Authors: William D. Cohan
In February, disaster struck. Not only were the monthly British inflation numbers terrible but also President Clinton had blasted the
Japanese on their trading policies, threatening tariffs and quotas. “Sterling went into a free fall,” he observed. “It was classic—the market found me.” During the course of fifteen trading days in February, the pound lost
10 percent of its value against the yen. “I was selling out of the position as fast as I could but I was selling just to stand still because I was short these puts,” he said. “It was a disaster. Markets have a great way of taking it out of you.” At one point during the trade’s collapse, Siva-Jothy remembered being overcome by a desire to stand up and walk out. But he stayed and took the pain. By the time the final accounting was in, Siva-Jothy had lost somewhere between $100 million and $200 million—and he was just one trader making one bet.
Another trader,
Lawrence Becerra, had joined Goldman in London in 1992 as a senior proprietary trader. “
Becerra was probably the trader with the highest appetite for risk of all of those people,” remembered
David Schwartz. Becerra had put on a large trade involving the Italian Treasury market. “They kept on piling on the position,” Schwartz said, “and it kept on going against him. And the culture at the time—and this was throughout the trading culture—was that you don’t tell a trader what to do. And O’Brien obviously understood that they were losing money and losing a lot of it, but Becerra believed in the trade and, I guess, Mike did as well. But the trade just never worked out. Eventually, they had to cut it, and in cutting it, they lost even more money.”
Before long, the losses in London had spiraled so far out of control, Corzine and Winkelman flew to London to see if anything could be salvaged from the trading positions. Winkelman met with Siva-Jothy. “Christian, sit down, what’s this all about?” Winkelman asked him.
“I’ve lost [more than $100 million],” he said. “I’ve liquidated everything. What do you want me to do?”
“If you hadn’t liquidated and come in here, you wouldn’t be working at Goldman Sachs anymore,” Winkelman told him. “What I want you to do now is go out and make it back, with lower risk limits.” Siva-Jothy was surprised—and impressed—that he hadn’t been fired. (He actually was promoted to run the entire revamped proprietary trading desk in Europe.) He then established a new trade betting that fixed-income securities would fall in value. When the Fed started tightening the money supply and
interest rates rose, bond prices fell, and his short bet began paying off. He made back about 35 percent of what he had lost.
Back in New York, though, the losses were still resonating. “
When the market went against us, the lesson I took away was the lack of discipline in that department,” Paulson said. “And a real lack of rigor. And there was an arrogance: ‘We know that the market’s going to be like this … and we like it better every month. Because we just think the markets are going to come back.’ Of course, Goldman Sachs wasn’t a hedge
fund. And we just couldn’t afford to do that. There wasn’t the level of scrutiny we should have had at the Management Committee level.”
One of the problems, it turned out, was that Corzine was wearing two hats at once. He was both co-CFO and co-head of fixed-income. “He wasn’t independent,” explained one partner, from the investment banking side of Goldman. “You just really need independent control functions and it just is critical that you have that to run any kind of trading business. You need to have people on the control side and the compliance side to independently mark the books, to go head to head with the traders, to have a totally independent career track. And you need to look at everything in terms of the size. You know Bob Rubin always talked about small but deep holes. You can’t afford to lose a lot of money even if the odds are very low. You just have to protect yourself.”
One of the ways Friedman sought to protect the firm from the growing monthly losses was by cutting expenses, which on Wall Street means cutting people, since by far the largest single cost at a Wall Street firm was—and is—compensation. But Friedman was hesitant to unilaterally make the decision to cut people as the year unfolded, in part because he had already decided to retire and didn’t think it would be fair to his partners to saddle them with the lower growth prospects that having fewer traders might cause. He also knew that it was possible that the trading environment could improve suddenly, and without traders in the seats, money could be left on the table. He put the question of cutting people to a vote, but he and the financial types were the only ones who thought the firm should do it. As the losses continued, Friedman broached the subject again, and again he got shot down. “
I was always very, very careful with my management clout,” he said. “When you are the senior partner at Goldman Sachs, you have more power than you needed. Your job was to make sure that people felt included and free and empowered and obliged to tell you stuff you didn’t want to hear. I would always lean over backward to get people involved in the decisions.”
But by the summer, as the trading losses mounted, Friedman was increasingly frazzled. Bob Hurst remembered seeing Friedman in Jackson Hole, Wyoming, and thinking that the senior partner was hurting.
“ ‘Your job’s impossible,’ ” Hurst remembered telling Friedman. “ ‘I have no interest in it.’ I said it from a perspective of I thought he had a couple of years to go and not that he was quitting that fall.” Another partner put it more bluntly: “Steve hated his job as CEO. He hated it because he felt he had lost control of his life.”
Hurst remembered hearing about a telephone call between Friedman and Corzine where Corzine told Friedman that another $50 million had been lost in London that week. Friedman was trying to get Corzine to cut back the trading positions. “He just won’t do it,” Friedman told Hurst. “He says it’s a great trade.” Part of the problem for Friedman was that, without Rubin, he was not expert enough in fixed-income to know for sure whether to overrule Corzine. The other part of the problem was that 1992 and 1993 had been such amazingly profitable years in fixed-income that Corzine would have been difficult to overrule under any circumstances.
While Friedman couldn’t stop the trade, he did start insisting that personnel cuts be made. “
But people weren’t as worried as I was,” he said. Friedman started to micromanage. “I spent a lot of time with the traders,” he said. “I was not really happy with how a lot of that was going. We were in an industry-wide bear market and our traders were out of sync. I really made them contract a lot of their positions. I’d see guys who hadn’t made any money in their positions for whatever the hell it was, nine out of ten months.… So, we reduced our positions sharply and maintained a lot of liquidity. I did feel our traders had been much too confident about their abilities.”
As the year dragged on, the pain across the Goldman partnership became more acute. “Every month, Corzine and Winkelman would stand up and say, ‘I’m sorry, guys, we’ve lost another hundred and fifty million bucks,’ ” remembered one partner from the banking side of Goldman. “My capital account in 1993 was like seven million dollars, something like that. And it went down to four million dollars. Every month, it went down three hundred thousand, four hundred thousand dollars. And you’re just saying like, ‘What the fuck? This is unbelievable.’ It was pretty out of control, but no one knew. People were just completely off the reservation.” There was also a growing concern among the partners that because their liability was not limited, their entire net worth was on the line as the losses mounted. Some partners were beginning to think that everything they had built up for so long at Goldman might be at serious risk of being lost, since their capital remained at the firm and their annual cash compensation was limited to an 8 percent dividend on their capital account. “Partners are seen outside as mega-rich, but that is not the case at all,” Mike O’Brien told
The Independent,
a U.K. newspaper, in September 1992. “Their capital stays with the firm. My C-registration Ford Granada is testament to that.” (On the other hand, one of O’Brien’s London partners,
David Morrison, drove a Ferrari around town.) For the banking partner who started 1994 with a $7 million capital account and
ended with a $4 million capital account, after absorbing the trading losses, his cash compensation for the year decreased to $320,000, from $560,000. Suddenly, some serious sand had been tossed into the gravy train’s engine.
Toward the end of the August, while his concern for both his own and the firm’s health continued to increase, Friedman’s hints about his future were becoming less opaque. “
We had a really bad dynamic in the firm,” Corzine recalled. “It was made all the worse almost every other day by something coming out about Maxwell. Pretty tense period of time.” Finally, a decision was made to cut the losses on the bad trades. “It didn’t matter how intelligent the trades were …,” Corzine said, but a change had to be made. “I didn’t think it was existential. But you
have
to stay calm or you can’t make good decisions. Otherwise, you end up making an emotional decision as opposed to a calculated, probability-based decision.”
Corzine also remembered a conversation he had with Friedman in the late summer that left him “with the idea” that the senior partner was getting ready to retire. “We had an indirect conversation that led me to believe my promotion was what would take place,” Corzine said. He could tell something was not right with Friedman. “He did not feel well,” he continued. “You could see it on his face as we were trying to get our world squared. As for Steve, it wasn’t obvious that it was only a health issue that was troubling him. This was another one of those times when people who run firms that take on risk—they may earn a lot of money, but they earn their keep.” Other partners were aware of Friedman’s health problems, too. “He had things where his heart, when he traveled—it’s just the rigors of the job—and his heartbeat would speed way up,” one of them said. “And it scared him.”
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T
HROUGHOUT
1994, Friedman and Katz had had a number of dinners to discuss how the succession plan at the firm would unfold. They intentionally chose to meet in offbeat neighborhoods around New York where they assumed few Goldman partners would be hanging out. At the first dinner, they chose an Italian restaurant on West Seventeenth Street, far from the usual haunts of the Upper East Side, but were interrupted by a partner who was dining there.
By discussing repeatedly how the announcement should be made and how the new senior partner should be selected, Friedman and Katz were hoping to avoid the internecine political warfare that generally accompanies Wall Street succession. “
I wanted to avoid anything that was political, and I wanted to give myself and other management committee
members the opportunity to continue to evaluate how different people worked together,” Friedman explained in October 1994. “We had seen numerous firms in which the succession dragged on and had been the subject of rumors and, thus, divisions, or where they had a long, drawn-out transition with too many hands on the steering wheel. We were convinced our firm could avoid that.”
Friedman had wanted to “drop his bombshell” in August, but after more conversations with Katz and Rubin, he decided that the
Management Committee’s schedules would be easier to coordinate after Labor Day, when everyone was back in New York after the summer holidays. On Tuesday, September 6, the calls went out to the Management Committee to make sure they were in New York the next day. “
I had no special call from him,” Paulson said. “No warning. We were told we were supposed to be there. He wanted us all there.” Usually, Paulson would join the Management Committee meetings from Chicago by videoconference and would often forget that he was on camera and start reading the newspaper. Someone in New York would step out of the meeting and call him and tell him, “Don’t forget you’re on the screen. Stop picking your nose.”
This time, Paulson flew to New York. “
I knew something was up,” he said. “It was right after Labor Day.” For Bob Hurst, who is Jewish, attending the special Wednesday meeting meant not observing the second day of Rosh Hashanah as he usually did. But Bob Katz insisted he be there. When Hurst asked Katz what the meeting was about, he told him, “I can’t tell you.” When everyone on the Management Committee had assembled, Friedman told his most senior partners that within the next week, he planned to retire and to name his successor, or successors. “It was an enormous shock,” Hurst said. Another partner told Friedman to stop joking around. “I’m not kidding,” Friedman said. Paulson, for one, could not believe what he was hearing. Had Friedman lost his mind? Right afterward, he went to see Friedman, alone. “
You can’t leave right in the middle of all this,” Paulson said he told him. “You’ve got to stay for a transition.” Without going into too much detail, that’s when Friedman told Paulson about his heart ailment. Paulson was shocked but didn’t say much. “Steve looked younger than I did,” recalled one Management Committee member when Friedman later told him, too, about his health issues. “He was vigorous. I had no idea until he told me about the problem. And so it just came as a shock.… The pressure was immense. I think people that criticize him and come down hard on him for it—John Weinberg and others did—never knew what he was going through, never walked in his shoes.” Barbara Friedman was especially concerned that he
had informed his partners that his decision was definitive and final. He assured her that he had been crystal clear.
Suddenly, despite the best efforts of Friedman and Katz to plan out the succession, the power vacuum at the top of Goldman Sachs was palpable for the first time. Other leadership changes at the firm may have been equally sudden—for instance, after Levy’s death or Catchings’s decapitation—but the successors had been carefully groomed or were obvious. Not in 1994. An immediate power struggle ensued, unlike any other in the firm’s long history. What made the dynamic even more intense was Friedman’s directive to the group that he intended to announce the new leadership team at the regularly scheduled monthly partners’ meeting the following Monday, five days later. The decision had to be made by Sunday night. “There were guys who had the bit in their mouth and really wanted to run Goldman,” said a member of the
Management Committee.