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Saturday, October 27, 2012

Reading List: Why I Left Goldman Sachs

Smith, Greg. Why I Left Goldman Sachs. New York: Grand Central, 2012. ISBN 1-4555-2747-5.
When Greg Smith graduated from Stanford in 2001, he knew precisely what career he wished to pursue and where—high stakes Wall Street finance at the firm at the tip of the pyramid: Goldman Sachs. His native talent and people skills had landed him first an internship and then an entry-level position at the firm, where he sought to master the often arcane details of the financial products with which he dealt and develop relationships with the clients with whom he interacted on a daily basis.

Goldman Sachs was founded in 1869, and rapidly established itself as one of the leading investment banks, market makers, and money managers, catering to large corporations, institutions, governments, and wealthy individual clients. While most financial companies had transformed themselves from partnerships to publicly-traded corporations, Goldman Sachs did not take this step until 1999. Remaining a partnership was part of the aura of the old Goldman: as with a private Swiss bank, partners bore unlimited personal liability for the actions of the firm, and clients were thereby reassured that the advice they received was in their own best interest.

When the author joined Goldman, the original partnership culture remained strong, and he quickly learned that to advance in the firm it was important to be perceived as a “culture keeper”—one steeped in the culture and transmitting it to new hires. But then the serial financial crises of the first decade of the 21st century began to hammer the firm: the collapse of the technology bubble, the housing boom and bust, and the sovereign debt crisis. These eroded the traditional sources of Goldman's income, and created an incentive for the firm to seek “elephant trades” which would book in excess of US$ 1 million in commissions and fees for the firm from a single transaction. Since the traditional business of buying and selling securities on behalf of a client and pocketing a commission or bid-ask spread was highly competitive (indeed, the kinds of high-roller clients who do business with Goldman could see the bids and offers in the market on their own screen before they placed an order), the elephant hunters were motivated to peddle “structured products”: exotic financial derivatives which the typical client lacked the resources to independently value, and were opaque to valuation by other than the string theorist manqués who invented them. In doing this business, Goldman transformed itself from a broker executing transactions on behalf of a client into a vendor, selling products to counterparties, who took the other side of the transaction. Now, there's nothing wrong with dealing with a counterparty: when you walk onto a used car lot with a wad of money (artfully concealed) in your pocket and the need for a ride, you're aware that the guy who walks up to greet you is your counterparty—the more you pay, the more he benefits, and the less valuable a car he manages to sell you, the better it is for him. But you knew that, going in, and you negotiate accordingly (or if you don't, you end up, as I did, with a 1966 MGB). Many Goldman Sachs customers, with relationships going back decades, had been used to their sales representatives being interested in their clients' investment strategy and recommending products consistent with it and providing excellent execution on trades. I had been a Goldman Sachs customer since 1985, first in San Francisco and then in Zürich, and this had been my experience until the late 2000s: consummate professionalism.

Greg Smith documents the erosion of the Goldman culture in New York, but when he accepted a transfer to the London office, there was a culture shock equivalent to dropping your goldfish into a bowl of Clorox. In London, routine commission (or agency) business generating fees around US$ 50,000 was disdained, and clients interested in such trades were rudely turned away. Clients were routinely referred to as “muppets”, and exploiting their naïveté was a cause for back-slapping and booking revenues to the firm (and bonuses for those who foisted toxic financial trash onto the customers).

Finally, in early 2012, the author said, “enough is enough” and published an op-ed in the New York Times summarising the indictment of the firm and Wall Street which is fully fleshed out here. In the book, the author uses the tired phrase “speaking truth to power”, but in fact power could not be more vulnerable to truth: at the heart of most customer relationships with Goldman Sachs was the assumption that the firm valued the client relationship above all, and would act in the client's interest to further the long-term relationship. Once clients began to perceive that they were mocked as “muppets” who could be looted by selling them opaque derivatives or unloading upon them whatever the proprietary trading desk wanted to dump, this relationship changed forever. Nobody will ever do business with Goldman Sachs again without looking at them as an adversary, not an advisor or advocate. Greg Smith was a witness to the transformation which caused this change, and this book is essential reading for anybody managing funds north of seven digits.

As it happens, I was a customer of Goldman Sachs throughout the period of Mr Smith's employment, and I can completely confirm his reportage of the dysfunction in the London branch. I captured an hour of pure comedy gold in Goldman Sachs Meets a Muppet when two Masters of the Universe who had parachuted into Zürich from London tried to educate me upon the management of my money. I closed my account a few days later.

Posted at October 27, 2012 23:12