Authors: William D. Cohan
Salovaara’s highly profitable investment in the bonds of Tonka Corporation, the toy-truck maker—where the fund made $71 million on an investment of $84 million—was a case in point. Water Street began buying the distressed bonds of Tonka during the summer of 1990, shortly after the fund started, when toy maker
Mattel, Inc., made an amorphous public announcement about wanting to make an acquisition. Tonka, although struggling, was an obvious acquisition target for Mattel, so Salovaara made the decision to start loading up on its bonds, which were trading at a discount given the company’s financial difficulties. It was a risky bet, to be sure, because if no acquisition emerged, Tonka could be in serious financial trouble.
In late September,
John Vogelstein, a principal at buyout firm
Warburg Pincus—the largest shareholder in Mattel—called Salovaara and told him Mattel was considering making an offer for Tonka. After the discussion, Water Street bought more Tonka bonds. In the end, Mattel did not make an offer for Tonka, since a third toy maker, Hasbro, made an offer for Tonka instead, and Mattel chose not to compete. Eventually, Hasbro acquired Tonka, but not until Hasbro increased its original offers for the Tonka bonds in order to win Salovaara’s support for the deal, leading
to huge financial gains for Water Street—and speculation that Water Street had used inside information about a potential deal for Tonka to load up on its bonds. The
Wall Street Journal
reported that Vogelstein and Salovaara had spoken, and then Water Street bought more Tonka bonds. This “
led to concerns among some Goldman clients, and was viewed as an embarrassment by some Goldman partners,” according to the
New York Times.
But this was a seriously gray area since insidertrading laws apply to trading in stocks, not bonds—although there remains to this day no good reason for a legal distinction to be made, especially since the bond market is exponentially larger than the stock market and inside information just as valuable. The SEC did investigate the matter, though, without making public its findings.
The Water Street fund was also the focus of other charges of conflicts of interest with other Goldman clients, such as the
Journal Company, a bankrupt owner of newspapers that Goldman had previously worked with as an investment banker, and
USG Corp., a gypsum-board manufacturer working hard to restructure out of bankruptcy, for which Goldman had underwritten securities. Despite Water Street’s success, the negative publicity around the appearance of conflicts of interest was more than Goldman bargained for. In early May 1991, the firm announced that Water Street would immediately stop making investments and wind down. “
The intensity of the unforeseen reactions was out of the range we had anticipated,” a Goldman official told the
Times,
speaking on condition he not be named. “This is a client-driven firm. We are sensitive to the perceptions of people.” By July, the three Goldman partners—Salovaara, Eckert, and Brody—announced they were leaving the firm.
Other senior Goldman partners were leaving, too, including Geoff Boisi, the head of investment banking and subject of the slavish profile in the
New York Times
. Friedman had a bruising falling-out with Boisi, his onetime protégé in Goldman’s merger department. “
No star shone brighter than Boisi’s,”
Lisa Endlich wrote. “He was dyed-in-the-wool Goldman Sachs, a culture carrier of the first order and a formidable money generator. Like most of those who rose to the top of Goldman Sachs’ banking hierarchy, Boisi was intensely ambitious, with an understanding wife and family. The claims of the job seemed to have no limit.” After graduating from Wharton in 1971, he joined Goldman’s M&A department and became a partner in 1978. Two years later, he was head of the merger department. By 1988, he was named head of investment banking and went on the Management Committee. There was little question Boisi’s ambitions and talents made him a leading candidate to
be part of the succession equation at Goldman Sachs whenever Friedman and Rubin decided to retire. But, in 1990, Boisi unexpectedly gave up his job running investment banking to take charge of strategic planning at the firm. He was forty-four years old. Neither Boisi nor Friedman will discuss what happened, but the scars in both men remain visible.
——
T
HE
W
ATER
S
TREET
debacle aside, being a principal required capital. Goldman had at its disposal its partners’ capital, the profits it retained annually, the $500 million Sumitomo had invested in 1987, and billions of dollars in borrowings. Nothing was more highly prized than equity capital, though, since that money could be leveraged—borrowed against—to create a bigger pile of cash that could be used to invest and to make bets. The downside of equity capital was that it could be expensive financing, in that it usually required parting with an ownership stake in the company. For instance, for its $500 million, Sumitomo owned a 12.5 percent nonvoting stake in Goldman, an investment Sumitomo assumed would increase in value over time as long as Goldman was prudent. Of course, from Goldman’s perspective, if the firm did well and its value increased, Sumitomo’s equity would likely be worth far more than the $500 million invested—which is exactly what happened—but if the firm did poorly, there was no obligation to pay the money back to the investor. By contrast, debt financing can often be far cheaper than equity financing, since a debt investor expects to receive for his borrowed money the return of the original principal plus a fixed rate of interest. Most companies have a mix of both debt and equity financings.
In 1990, in order to supplement the Sumitomo investment, Goldman obtained another $275 million from a consortium of seven large insurance companies in the United States, United Kingdom, and Japan. Two years later, in April 1992, Goldman turned to a new outside investor—a
Hawaiian educational trust,
Kamehameha Schools/
Bishop Estate—for another $250 million in equity. The trust, known as the Bishop Estate, was established in 1884 after the death of Princess Bernice Pauahi Bishop, a great-granddaughter of King Kamehameha I, who unified the Hawaiian Islands in the early 1800s and kept them independent from European colonizers. At the time of her death, Princess Pauahi owned approximately five hundred thousand acres of prime Hawaiian real estate, among the most valuable oceanfront property anywhere, and this acreage became the chief asset of the Bishop Estate. The chief beneficiary of the trust is the Kamehameha Schools, a private institution
for children of Hawaiian ancestry. Although Goldman would not say specifically what percent of the firm the Bishop Estate received for its $250 million, the
New York Times
reported that the money bought between 5 percent of the firm, valuing Goldman at $5 billion, and 6.25 percent, valuing Goldman at $4 billion. Given that the valuation of Goldman was $4 billion for Sumitomo’s investment five years earlier, the likelihood was that Goldman was worth $5 billion in 1992 and that the Bishop Estate’s investment was closer to a 5 percent stake.
Most Goldman partners credited
Jon Corzine, the co-head of fixed-income and CFO, with arranging for this investment, but the lead was really brought in by an obscure fixed-income institutional salesman in the San Francisco office named
Fred Steck.
Two years later, after another $250 million cash infusion into Goldman from the Bishop Estate, Steck was up for partner. A bunch of senior Goldman partners were discussing whether Steck had the right stuff. “Fred Steck, you know, I don’t really think Fred Steck should be a partner,” one of them said. “He doesn’t have the capability and he’s not broad-based. I’m not sure it’s the right thing.” But Corzine stood up for Steck. “Shut the fuck up,” Corzine said. “He just saved the firm.” Steck became a partner.
O
ne of the people Goldman hired as a consultant during its consultant-hiring spree was
Lawrence Summers, a Philadelphia-born Harvard economist whose two uncles—Paul Samuelson and
Kenneth Arrow—had both won Nobel Prizes in economics. Summers’s parents, Robert and Anita, were also economics professors.
During the summer of 1986, when Rubin and Friedman were still the co-heads of Goldman’s fixed-income group,
Jacob Goldfield, a precocious and gifted young Goldman trader, suggested to Rubin that he and Summers should meet. Goldfield grew up in the Bronx, where his mother was a clerk in the New York City Health Department and his father had a small store, wholesaling women’s clothing. After graduating from high school in the Bronx, Goldfield studied physics at Harvard but also dabbled in graduate-level courses that interested him, including econometrics. At Harvard, Goldfield was famous for being really smart. One day, he and a friend, also a physics major, were studying for the exam in econometrics and decided to go see Summers the day before the exam, since Goldfield’s friend knew Summers and figured he could help them understand the difficult subject matter. Summers tried to help the two undergrads but finally gave up. Time was too short and the subject matter too complex. Even Summers hinted he would have trouble getting an A on the exam. In the end, Goldfield took the exam and got the highest grade the professor had ever given on a final. This was sometimes the way things went with Goldfield, whose intuition and different way of thinking generated occasional flashes of brilliance. Since Summers was in the economics department, he ended up hearing about Goldfield’s rather astounding achievement on the econometrics final. This led to their having regular discussions and the occasional meal together.
After graduating from Harvard, Goldfield bounced around Europe for a bit and then headed back home to the Bronx, where he lived with
his parents. While at home, he took the LSAT and applied to Harvard and Yale law schools. He chose Harvard Law because he believed it to be less intellectual than Yale and therefore more practical and likely to lead to a better career (ironically, the opposite of Rubin’s reasoning). After his first year at Harvard Law, he managed to get an interview at Goldman for a summer job, which was not easy, since the firm did not recruit at Harvard Law, even though its two senior partners-to-be—Rubin and Friedman—were both lawyers. Through the Harvard Business School, Goldfield finagled an invite for lunch with a number of Goldman’s leaders. He got the summer job in the sales and trading group. Then, so he wouldn’t go to another firm, Goldman offered Goldfield a full-time job trading
government bond options. He dropped out of
Harvard Law School and joined Goldman Sachs.
Goldfield got off to a bit of an odd start. One day filling in for a trader, he lost $140,000 on a trade, some 7 percent of the annual revenues for this government bond option group. This was not auspicious. Then, a week or so later, filling in again—his supervisors were apparently not as horrified by the initial 7 percent loss as Goldfield was—he made $1.1 million on a trade, more than half the group’s annual revenues. “
For what it was, it was shocking,” he said. Although he was not entirely sure how this happened, he would study the data on the hour-long subway rides to his parents’ apartment in the Bronx, where he was living at the time. The next year, the revenues in this little group shot up exponentially to around $35 million, from $2 million.
His unprecedented success got him noticed during his first year at the firm. First, Corzine came by his desk and congratulated him. Then, one day, relatively early on in his tenure at the firm, Rubin called him in the Bronx. His mother answered the phone. They developed a close friendship. It turned out Rubin wanted to adopt Goldfield, metaphorically speaking. Rubin’s infatuation with Goldfield put him in awkward positions. “He went very far out of his way to include me in meetings where I didn’t belong,” he said. “There would be meetings to figure out what we should do about some big thing and all the senior people would be involved, and me—that kind of thing.” But Rubin took mentoring seriously, especially when he found someone unusually bright or creative. “This was bad because of course it created resentment,” Goldfield said, “but obviously interesting.”
That’s when Goldfield thought about introducing Rubin to Summers. “At some point,” Goldfield recalled, “I said to Rubin, ‘Oh, I have this smart friend’ ”—Summers—“I guess I already appreciated that he valued intellect highly.” Summers and Goldfield had kept in touch during
the five years since he had graduated from Harvard, especially on topics of mutual interest. “We had a lot of energy for very long calls,” Goldfield said. Sometime in 1986, the three men had lunch in Rubin’s office, off the equity floor. The lunch did not go all that well actually, and Summers figured—incorrectly—that he had heard the last of Rubin. (Summers was not the only smart economist Rubin brought to Goldman. For instance, Goldfield remembered
Paul Krugman, from Princeton, also dropping by 85 Broad Street to meet with Goldman partners.)
Over time, Rubin developed a special affinity for Summers. By this point, Summers had served a stint as an economist on Reagan’s first Council of Economic Advisers (even though he was a Democrat) and had returned to Harvard as a full professor of economics, one of the youngest ever. These significant accomplishments at an early age once again caught Rubin’s attention. “It’s easy to see why Bob and Larry developed a close working relationship,” Goldfield said. “Bob liked bright people who would challenge him. Larry greatly valued Bob’s judgment and appreciated his astonishing ability to form a consensus on difficult decisions.” At one point, Summers came to Goldman and gave a lecture about the
efficient market hypothesis.
The two men also shared an interest in Democratic Party politics. Although Rubin had been elected the president of his fourth-grade class and had dabbled in a few local New York political campaigns, his interest in national politics advanced after outgoing treasury secretary Henry Fowler joined Goldman in 1969.
“ ‘Joe,’ as everyone called Fowler, was a courtly Virginia lawyer whose ancestors had come to America in the seventeenth century,” Rubin explained. “Many people at Goldman were not that interested in what Fowler had done in government. But to me, Joe was a fascinating figure—someone who had gone to Washington during the
New Deal and served in every Democratic administration thereafter.” During one of their many discussions about politics, Rubin mentioned to Fowler that he would like to become more involved. Fowler called
Robert Strauss, the irrepressible
Akin Gump attorney and legendary behind-the-scenes fixer who had become treasurer of the
Democratic National Committee in 1971.