Authors: William D. Cohan
On July 8, by unanimous voice vote, Whitehead was confirmed as deputy secretary of state. His tenure at Goldman Sachs was officially over. He returned his book advance to
McGraw-Hill. He never finished the book he set out to write about how corporations do well by doing good.
V
ery little changed at Goldman following Whitehead’s retirement. “
If anything did, I don’t know what it would have been,” Doty said. “John Weinberg continued in there. And he was placing more reliance on Rubin and Friedman.” One of Weinberg’s first decisions as sole head of Goldman was to take Rubin and Friedman out of their comfort zones—Rubin had been head of the firm’s trading and arbitrage businesses (with the additional responsibility for J. Aron) and Friedman had been head of the firm’s investment banking business—and make them co-heads of the firm’s fledgling fixed-income division, which had been run for about eight years by
Frank Smeal, who had joined Goldman in 1977 after a thirty-year career at
Morgan Guaranty Trust. At first, Weinberg was just going to give the job to Friedman alone, but when Rubin heard about the potential change, he convinced Weinberg that he should be Friedman’s partner to make sure a trading mentality was also part of the fixed-income leadership equation. Although Weinberg said he had no intention to retire anytime soon, he figured Friedman and Rubin would have the job for “a couple of years,” which would be important to round out their knowledge of the firm’s businesses. But Weinberg was not willing to anoint Rubin and Friedman as his successors. “They are very capable, very talented people,” Weinberg told the
Times
. “But we have a lot of talented guys around here.”
The
Times
article made the point that Smeal had improved the division since he took it over but there was plenty of work still to be done, as Goldman badly lagged Salomon Brothers and other fixed-income powerhouses in the often-lucrative issuance of both mortgage-backed securities and high-yield bonds. Others thought Smeal had done a lousy job at making Goldman competitive in fixed income. Friedman recalled “
talking to a guy who was a heavy partner at Salomon Brothers” who told him, “I hate competing with you guys in the merger area. I really hate it. You
have your act together and you’re able to get your firm organized in this area. But I love competing with you in debt capital markets.” Friedman said, “And they did, at that time, they beat our brains out.” Friedman saw huge potential in Goldman’s bond business and knew Smeal was not the right guy to run it. “
Our bond business was
really
disturbing,” he explained. “It had the wrong strategy.”
For an M&A guy like Friedman to go from running investment banking to running fixed income could not have been an easy transition—to say nothing of being highly unusual—and he compensated for it by asking a blitzkrieg of questions until he got the information he felt he needed to make the right decisions. Fortunately, Friedman had Rubin as his partner running the group, and Rubin did understand trading and debt from a market perspective, as opposed to the more theoretical perspective that an M&A banker would have. They were an effective team.
Friedman was taken aback by the shape he found the fixed-income group when he and Rubin arrived. “
It was a shock when you got there,” he said, “just how far behind the rest of the firm they were.” He was especially concerned that there was “no brainpan” to deal with what they both quickly discovered was a major problem right from the start. “
The top of that division was an intellectual vacuum,” he said. The fixed-income division traded nearly every debt-related security available, including
government bonds,
high-grade corporate bonds, high-yield bonds, and mortgage-backed securities. “
The business was big, with a lot of risk,” Rubin explained. Much to their surprise, Rubin and Friedman discovered that Goldman’s “traders had large, highly leveraged positions, many of them illiquid, meaning that they couldn’t be sold even at generous discounts to the price of the last trade,” he continued. “As losses mounted, Steve and I tried to figure out what to do.” Not only did Friedman and Rubin—understandably—not know what to do but neither apparently did Goldman’s fixed-income traders.
The traders had lost more than $100 million. “
Today that wouldn’t mean much,” Rubin allowed, “but in that world at that time, it was very meaningful.” Worse, they couldn’t figure out a way to stop the bleeding. “Suddenly, our biggest trading operation had gone sour, and we didn’t understand why or what the future might bring,” he continued.
Question time. Friedman and Rubin headed to the trading room. “Let’s all sit down and try to understand what we’re holding,” they told the traders. “If we have positions we shouldn’t have, let’s get rid of them.” The problem was that the bonds Goldman was trading had embedded options that the Goldman traders hadn’t accounted for in a rapidly
changing interest-rate environment. For instance, as interest rates fell during 1985 and 1986, home owners rushed to refinance their mortgages, as would be expected. This caused Goldman’s portfolio of mortgage-backed securities, which contained mortgages with higher interest rates, to be paid off early (through the refinancings) and to lose value rather than increase in value as would be expected when interest rates fell, since the value of a bond with a higher interest rate increases when relative interest rates fall. Goldman had a similar problem in its portfolio of corporate bonds. “
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,” Rubin observed. This tendency was compounded by the fact that traders had an intuitive expectation that bonds could always be traded at or near the price of the last trade, a fine thought when markets are functioning relatively normally. “But when conditions deteriorate severely,” Rubin explained, “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.… Unexpected losses can develop rapidly and be huge.”
Understandably, the losses in the fixed-income group led to some serious griping around the firm, especially when the firm lost another $200 million in fixed-income trading in February 1986. “
They really got clobbered,” Friedman explained. “They didn’t have sufficient integration with research. And the internal morale was such that when you’d have monthly partners meetings, investment bankers would be saying to traders as they came off the elevator to go into the meeting, ‘Well how much money did you guys lose this month?’ That’s not a great morale thing.”
Friedman and Rubin set about changing the gestalt of the fixed-income group by taking a most un-Goldman-like step: they hired a group of senior traders from Salomon Brothers—the fixed-income leader—to perform an extreme makeover. First, Goldman hired
Thomas Pura, thirty-two, who chose to go to Harvard instead of signing up with the Kansas City Royals after high school. He regularly participated in Ironman triathlons and brought to the department “a new intensity and a risky style of trading that was bolder and more aggressive than anything Goldman Sachs fixed-income had ever seen,” according to
Lisa Endlich in
Goldman Sachs: The Culture of Success
. Then Goldman hired
David DeLucia, thirty-three, to head up corporate bond trading, sales, and syndication in New York and transferred to London the previous head of the business,
J. Nelson Abanto. Finally, Goldman hired
Michael Mortara,
thirty-eight, to lead Goldman’s mortgage-backed securities trading business soon after Salomon fired him and
Lew Ranieri, the architect of the securitization business on Wall Street. “Hiring outsiders for senior positions was rare enough at Goldman,”
Beth Selby wrote in
Institutional Investor
in December 1990. “[B]ut to bring each in as a partner was almost too much for the culture to bear, so the duo”—Friedman and Rubin—“pulled back. The new [Salomon] partners were told that although they were masters of their trading desks, they must staff those businesses from within the firm—no more new blood.”
——
W
HILE
G
OLDMAN’S TRADERS
struggled with how to stanch the bleeding, Goldman’s M&A group was booming. Its prowess was so great that the firm took the rare step of participating in a long Sunday
New York Times
profile of Geoff Boisi, the thirty-eight-year-old partner who followed Friedman as head of the firm’s M&A group and had just been named co-head of investment banking. Such a massive helping of publicity for a young banker was most unusual at any Wall Street firm, virtually unheard of at Goldman Sachs—and usual fatal. Boisi explained that 1985 was his group’s “
absolute best year ever”—the contrast with the bond traders could not be more stark—and that Goldman had worked with major companies on a string of high-profile deals, including General Foods in its merger with
Philip Morris and
Procter & Gamble in its purchase of
Richardson-Vicks, and the deal by which
Macy’s again became a private company (and would lead to its bankruptcy a few years later). Of Boisi’s additional role, Weinberg told the
Times,
“We are adding to his responsibilities. He is one of the substantial number of very bright individuals at Goldman Sachs. M&A is a very visible activity. He’s done an outstanding job. He certainly deserves everything he gets.”
Of course, there were the expected nods to teamwork and long hours. Boisi’s role in selling General Foods to Philip Morris captured well the life of an M&A banker at Goldman. For months prior to Philip Morris’s offer, Goldman had warned General Foods it might be vulnerable to a hostile takeover, given the popularity of its well-known consumer brands. General Foods’ management listened to Boisi and put in place a few defense strategies. Through the summer of 1985 rumors swirled that an offer might be made for the company. On September 24, Philip Morris launched a hostile offer of $111 a share in its stock for General Foods, valuing it at $5 billion. Boisi and his team plus another set of advisers at
Morgan Stanley canvassed the market to see if a higher bidder could be found, one that would be friendly. By the end of the week, with Hurricane Gloria wracking the East Coast, Philip Morris raised its bid to $120
a share. General Foods capitulated, in part because Goldman’s analysis showed that few potential bidders could match Philip Morris’s offer. “We worked round the clock,” Boisi said. (And again one of its clients was sold.)
As the legal documents were being drafted deep into the night before they were to be signed, Boisi left around 3:00 a.m. to try to make it home to Long Island before the hurricane hit. When the deal was signed he was notified by a conference call, on which everyone cheered. “It’s a difficult life,” he said. “There have been more times than I care to remember when the phone rings, I just pick up my briefcase and go out to the airport. No clothes. No toothbrush. A couple of days later the clothes arrive. The deal dictates your schedule.” All this success, of course, meant that Boisi was becoming increasingly wealthy, a subject he declined to discuss. Instead, he professed his loyalty to Goldman. “Right now, I can’t think of anything more exciting than being at Goldman Sachs.” Six years later, in 1991, after a power struggle with Rubin and Friedman, he left Goldman.
The
Times
featured Goldman again six months later, in April 1986, in another long Sunday piece that began by explaining the crucial role John Weinberg had played in the November 1985, $6.3 billion merger of General Electric and
RCA, the largest non-oil merger ever. GE CEO Jack Welch called Weinberg personally to get him involved and the Goldman team—of course—“
worked day and night over the Thanksgiving Day weekend” to get the deal done. Goldman’s fee for the deal was more than $7 million, a whopping amount at the time. Still, all those months later, the article revealed that Weinberg was still smarting a little from the fact that the media attention for the deal seemed to go to
Felix Rohatyn, at Lazard, which represented RCA, a longtime client. Rohatyn had let the media know he had initiated the deal at a breakfast at his Fifth Avenue apartment with Welch. There was lavish front-page coverage of the deal in both the
Times
and the
Wall Street Journal,
highlighting Rohatyn’s role in bringing the two sides together. A week later,
Time
weighed in with a rare business cover story, “Merger Tango,” about this deal and others. Rohatyn “always says he does everything,” Weinberg said. “A lot of the things I do are unknown—they won’t be in my obituary but I won’t be here to read it anyway.” Indeed, a subsequent
New York Times Magazine
article about the deal—close to seven thousand words long—mentioned Goldman only once and Weinberg not at all. (Rohatyn had nineteen mentions in the article.)
Weinberg’s griping about lack of attention for Goldman’s role in the RCA deal was not only out of character but was also a bit odd since
Forbes
had, in February, just done a short profile of Goldman and Weinberg—including his photograph—and emphasized how obscenely profitable the firm had become. The magazine estimated Goldman had made $500 million in pretax profit in 1985, on revenue of $1.7 billion, a luxurious margin of 29 percent. Merrill Lynch made one-third as much money with four times more revenue. The
Forbes
piece wondered how many of the firm’s seventy-nine partners made more than $1 million a year. “We all do,” one partner told the magazine. When asked how Goldman had become so profitable, Weinberg replied that teamwork and the compensation system for the firm’s 4,600 nonpartners was the key. He said nonpartners in operations or risk management earned as much as did those professionals with glamour jobs in M&A. “That has left [Goldman] largely free of the infighting and backbiting that plague other firms,” Weinberg observed. Still, despite the teamwork, there were occasionally some gaffes that, Weinberg said, “irritated” the entire firm. In April, Jim Cramer told a newspaper that he earned enough money that “there isn’t anything I see in a store that I can’t buy.” Far preferable was Friedman’s habit of carrying around his paperwork in “
a battered L. L. Bean bag” while also owning a large duplex apartment on the East River in Manhattan. There was a long tradition at some Wall Street firms—like Goldman and Lazard—of being scrupulous about keeping the offices modest, lest clients start thinking the fees they were paying were too high. Ostentatious displays of wealth were reserved for the home, or homes.