Goldman seems to be making a renewed effort at PR in the wake of the letter by derivatives staffer Greg Smith (“muppets” was revealed to be the new term of art). That observation probably came as no surprise to anyone save Goldman staffers, most of whom probably thought they had conned their clients into believing otherwise, and a few like Smith who believed the party line.
The Goldman CEO, Lloyd Blankfein, with a very friendly outlet, Bloomberg News. The chat served to remind viewers of how inward looking and self referential the financial services industry has become.
We need to deal with the obvious misrepresentations before getting to the unintended revelations:
…..we’ll have to do a better job, getting out there and telling people how important this industry is, what it does when we advise companies on their growth plans and finance their growth plans and manage their assets for them and how important this is for the economy, the markets and obviously society at large.
Yves here. First, since your industry succeeded in holding up governments around the world and continues to do so (witness the backdoor bailout of German and French banks at the expense of ordinary citizens in the rolling Eurocrisis), you can spare us the false modesty. Second, you don’t advise companies on “growth plans”, you advise them on transactions. Third, you and your cohorts have done a crappy job at anything other than looting. Andrew Haldane of the Bank of England did a quick and dirty estimate of the cost of the last crisis, and his low figure was one times global GDP. If you try to make the big banks like Goldman repay the costs of the damage they didn’t, they can’t even begin to. If you try amortizing that low estimate of the losses over 20 years, the big banks can’t even afford the first year levy. It exceeds their market capitalization. So firms like Goldman don’t create value, they destroy it in a massive, profligate manner.
But Blankfein tries to pass off the idea that Goldman is misunderstood, as opposed to all together too well understood:
I think the average American probably had no and had never heard of Goldman Sachs before three years ago. Shame on us in a way for not anticipating how important that would be. We’re an institutional business with no consumers. It turns out, another name for consumers are citizens and taxpayers. They became important for reasons that are obvious. They always should have been important, but it wasn’t part of our audience as we thought about it. Now we will have to develop those muscles a little better than we have. Shame on us.
Translation: We should have been buying more retail advertising, like JP Morgan does, so all those financial section editors would have to think twice before dumping on us.
Later in the interview. in response to whether Goldman would have survived if it didn’t have access to the Fed’s discount window:
We did not have access to the Fed window as the bank leading up to the crisis because frankly we run ourselves very conservatively. One of the reasons why we came out of that crisis, that moment so well is because we went into so strong. Today, we carry over $170 billion of liquidity. We are very highly capitalized among the highest tier in our industry. We don’t borrow from the discount window.
This is such tripe. Goldman became a bank holding company in the crisis, remember? That was so the Fed could intervene if needed. Having access to the discount window all sorts of backdoor and direct bailouts, like the TARP, the Primary Dealer Credit Facility, guaranteeing money market funds, rescuing AIG, kept Goldman afloat. As derivatives trader and now venture capitalist Roger Ehrenberg wrote in 2009:
Goldman is a great firm with a stellar culture, and in most circumstances it’s risk management and funding practices have been second to none. Except when the crisis hit. It stood with the rest of Wall Street as a firm with longer-dated, less liquid assets funded with extremely short-dated liabilities….In exchange for giving the firm life (TARP, FDIC guarantees, synthetic bail-out via AIG, etc.), the US Treasury (and the US taxpayer by extension) got some warrants on $10 billion of TARP capital injected into the firm…
There is not a Wall Street derivatives trader on the planet that would have done the US Government deal on an arms-length basis. Nothing remotely close. Goldman’s equity could have done a digital, dis-continuous move towards zero if it couldn’t finance its balance sheet overnight. Remember Bear Stearns? Lehman Brothers? These things happened. Goldman, though clearly a stronger institution, was facing a crisis of confidence that pervaded the market. Lenders weren’t discriminating back in November 2008. If you didn’t have term credit, you certainly weren’t getting any new lines or getting any rolls, either. So what is the cost of an option to insure a $1 trillion balance sheet and hundreds of billions in off-balance sheet liabilities teetering on the brink? Let’s just say that it is a tad north of $1.1 billion in [option] premium. And the $10 billion TARP figure? It’s a joke. Take into account the AIG payments, the FDIC guarantees and the value of the markets knowing that the US Government won’t let you go down under any circumstances. $1.1 billion in option premium? How about 20x that, perhaps more. But no, this is not the way it went down….
Where we are left today, dear taxpayer, is a lot poorer. Unless you are a major shareholder and/or bonusable employee of Goldman Sachs. Brains, ingenuity and value creation should be rewarded in all fields, Wall Street included. But when value created is the direct result of the risks borne by others for your benefit, the sharing of benefits needs to be re-allocated. This has not and apparently will not be done, and we, dear taxpayer, are the worse for it.
Now let’s get to the juicy bit. While Blankfein tries to maintain that Goldman can manage its conflicts of interests, he paints the firm as so inherent conflict-ridden as to make the case that clients can’t be well served dealing with a firm that can’t have an undivided loyalty to you. That is tantamount to an admission that big corporate and institutional clients would be better served if there were more players, better yet, firms that were more specialized.
Let’s start with his basic premise:
I think no one who is going to be effective in this business can avoid conflicts of interest coming up. You can do that if you only represent one client in every industry, in which case you won’t really be able to be that effective, knowledgeable, or influential. You won’t be able to get anything done.
Ahem, that’s an investment banking side argument, and it isn’t remotely true. As debunked above, investment banks are not strategic advisors. And even then, he’s also wrong on his premise that “you wouldn’t be effective or knowledgeable” if you represent only one client in an industry. That has long been Bain’s business model, and Bain has long been one of the top three consulting firms.
The reason that banks have industry specialization on the banking side is a bad reason: CEO and CFOs feel more comfortable with a banker who knows the gossip and the deals in their industry. But guess what? That patter is irrelevant to getting deals done. A generalist banker (say at a boutique like Rothschild) can work up the industry comparisons in very short order. And the knowledge of how to price securities offering is held on the sales and trading side of the firm, not among the glad-handed investment bankers.
We have this bit:
If you advise a client today, you have to lend to that client. If you lend to that client, they have to pay back. Now you have a stake in the outcome of their business decisions. You give them advice, but since you are a lender to them, like every bank has to be today, you have conflicts of interest. They always have to be managed.
Again, for a Goldman, that takes place in the context of M&A, and the lending role is exaggerated. Takeover loans are put into collateralized loan obligations and are sold to investors. The lead banks retain a small slice (for credibility reasons, unlike mortgage backed securities, investors like to see the lead banks have some skin in the game) but most is sold off. And a bank like Goldman would likely hedge at least some of the credit risk with credit default swaps.
With prime brokerage clients, the conflicts are even more rife. Goldman lends to many of its hedge fund clients (that’s where the real juice is), yet hedgies are acutely aware that their broker can and will trade against them, and so go to great lengths to disguise their positions and intentions by trading through multiple firms. Consider how this conflict worked against dealers in the case of Long Term Capital Management: the firm was massively leveraged, and when traders realized it was hugely on the wrong side of certain trades, they began exploiting its distress, which only made matters worse for the firm and ultimately for the dealers, who had to bail out LTCM so it could be wound down in an orderly manner. But preying on smaller hedge funds that got it wrong has never bothered the big banks, and many feel they were treated badly in the crisis when their prime brokers squeezed them by raising haircuts far beyond what seemed to be warranted even given the terrible market conditions.
The problem, of course, is that clients see the roles differently that Goldman does. This is Blankfein’s account:
For example, in the market making business, we give prices to our client and a client decides whether to trade or not. We hope as a result of that exchange, we will make money and not lose money. If over time we lose money, we will be out of business. We have other businesses or we are an adviser and other businesses where we are a pure fiduciary. One of the things we set up to do when we wrote our business standards report is go out and carefully delineate for our audience what our roles and responsibilities are in each segment of our business. As an adviser, we work for the best interests of our clients. As a fiduciary, our clients to come first. As a market maker, we have to protect Goldman Sachs.
But remember the Greg Smith letter. As a salesman, he saw his role as advisory (and there is a tension in being a salesman of any sort for a bigger firm: the salesman is often more protective of his clients than the house is, since loyal clients might very well follow him if he leaves the firm). Yet it was very clear from Blankfein’s testimony before Congress in 2010 that he saw Goldman’s role in CDOs like Timberwolf as that of a market-maker (caveat emptor!) when some clients thought Goldman was acting in at least an advisory capacity. To pretend that firms like Goldman don’t prey on that gullability is naive.
So the newer, friendlier Lloyd Blankfein isn’t that much more persuasive than the old version, save maybe to those who hold similar views. But until Blankfein and his ilk are subject to meaningful pressure, all he need to do is make occasional contrite gestures, like this Bloomberg chat, as he carries on as before.