Greg Smith vs. Goldman Sachs

When I read Greg Smith's op ed in the New York Times my very strong impression was, "Nothing new here, so what, not worth reading." That's certainly true as far as I was concerned, but when a friend not in finance told me the contents of the editorial was a surprise, I thought I had better weigh in.  I even feel somewhat duty-bound to do so, because I spent many years on the "sell side," that is, at firms like Goldman Sachs.

In fact I started my career at Salomon Brothers, the setting of Michael Lewis' "Liar's Poker."  Lewis was three years ahead of me, and spoke to my training class, as mentioned in his book, around the time of the great crash of '87.  Anyone who thought Smith's litany of complaints about Goldman Sachs were new or surprising has either not read Lewis' book, or has forgotten the contents--which is fair enough, since the book was published more than twenty years ago.

For those of us who were working at Salomon Brothers when Liar's Poker was published in 1989, the contents of the book came as no surprise.  In fact, we all thought he nailed it.  Salomon in the day was a rough and tumble place where foul language, sports analogies, and ruthless internal competition ruled every day.  This was not a place for brainy professors to come to share their knowledge and help client CFOs benefit society. This was a place to out-sell the guy sitting next to you so you would get a bigger piece of the bonus pool at the end of the each year.

How you did that was your problem.  The idea at Salomon then and at Goldman now is that you as a salesman have to make as many sales as you possibly can. That means you have to get your customer to like you so that he will want to trade with you.  But for most of the products that Salomon sold (and Goldman Sachs sells), the products were OTC--over the counter. There is no commission per se, there is just the bid and offer price.  So it's not only a volume game, it's also a price mark-up game.  If you think your customer will pay 101 rather than 100 for bonds, you can offer them at 101 and see if he bites.

This is all in Michael Lewis' book.  Here's an excerpt from page 35:

In any market, as in any poker game, there is a fool.  The astute investor Warren Buffett is fond of saying that any player unaware of the fool in the market probably is the fool in the market.  Salomon bond traders knew about the fools because that was their job.  Knowing about markets is knowing about other people's weaknesses.  And a fool, they would say, was a person who was willing to sell a bond for less or buy a bond for more than it was worth.

Or let's hear from Larry Fink, now the head of Blackrock, as quoted in Liar's Poker, talking about the savings and loan customers who traded with the big investment banks like Salomon:

October 1981 was the most irresponsible period in the history of the capital markets.  The thrifts that did the best did nothing.  The ones that did the big trades got raped.

So now, 23 years later, for Greg Smith to raise eyebrows by "exposing" some of the less palatable aspects of Goldman's business practices seems a bit much.  For one thing, Liar's Poker was a #1 bestseller.  Everyone has read it.  For another, anyone who pays the least bit of attention to the news knows that Goldman got into some very hot water three years ago for helping a hedge fund manager "short" subprime mortgage securities to a Goldman client.  But if you're truly worried about Goldman now, you certainly should have been concerned in 2000, when Roger Lowenstein published his book on the collapse of mega-hedge fund Long-Term Capital Management (LTCM), "When Genius Failed."

In that book, Lowenstein describes the scene when employees of Goldman Sachs were at LTCM's office in Greenwich, Connecticut, as LTCM tried to avert collapse from a concentration of too many trading positions all going bad at once.  Goldman was there to do "due diligence," that is, to conduct an inspection of LTCM's books so that they could represent LTCM's condition to investors to help LTCM secure financing.  It's like a large-scale credit check.  As Lowenstein portrays it:

A key member of the Goldman team was Jacob Goldfield, a lanky and brilliant but abrasive trader.  According to witnesses, the headstrong Goldfield appeared to be downloading Long-Term's positions, which the fund had so zealously guarded, from Long-Term's own computers directly into an oversized laptop (a detail that Goldman later denied.)  Meanwhile, Goldman's traders in New York sold some of the very same positions.  At the end of one day, when the fund's positions were worth a good deal less, some Goldman traders at Long-Term's offices sauntered up to the trading desk and offered to buy them. Brazenly playing both sides of the street, Goldman represented mercenary banking at its ugliest. To JM (head of LTCM) and his partners, Goldman was raping Long-Term in front of their very eyes.

In other words, Goldman was exploiting its priviledged position of trust and confidentiality to identify exactly what LTCM would need to dump in a massive fire sale, and beat them to the punch, profiting from the deluge of liquidation that surely would follow. Lowenstein's book is in its sixth printing as of 2008, and was a Business Week "Best Book of the Year" in the year it was published.  This is not "new news."

It's not that Goldman's comportment is unusually bad.  Nor, obviously, is it particularly good.  But scolding Goldman because some salespeople referred to clients as "muppets," to paraphrase Martin Sheen in "Apocalypse Now," is like handing out speeding tickets at the Indy 500. It's the nature of the beast.

As a fresh college graduate years before working for Salomon Brothers, I spent a year treading water in the town of my university before embarking on a short stint as a teacher. Job pickings were slim, so I decided to try my hand at being a waiter at the best restaurant in town. It was no lay-up.  To be merely considered for a waiter slot, I first had to be a busboy. To be a busboy, I had to work for free, for some undetermined period of time, in a sort of busboy audition. After one day I threw in the towel.

I didn't make any money, but I got a good glimpse behind the scenes.  In the confines of the tables, all was well, and elegant.  In the kitchen, it was a swearfest. "Where is the f*cking side of potatoes," and "That SOB at Table 14 is gonna be wearing his soup" is all you could hear, all night long, on the other side of the metal doors leading to the kitchen.

Greg Smith was a waiter at the restaurant that is Goldman Sachs. He was a salesman, and worse than that, he peddled equity derivatives. To say the least, equity derivatives are not the flavor of the month.  Volumes have dried up, and the money that banks are making is coming from fixed income, not equities.  Smith was a Vice President among thousands of vice presidents at Goldman Sachs.  The interesting question is not who is right in the "he said, she said" duel between Smith and Goldman Sachs, but rather, why did the New York Times give Smith prime time status?

If you're in the market for a home, you seek out the services of a real estate agent. You develop a relationship with that person. You talk about your kids, you talk about where you went for vacation.  Do you expect that the realtor, knowing all too well the seller is paying the realtor's fee, is going to work tirelessly to reduce the sale price for you?  Do you think the realtor is going to tell you, hang tight, I think they will come down by 5 percent?  Of course you don't.

Greg Smith seems to have mistaken his employer for the Red Cross, even though he managed to sell quite a few Goldman products over the years. His efforts will be seen for what they are: Sour grapes, and small, petty ones at that.  It's a shame, because the world of finance is sorely in need of a higher ethical standard.  But for now it's business as usual, and anyone who thinks otherwise is a muppet, not an muppeteer.