacking the protesters and their movement. “The top one percent of New Yorkers pay over 40 percent of all income taxes, providing huge benefits to everyone in our city and state,” he said. “Paulson & Co. and its employees have paid hundreds of millions of dollars in New York City and New York State taxes in recent years and have created over 100 high-paying jobs in New York City since its formation.” The truth was, Paulson was furious that the protesters had singled him out. Last year, he lost billions of dollars on bad bets on gold and the banking sector. One of his funds posted a 52 percent loss. “The ironic thing is John lost a lot of money this year,” a person close to Paulson told me. “The fact that John got roped into this debate highlights their misunderstanding.”
It’s certainly true that Wall Street’s money played an important part in New York’s comeback, helping to transform the city from a symbol of urban decay into a gleaming leisure theme park. Consciously or not, as a city, New York made a bargain: It would tolerate the one percent’s excessive pay as long as the rising tax base funded the schools, subways, and parks for the 99 percent. “Without Wall Street, New York becomes Philadelphia” is how a friend of mine in finance explains it.
In this view, deleveraging Wall Street means killing the goose. The next decade or so will answer the question of whether a Wall Street that’s built on a more stable foundation—and with smaller bonuses—can sustain the city the way the last one did. But as banks cast about for a new business model, the city’s economy will need to find new sources of growth (this is why the Bloomberg administration has aggressively courted the tech and science industries).
Questions about how the banking industry—and the New York economy itself—will reconstitute are being widely debated amid a grudging new consensus among financial types that the past decades represented a distorted type of capitalism. Partly, they acknowledge, the profits of past years were a function of highly specific policies—the repeal of Glass-Steagall, Alan Greenspan’s expansionist monetary policy, the government’s headlong push to encourage home ownership—that allowed Wall Street compensation to explode.
Like an addict, Wall Street is now taking its first step toward recovery by accepting its failings. “TARP led to a lot of this anger,” said Jamie Dimon. “People said, ‘Well, you got bailed out and you would have failed.’ It’s not true in our case, but I can understand why people are upset about that.”
And Dimon acknowledges the issue highlighted by Occupy Wall Street. “I do think we’ve become a less equitable society,” he told me. “So I’d ask the question—let’s say we agree it’s become less equitable—what would you do about it?”
This brand of self-criticism is clearly smart politics. But it also appears to be somewhat sincere. In recent months, a parade of financiers have jockeyed to get on the side of the Occupiers. At a public forum at UCLA’s Anderson School of Management this past November, Bill Gross, the co-head of the massive bond giant PIMCO, told the audience that he shares “sympathy for labor as opposed to capital.” Gross, a registered Republican, articulated the view that finance, and Wall Street compensation, had become disconnected from the real economy. “It’s been several decades when money and finance have dominated at the expense of labor and Main Street. How can one not sympathize with their predicament?”
Page Seven
And, knowing a losing position when they see one, much of Wall Street is onboard with some of the tax changes Obama has been proposing. “I would tax dividends and interest income higher and capital gains,” said Dimon. “Have a higher tax rate. If you said there’d be a certain percent rate for people making over a million dollars and a higher percent rate for people making over $10 million, no problem with me. I don’t think people should be able to pass unlimited amounts on to their kids.”
Even Home Depot founder and financier Ken Langone (“You bet I’m a fat cat,” he told me proudly) isn’t arguing for the status quo. “I would enthusiastically embrace a tax increase,” he told me. “I’m more than willing to pay taxes. I’m saying, take the money and use it to lower the debt.”
Last Tuesday, about 150 people packed into the soaring marble-floored atrium of the Museum of American Finance, housed in the former Bank of New York Building on Wall Street. Large murals on the wall extolled American industry and Wall Street’s role in building businesses. The gathering was a conference honoring the long career of legendary Vanguard Group founder Jack Bogle, but as I listened to the conversation, the hypercapitalism of the aughts sounded like a museum exhibit from an earlier time. Bogle, who built Vanguard into a $1.6 trillion mutual-fund giant, was the guest of honor, but the clear star of the event was Paul Volcker, who caused heads to crane when the genial six-foot-eight former Fed chairman arrived carrying a stack of newspapers and took his place in the audience as Ken Feinberg and Lynn Turner, the former chief accountant for the SEC, debated how Wall Street compensation got so insane. During their panel, I noticed Volcker flipping through his copy of the Financial Times, stopping to read an article headlined “Forget Big Bonuses, a Pay Squeeze Is Coming.”
During a break in the panels, attendees streamed up to Volcker, and a book editor implored him to write his memoirs. It was a dramatic reversal for Volcker, who had been shunted aside during the financial-reform debate but found himself back in the center after Obama embraced a version of his prescriptions. “It’s beginning to have an impact,” he told me when I asked about how his rule is changing Wall Street. “It is a factor in moderating compensation, because compensation was very high for these traders, and that kind of spread through the business into people who didn’t feel like they had a fiduciary responsibility.” As much as anything else, the daylong conference at the museum exposed a generation gap. The Wall Street that spawned the careers of Bogle and Volcker was very different from the one that attracted the next generation of hyperambitious young people to New York and Greenwich, Connecticut, eager to have their lives measured by a number—seven figures or more, they hoped. For those people, especially, it’s difficult to get their minds around a Wal-Mart future for finance. “It’s been three years, and people have to readjust their spending habits,” a former Lehman executive told me. “People have been in different stages of denial.”
Of course, many still argue that the new rules will have unintended consequences. “Banking is very global now,” said Dimon. “If rules are written in a way where American banks can’t compete and are disadvantaged versus non-U.S. banks, that’ll be a problem for banks and for American competitiveness. Banking cannot be made into a utility.”
Some hedge-funders are still going to find ways to make billions, even in this new environment—one of Ray Dalio’s Bridgewater Associates funds made a return last year of over 20 percent. While the big banks’ rank and file saw their cash bonuses slashed, the money that was deferred may eventually end up in their bank accounts; and the CEOs tended to do rather well. Also, it should be remembered that anytime Wall Street has been faced with new regulatory obstacles, it has fairly quickly found ways around them. Many of Dodd-Frank’s rules are still being argued in Washington, and Republicans seem bent on reversing a lot of them.
But for now, the strictures that are holding the banks back now are tighter than any since the thirties. And those laws kept banking reliably risk-free and dull until the deregulation mania of the eighties and nineties unleashed finance. The system is being designed so that Wall Street grows only as fast as Main Street. “The bubble can’t happen again,” Jack Bogle told me. “The underlying reason is, corporations make money. We do things that make society better. But they grow, and this won’t surprise anyone, at rate of GDP.” On Wall Street, recent history was the exception. “Reversion to the mean is the rule of the financial market.”
(Photo: Howard Schatz. An homage to Robert Longo. Model: Michael Scirrotto; Styling by Nikko Kefalas; Grooming by Danielle Cirilli.)
ODAY is my last day at Goldman Sachs. After almost 12 years at the firm — first as a summer intern while at Stanford, then in New York for 10 years, and now in London — I believe I have worked here long enough to understand the trajectory of its culture, its people and its identity. And I can honestly say that the environment now is as toxic and destructive as I have ever seen it.
To put the problem in the simplest terms, the interests of the client continue to be sidelined in the way the firm operates and thinks about making money. Goldman Sachs is one of the world’s largest and most important investment banks and it is too integral to global finance to continue to act this way. The firm has veered so far from the place I joined right out of college that I can no longer in good conscience say that I identify with what it stands for.
It might sound surprising to a skeptical public, but culture was always a vital part of Goldman Sachs’s success. It revolved around teamwork, integrity, a spirit of humility, and always doing right by our clients. The culture was the secret sauce that made this place great and allowed us to earn our clients’ trust for 143 years. It wasn’t just about making money; this alone will not sustain a firm for so long. It had something to do with pride and belief in the organization. I am sad to say that I look around today and see virtually no trace of the culture that made me love working for this firm for many years. I no longer have the pride, or the belief.
But this was not always the case. For more than a decade I recruited and mentored candidates through our grueling interview process. I was selected as one of 10 people (out of a firm of more than 30,000) to appear on our recruiting video, which is played on every college campus we visit around the world. In 2006 I managed the summer intern program in sales and trading in New York for the 80 college students who made the cut, out of the thousands who applied.
I knew it was time to leave when I realized I could no longer look students in the eye and tell them what a great place this was to work.
When the history books are written about Goldman Sachs, they may reflect that the current chief executive officer, Lloyd C. Blankfein, and the president, Gary D. Cohn, lost hold of the firm’s culture on their watch. I truly believe that this decline in the firm’s moral fiber represents the single most serious threat to its long-run survival.
Over the course of my career I have had the privilege of advising two of the largest hedge funds on the planet, five of the largest asset managers in the United States, and three of the most prominent sovereign wealth funds in the Middle East and Asia. My clients have a total asset base of more than a trillion dollars. I have always taken a lot of pride in advising my clients to do what I believe is right for them, even if it means less money for the firm. This view is becoming increasingly unpopular at Goldman Sachs. Another sign that it was time to leave.
How did we get here? The firm changed the way it thought about leadership. Leadership used to be about ideas, setting an example and doing the right thing. Today, if you make enough money for the firm (and are not currently an ax murderer) you will be promoted into a position of influence.
What are three quick ways to become a leader? a) Execute on the firm’s “axes,” which is Goldman-speak for persuading your clients to invest in the stocks or other products that we are trying to get rid of because they are not seen as having a lot of potential profit. b) “Hunt Elephants.” In English: get your clients — some of whom are sophisticated, and some of whom aren’t — to trade whatever will bring the biggest profit to Goldman. Call me old-fashioned, but I don’t like selling my clients a product that is wrong for them. c) Find yourself sitting in a seat where your job is to trade any illiquid, opaque product with a three-letter acronym.
Today, many of these leaders display a Goldman Sachs culture quotient of exactly zero percent. I attend derivatives sales meetings where not one single minute is spent asking questions about how we can help clients. It’s purely about how we can make the most possible money off of them. If you were an alien from Mars and sat in on one of these meetings, you would believe that a client’s success or progress was not part of the thought process at all.
It makes me ill how callously people talk about ripping their clients off. Over the last 12 months I have seen five different managing directors refer to their own clients as “muppets,” sometimes over internal e-mail. Even after the S.E.C., Fabulous Fab, Abacus, God’s work, Carl Levin, Vampire Squids? No humility? I mean, come on. Integrity? It is eroding. I don’t know of any illegal behavior, but will people push the envelope and pitch lucrative and complicated products to clients even if they are not the simplest investments or the ones most directly aligned with the client’s goals? Absolutely. Every day, in fact.
It astounds me how little senior management gets a basic truth: If clients don’t trust you they will eventually stop doing business with you. It doesn’t matter how smart you are.
These days, the most common question I get from junior analysts about derivatives is, “How much money did we make off the client?” It bothers me every time I hear it, because it is a clear reflection of what they are observing from their leaders about the way they should behave. Now project 10 years into the future: You don’t have to be a rocket scientist to figure out that the junior analyst sitting quietly in the corner of the room hearing about “muppets,” “ripping eyeballs out” and “getting paid” doesn’t exactly turn into a model citizen.
When I was a first-year analyst I didn’t know where the bathroom was, or how to tie my shoelaces. I was taught to be concerned with learning the ropes, finding out what a derivative was, understanding finance, getting to know our clients and what motivated them, learning how they defined success and what we could do to help them get there.
My proudest moments in life — getting a full scholarship to go from South Africa to Stanford University, being selected as a Rhodes Scholar national finalist, winning a bronze medal for table tennis at the Maccabiah Games in Israel, known as the Jewish Olympics — have all come through hard work, with no shortcuts. Goldman Sachs today has become too much about shortcuts and not enough about achievement. It just doesn’t feel right to me anymore.
I hope this can be a wake-up call to the board of directors. Make the client the focal point of your business again. Without clients you will not make money. In fact, you will not exist. Weed out the morally bankrupt people, no matter how much money they make for the firm. And get the culture right again, so people want to work here for the right reasons. People who care only about making money will not sustain this firm — or the trust of its clients — for very much longer.
Greg Smith is resigning today as a Goldman Sachs executive director and head of the firm’s United States equity derivatives business in Europe, the Middle East and Africa.
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